DAVITA HEALTHCARE PARTNERS INC. – 10-K – Management’s Discussion and Analysis of Financial Condition and Results of Operations.

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Forward-looking statements

  This Management's Discussion and Analysis of Financial Condition and Results of Operations contain statements that are forward-looking statements within the meaning of the federal securities laws. This Annual Report on Form 10-K contains 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, including earnings per share, and incorporation of HCP's operating results into the Company's consolidated operating results. 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 the continued downward pressure on average realized payment rates from, and a reduction in the number of patients under higher-paying commercial payor 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 health care reform legislation that was enacted in the U.S. in March 2010, changes in pharmaceutical or anemia management practice patterns, payment policies, or pharmaceutical pricing, legal compliance risks, including our continued compliance with complex government regulations, current or potential investigations by various government entities and related government or private-party proceedings, 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 ACOs, IPAs and integrated delivery systems, or to businesses outside of dialysis and HCP's business, our ability to complete any 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, 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 fact that HCP faces certain competitive threats that could reduce its profitability, the risk that the cost of providing services under HCP's agreements may exceed our compensation, the risk that reductions in reimbursement 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 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 Annual Report on Form 10-K. 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.  

The following should be read in conjunction with our consolidated financial statements and "Item 1. Business".

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DaVita HealthCare Partners Inc. overview

  With our recent acquisition of HCP on November 1, 2012, we believe the Company is well positioned to capitalize on anticipated trends in U.S. healthcare, including our continued growth opportunities in dialysis care services as well as growth in managed healthcare services, especially to the Medicare-eligible population.  As a result of the acquisition, the Company now primarily operates two major lines of business and, to a lesser extent, various other ancillary services and strategic initiatives, which includes our international dialysis operations. Our largest line of business is our U.S. dialysis and related lab services business, 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 with nearly three decades of providing coordinated, outcomes-based medical care in a cost-effective manner.  On November 1, 2012 we completed our acquisition of HCP pursuant to an Agreement and Plan of Merger dated May 20, 2012, whereby HCP became a wholly-owned subsidiary of the Company. HCP is one of the country's largest operators of medical groups and physician networks generating approximately $2.4 billion in annual revenues and approximately $488 million in operating income for the year ended December 31, 2011. The operating results of HCP are included in our consolidated financial results from November 1, 2012.  The total consideration paid at closing for all of the outstanding common units of HCP was approximately $4.70 billion, which consisted of $3.64 billion in cash, net of cash acquired, and 9,380,312 shares of our common stock valued at approximately $1.06 billion. The total acquisition consideration is subject to a post-closing working capital adjustment. The acquisition agreement also provides that as further consideration, we will pay the common unit holders of HCP a total of up to $275 million in cash if certain performance targets are achieved by HCP in 2012 and 2013.  In conjunction with the acquisition, we amended our Credit Agreement to allow for additional borrowings of $3.0 billion and also issued new senior notes for $1.25 billion, all of which was used to finance the acquisition, pay off a portion of our and HCP's existing debt, and to pay fees and expenses.  Our overall financial performance was strong for 2012 and was characterized by strong treatment volume growth, primarily from acquisitions and non-acquired growth rates and by productivity improvements and cost control initiatives in our dialysis business. The improvements were primarily the result of decreased operating costs per treatment due to a decline in the utilization of physician-prescribed pharmaceuticals due to continued evolution of clinical practices and physicians responding to the new FDA label for EPO.  

Some of our major accomplishments and financial operating performance indicators in 2012 and year over year were as follows:

• superior clinical outcomes-we provided our best clinical outcomes for the

         thirteenth straight year;          •   the acquisition of HCP generated incremental operating income of $67          million in 2012;    

• consolidated net revenue growth of approximately 21.6% of which 12.7% is

         related to our U.S. dialysis operations;    

• an increase of approximately 12.5% in the overall number of treatments

         that we provided;       •   normalized non-acquired treatment growth of 4.8%;    

• consolidated operating income growth of approximately 12.3%, which

includes the impact of the legal settlement and related expenses and

transaction expenses associated with the acquisition of HCP. Excluding

these items adjusted consolidated operating income would have increased by

         22.4%; and       •   strong operating cash flows of $1,101 million.                                            77 

-------------------------------------------------------------------------------- However, we believe that 2013 will continue to be challenging as we undertake initiatives to mitigate the planned 2% reduction in our Medicare reimbursement rates that are scheduled to take effect on March 1, 2013 as a result of government sequestration and the risks and challenges associated with our entry into our new line of business, as a result of the acquisition of HCP. In addition, Congress could also make significant changes to Medicare and Medicaid reimbursement rates and, along with the utilization of physician-prescribed pharmaceuticals and pharmaceutical cost may have a significant impact on our operating results. We also remain committed to our international expansion plans that will continue to require a significant investment in 2013. In addition, if the percentage of our dialysis patients with commercial payors continues to deteriorate, our operating results could be adversely affected.  

Following is a summary of consolidated operating results for reference in the discussion that follows. The operating results of HCP are included in our operating results effective November 1, 2012.

                                                                     Year ended December 31,                                                     2012                    2011                    2010                                                         (dollar amounts rounded to nearest million) Net revenues: Total consolidated net revenues              $ 8,186                 $ 6,732                 $ 6,220 Add: Provision for uncollectible accounts        235                     190                     166  Consolidated revenues before the provision for uncollectible accounts                   $ 8,421                 $ 6,922                 $ 6,386  Patient service revenues                     $ 7,352                 $ 6,471                 $ 6,049 Less: Provision for uncollectible accounts      (235 )                  (190 )                  (166 )  Net patient service revenues                   7,117                   6,281                   5,883 HCP capitated revenues                           419                      -                       - Other revenues                                   650                     451                     337  Total net consolidated revenues              $ 8,186        100 %    $ 

6,732 100 % $ 6,220 100 %

  Operating expenses and charges: Patient care costs                           $ 5,579         68 %    $ 4,634         69 %    $ 4,428         71 % General and administrative                       894         11 %        685         10 %        572          9 % Depreciation and amortization                    342          4 %        264          4 %        231          4 % Provision for uncollectible accounts               4          -            3          -            4          - Legal settlement and related expenses             86          1 %          -          -            -          - Equity investment income                         (16 )        -           (9 )        -           (9 )        -  Total operating expenses and charges           6,889         84 %      5,577         83 %      5,226         84 %  Operating income                             $ 1,297         16 %    $ 1,155         17 %    $   994         16 %                                             78 

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The following table summarizes consolidated net revenues:

                                                                 Year ended December 31,                                                    2012                   2011                2010                                                     (dollar amounts rounded to nearest million) Net revenues: Dialysis and related lab services patient service revenues                              $        7,317         $        6,474        $    6,053 Less: Provision for uncollectible accounts                                                (234 )                 (190 )            (166 )  Dialysis and related lab services net patient service revenues                               7,083                  6,284             5,887 Other revenues                                            12                     11                11  Total net dialysis and related lab services revenues                                      7,095                  6,295             5,898  HCP capitated revenues                                   419                     -                 - HCP net patient service revenues (less provision for uncollectible accounts of $1)                                                       34                     -                 - Other revenue                                             24                     -                 -  Total net HCP revenues                                   477                     -                 -  Other-ancillary services and strategic initiatives revenues                                     625                    446               326 Other-ancillary services and strategic initiatives net patient service revenues                  17                      8                 6  Total net other-ancillary services and strategic initiatives revenues                           642                    454               332  Total net segment revenues                             8,214                  6,749             6,230 Elimination of intersegment revenues                     (28 )                  (17 )             (10 )  Consolidated net revenues                     $        8,186         $        6,732        $    6,220   

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

                                                                     Year ended                                                 2012(1)                 2011                 2010                                                   (dollar amounts rounded to nearest million) Dialysis and related lab services          $          1,379          $      1,236         $    1,050 HCP services                                             67                    -                  - Other-ancillary services and strategic initiatives loss                              (66 )                 (34 )              (11 )  Total segment operating income                        1,380                 1,202              1,039 Reconciling items: Corporate support costs                                 (52 )                 (47 )              (45 ) Transaction expenses                                    (31 )                  -                  -  Consolidated operating income                         1,297                 1,155                994 Reconciliation of non-GAAP measure: Add: Legal settlement and related expenses                                                 86                    -                  - Transaction expenses                                     31                    -                  -  Adjusted consolidated operating income(1)                                  $          1,414          $      1,155         $      994     

(1) For the year ended December 31, 2012, we have excluded an $86 million legal

settlement and related expenses and $31 million of transaction expenses

associated with the acquisition of HCP from operating expenses and operating

income. 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                                            79 

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these presentations enhance a user's understanding of our normal consolidated

operating income by excluding an unusual charge of $86 million for a legal

settlement and related expenses that resulted from the settlement of the

Woodard Private Civil Suit (see Note 16 to the consolidated financial

statements) and an unusual amount of transaction expenses totaling $31

million that resulted from the acquisition of HCP, and therefore, these

adjusted consolidated operating income amounts are meaningful and comparable

to our prior period results and indicative of our normal consolidated

    operating income.   Consolidated net revenues  Consolidated revenues before the provision for uncollectible accounts related to patient service revenues for 2012 increased by approximately $1,499 million, or approximately 21.7%, from 2011. Consolidated net revenues for 2012 increased by approximately $1,454 million or approximately 21.6% from 2011. This increase in the consolidated net revenues was primarily due to an increase in dialysis and related lab services net revenues of approximately $800 million, principally due to strong volume growth from additional treatments from non-acquired growth and dialysis center acquisitions and from an increase of $2 in the average dialysis revenue per treatment, primarily from an increase in our Medicare reimbursements, partially offset by an increase in the provision for uncollectible accounts of $45 million. Consolidated net revenues also increased by $477 million as a result of the acquisition of HCP on November 1, 2012 and increased by approximately $188 million associated with the ancillary services and strategic initiatives driven primarily from growth in our pharmacy services and from our disease management services.  Consolidated revenues before the provision for uncollectible accounts related to patient service revenues for 2011 increased by approximately $536 million, or approximately 8.4%, from 2010. Consolidated net revenues for 2011 increased by approximately $512 million or approximately 8.2% from 2010. This increase in consolidated net revenues was primarily due to an increase in dialysis and related lab services net revenues of approximately $397 million, principally due to strong volume growth from additional treatments from non-acquired growth and acquisitions including the acquisition of DSI, partially offset by a decline of $7 in the average dialysis revenue per treatment, primarily from a decrease in our Medicare revenues as a result of operating in the new single bundled payment system and an increase in the provision for uncollectible accounts of $24 million. Consolidated net revenues also increased as a result of an increase of approximately $122 million in the ancillary services and strategic initiatives net revenues driven primarily from growth in our pharmacy services and from our disease management services.  

Consolidated operating income

  Consolidated operating income of $1,297 million for 2012 increased by approximately $142 million, or 12.3%, from 2011 which includes the $86 million legal settlement and related expenses and the $31 million of transaction expenses associated with the acquisition of HCP. Excluding these items in 2012, adjusted consolidated operating income would have increased by $259 million, or 22.4%, primarily due to an increase in the dialysis and related lab services net revenues as a result of strong volume growth in revenue from additional treatments as a result of non-acquired growth and acquisitions, and from an increase in our average dialysis revenue per treatment of approximately $2, partially offset by an increase in the provision for uncollectible accounts of $45 million. Adjusted consolidated operating income also increased as a result of the acquisition of HCP on November 1, 2012, an overall decline in pharmaceutical costs mainly from a decline in the intensities of physician-prescribed pharmaceuticals, lower transaction and integration costs associated with the acquisition of DSI that occurred in 2011 and from productivity improvements. However, consolidated operating income was negatively impacted by an increase in the unit cost of EPO, higher labor and benefit costs, an increase in our professional fees for compliance and legal initiatives, and for information technology matters and an increase in expenses and operating losses associated with our international expansion.  Consolidated operating income of $1,155 million for 2011 increased by approximately $161 million, or 16.2%, from 2010. The increase in consolidated operating income in 2011 was primarily due to an increase in the dialysis and related lab services net revenues as a result of strong volume growth in revenue from additional                                           80 

-------------------------------------------------------------------------------- treatments as a result of non-acquired growth and acquisitions, partially offset by a decline in our average dialysis revenue per treatment of approximately $7 and an increase in the provision for uncollectible accounts of $24 million. Consolidated operating income also increased as a result of overall lower pharmaceutical costs mainly from a decline in the intensities of physician-prescribed pharmaceuticals, additional operating income from the acquisition of DSI and from cost control initiatives. However, consolidated operating income was negatively impacted by higher labor and benefit costs, an increase in our professional fees for legal and compliance matters, and for information technology matters, transaction and integration costs associated with the acquisition of DSI, an increase in EPO pharmaceutical costs and an increase in expenses associated with our international expansion.  

