DaVita Inc. — Q1 2011 Form 10-Q
Business context and period: Unaudited results for the three months ended March 31, 2011, compared primarily with Q1 2010. DaVita’s principal business is dialysis and related laboratory services, alongside ancillary services and strategic initiatives. Dollar amounts below are in millions unless stated otherwise.
Key financial results
| Metric | Q1 2011 | Q1 2010 | Change |
|---|---|---|---|
| Net operating revenue | $1,606 | $1,559 | +3.0% |
| Operating income | $235.6 | $242.7 | -2.9% |
| Operating margin | 14.7% | 15.6% | -0.9 percentage points |
| Income before taxes | $177.8 | $198.9 | -10.6% |
| Net income attributable to DaVita | $94.5 | $109.4 | -13.6% |
| Diluted EPS | $0.96 | $1.04 | -7.7% |
| Cash from operating activities | $329.8 | $261.8 | +26.0% |
- Revenue growth reflected 7.2% more dialysis treatments year over year, including growth at existing and new centers and acquisitions, plus higher ancillary-services revenue. Average dialysis revenue per treatment fell to $326 from $344, principally reflecting Medicare bundled-payment implementation, commercial payor mix, and lower prescribed pharmaceutical intensity.
- Patient care costs were $1,116, or 69% of revenue; general and administrative expense was $151.6, or 9%; depreciation and amortization was $62.0; and provision for uncollectible accounts was $42.3. Management cited lower pharmaceutical costs but higher labor, payroll, center operating, and acquisition/compliance-related professional costs.
- Debt expense rose to $58.6 from $44.6, reflecting the newer, higher-rate credit facilities and interest-rate hedging costs. The effective interest rate averaged 5.20% in Q1 2011 versus 4.67% a year earlier.
Balance sheet, debt, and liquidity
- At March 31, cash and cash equivalents were $1,006; current assets $2,727; and current liabilities $1,007. Accounts receivable was $1,069, equivalent to approximately 62 days of revenue versus 61 days at year-end, attributed to a slight slowdown in collections.
- Total debt principal was $4,301, with carrying value of $4,293, compared with $4,317 principal at December 31, 2010. Q1 mandatory term-loan principal payments totaled $16.9.
- The company had $250 of revolving credit facilities, of which approximately $45.8 was committed for letters of credit. It reported that interest rates were economically fixed on primarily all of its debt through swaps and caps; $500 of Term Loan B remained exposed to LIBOR movements above a 1.50% floor.
- Operating cash flow was $329.8. Investing cash outflow was $145.4, including $67.5 for property and equipment and $81.5 for acquisitions. Cash increased by $145.9 to $1,006.
- Noncontrolling interests subject to put provisions were recorded at $406. These potential purchase obligations are valued using estimates and may fluctuate.
Material changes and management outlook
- Compared with Q4 2010, revenue declined about 2.6% and operating income about 7.5%. Management attributed the sequential decline mainly to fewer treatment days, lower revenue per treatment, seasonal payroll taxes, and reduced productivity, partly offset by lower pharmaceutical and benefit costs.
- Dialysis and related lab services generated $1,503 of external revenue and $250.2 of segment operating income. Ancillary services and strategic initiatives generated $103.4 of external revenue and an operating loss of $6.4, versus a $1.6 loss a year earlier; pharmacy growth lifted revenue but also increased operating costs.
- Management forecast 2011 operating income of $1,040–$1,100 and operating cash flow of $840–$940; 2012 operating income was projected at $1,100–$1,200. These projections are subject to significant risks and are not guarantees.
- Management expected 2011 capital expenditures of approximately $240 for routine maintenance and IT, including the new headquarters, plus $150 for new-center development and relocations. It stated that liquidity and operating cash flow should be sufficient for scheduled debt service and other obligations over the foreseeable future.
- On February 4, 2011, DaVita agreed to acquire DSI Renal for approximately $689.2, subject to adjustments and FTC approval. The company expected a third-quarter close and anticipated required center divestitures. During Q1 it also acquired 17 centers for $81.5.
- Medicare’s bundled payment system took effect January 1, 2011. A CMS interim final rule issued April 1, after quarter-end, corrected a transition adjustment; DaVita said it would increase Medicare revenue per treatment by approximately 3.1% from Q1 levels for the remainder of 2011. Beginning in 2012, the system includes inflation updates less a productivity adjustment and a potential 2% quality-related withhold.
Risks, contingencies, and unusual items
- Key business risks include commercial reimbursement pressure and loss of higher-paying commercial patients; changes to Medicare, Medicaid, and VA payment rates; bundled-payment implementation and billing accuracy; pharmaceutical utilization and pricing; labor availability and costs; competition; and the company’s substantial debt.
- Federal inquiries and litigation concern historical pharmaceutical billing, physician relationships, and joint ventures. The company reported that it was cooperating and, to its knowledge, no federal proceedings had been initiated in connection with the inquiries. Some relators are pursuing civil claims independently; outcomes and potential damages were not estimable. Adverse findings could lead to significant penalties, repayments, or exclusion from government programs.
- Other contingencies include commercial-payor claims related to historical billing and California wage-and-hour class-action matters. DaVita said it could not predict certain outcomes; it did not anticipate a material settlement for the described California claims. A separate arbitration panel denied class certification in February 2011, with individual claims remaining.
- The company implemented interest-rate swaps and caps in January 2011. Fair values at quarter-end were a $0.9 liability for swaps and a $9.6 asset for caps; approximately $11.8 of existing pretax swap losses in other comprehensive income was expected to be reclassified into income over the next 12 months.
- DaVita repurchased $13.6 of shares during Q1. From April 1 through April 30, it repurchased a further $84.4; these subsequent purchases are not Q1 cash flows. On May 2, it extended and amended its Amgen EPO agreement through December 31, 2011.
- Management concluded disclosure controls were effective and reported no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- How Medicare’s bundled-payment correction and subsequent reimbursement levels affect revenue per treatment, including realization of the stated 3.1% increase.
- Whether commercial payor rates and patient mix continue to weaken, and whether treatment-volume growth offsets lower revenue per treatment.
- Progress, FTC conditions, required divestitures, financing, and integration risks for the proposed DSI acquisition.
- Whether 2011 operating income, operating cash flow, and capital-spending guidance remain achievable amid labor, compliance, and reimbursement pressures.
- Debt-service capacity and interest-rate exposure, including the remaining unhedged portion of Term Loan B and the potential cash use from put provisions.
- Developments in federal investigations, relator litigation, historical billing claims, and other contingencies, for which potential outcomes or damages were not clearly quantified.