Business Context and Reporting Period
Company: DaVita Inc.
Filing Type: Form 10-K
Period Ended: December 31, 2003
Business Overview: DaVita is the second-largest provider of dialysis services in the United States for patients with end-stage renal disease (ESRD). As of December 31, 2003, the company operated or provided administrative services to approximately 570 outpatient dialysis centers in 34 states and the District of Columbia, serving approximately 48,500 patients. The company also provides acute inpatient dialysis services in approximately 300 hospitals. More than 96% of revenues are derived from direct dialysis services.
Key Financial Metrics
| Metric | 2003 | 2002 | 2001 |
|---|---|---|---|
| Net Operating Revenues | $2,016.4 million | $1,854.6 million | $1,650.8 million |
| Operating Income | $378.5 million | $383.8 million | $310.9 million |
| Net Income | $175.8 million | $157.3 million | $137.3 million |
| Diluted EPS | $2.49 | $1.96 | $1.52 |
| Cash Flow from Operations | $293.6 million | $342.0 million | $264.8 million |
| Long-Term Debt | $1,117.0 million | $1,311.3 million | $811.2 million |
| Working Capital | $242.2 million | $251.9 million | $176.0 million |
| Debt Leverage Ratio | 2.3x | N/A | N/A |
Note: 2003 revenues included $24 million in recoveries from prior years' Medicare laboratory services. Operating income excluding non-continental operations, prior year recoveries, and goodwill amortization was $355 million.
Material Changes vs. Prior Period
- Revenue Growth: Net operating revenues increased 8.7% to $2.016 billion, driven by a 6.7% increase in dialysis treatments and a rise in average revenue per treatment to $303 (from $291 in 2002). Growth was attributed to new center openings (40% of growth) and increased treatment volume (60%).
- Operating Income: Reported operating income decreased slightly to $378.5 million from $383.8 million in 2002. However, adjusted operating income (excluding non-continental operations and prior year recoveries) increased to $355 million from $319 million.
- Debt Restructuring: The company significantly restructured its capital structure in 2003. It redeemed all outstanding $125 million 5 5/8% Convertible Notes and all $345 million 7% Convertible Notes. It also amended its credit facility, resulting in refinancing charges of $26.5 million.
- Stock Repurchases: The company repurchased 3.44 million shares of common stock for $107.2 million in 2003, compared to 27.3 million shares for $642.2 million in 2002.
- Cost Structure: Patient care costs remained at 68% of revenues. General and administrative expenses increased to $160 million (8% of revenue) due to higher labor costs related to compliance and support functions.
Guidance, Outlook, and Risks
Outlook and Guidance
Management targets operating income between $360 million and $385 million for 2004, compared to $355 million in 2003. The company projects an average annual increase in operating income of 3% to 8% over the next three years. Non-acquired treatment volume growth is expected to remain in the 3.0% to 5.0% range.
Management Commentary
Management highlighted improvements in clinical outcomes (DaVita Quality Index) and significant reductions in teammate turnover as key drivers of performance. The company continues to invest in billing and collection systems to ensure reliable revenue capture.
Risks and Contingencies
- Government Inquiries: The company is cooperating with the U.S. Attorney's Office and the HHS Office of Inspector General regarding a review of historical billing practices, operating procedures, and financial relationships with physicians. The outcome and potential penalties are uncertain.
- Medicare Laboratory Disputes: A third-party carrier review of the Florida-based laboratory resulted in significant overpayment determinations. While an administrative law judge invalidated determinations for the first two review periods, approximately $11 million in claims for subsequent periods remain under appeal.
- Reimbursement Rates: Approximately 58% of dialysis revenue comes from government programs (Medicare/Medicaid). Medicare rates have not increased since 2001, with the next scheduled increase of 1.6% not occurring until 2005. Commercial payor rates are under negotiation pressure.
- Pharmaceutical Costs: Erythropoietin (EPO) accounts for approximately one-fourth of dialysis revenues. The company relies on a single supplier (Amgen) and faces risks regarding price increases or the introduction of new products like Aranesp.
- Regulatory Compliance: The company faces extensive federal and state regulations, including anti-kickback statutes and Stark laws, regarding relationships with referring physicians.
Investor Verification Checklist
- Government Inquiry Status: Verify the current status of the U.S. Attorney's Office and OIG review and any potential financial exposure.
- Medicare Lab Recovery: Confirm the resolution of the remaining $11 million in disputed Medicare laboratory claims and the timeline for collection.
- Commercial Payor Mix: Monitor the percentage of patients covered by commercial plans versus government programs, as commercial rates are significantly higher and critical to margins.
- EPO Pricing and Usage: Track changes in EPO pricing from Amgen and the adoption of alternative drugs like Aranesp, which could impact revenue and costs.
- Debt Covenants: Review the terms of the amended credit facility and the company's ability to maintain the target debt leverage ratio of 3.0 to 3.5.