U.S. Dialysis and related lab services business

  Our U.S. dialysis and related lab service businesses is a leading provider of kidney dialysis services through a network of 1,954 outpatient dialysis centers throughout 44 states and District of Columbia, serving a total of approximately 153,000 patients. We also provide acute inpatient dialysis services in approximately 970 hospitals. We estimate that we have approximately a 34% market share in the U.S. based upon the number of patients that we serve. In 2012, our overall network of U.S. outpatient dialysis centers increased by 145 centers primarily as a result of acquisitions of dialysis centers and from opening new dialysis centers. In addition, the overall number of patients that we serve in the U.S. increased by approximately 8.0% as compared to 2011. All references in this document to dialysis and related lab services refer only to our U.S. dialysis and related lab services business.  Our dialysis and related lab services stated mission is to be the provider, partner and employer of choice. We believe our attention to these three stakeholders-our patients, our business partners, and our teammates-represents the major driver of our long-term performance, although we are subject to the impact of external factors such as government policy and physician practice patterns. Accordingly, two principal non-financial metrics we track are quality clinical outcomes and teammate turnover. We have developed our own composite index for measuring improvements in our clinical outcomes, which we refer to as the DaVita Quality Index (DQI). Our clinical outcomes as measured by DQI have improved over each of the past several years which we believe directly decreases patient mortalities. Although it is difficult to reliably measure clinical performance across our industry, we believe our clinical outcomes compare favorably with other dialysis providers in the U.S. and generally exceed the dialysis outcome quality indicators of the National Kidney Foundation. In addition, over the past several years our teammate turnover has remained relatively constant, which we believe was a major contributor to our continued clinical performance improvements and also a major driver of our ability to maintain or improve clinical hours per treatment. We will continue to focus on these stakeholders and our clinical outcomes as we believe these are fundamental long-term value drivers.  Our national scale and size, among other things, allows us to provide industry-leading quality care with superior clinical outcomes that attracts patients and referring physicians, as well as qualified medical directors, provides our dialysis patient base with a large number of out-patient dialysis centers to choose from with convenient locations and access to a full range of services and provides us the ability to effectively and efficiently manage certain costs while maintaining strong legal and compliance programs.  Approximately 86% of our 2012 consolidated net revenues were derived directly from our dialysis and related lab services business. Approximately 80% of our 2012 dialysis and related lab services revenues were derived from outpatient hemodialysis services in the 1,929 U.S. centers that we consolidate. On a pro-forma basis, our dialysis and related lab services business net revenues for fiscal 2012 would have represented approximately 68% of our consolidated net revenues assuming HCP was acquired on January 1, 2012. Other dialysis services, which are operationally integrated with our dialysis operations, are peritoneal dialysis, home-based hemodialysis, hospital inpatient hemodialysis services and management and administrative services. These services collectively accounted for the balance of our 2012 dialysis and related lab services revenues.                                           81

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 The principal drivers of our dialysis and related lab services revenues are:         •   the number of treatments, which is primarily a function of the number of

chronic patients requiring approximately three treatments per week, as

well as, to a lesser extent, the number of treatments for peritoneal

dialysis services and home-based dialysis and hospital inpatient dialysis

         services; and       •   average dialysis revenue per treatment.   The total patient base is a relatively stable factor, which we believe is influenced by a demographically growing need for dialysis services as indicated by the United States Renal Data System that reported an approximate compound growth rate of 4.0% over the last several years for the dialysis patient population, our relationships with referring physicians, together with the quality of our clinical care which can lead to reduced patient mortality rates, and our ability to open and acquire new dialysis centers. In 2012, we were able to increase our overall network of patients that we serviced in the U.S. by approximately 8% as compared to 2011.  Our average dialysis and related lab services revenue per treatment in 2012 was primarily driven by our mix of commercial and government (principally Medicare and Medicaid) patients, commercial and government payment rates, our billing and collecting operations performance, and to a lesser extent the mix and intensity of physician-prescribed pharmaceuticals that are separately billable since payment for these pharmaceuticals are included in Medicare's single bundled payment rate system and can also be included as part of a single bundled payment rate for all dialysis services provided under some of our commercial contracts that cover certain patients.  On average, dialysis-related payment rates from commercial payors are significantly higher than Medicare, Medicaid and other government program payment rates, and therefore the percentage of commercial patients to total patients represents a major driver of our total average dialysis revenue per treatment. The percentage of commercial patients covered under contracted plans as compared to commercial patients with out-of-network providers continued to increase and can also significantly affect our average dialysis revenue per treatment since commercial payment rates for patients with out-of-network providers are on average higher than in-network payment rates. In 2012, the growth of our government-based patients continued to outpace the growth of our commercial patients, which has been a trend that we have experienced for the past several years. We believe the growth in our government-based patients is driven primarily by improved mortality and the current economic environment that has resulted in a decrease in the number of individuals that are covered under commercial insurance plans. This trend has negatively impacted our average dialysis revenue per treatment over the last several years as a result of receiving a larger proportion of our revenue from government-based payors, such as Medicare, that reimburse us at lower payment rates.  

The following table summarizes our dialysis and related lab services revenues for the year ended December 31, 2012:

                                                                 Revenues           Medicare and Medicare-assigned plans                       59 %           Medicaid and Medicaid-assigned plans                        5 %           Other government-based programs                             2 %            Total government-based programs                            66 %           Commercial (including hospital dialysis services)          34 %            Total dialysis and related lab services revenues          100 %    Government dialysis-related payment rates in the U.S. are principally determined by federal Medicare and state Medicaid policy. For patients with Medicare coverage, all ESRD payments for dialysis treatments and related lab services are made under a bundled payment rate which provides a fixed rate to encompass all goods and services provided during the dialysis treatment, including pharmaceuticals that were historically separately                                           82  -------------------------------------------------------------------------------- reimbursed to the dialysis providers, such as EPO, vitamin D analogs and iron supplements, as well as laboratory testing. The initial 2011 bundled rate included reductions of 2% from the prior reimbursement and further reduced overall rates by 5.94%. These reductions were tied to an expanded list of case-mix adjustors which can be earned back based upon the presence of certain patient characteristics and co-morbidities at the time of treatment. There are also other provisions which may impact payment including an outlier pool and a low volume facility adjustment.  Another important provision in the law is an annual adjustment, or market basket update, to the base ESRD PPS. Absent action by Congress the PPS base rate will be automatically updated by a formulaic inflation adjustment.  

On November 1, 2011, CMS issued the final ESRD PPS rule for 2012, which increased the base rate by 2.1%, representing a market basket of increase of 3.0% less a productivity adjustment of 0.9%.</p>

  On November 9, 2012, CMS issued the final ESRD PPS rule for 2013. The base rate will increase by 2.3%, resulting from a market basket increase of 2.9% less a productivity adjustment of 0.6%. This increase in the ESRD PPS base rate is to be reduced by the Budget Control Act of 2011 sequestration, discussed below. The final rule implements the reduction in bad debt payments to dialysis facilities (as well as to all other providers eligible for bad debt payments) mandated under the Middle Class Tax Extension and Job Creation Act of 2012 and adds new quality reporting measures.  The new payment system presents operating, clinical and financial risks. For example, with regard to the expanded list of case-mix adjustors, there is a risk that our dialysis centers or billing and other systems may not accurately document and track the appropriate patient-specific characteristics, resulting in a reduction or overpayment in the amounts of the payments that we would otherwise be entitled to receive.  On December 7, 2012, the U.S. General Accountability Office (GAO) released a letter report entitled "End-Stage Renal Disease: Reduction in Drug Utilization Suggests Bundled Payment is Too High". The GAO found ESRD drug utilization in 2011 was about 23% lower, on average, than it was in 2007. This was primarily the result of a decline in EPO usage. The GAO concluded the bundled payment rate was excessive given the changes in ESRD drug utilization. Because the Department of Health and Human Services (HHS) claimed it did not have authority to rebase the bundled payment rate, GAO recommended Congress should require the Secretary of HHS to take such action.  Subsequently, on January 1, 2013, Congress passed the American Taxpayer Relief Act of 2012 (ATRA) which includes a provision that incorporates the GAO's recommendations. The ATRA directs CMS to compare the utilization of drugs and biologicals (EPO and other former composite drugs) from 2007 (before the ESRD PPS) to the utilization after the implementation of the ESRD PPS in 2012 and adjust the ESRD PPS rate to account for reductions in utilization of these drugs. The adjustment also must account for the most current data on average sales prices and changes in prices for drugs reflected in the ESRD market basket percentage increase. The adjustment would apply to services furnished on or after January 1, 2014. The Congressional Budget Office (CBO) projected budget savings of $4.9 billion over ten years. In addition, GAO is required to produce an updated report no later than December 31, 2015.  As a result of the Budget Control Act of 2011 and subsequent activity in Congress, the federal government is faced with a $1.2 trillion sequester (across-the-board spending cuts) in discretionary programs. In particular, Medicare providers face a maximum of a 2% reduction in reimbursements in fiscal year 2013. Under the American Taxpayer Relief Act of 2012, the sequester was postponed until March 1, 2013. Should Congress fail to act by that date, the sequestration will take effect. The across-the-board cuts pursuant to the sequester would have an adverse affect on our revenues, earnings and cash flows.  

In addition, under the original ESRD PPS statute and regulations, beginning January 1, 2014, certain oral-only ESRD drugs (currently paid separately to pharmacies under Medicare Part D) would have been included in

                                       83  -------------------------------------------------------------------------------- the ESRD bundled payment to dialysis facilities. Under the American Taxpayer Relief Act of 2012, the inclusion of oral-only medications in the bundled rate will be delayed until January 1, 2016. The Act also requires CMS to monitor the bone and mineral metabolism of ESRD patients along with the case-mix adjustments made under the ESRD PPS. Inadequate pricing could have a significant negative financial impact on our dialysis facilities given the volume and value of these drugs.  We expect to continue experiencing increases in operating costs that are subject to inflation, such as labor and supply costs, regardless of whether there is a compensating inflation-based increase in Medicare payment rates or in payments under the bundled payment rate system.  Dialysis payment rates from commercial payors can vary and a major portion of our commercial rates are set at contracted amounts with payors and are subject to intense negotiation pressure. Our commercial payment rates also include payments for out-of-network patients that on average are higher than our in-network contract rates. In 2012, we were successful in increasing some of our commercial payment rates which contributed to an increase in our average dialysis revenue per treatment. In 2012, we continued to enter into some commercial contracts covering certain patients that will primarily pay us a single bundled payment rate for all dialysis services provided to these patients. We are continuously in the process of negotiating agreements with our commercial payors, and payors are aggressive in their negotiations. If our negotiations result in overall commercial rate reductions in excess of overall commercial rate increases, this would have a material adverse effect on our operating results. In addition, if there is an increase in job losses in the U.S. as a result of current economic conditions, or depending upon changes to the healthcare regulatory system, we could experience a decrease in the number of patients covered under commercial plans.  Approximately 5% of our dialysis and related lab services revenues for the year ended December 31, 2012, were from physician-prescribed pharmaceuticals that are separately billable, with EPO accounting for approximately 3% of our dialysis and related lab services revenues. The impact of physician-prescribed pharmaceuticals on our overall revenues that are separately billable in 2012 and 2011 has significantly decreased from prior years primarily as a result of Medicare's single bundled payment system, as well as some additional commercial contracts that pay us a single bundled payment rate.  Our operating performance with respect to dialysis services billing and collection can also be a significant factor in the average dialysis and related lab services revenue per treatment we realize. Over the past several years we have invested heavily in upgrades to our systems and internal processes that we believe have helped improve our operating performance and reduced our regulatory compliance risks and we expect to continue to improve these systems and processes. In 2012, we continued to upgrade our information technology systems and implemented process changes. We will continue to upgrade our systems and modify our processes in 2013 to improve our ability to capture the necessary patient characteristics, co-morbidities and certain other factors under Medicare's bundled payment system. We believe this will potentially enable us to capture additional reimbursement amounts from Medicare and enhance our overall billing and collection performance. However, as we continue to make upgrades to our systems and processes, or as payors change their systems and requirements, we could experience a negative impact to our cash collection performance which would affect our dialysis and related lab services revenue per treatment.  Our dialysis and related lab services revenue recognition involves significant estimation risks. Our estimates are developed based on the best information available to us and our best judgment as to the reasonably assured collectability of our billings as of the reporting date based upon our actual historical collection experience. Changes in estimates are reflected in the then-current period financial statements based upon on-going actual experience trends, or subsequent settlements and realizations depending on the nature and predictability of the estimates and contingencies.  Our annual average dialysis and related lab services revenue per treatment was approximately $332, $330 and $337 for 2012, 2011 and 2010, respectively. In 2012, the average dialysis and related lab services revenue per treatment increased by approximately $2 per treatment primarily due to an increase in our Medicare                                           84 

-------------------------------------------------------------------------------- reimbursements and an increase in some of our commercial payment rates, partially offset by a decline in the commercial payor mix, and a decline in the intensities of physician-prescribed pharmaceuticals. In 2011, the average dialysis and related lab services revenue per treatment decreased by approximately $7 per treatment primarily due to a decline in our Medicare reimbursements as a result of operating in the new single bundled payment system, a decline in the commercial payor mix, and a decline in the intensities of physician-prescribed pharmaceuticals, partially offset by an increase in some of our commercial payment rates.  Our average dialysis and related lab services revenue per treatment can be significantly impacted by several major factors, including our commercial payment rates; government payment policies regarding reimbursement amounts for dialysis treatments and pharmaceuticals under Medicare's bundled payment rate system, including our ability to capture certain patient characteristics; changes in the mix of government and commercial patients; and changes in the mix and intensities of physician-prescribed pharmaceuticals that are billed separately.  The principal drivers of our dialysis and related lab services patient care costs are clinical hours per treatment, labor rates, vendor pricing of pharmaceuticals, utilization levels of pharmaceuticals, business infrastructure costs, which include the operating costs of our dialysis centers, and legal and compliance costs. However, other cost categories can also represent significant cost variability, such as employee benefit costs and insurance costs. Our average clinical hours per treatment in 2012 decreased compared to 2011, which was the result of improved process efficiencies primarily from an experienced steady workforce and continued investment in training in our internal procedures and practices. We are always striving for improved productivity levels, however, changes in federal and state policies or regulatory billing requirements, which can lead to increased labor costs in order to implement these new requirements, can adversely impact our ability to achieve optimal productivity levels. In addition, improvements in the U.S. economy could stimulate additional competition for skilled clinical personnel and result in higher teammate turnover which would adversely affect productivity levels. In 2012 and 2011, we experienced an increase in our clinical labor rates of approximately 2.0% in both years, as clinical labor rates have increased consistent with general industry trends, mainly due to the demand for skilled clinical personnel, along with general inflation increases. However, in 2012, we continued to implement certain cost control initiatives to manage our overall operating costs, including labor rates. In 2012, we experienced an increase in our overall EPO unit costs. In December 2012, we entered into an amendment to our agreement with Amgen that makes non-material changes to certain terms of the agreement for the period from January 1, 2013 through December 31, 2013. Under the terms of the original agreement before the amendment, we were required to purchase EPO in amounts necessary to meet no less than 90% of our requirements of ESAs and are still required to do so after 2013. In addition, all of the other conditions as specified in the original agreement entered into in November 2011 still apply. In 2012, we also experienced increases in our infrastructure and operating costs of our dialysis centers, primarily due to the number of new dialysis centers opened, and general increases in rent, utilities and repairs and maintenance.  Our dialysis and related lab services general and administrative expenses represented 8.9% of our dialysis and related lab services net revenues in 2012 as compared to 8.6% in 2011. This continues to represent a fairly significant increase in the dollar amount of our general and administrative expenses that we have experienced over the last several years, primarily related to strengthening our dialysis business, improving our regulatory compliance and other operational processes, responding to certain legal and compliance matters, and professional fees associated with information technology matters. We expect that these levels of expenditures on our dialysis and related lab services general and administrative expenses in 2013 will continue and could possibly increase as we seek out new business opportunities within the dialysis industry and continue to invest in improving our information technology infrastructure and the level of support required for our regulatory compliance and legal matters.                                           85

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Results of Operations

The following table reflects the results of operations for the U.S. dialysis and related lab services business:

                                                                    Year ended December 31,                                          2012                             2011                             2010                                                        (dollar amounts rounded to nearest million) Net revenues: Net revenues                   $      7,095                     $      6,295                     $      5,898 Add: Provision for uncollectible accounts                  234                              190                              166  Dialysis and related lab services revenues before the provision for uncollectible accounts         $      7,329                     $      6,485                     $      6,064  Dialysis and related lab services patient service revenues                       $      7,317                     $      6,474                     $      6,053 Less: Provision for uncollectible accounts                 (234 )                           (190 )                           (166 )  Dialysis and related lab services net patient service revenues                      7,083                            6,284                            5,887 Other revenues                           12                               11                               11  Total net dialysis and related lab services revenues                       $      7,095          100 %             6,295          100 %             5,898          100 %  Operating expenses and charges: Patient care costs                    4,701           66 %             4,264           68 %             4,165           71 % General and administrative              629            9 %               544            9 %               465            8 % Depreciation and amortization                            310            4 %               260            4 %               227            4 % Legal settlement and related expenses                         86            1 %                -            -                   -            - Equity investment income                (11 )         -                   (9 )         -                   (9 )         -  Total operating expenses and charges                           5,715           81 %             5,059           80 %             4,848           82 %  Operating income               $      1,379           19 %      $      1,236           20 %      $      1,050           18 %  Dialysis treatments              22,053,597                       19,599,472                       17,963,862 Average dialysis treatments per treatment day                                  70,346                           62,618                           57,393 Average dialysis and related lab services revenue per treatment          $        332                     $        330                     $        337   Net revenues  Dialysis and related lab services revenues before the provision for uncollectible accounts for 2012 increased by approximately $844 million or approximately 13.0% from 2011. Dialysis and related lab services net revenues for 2012 increased by approximately $800 million or approximately 12.7% from 2011. The increase in net revenues was primarily due to strong volume growth from additional treatments of approximately 12.5% due to an increase in non-acquired treatment growth at existing and new dialysis centers and growth through acquisitions of dialysis centers, an increase in the average dialysis revenue per treatment of approximately $2, or 0.6%, partially offset by an increase in the provision for uncollectible accounts of $44 million. The increase in the average dialysis revenue per treatment in 2012, as compared to 2011, was primarily due to an increase in our Medicare reimbursements and an increase in some of our commercial payment rates, partially offset by a decline in the commercial payor mix and a decline in the intensities of physician-prescribed pharmaceuticals.                                           86  -------------------------------------------------------------------------------- Dialysis and related lab services revenues before the provision for uncollectible accounts for 2011 increased by approximately $421 million or approximately 6.9% from 2010, excluding the provision for uncollectible accounts. Dialysis and related lab services net revenues for 2011 increased by approximately $397 million or approximately 6.7% from 2010. The increase in net revenues was primarily due to strong volume growth from additional treatments of approximately 9.1% due to an increase in non-acquired treatment growth at existing and new centers and growth through acquisitions, which includes additional treatments associated with the acquisition of DSI. However, this increase was partially offset by a decrease in the average dialysis revenue per treatment of approximately $7, or 2.1% and an increase in the provision for uncollectible accounts of $24 million. The decrease in the average dialysis revenue per treatment in 2011, as compared to 2010, was primarily due to a decline in our Medicare reimbursements as a result of operating in the new single bundled payment system, continued decline in the commercial payor mix and a decline in the intensities of physician-prescribed pharmaceuticals, partially offset by an increase in some of our commercial payment rates.  

The following table summarizes our dialysis and related lab services revenues by modality for the year ended December 31, 2012:

                                                                 Revenue                                                             percentages         Outpatient hemodialysis centers                               80 %         Peritoneal dialysis and home-based hemodialysis               15 %         Hospital inpatient hemodialysis                                5 %          Total dialysis and related lab services revenues             100 %    Approximately 66% of our total dialysis and related lab services revenues for the year ended December 31, 2012 were from government-based programs, principally Medicare, Medicaid, and Medicare-assigned plans, representing approximately 90% of our total patients. Over the last several years, we have been experiencing growth in our government-based patients that has been outpacing the growth in our commercial patients which has negatively impacted our average dialysis and related lab services revenue per treatment. Our overall percentage of patients and revenues associated with commercial payors continued to decline in 2012 as compared to 2011. Less than 1% of our dialysis and related lab services revenues are due directly from patients. No single commercial payor associated with our dialysis and related lab services business accounted for more than 10% of total dialysis and related lab services revenues for the year ended December 31, 2012.  On average we are paid significantly more for services provided to patients covered by commercial insurance plans in the U.S. than we are for patients covered by Medicare, Medicaid or other government plans such as Medicare-assigned plans. Patients covered by commercial health plans transition to Medicare coverage after a maximum of 33 months. As a patient transitions from commercial coverage to Medicare or Medicaid coverage, the payment rates normally decline substantially. Medicare payment rates are insufficient to cover our costs associated with providing dialysis treatments, and therefore we lose money on each Medicare treatment.  Nearly all of our net earnings from our dialysis and related lab services are derived from commercial payors, some of which pay at established contract rates and others which pay negotiated payment rates based on our usual and customary fee schedule for our out-of-network patients, which are typically higher than contracted rates. If we experience a net overall reduction in our contracted and non-contracted commercial rates as a result of these negotiations or restrictions, it could have a material adverse effect on our operating results.  

Operating expenses and charges

  Patient care costs. Dialysis and related lab services patient care costs are those costs directly associated with operating and supporting our dialysis centers and consist principally of labor, pharmaceuticals, medical supplies and operating costs of the dialysis centers. The dialysis and related lab services patient care costs on a per treatment basis were $213 and $218 for 2012 and 2011, respectively. The $5 decrease in the per treatment costs in 2012 as compared to 2011 was primarily attributable to a decline in the intensities of physician-prescribed pharmaceuticals and productivity improvements, partially offset by higher labor costs, and higher EPO unit costs.                                           87  -------------------------------------------------------------------------------- The dialysis and related lab services patient care costs on a per treatment basis were $218 and $232 for 2011 and 2010, respectively. The $14 decrease in the per treatment costs in 2011 as compared to 2010 was primarily attributable to a decline in the intensities of physician-prescribed pharmaceuticals and continued cost control initiatives, partially offset by higher labor and benefit costs, and higher EPO unit costs.  General and administrative expenses. Dialysis and related lab services general and administrative expenses in 2012 increased by approximately $85 million as compared to 2011. The increase was primarily due to increases in labor and benefit costs, an increase in our professional expenses for legal and compliance initiatives and for information technology matters, partially offset by a decline in the transaction and integration costs associated with the acquisition of DSI that occurred in the third quarter of 2011. General and administrative expenses in 2011 increased by approximately $79 million as compared to 2010 primarily due to increases in labor and benefit costs, an increase in our professional expenses for legal and compliance initiatives and for information technology matters as well as transaction and integration costs associated with the acquisition of DSI.  Depreciation and amortization. Dialysis and related lab services depreciation and amortization expenses for 2012 increased by approximately $50 million as compared to 2011 and increased by $33 million in 2011 as compared to 2010. The increases were primarily due to growth through new dialysis center developments and acquisitions. The increase in 2012 was also due to additional depreciation associated with the opening of our new corporate headquarters in August 2012.  Provision for uncollectible accounts receivable. The provision for uncollectible accounts receivable for U.S. dialysis and related lab services was 3.2% for 2012, 2.9% for 2011, and 2.7% for 2010. The increase in the provision for uncollectible accounts receivable in 2012 was primarily due to an increase in our provision for uncollectible accounts to 3.5% due to higher non-covered Medicare charges that resulted in additional write-offs in the fourth quarter of 2012. We currently expect this level of the provision for uncollectible accounts to continue into 2013, although it may increase if we encounter collection issues as a result of sustained weakness in the U.S. economy.  Legal settlement and related expenses. We reached an agreement to settle all allegations relating to claims arising out of the previously disclosed litigation filed in 2002 in the U.S. District Court in the Eastern District of Texas. In connection with this settlement we incurred costs and expenses of $86 million in 2012 that consisted of $55 million for the settlement plus attorney fees and other related expenses. The settlement resolved federal program claims regarding EPO that were or could have been raised in the complaint relating to historical EPO practices dating back to 1997. See Note 16 to the consolidated financial statements for additional details.  Equity investment income. Equity investment income was approximately $11.0 million in 2012 as compared to $9.0 million in 2011 and $9.0 million in 2010. The increase in equity investment income in 2012 as compared to 2011 was primarily due to the profitability of certain of our dialysis nonconsolidated joint ventures. Equity investment income in 2011 as compared to 2010 was flat, but was impacted by an increase in the profitability of certain of our nonconsolidated joint ventures, offset by a decrease in the operating performance of certain other joint ventures.  

Dialysis operating income

  Dialysis and related lab services operating income for 2012 increased by approximately $143 million as compared to 2011 including the legal settlement and related expenses of $86 million, as discussed above. Excluding this item from 2012, dialysis and related lab services adjusted operating income would have increased by $229 million. The increase in the adjusted operating income for 2012 as compared to 2011 was primarily due to strong treatment growth as a result of additional dialysis treatments from non-acquired growth and acquisitions of dialysis centers, and an increase in the average dialysis revenue per treatment of approximately $2 as described above, partially offset by an increase in our provision for uncollectible accounts of $44 million. The                                           88 

-------------------------------------------------------------------------------- dialysis and related lab services operating income also increased as a result of a decline in the intensities of physician-prescribed pharmaceuticals, productivity improvements and lower transaction and integration costs associated with the acquisition of DSI that occurred in 2011. However, the dialysis and related lab services operating income was negatively impacted by an increase in the unit cost of EPO , higher labor and benefit costs, payroll taxes, an increase in our professional fees in conjunction with compliance and legal initiatives and for information technology matters.  Dialysis and related lab services operating income for 2011 increased by approximately $186 million as compared to 2010. The increase in the operating income for 2011 as compared to 2010 was primarily due to strong treatment growth as a result of additional dialysis treatments from non-acquired growth and acquisitions of dialysis centers, partially offset by a decrease in the average dialysis revenue per treatment of approximately $7 and an increase in our provision for uncollectible accounts of $24 million. The dialysis and related lab services operating income also increased as a result of a decline in the intensities of physician-prescribed pharmaceuticals, and additional operating income from the acquisition of DSI. However, the dialysis and related lab services operating income was negatively impacted by higher labor and benefit costs, an increase in the unit cost of EPO, an increase in our professional fees in conjunction with compliance and legal initiatives and for information technology matters, as well as transaction and integration costs associated with the acquisition of DSI.  HCP business  HCP is a patient- and physician-focused, integrated health care delivery and management company with nearly three decades of providing coordinated, outcomes-based medical care in a cost-effective manner. Through capitation contracts with some of the nation's leading health plans, as of December 31, 2012, HCP had approximately 724,000 current members under its care in southern California, central and south Florida and southern Nevada. Of these, approximately 201,300 individuals were patients enrolled in Medicare Advantage. The remaining approximately 522,700 individuals were managed care members whose health coverage is provided through their employer or who have individually acquired health coverage directly from a health plan or as a result of their eligibility for Medicaid benefits. Additionally, HCP operates in its New Mexico market under a fee-for-service reimbursement structure. In addition to its managed care business, during the year ended December 31, 2012, HCP provided care in all markets to over 530,000 patients whose health coverage is structured on a fee-for-service basis, including patients enrolled through traditional Medicare and Medicaid programs, preferred provider organizations and other third party payors.  The patients of HCP's associated physicians, physician groups and IPAs benefit from an integrated approach to medical care that places the physician at the center of patient care. As of December 31, 2012, HCP delivered services to its members via a network of over 2,000 associated groups and other network primary care physicians, 145 network hospitals, and several thousand associated group and network specialists. Together with hundreds of case managers, registered nurses and other care coordinators, these medical professionals utilize a comprehensive data analysis engine, sophisticated risk management techniques and clinical protocols to provide high-quality, cost effective care to HCP's members. The total amount of revenue from HCP for the year ended December 31, 2012, which includes two months of operations, was approximately $477 million, or approximately 5.8% of our consolidated net revenues.  

Key Financial Measures and Indicators

Operating Revenues

  General. HCP's consolidated revenues consist primarily of (i) HCP capitated revenues, including revenues attributable to capitation arrangements contracts with health plans and, to a lesser extent, revenues from patient services arrangements and (ii) other operating revenues, each as described in more detail below. On a pro-forma basis, HCP's business net revenues for fiscal 2012 would have represented approximately 26% of our consolidated net revenues assuming HCP was acquired on January 1, 2012.                                           89  -------------------------------------------------------------------------------- HCP revenues. HCP capitated revenues consist primarily of fees for medical services provided under capitated contracts with various health plans or under fee-for-service arrangements with privately insured individuals. Capitation revenue derived from health plans typically results from either (i) premium payments by CMS to HCP's health plan customers under Medicare Advantage with respect to seniors, disabled and other eligible persons (which are referred to herein as HCP's senior membership), (ii) premium payments by state governments to HCP's health plan customers under Medicaid managed care programs (which are referred to herein as HCP's Medicaid membership), and (iii) premium payments from public and private employers and individuals to HCP's health plan customers with respect to their employees (which are referred to herein as HCP's commercial membership). Capitation payments under health plan contracts are made monthly based on the number of enrollees selecting an HCP associated group physician employed or associated with one of HCP's medical group entities as their primary health care provider. The amount of monthly capitation HCP receives from health plans on behalf of a member generally does not vary during a given calendar year, regardless of the level of actual medical services utilized by the member. Due to differing state laws affecting health care entities, HCP's capitation contracts fall into two general categories. As described in more detail below, in central Florida and southern Nevada, HCP utilizes a global capitation model in which it assumes the financial responsibility for both professional (physician) and institutional (or hospital) services for covered benefits. In southern California, HCP utilizes variants of a different model for capitation under which it is directly financially responsible for covered professional services, but indirectly financially responsible for covered institutional expenses. HCP's associated medical groups also receive specified incentive payments from health plans based on specified performance and quality criteria. These amounts are accrued when earned, and the amounts can be reasonably estimated.    

• Global capitation model. HCP records the aggregate global capitation PMPM

fee as revenue and the amounts paid with respect to claims as medical

expenses or hospital expenses, as applicable, in its combined financial

statements (see "Operating Expenses-Medical Expenses" and "Operating

Expenses-Hospital Expenses" below). Revenue with respect to both

professional and institutional capitation is recorded in the month in

which enrollees are entitled to receive health care. In HCP's central

Florida market, HCP also receives capitation revenue and is liable for

corresponding expenses for prescription drug activity rendered on behalf

of HCP's senior members through the Part D component under the Medicare

         Advantage program.    

• Risk-sharing model. As compensation under its various managed care-related

administrative services agreements with hospitals, HCP is entitled to

receive a percentage of the amount by which the institutional capitation

         revenue received from health plans exceeds institutional expenses, and any          such risk-share amount to which HCP is entitled is recorded as medical          revenues. In addition, pursuant to such managed care-related          administrative services agreements, HCP agrees to be responsible should

the third party incur institutional expenses in excess of institutional

capitation revenue. As with global capitation, revenue with respect to

professional capitation is reported in the month in which enrollees are

entitled to receive health care. Risk-share revenues (that is, the portion

of the excess or deficit of institutional capitation revenue to which HCP

         is entitled less institutional expenses), in contrast, are based on the          number of enrollees and estimates of institutional utilization and          associated costs incurred by assigned health plan enrollees, and the

amounts accrued when earned can be reasonably estimated. Differences

between actual contract settlements and estimated receivables and payables

          are recorded in the year of final settlement.          •   Retroactive revenue-adjustments. The Medicare Advantage revenue received

by HCP's health plan customers is adjusted periodically to give effect to

the relative clinical and demographic profile of the members for whom HCP

is financially responsible. The model employed by CMS bases a portion of

the total reimbursement payments on various clinical and demographic risk

factors, including hospital inpatient diagnoses, additional diagnosis data

from ambulatory treatment settings, hospital outpatient department and

physician visits, gender, age and Medicaid eligibility. Under this

methodology, health plans must capture, collect and submit diagnosis code

         information to CMS. Capitation payments under this methodology are paid at          interim rates during the year and retroactive adjustments occur in                                            90 

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       subsequent periods (generally in the third quarter of the same year, with        a final adjustment in the third quarter of the following year) after the

data is compiled by CMS. HCP estimates the amount of such adjustments in

revenues during the first and second quarters of any given year and

adjusts its estimates during the third quarter, upon receipt of payments

from CMS. Differences between actual contract settlements and estimated

       revenues are recorded in the year of final settlement. To date, all such        adjustments have resulted in increases in revenue.    

• Patient service revenues. Patient service revenues are recorded when the

services are provided. Such revenues are based on a negotiated fixed-fee

schedule with the applicable health plan.

   Other Operating Revenues. In addition to the revenues discussed above, other operating revenues primarily represents (i) payments received from payors not directly related to patient care, (ii) revenues received by The Camden Group, a medical consulting firm and HCP's wholly owned subsidiary; and (iii) management fees HCP receives with respect to its role as the manager of Magan Medical Group (Magan JV or Magan) an unconsolidated joint venture with Magan Medical Clinic, Inc., located in southern California, in which HCPAMG owns a 50% interest.  

Patient Care Costs

  General. HCP's largest patient care costs are the costs of medical services provided pursuant to its capitation contracts, which consist of medical expenses, hospital expenses and clinical support and other operating costs, as further described below. Under both the global capitation and the risk-share capitation models, costs of medical services are recognized in the month in which the related services are provided. In addition, medical expenses and hospital expenses include an estimate of such expenses that have been incurred but not yet reported. For further information on how HCP estimates such claims, see "Critical Accounting Policies and Estimates-Medical Claims Liability and Related Payable, Medical Expense and Hospital Expense" below.  Medical expenses. Medical expenses consist of payments for professional and ancillary services to independent primary care physicians, specialists, ancillary providers and hospitals (including, with respect to hospitals, for outpatient services) pursuant to agreements with those entities. The structure of such expenses can consist of, among other things, sub-capitation and fee-for-service payments. In addition, medical expenses include compensation and related expenses incurred with respect to HCP's associated group primary care physicians and specialists, registered nurses, physician assistants and hospitalists.  Hospital expenses. Hospital expenses consist of payments for institutional services to contracted and non-contracted hospitals for both inpatient and outpatient services, skilled nursing facilities, and to other institutional providers. Hospital expenses are only incurred in connection with the services HCP provides in central Florida and southern Nevada. In those regions, as described above, HCP enters into contracts with health plans pursuant to which it assumes the risk for institutional hospital services. In California, in contrast, HCP's medical groups are not permitted to contract with health plans to directly assume the risk for institutional services. Accordingly, the risk-share revenue that HCP records in California is net of reported claims and estimates of hospital utilization and associated costs incurred by assigned health plan enrollees, and no portion of institutional hospital costs incurred with respect to HCP's California operations is included in hospital expenses as presented.  Clinic support and other operating costs. Clinic support and other operating costs primarily consist of the costs incurred with respect to compensation of administrative and other support staff employed at HCP's medical clinics, clinic rent and utilities, medical supplies and other direct costs incurred to support clinic operations. Also included in clinic support costs are direct costs incurred to support .  Other operating expenses. General and administrative expenses are those costs directly related to corporate administrative functions in supporting HCP and consist primarily of salaries and benefits, professional fees and occupancy costs. Depreciation and amortization expenses primarily relates to the depreciation and amortization of the fair values of property and equipment and intangible assets as remeasured in connection with the acquisition of HCP.                                           91  -------------------------------------------------------------------------------- Equity investment income. As discussed above, HCPAMG is a 50% owner of the Magan JV with Magan Medical Clinic, Inc. In addition, HCP also owns a 67% ownership interest in CMGI. We account for these equity interests under the equity method of accounting, meaning that its assets and liabilities are not consolidated with ours, but we record our pro rata share of the entities' earnings as equity investment income.  

Results of Operations

HCP consolidated operating results for the year ended December 31, 2012, is comprised of operating results for the period November 1, 2012 through December 31, 2012, were as follows:

                                                             November 1, 2012  through                                                               December 31, 2012                                                          (dollars amounts rounded to                                                               nearest millions) Net revenues: HCP capitated revenue                         $            419                                88 %  Patient service revenue                                     36 Less: Provision for uncollectible accounts                                                    (2 )  Net patient service revenue                                 34                                 7 %  Other revenues                                              24                                 5 %  Total net revenues                            $            477                               100 %  Operating expense: Patient care costs                            $            339                                71 % General and administrative expense                          52                                11 % Depreciation and amortization                               24                                 5 % Equity investment income                                    (5 )                              (1 )%  Total expenses                                             410                                86 %  Operating income                              $             67                                14 %   

Capitated membership information

  The table set forth below provides (i) the total number of managed care members to whom HCP provided healthcare services as of December 31, 2012, and (ii) the aggregate member months for the period November 1, 2012 through December 31, 2012. Member months represent the aggregate number of months of healthcare services HCP has provided to managed care members during a period of time.                                                              Member months                                                          for the period                                       Members at        November 1, 2012                                      December 31,            through                                          2012           December 31, 2012             Payor classification:             Commercial                     442,700                 885,200             Senior                         201,300                 385,300             Medicaid                        80,000                 152,100                                             724,000               1,422,600    In addition to the members above, HCP provided healthcare services to approximately 49,300 members as of December 31, 2012 related to its Magan JV, which is an unconsolidated entity that is accounted for as an equity investment, and approximately 97,800 member months for the period November 1, 2012 through December 31, 2012.                                           92 

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Revenues

The following table provides a breakdown of HCP's sources of revenues:

                                                           For the period November 1, 2012                                                             through December 31, 2012                                                               (dollars in millions) HCP revenues: Commercial revenues                            $               112                               24 % Senior revenues                                                298                               62 % Medicaid revenues                                                9                                2 %  Total capitated revenues                                       419                               88 % Patient service revenue, net of provision for uncollectible accounts                            34                                7 % Other revenues                                                  24                                5 %  Total net revenues                             $               477                              100 %    Patient care costs 

The following table reflects HCP's patient care costs comprised of medical expenses, hospital expenses, clinic support and other operating costs:

                                                          For the period                                                       November 1, 2012                                                            through                                                       December 31, 2012                                                     (dollars in millions)         Medical expenses                           $                   226         Hospital expenses                                               52         Clinic support and other operating costs                        61          Total                                      $                   339    Other operating expenses  

HCP's general and administrative costs were $52 million, or 11%, in 2012 for the period November 1, 2012 through December 31, 2012.

  HCP's depreciation and amortization of $24 million for the period November 1, 2012 through December 31, 2012 reflects the expense based upon the fair value of equipment, leasehold improvements and intangible assets we recognized in the HCP acquisition.  Other items  HCP's share of equity investment income from our joint venture relationship and our investment in CMGI was $5 million for the period November 1, 2012 through December 31, 2012 and were impacted by an increase in membership during that period and an increase in profitability in CMGI.  

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 December 31, 2012 these consisted primarily of pharmacy services, infusion therapy services, disease management services, vascular access services, ESRD clinical research programs, physician services, direct primary care and our international dialysis                                           93  -------------------------------------------------------------------------------- operations. See "Divestiture of HomeChoice Partners, Inc." for a description of the divestiture of our infusion therapy business that occurred on February 1, 2013. Results for this divested infusion therapy business have been reported as discontinued operations for all periods presented. The remaining ancillary services and strategic initiatives generated approximately $642 million of net revenues in 2012, representing approximately 8% of our consolidated net revenues. On a pro-forma basis our ancillary services and strategic initiatives net revenues for fiscal 2012 would have represented approximately 6% of our consolidated net revenues assuming HCP was acquired on January 1, 2012. 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 in 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, which occurred in 2011 when we recorded a non-cash goodwill impairment charge relating to our infusion therapy business, and could also result in significant termination costs if we were to exit a certain line of business.  As of December 31, 2012, we provided dialysis and administrative services to a total of 36 outpatient dialysis centers located in eight countries outside of the U.S. Our international dialysis operations are still currently in a start-up phase in which we primarily commenced operations during the fourth quarter of 2011. The total net revenues generated from our international operations, as reflected below, were not material during 2012.  

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

                                                          Year ended                                              2012           2011       2010                                                 (dollar amounts rounded                                                  to nearest in million)              U.S. revenues              Net patient service revenues   $     8        $    7      $   6              Other revenues                     620           446        326               Total                              628           453        332              International revenues              Net patient service revenues         9             1         -              Other revenues                       5            -          -               Total                               14             1         -               Total net revenues             $   642        $  454      $ 332               Segment operating loss         $   (66 )      $  (34 )    $ (11 )    Net revenues  

The ancillary services and strategic initiatives net revenues for 2012 increased by approximately $188 million or 41.4% as compared to 2011, primarily from growth in pharmacy services, and from our special needs plan.

The ancillary services and strategic initiatives net revenues for 2011 increased by approximately $122 million or 36.7% as compared to 2010, primarily from growth in pharmacy services, and from our special needs plan.

Operating expenses

Ancillary services and strategic initiatives operating expenses for 2012 increased by approximately $220 million from 2011. This increase in operating expenses was primarily due to an increase in volume in our

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pharmacy business, an increase in our claims expenses associated with our special needs plan, an increase in expenses associated with our international dialysis expansion and an increase in labor and benefit costs.

  Ancillary services and strategic initiatives operating expenses for 2011 increased by approximately $145 million from 2010. This 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 and an increase in labor and benefit costs.  

Ancillary services and strategic initiatives operating loss

  Ancillary services and strategic initiatives operating losses for 2012 increased by approximately $32 million from 2011. This increase in operating losses was primarily due to an increase in expenses associated with our international dialysis expansion and a decline in the operating performance of our special needs plan, ESRD clinical research and our direct primary care, partially offset by an increase in the operating performance of our pharmacy business.  Ancillary services and strategic initiatives operating losses for 2011 increased by approximately $23 million from 2010. This increase in operating losses was primarily due to an increase in expenses associated with our international dialysis expansion, partially offset by an increase in the operating performance of our pharmacy business and in our vascular access services.  

Corporate level charges

  Debt expense. Debt expense for 2012, 2011, and 2010 consisted of interest expense of approximately $276 million, $231 million, and $172 million, respectively, and the amortization and accretion of debt discounts and premiums and the amortization of deferred financing costs of approximately $13 million in 2012, $10 million in 2011 and $9 million in 2010. The increase in interest expense in 2012 as compared to 2011 was primarily related to the issuance of our New Term Loans for $3,000 million under our amended Senior Secured Credit Facilities that we entered into in the fourth quarter of 2012 and the issuance of our 5 3/4% New Senior Notes for $1,250 million on August 28, 2012. However, debt expense in 2012 benefited from lower rates and lower average outstanding balances associated with our Term Loan A-2 which was paid off on November 1, 2012 and with our Term Loan B. Our overall weighted average effective interest rate in 2012 was 5.16% as compared to 5.28% in 2011.  The increase in interest expense in 2011 as compared to 2010 was primarily related to additional borrowings under our Senior Secured Credit Facilities that were issued in the fourth quarter of 2010 and additional borrowings associated with the new Term Loan A-2 that contain significantly higher interest rates than our previous facility. In addition, debt expense in 2011 was also impacted by the amount of interest rate swaps that resulted in a higher overall weighted average effective interest rate on the Term Loan A and from the amortization of an interest rate cap premium associated with our Term Loan B. However, debt expense in 2011 benefited from lower rates and lower outstanding balances associated with our new senior notes that were issued in the fourth quarter of 2010. Our overall weighted average effective interest rate in 2011 was 5.28% as compared to 4.68% in 2010.  Corporate support costs. Corporate support consists primarily of labor, benefits and stock-based compensation costs for departments which provide support to all of our operating lines of business and were approximately $52 million in 2012, $47 million in 2011 and $45 million in 2010. These expenses are included in our consolidated general and administrative expenses. The increases in these costs in 2012 and 2011 were primarily due to higher labor and benefit costs.  

Transaction expenses. In 2012, we incurred approximately $31 million of transaction expenses associated with the acquisition of HCP, which are included in our consolidated general and administrative expenses.

                                       95  -------------------------------------------------------------------------------- Other income. Other income was approximately $4 million, $3 million, and $3 million in 2012, 2011, and 2010, respectively, and consisted principally of interest income. Other income in 2012 increased from 2011, primarily as a result of higher average cash balances. Other income in 2011 was slightly down from 2010, primarily as a result of lower average interest rates and lower average cash balances.  Provision for income taxes. The provision for income taxes for 2012 represented an effective annualized tax rate of 35.9%, compared with 35.5% and 34.9% of income from continuing operations in 2011 and 2010, respectively. The effective tax rate in 2012 was higher primarily due to non-deductible transaction costs associated with the acquisition of HCP and international acquisition costs.  Impairments and valuation adjustments. We perform impairment or valuation reviews for our property and equipment, amortizable intangible assets, equity investments in non-consolidated businesses, and our investments in ancillary services and strategic initiatives at least annually and whenever a change in condition indicates that an impairment review is warranted. Such changes include shifts in our business strategy or plans, the quality or structure of our relationships with our partners, or when a center experiences deteriorating operating performance. Goodwill is also assessed at least annually for possible valuation impairment using fair value methodologies. These types of adjustments are charged directly to the corresponding operating segment that incurred the charge. There were no other significant impairments or valuation adjustments recognized during 2012.  Noncontrolling interests  Net income attributable to noncontrolling interests for 2012, 2011 and 2010 was approximately $105 million, $95 million and $79 million, respectively. The increases in noncontrolling interests in 2012 and 2011 were primarily due to increases in the number of new joint ventures and increases in the profitability of our dialysis-related joint ventures. The percentage of U.S. dialysis and related lab services net revenues generated from dialysis-related joint ventures was approximately 19% in 2012 and 18% in 2011.  

Accounts receivable

  Our U.S. dialysis and related lab services accounts receivable balances at December 31, 2012 and 2011 represented approximately 59 days of revenue for 2012 and 64 days of revenue for 2011, net of bad debt allowance. Our days outstanding in 2012, represent solid improved cash collections from accounts that are under six months old that enabled us to keep pace with our growth in revenue.  As of December 31, 2012 and 2011, our dialysis and related lab services unreserved accounts receivable balances that were more than six months old were approximately $225 million and $184 million, respectively, representing approximately 19% and 16% of our dialysis accounts receivable balances, respectively. During 2012, we experienced a slow down in cash collections from certain non-government payors. There were no significant unreserved balances over one year old. Less than 1% of our revenues are classified as patient pay. Substantially all revenue realized is from government and commercial payors, as discussed above.  Amounts pending approval from third-party payors as of December 31, 2012 and 2011, other than the standard monthly billing, consisted of approximately $41 million in 2012 and $57 million in 2011, associated with Medicare bad debt claims, classified as other receivables. Currently, a significant portion of our Medicare bad debt claims are typically paid to us before the Medicare fiscal intermediary audits the claims. However, the payment received from Medicare is subject to adjustment based upon the actual results of the audits. Such audits typically occur one to four years after the claims are filed. As a kidney dialysis provider, our revenue is not subject to cost report settlements, except for potentially limiting the collectability of these Medicare bad debt claims.                                           96 

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Liquidity and capital resources

  Available liquidity. As of December 31, 2012, our cash balance was $534 million and we had an undrawn revolving line of credit under our Senior Secured Credit Facilities totaling $350 million, of which approximately $115 million was committed for outstanding letters of credit. In addition, we had an undrawn revolving line of credit of approximately $16 million of which $1 million was committed for outstanding letter of credit related to HCP. We believe that we will have sufficient liquidity, operating cash flows and access to borrowings to fund our scheduled debt service and other obligations for the foreseeable future. Our primary sources of liquidity are cash from operations and cash from borrowings.  Cash flow from operations during 2012 amounted to $1,101 million, compared with $1,180 million for 2011. The decrease in our operating cash flows in 2012 as compared to 2011 was primarily due to an increase in income tax payments and the timing of other working capital items, partially offset by an increase in our cash collections from accounts that are less than six months old. Cash flow from operations in 2012 included cash interest payments of approximately $258 million and cash tax payments of $332 million. Cash flow from operations in 2011 included cash interest payments of approximately $236 million and cash tax payments of $146 million.  Non-operating cash outflows in 2012 included $550 million for capital asset expenditures, including $278 million for new center developments and relocations, and $272 million for maintenance and information technology. We also spent an additional $4,294 million for acquisitions. During 2012, we also received $22 million from the maturity and sale of investments. However, some of these proceeds were either used to repurchase other investments or was used to fund distributions from our deferred compensation plans. In addition, during 2012, we received $69 million associated with stock option exercises and other share issuances and the related excess tax benefits. We also made distributions to noncontrolling interests of $114 million, and received contributions from noncontrolling interests of $37 million associated with new joint ventures and from additional equity contributions. We did not repurchase any shares of our common stock in 2012.  Non-operating cash outflows in 2011 included $400 million for capital asset expenditures, including $176 million for new center developments and relocations, and $224 million for maintenance and information technology. We also spent an additional $1,077 million for acquisitions. During 2011, we also received $49 million from the maturity and sale of investments. However, the majority of these proceeds was either used to repurchase other investments or was used to fund distributions from our deferred compensation plans. In addition, during 2011, we received $32 million associated with stock option exercises and other share issuances and the related excess tax benefits. We also made distributions to noncontrolling interests of $101 million, and received contributions from noncontrolling interests of $21 million associated with new joint ventures and from additional equity contributions. In addition, we repurchased 3.8 million shares of our common stock for approximately $323 million.  During 2012, we acquired a total of 93 U.S. dialysis centers (nine of which were previously under management and administrative services agreements), opened 70 new U.S. dialysis centers, sold one center, merged nine centers and added one center in which we own a minority equity interest. In addition, we acquired 13 dialysis centers, opened nine new dialysis centers and also added three dialysis centers under management and administrative service agreements all of which are located outside of the U.S. During 2011, we acquired a total of 178 dialysis centers, eight of which were located outside of the U.S., opened 65 new dialysis centers, sold two centers, merged seven centers, and divested a total of 30 dialysis centers in connection with the acquisition of DSI. We also added three dialysis centers under management and administrative service agreements that are located outside of the U.S. and added one center in which we own a minority equity interest.  

During the year 2012, we made mandatory principal payments under our Senior Secured Credit Facilities totaling $50.0 million on the Term Loan A, $1.5 million on the Term Loan A-2 (prior to the Term Loan A-2 being fully paid off) and $17.5 million on the Term Loan B.

                                       97  -------------------------------------------------------------------------------- As of December 31, 2012, we maintained a total of nine interest rate swap agreements with amortizing notional amounts totaling $900 million. These agreements had the economic effect of modifying the LIBOR variable component of our interest rate on an equivalent amount of our Term Loan A to fixed rates ranging from 1.59% to 1.64%, resulting in an overall weighted average effective interest rate of 4.11%, including the Term Loan A margin of 2.50%. The swap agreements expire by September 30, 2014 and require monthly interest payments. During the year ended December 31, 2012, we accrued net charges of $13.0 million from these swaps which are included in debt expense. As of December 31, 2012, the total fair value of these swap agreements was a liability of $19.0 million. We estimate that approximately $11.9 million of existing unrealized pre-tax losses in other comprehensive income at December 31, 2012 will be reclassified into income in 2013.  As of December 31, 2012, we maintained five 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 Term Loan B debt. The cap agreements expire on September 30, 2014. As of December 31, 2012, the total fair value of these cap agreements was an asset of $0.07 million. During the year ended December 31, 2012, we recorded $0.8 million, net of tax, as a decrease to other comprehensive income due to unrealized valuation changes in the cap agreements.  As a result of the embedded LIBOR floors in some of our debt agreements and the swap and cap agreements, our overall weighted average effective interest rate on the Senior Secured Credit Facilities was 4.02%, based upon the current margins in effect of 2.50% for both the Term Loan A and for the Term Loan A-3 and 3.00% for both the Term Loan B and for the Term Loan B-2, as of December 31, 2012.  As of December 31, 2012, interest rates on our Term Loan B and Term Loan B-2 debt are effectively fixed because of an embedded LIBOR floor which is higher than actual LIBOR as of such date. Furthermore, the interest rate on the $1,250 million of our Term Loan B is subject to interest rate caps if LIBOR should rise above 4.00%. Interest rates on our senior notes are fixed by their terms. The LIBOR variable component of our interest rate on our Term Loan A is economically fixed as a result of interest rate swaps and the Term Loan A-3 is based upon LIBOR plus an interest rate margin.  

Our overall weighted average effective interest rate during 2012 was 4.93% and as of December 31, 2012 was 4.73%.

As of December 31, 2012, we had undrawn revolving line of credit totaling $366 million of which approximately $116 million was committed for outstanding letters of credit.

2012 Acquisition of HCP

  On November 1, 2012 we completed our acquisition of HCP pursuant to an Agreement and Plan of Merger dated May 20, 2012, whereby HCP became a wholly-owned subsidiary of the Company. HCP is one of the country's largest operators of medical groups and physician networks generating approximately $2.4 billion in annual revenues and approximately $488 million in operating income for the year ended December 31, 2011. The operating results of HCP are included in our consolidated financial results from November 1, 2012.  The total consideration paid at closing for all of the outstanding common units of HCP was approximately $4.70 billion, which consisted of $3.64 billion in cash, net of cash acquired, and 9,380,312 shares of our common stock valued at approximately $1.06 billion. The total acquisition consideration is subject to a post-closing working capital adjustment. The acquisition agreement also provides that as further consideration, we will pay the common unit holders of HCP a total of up to $275 million in cash if certain performance targets are achieved by HCP in 2012 and 2013.                                           98 

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2012 Capital structure changes and other items

  In conjunction with the acquisition of HCP, on November 1, 2012, we borrowed an additional $3,000 million under an amended Credit Agreement. The amended Credit Agreement consists of a new five year Term Loan A-3 facility in an aggregate principal amount of $1,350 million and a new seven year Term Loan B-2 facility in an aggregate principal amount of $1,650 million. The new Term Loan A-3 initially bears interest at LIBOR plus an interest rate margin of 2.50% subject to adjustment depending upon our leverage ratio and can range from 2.00% to 2.50%. This new Term Loan A-3 requires annual principal payments of $67.5 million in 2013 and 2014, $135.0 million in 2015, and $202.5 million in 2016 with the balance due of $877.5 million in 2017. The Term Loan B-2 bears interest at LIBOR (floor at 1.00%) plus an interest rate margin of 3.00%. The Term Loan B-2 requires annual principal pay-outs of $16.5 million in 2013 through 2018 with the balance of $1,551 million due in 2019. The new borrowings under the Credit Agreement are guaranteed by substantially all of our direct and indirect wholly-owned domestic subsidiaries and are secured by substantially all of our and our guarantors' assets. In addition, we also amended certain financial covenants and various other provisions to provide operating and financial flexibility. However, the amended Credit Agreement still contains certain customary affirmative and negative covenants such as various restrictions on investments, acquisitions, the payment of dividends, redemptions and acquisitions of capital stock, capital expenditures and other indebtedness, as well as limitations on the amount of tangible net assets in non-guarantor subsidiaries. Many of these restrictions will not apply as long our leverage ratio is below 3.50:1.00. In addition, the Credit Agreement requires compliance with financial covenants including an interest coverage ratio and a leverage ratio that determines the interest rate margins as described above.  On August 28, 2012, we also issued $1,250 million of 5 3/4% New Senior Notes. The 5 3/4% New Senior Notes will pay interest on February 15 and August 15 of each year, beginning February 15, 2013. The 5 3/4% New Senior Notes are unsecured senior obligations and rank equally to other unsecured senior indebtedness. The 5 3/4% New Senior Notes are guaranteed by certain domestic subsidiaries of the Company. We may redeem some or all of the 5 3/4% New Senior Notes at any time on or after August 15, 2017 at certain redemption prices and prior to such date at a make-whole redemption price. We may also redeem up to 35% of the 5 3/4% New Senior Notes at any time prior to August 15, 2015 at certain redemption prices with the proceeds of one or more equity offerings.  We received total proceeds of $4,250 million from these additional borrowings, $3,000 million from the borrowings on the new Term Loan A-3 and new Term Loan B-2, and an additional $1,250 million from the 5 3/4% New Senior Notes. We used a portion of the proceeds to finance the acquisition of HCP, pay-off the existing Term Loan A-2 outstanding principal balance and to pay off a portion of HCP's existing debt as well as to pay fees and expenses of approximately $71.8 million.  

Divestiture of HomeChoice Partners, Inc.

  On February 1, 2013, we completed the sale of HomeChoice Partners Inc. (HomeChoice) to BioScrip, Inc. pursuant to a stock purchase agreement (the Agreement) dated December 12, 2012 for $70 million in cash, subject to various post-closing adjustments of which we will receive approximately 90% of the proceeds. The Agreement also provides that as additional consideration we can earn up to a total of 90% of $20 million if certain performance amounts exceed certain thresholds over the next two years.  

HomeChoice is a regional provider of home infusion services that provides specialized pharmacy nursing and nutritional services to patients in their homes. HomeChoice generated approximately $68 million in revenues for the year ended December 31, 2012.

  The asset and liabilities associated with HomeChoice are classified as held for sale on our consolidated balance sheet and are included in other current assets and other liabilities, respectively. The operating results for HomeChoice have been reported in income from operations of discontinued operations, net of tax, for all periods presented.                                           99 

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Goodwill impairment

  In 2011, we determined that circumstances indicated it was more likely than not that the fair value of one of our ancillary businesses, HomeChoice, was less than its carrying amount. The primary factor in forming our conclusion was the recent decline in the operating performance of the business caused mainly by rapid expansion. This led management to revise its view of the businesses organizational growth capability and scale back significantly its current plans for future growth initiatives and to update the HomeChoice forecasts and current operating budgets accordingly. These revisions reflected the current and expected future cash flows that we believed market participants would use in determining the fair value HomeChoice. As a result, in the second quarter of 2011, we estimated that the carrying amount of goodwill related to this business exceeded its implied fair value by $24 million, resulting in a pre-tax goodwill impairment charge of that amount. This amount is included as a component of income from operations of discontinued operations. As of December 31, 2011, after giving effect to this impairment charge, we had approximately $32 million of goodwill remaining related to this business.  

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 2012, we granted 1,365,321 stock-settled stock appreciation rights with a grant-date fair value of $30.8 million and a weighted-average expected life of approximately 3.7 years, 309,057 stock units with a grant-date fair value of $33.9 million and a weighted-average expected life of approximately 2.8 years, and cash-settled stock-based awards on 13,867 shares with a fair value at December 31, 2012 of $0.7 million.  

Long-term incentive compensation

  For the years ended December 31, 2012 and 2011, we recognized $45.8 million and $48.7 million, respectively, in long-term incentive compensation costs. Long-term incentive program (LTIP) compensation includes both stock-based compensation (principally stock-settled stock appreciation rights and restricted 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 allocated among the dialysis and related lab services business, corporate support costs, and the ancillary services and strategic initiatives.  As of December 31, 2012 there was $131.8 million in total estimated but unrecognized long-term incentive compensation for LTIP awards outstanding, including $104.7 million for nonvested stock-based awards 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 2.2 years, and the stock-based component of these LTIP costs over a weighted average remaining period of 1.4 years.  During the years ended December 31, 2012 and 2011, we received $2.1 million and $5.4 million, respectively, in cash proceeds from legacy stock option exercises and $89.0 million and $38.2 million, respectively, in total actual tax benefits upon the exercise of stock awards.  

2011 acquisition

  On September 2, 2011, we completed our acquisition of all of the outstanding common stock of CDSI I Holding Company, Inc., the parent company of dialysis provider DSI pursuant to an agreement and plan of merger for approximately $723 million in net cash, plus the assumption of certain liabilities totaling approximately $6.5 million, subject to certain post-closing adjustments. DSI had 113 outpatient dialysis centers that provided services to approximately 8,000 patients in 23 states. We also incurred approximately $22 million in transaction and integration costs during the year ended December 31, 2011 associated with this acquisition that are included in general and administrative expenses.                                          100  -------------------------------------------------------------------------------- Pursuant to a consent order issued by the Federal Trade Commission on September 2, 2011, we agreed to divest a total of 30 outpatient dialysis centers and several home-based dialysis programs in order to complete the acquisition of DSI. In conjunction with the consent order, on September 30, 2011, we completed the sale of 28 outpatient dialysis centers to Dialysis Newco, Inc. (Dialysis Newco) a portfolio company of Frazier Healthcare VI, L.P. and New Enterprise Associates 13, Limited Partnership pursuant to an asset purchase agreement dated August 26, 2011. Effective October 31, 2011, we also completed the sale of two additional outpatient dialysis centers to Dialysis Newco that were previously pending state regulatory approval. We received total net cash consideration of approximately $84 million for all of the outpatient dialysis centers that were divested.  

2011 capital structure changes and other items

  On August 26, 2011$100 million, to a total of $350 million, and entered into an additional $200 million Term Loan A-2. The new Term Loan A-2 required a principal payment of $0.5 million on December 31, 2011 and thereafter requires annual principal payments of $2.0 million with the balance of $191.5 million due in 2016, and bears interest at LIBOR (floor of 1.00%) plus an interest rate margin of 3.50% subject to a rating based step-down to 3.25%. On November 1, 2012, the total existing Term Loan A-2 outstanding principal balance was paid off. See above for further details.  During the year ended December 31, 2011 we made mandatory principal payments under our Senior Secured Credit Facilities totaling $50 million on the Term Loan A, $0.5 million on Term Loan A-2 and $17.5 million on the Term Loan B.  

Interest rate swaps and caps

  In January 2011, we entered into nine interest rate swap agreements with amortizing notional amounts totaling $1.0 billion that went effective on January 31, 2011, as a means of hedging our exposure to and volatility from variable-based interest rate changes as part of our overall risk management strategy. As of December 31, 2011, we maintained a total of nine interest rate swap agreements with amortizing notional amounts totaling $950 million. These agreements had the economic effect of modifying the LIBOR variable component of our interest rate on an equivalent amount of our Term Loan A to fixed rates ranging from 1.59% to 1.64%, resulting in an overall weighted average effective interest rate of 4.11%, including the Term Loan A margin of 2.50%. During the year ended December 31, 2011, we accrued net charges of $12.6 million from these swaps which are included in debt expense. As of December 31, 2011, the total fair value of these swap agreements was a liability of $23.1 million.  In addition, in January 2011, we also entered into five interest rate cap agreements with notional amounts totaling $1.25 billion that went effective on January 31, 2011. 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 Term Loan B debt. The cap agreements expire on September 30, 2014. As of December 31, 2011, the total fair value of these cap agreements was an asset of $1.4 million. During the year ended December 31, 2011, we recorded $5.2 million, net of tax, as a decrease to other comprehensive income due to unrealized valuation changes in the cap agreements, net of the amortization of the interest rate cap premiums that were reclassified into net income.  As a result of the embedded LIBOR floors in some of our debt agreements and the swap and cap agreements, our overall weighted average effective interest rate on the Senior Secured Credit Facilities was 4.61%, based upon the current margins in effect of 2.50% for the Term Loan A, 3.50% for the Term Loan A-2 and 3.00% for the Term Loan B, as of December 31, 2011.  As of December 31, 2011, interest rates on our Term Loan A-2 and Term Loan B debt were effectively fixed because of an embedded LIBOR floor which is higher than actual LIBOR as of such date. Furthermore, the                                          101  -------------------------------------------------------------------------------- interest rate on the $1,250 million of our Term Loan B is subject to interest rate caps if LIBOR should rise above 4.00%. Interest rates on our senior notes are fixed by their terms. The LIBOR variable component of our interest rate on our Term Loan A is economically fixed as a result of interest rate swaps.  

Our overall weighted average effective interest rate in 2011 was 5.28% and as of December 31, 2011 was 5.27%.

  Stock repurchases  We did not repurchase any of our common stock in 2012. During 2011, we repurchased a total of 3,794,686 shares of our common stock for $323.3 million, or an average price of $85.21 per share, pursuant to a previously announced authorization by the Board of Directors on November 3, 2010, that authorized an additional $800 million of share repurchases of our common stock. As a result of these transactions, the total outstanding authorization for share repurchases as of December 31, 2011 was $358.2 million. This stock repurchase program has no expiration date.  Other items  On July 22, 2010, we entered into a First National Service Provider Agreement, or the Agreement, with NxStage Medical Inc. (NxStage). Under the terms of the Agreement we have the ability to continue to purchase NxStage System One hemodialysis machines and related supplies at discount prices. In addition, we may, in lieu of cash rebate, vest in warrants to purchase NxStage common stock based upon achieving certain System One home patient growth targets by June 30, 2011, 2012 and 2013. The warrants are exercisable for up to a cumulative total of 5.5 million shares of common stock over the three years at an initial exercise price of $14.22 per share. From the period July 1, 2010 through June 30, 2011, we earned warrants to purchase 250,000 shares of NxStage common stock. In October 2011 we exercised our right to purchase 250,000 shares of NxStage common stock at $14.22 per share, for a total of approximately $3.6 million and in February 2012, we sold all 250,000 shares for approximately $5.2 million.  

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 facilities are leased. We have potential acquisition obligations for several joint ventures and for some of our non-wholly-owned subsidiaries in the form of put provisions. 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 intended to approximate fair value. For additional information see Note 22 to the consolidated financial statements.  We also have potential cash commitments to provide operating capital advances as needed to several other dialysis centers that are wholly-owned by third parties or centers in which we own an equity investment, as well as to physician-owned vascular access clinics that we operate under management and administrative services agreements.                                          102 

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The following is a summary of these contractual obligations and commitments as of December 31, 2012 (in millions):

                                                Less Than         2-3          4-5         After                                               1  year         years        years       5 years        Total Scheduled payments under contractual obligations: Long-term debt                              $       224      $ 1,096      $ 2,789      $  4,371      $  8,480 Interest payments on the senior notes               149          345          345           538         1,377 Interest payments on the Term Loan B(1)              78          153           61            -            292 Interest payments on the Term Loan B-2(2)                                               67          131          129           115           442 Capital lease obligations                             4            9           11            72            96 Operating leases                                    330          594          493           791         2,208                                              $       852      $ 2,328      $ 3,828      $  5,887      $ 12,895  Potential cash requirements under existing commitments: Letters of credit                           $       116      $    -       $    -       $     -       $    116 Noncontrolling interests subject to put provisions                                          324          102           84            71           581 Pay-fixed swaps potential obligations                12            7           -             -             19 Operating capital advances                            3           -            -             -              3                                              $       455      $   109      $    84      $     71      $    719     

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

currently bears interest at LIBOR (floor of 1.50%) plus an interest rate

margin of 3.00%.

(2) Assuming no changes to LIBOR-based interest rates as the Term Loan B-2

currently bears interest at LIBOR (floor of 1.00%) plus an interest rate

margin of 3.00%

   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 December 31, 2012. This amount represents the estimated potential obligation that we would be required to pay based upon the 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. in connection with the Product Supply Agreement. Our total expenditures for the year ended December 31, 2012 on such products were approximately 3% of our total U.S. dialysis operating costs in each year. In January 2010, we entered into an agreement with Fresenius which committed us to purchase a certain amount of dialysis equipment, parts and supplies from them through 2013. Our total expenditures for the year ended December 31, 2012 on such products were approximately 2% of our total U.S. 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 (the Original 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 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. In December 2012 we entered into an                                          103  -------------------------------------------------------------------------------- amendment to our agreement with Amgen that makes non-material changes to certain terms of the agreement for the period from January 1, 2013 through December 31, 2013. Under the terms of the original agreement before the amendment, we were required to purchase EPO in amounts necessary to meet no less than 90% of our requirements of ESAs and are still required to do so after 2013. In addition, all of the other conditions as specified in the original agreement entered into in November 2011 still apply.  

Settlements of approximately $79 million of existing income tax liabilities for unrecognized tax benefits are excluded from the above table as reasonably reliable estimates of their timing cannot be made.

Contingencies

The information in Note 16 to the consolidated financial statements of this report is incorporated by reference in response to this item.

Critical accounting estimates and judgments

  Our consolidated financial statements and accompanying notes are prepared in accordance with United States generally accepted accounting principles. These accounting principles require us to make estimates, judgments and assumptions that affect the reported amounts of revenues, expenses, assets, liabilities, contingencies and temporary equity. All significant estimates, judgments and assumptions are developed based on the best information available to us at the time made and are regularly reviewed and updated when necessary. Actual results will generally differ from these estimates. Changes in estimates are reflected in our financial statements in the period of change based upon on-going actual experience trends, or subsequent settlements and realizations depending on the nature and predictability of the estimates and contingencies. Interim changes in estimates are applied prospectively within annual periods. Certain accounting estimates, including those concerning revenue recognition and accounts receivable, impairments of long-lived assets, accounting for income taxes, quarterly and annual variable compensation accruals, consolidation of variable interest entities, purchase accounting valuation estimates, fair value estimates, stock-based compensation and medical liability claims are considered to be critical to evaluating and understanding our financial results because they involve inherently uncertain matters and their application requires the most difficult and complex judgments and estimates.  Dialysis and related lab services revenue recognition and accounts receivable. There are significant estimating risks associated with the amount of dialysis and related lab services revenue that we recognize in a given reporting period. Payment rates are often subject to significant uncertainties related to wide variations in the coverage terms of the commercial healthcare plans under which we receive payments. In addition, ongoing insurance coverage changes, geographic coverage differences, differing interpretations of contract coverage, and other payor issues complicate the billing and collection process. Net revenue recognition and allowances for uncollectible billings require the use of estimates of the amounts that will ultimately be realized considering, among other items, retroactive adjustments that may be associated with regulatory reviews, audits, billing reviews and other matters.  Revenues associated with Medicare and Medicaid programs are recognized based on (a) the payment rates that are established by statute or regulation for the portion of the payment rates paid by the government payor (e.g., 80% for Medicare patients) and (b) for the portion not paid by the primary government payor, the estimated amounts that will ultimately be collectible from other government programs paying secondary coverage (e.g., Medicaid secondary coverage), the patient's commercial health plan secondary coverage, or the patient. Effective January 1, 2011, our dialysis related reimbursements from Medicare became subject to certain variations under Medicare's new single bundled payment rate system whereby our reimbursements can be adjusted for certain patient characteristics and certain other factors. Our revenue recognition depends upon our ability to effectively capture, document and bill for Medicare's base payment rate and these other factors. In addition, as a result of the potential range of variations that can occur in our dialysis-related reimbursements from Medicare under the new single bundled payment rate system, our revenue recognition is now subject to a greater degree of estimating risk.                                          104 

-------------------------------------------------------------------------------- Commercial healthcare plans, including contracted managed-care payors, are billed at our usual and customary rates; however, revenue is recognized based on estimated net realizable revenue for the services provided. Net realizable revenue is estimated based on contractual terms for the patients under healthcare plans with which we have formal agreements, non-contracted healthcare plan coverage terms if known, estimated secondary collections, historical collection experience, historical trends of refunds and payor payment adjustments (retractions), inefficiencies in our billing and collection processes that can result in denied claims for payments, slow down in collections, a reduction in the amounts that we expect to collect and regulatory compliance issues. Determining applicable primary and secondary coverage for our more than 153,000 U.S. patients at any point in time, together with the changes in patient coverages that occur each month, requires complex, resource-intensive processes. Collections, refunds and payor retractions typically continue to occur for up to three years or longer after services are provided.  We generally expect our range of dialysis and related lab services revenues estimating risk to be within 1% of its revenue, which can represent as much as 5% of dialysis and related lab services operating income. Changes in estimates are reflected in the then-current financial statements based on on-going actual experience trends, or subsequent settlements and realizations depending on the nature and predictability of the estimates and contingencies. Changes in revenue estimates for prior periods are separately disclosed and reported if material to the current reporting period and longer term trend analyses, and have not been significant.  

Lab service revenues for current period dates of services are recognized at the estimated net realizable amounts to be received.

  HCP revenue recognition. HCP revenues consist primarily of fees for medical services provided under capitated contracts with various health plans and under risk-sharing programs. Revenues with respect to both professional and institutional capitation are recognized in the month in which enrollees are entitled to receive health care and are based on the number of enrollees selecting an HCP associated group physician employed or affiliated with one of HCP's medical group entities as their primary health care provider. Capitation payments received for enrollees under Medicare Advantage plans are subject to retroactive adjustment depending upon certain clinical and demographic factors. We estimate the amount of current year adjustments in revenues during the first and second quarters of any given year and adjust our estimates during the third quarter upon receipt of payments from CMS related to prior year. Any difference between actual contract settlements and estimated revenues are recorded in the year of final settlement.  In addition, as compensation under HCP's various managed care-related agreements with hospitals, we are entitled to receive a percentage of the amount by which the institutional capitation revenue received from health plans exceeds institutional expenses, and any such risk-share amount to which we are entitled is recorded as HCP revenues. In addition, pursuant to such managed care-related agreements, HCP agrees to be responsible should the third party incur a deficit as a result of institutional expenses being in excess of institutional capitation revenue. As with global capitation, revenue with respect to professional capitation is reported in the month in which enrollees are entitled to receive health care. Risk-share revenues (that is, the portion of the excess of institutional capitation revenue to which HCP is entitled less institutional expenses), in contrast, are based on the number of enrollees and significant estimating risk relating to institutional utilization and associated costs incurred by assigned health plan enrollees. The medical groups also receive other incentive payments from health plans based on specified performance and quality criteria and the amounts accrued when earned can be reasonably estimated. Differences between actual contract settlements and estimated receivables and payables are recorded in the year of final settlement.  

Impairments of long-lived assets. We account for impairments of long-lived assets, which include property and equipment, equity investments in non-consolidated businesses, amortizable intangible assets and goodwill, in accordance with the provisions of applicable accounting guidance. Impairment reviews are performed at least annually and whenever a change in condition occurs which indicates that the carrying amounts of assets may not be recoverable.

                                          105  -------------------------------------------------------------------------------- Such changes include changes in our business strategies and plans, changes in the quality or structure of our relationships with our partners and deteriorating operating performance of individual dialysis centers or other operations. We use a variety of factors to assess the realizable value of assets depending on their nature and use. Such assessments are primarily based upon the sum of expected future undiscounted net cash flows over the expected period the asset will be utilized, as well as market values and conditions. The computation of expected future undiscounted net cash flows can be complex and involves a number of subjective assumptions. Any changes in these factors or assumptions could impact the assessed value of an asset and result in an impairment charge equal to the amount by which its carrying value exceeds its actual or estimated fair value.  Accounting for income taxes. We estimate our income tax provision to recognize our tax expense for the current year, and our deferred tax liabilities and assets for future tax consequences of events that have been recognized in our financial statements, measured using enacted tax rates and laws expected to apply in the periods when the deferred tax liabilities or assets are expected to be realized. We are required to assess our tax positions on a more-likely-than-not criteria and to also determine the actual amount of benefit to recognize in the financial statements. Deferred tax assets are assessed based upon the likelihood of recoverability from future taxable income and, to the extent that recovery is not likely, a valuation allowance is established. The allowance is regularly reviewed and updated for changes in circumstances that would cause a change in judgment about the realizability of the related deferred tax assets. These calculations and assessments involve complex estimates and judgments because the ultimate tax outcome can be uncertain and future events unpredictable.  Variable compensation accruals. We estimate variable compensation accruals quarterly based upon the annual amounts expected to be earned and paid out resulting from the achievement of certain teammate-specific and/or corporate financial and operating goals. Our estimates, which include compensation incentives for bonuses, and other awards, are updated periodically based on changes in our economic condition or cash flows that could ultimately impact the actual final award. Actual results reflected in each fiscal quarter may vary due to the subjectivity involved in anticipating fulfillment of specific and/or corporate goals, as well as the final determination and approval of amounts by our Board of Directors.  Consolidation of variable interest entities. We rely on the operating activities of certain entities that we do not directly own or control, but over which we have indirect influence and of which we are considered the primary beneficiary. Under accounting guidance applicable to variable interest entities, we have determined that these entities are to be included in our consolidated financial statements. The analyses upon which this determination rests are complex, involve uncertainties, and require significant judgment on various matters, some of which could be subject to reasonable disagreement. While this determination has a meaningful effect on the description and classification of various amounts in our consolidated financial statements, non-consolidation of these entities would not have had a material effect on our results of operations attributable to the Company for the year ended December 31, 2012.  Purchase accounting valuation estimates. We make various assumptions and estimates regarding the valuation of tangible and intangible assets, liabilities, contingent earn-out consideration, noncontrolling interests and contractual as well as non-contractual contingencies associated with our acquisitions. These assumptions can have a material effect on our balance sheet valuations and the related amount of depreciation and amortization expense that will be recognized in the future.  Fair value estimates. We have recorded certain assets, liabilities and noncontrolling interests (temporary equity) subject to put provisions at fair value. The FASB defines fair value which is measured based upon certain valuation techniques that include inputs and assumptions that market participants would use in pricing assets, liabilities and noncontrolling interests subject to put provisions. We have measured the fair values of our applicable assets, liabilities and noncontrolling interests subject to put provisions based upon certain market inputs and assumptions that are either observable or unobservable in determining fair values and have also classified these assets, liabilities and noncontrolling interests subject to put provisions into the appropriate fair value hierarchy levels. The fair value of our investments available for sale are based upon quoted market prices                                          106  -------------------------------------------------------------------------------- from active markets and the fair value of our swap and cap agreements were 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 at quoted intervals such as current interest rates, forward yield curves, implied volatility and credit default swap pricing. The fair value of funds on deposit with third parties are based primarily on quoted close or bid market prices of the same or similar assets. The fair value of our contingent earn-out considerations were primarily based upon unobservable inputs including projected EBITDA, the estimate of achieving other performance targets and the estimate probability of the earn-out payments being made by using option pricing techniques and simulation models of expected EBITDA and other performance targets. For our noncontrolling interests subject to put provisions we have estimated the fair values of these based upon 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, as well as other factors. The estimate of the fair values of the noncontrolling interests subject to put provisions 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 the noncontrolling interests subject to put provisions can also fluctuate and the implicit multiple of earnings at which these noncontrolling interests obligations may be settled will vary 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.  Stock-based compensation. 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. We estimate the fair value of stock awards using complex option pricing models that rely heavily on estimates from us about uncertain future events, including the expected term of the awards, the expected future volatility of our stock price, and expected future risk-free interest rates.  Medical liability claims associated with HCP. The medical groups are responsible for the medical services that associated physicians and contracted hospitals provide to assigned HMO enrollees. The Company provides medical services to health plan enrollees through a network of contracted providers under sub-capitation and fee-for-service arrangements, company-operated clinics and staff physicians. Medical costs for professional and institutional services rendered by contracted providers are recorded as medical expenses and hospital expenses, respectively, in the consolidated statements of income. Costs for operating medical clinics, including the salaries of medical and non-medical personnel and support costs, are recorded in clinic support and other operating costs.  An estimate of amounts due to contracted physicians, hospitals, and other professional providers is included in medical payables in the accompanying consolidated balance sheets. Medical claims payable include claims reported as of the balance sheet date and estimates of IBNR. Such estimates are developed using actuarial methods and are based on many variables, including the utilization of health care services, historical payment patterns, cost trends, product mix, seasonality, changes in membership, and other factors. The estimation methods and the resulting reserves are continually reviewed and updated. Many of the medical contracts are complex in nature and may be subject to differing interpretations regarding amounts due for the provision of various services. Such differing interpretations may not come to light until a substantial period of time has passed following the contract implementation. Any adjustments to reserves are reflected in current operations.  

Significant new accounting standards

  On January 1, 2012, we adopted the Financial Accounting Standards Board's (FASB), Accounting Standard Update (ASU) No. 2011-08, Intangibles-Goodwill and Other. This standard amends the two-step goodwill impairment test required under the prior accounting guidance. This amendment allows reporting entities the option to first assess certain qualitative factors to ascertain whether it is more likely than not that the fair value of                                          107

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 a reporting unit is less than its carrying amount to determine whether the two-step impairment test is necessary. If an entity concludes that certain events or circumstances demonstrate that it is more likely than not that the fair value of a reporting unit is less than its carrying amount, then the entity is required to proceed to step one of the two-step goodwill impairment test. The adoption of this standard did not have a material impact on our consolidated financial statements.  On January 1, 2012, we adopted FASB's ASU No. 2011-07, Health Care Entities-Presentation and Disclosure of Patient Service Revenue, Provision for Bad Debts, and the Allowance for Doubtful Accounts. This standard amends the prior presentation and disclosure requirements for health care entities that recognize significant amounts of patient service revenues at the time the services are rendered without assessing the patient's ability to pay. This standard requires health care entities to reclassify the provision for bad debts from an operating expense to a deduction from patient service revenues. In addition, this standard requires more disclosure on the policies for recognizing revenue, assessing bad debts, as well as quantitative and qualitative information regarding changes in the allowance for doubtful accounts. This standard was applied retrospectively to all prior periods presented. Upon adoption of this standard, we changed our presentation of our provision for uncollectible accounts related to patient service revenues as a deduction from our patient service operating revenues and enhanced our disclosures as indicated above. See Note 3 to the consolidated financial statements for further details.  On January 1, 2012, we adopted FASB's ASU No. 2011-05 as amended by ASU No. 2011-12, Comprehensive Income-Presentation of Comprehensive Income. This standard amends the prior presentation requirements for comprehensive income by eliminating the presentation of the components of other comprehensive income within the statement of equity. This standard allows two alternatives on how to present the various components of comprehensive income. These alternatives are either to report the components of comprehensive income separately on the income statement or to present total other comprehensive income and the components of other comprehensive income in a separate statement. This standard does not change the items that must be reported in other comprehensive income or when an item must be reclassified into net income. The FASB temporarily deferred the requirement to present separate line items on the statement of income for the amounts that would be realized and reclassified out of accumulated other comprehensive income into net income. No timetable has been set for FASB's reconsideration of this item. This standard, except for the deferred requirements described above, was applied retrospectively. Upon adoption of this standard, we presented total other comprehensive income and the components of other comprehensive income in a separate statement of comprehensive income.  On January 1, 2012, we adopted FASB's ASU No. 2011-04, Fair Value Measurement. This standard amends the current fair value measurement and disclosure requirements to improve comparability between U.S. GAAP and International Financial Reporting Standards (IFRS). The intent of this standard is to update the disclosures that describe several of the requirements in U.S. GAAP for measuring fair value and to enhance disclosures about fair value measurements in a manner that will improve consistency between U.S. GAAP and IFRS. This standard does not change the application of the requirements on fair value measurements and disclosures. This standard was applied prospectively, and did not have a material impact on our consolidated financial statements. 

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