DaVita HealthCare Partners Inc. — FY 2012 Form 10-K
Reporting period: Fiscal year ended December 31, 2012; filed February 28, 2013. The filing is an annual report, not a standalone quarterly filing. HealthCare Partners (HCP) results are consolidated only from its November 1, 2012 acquisition, so reported annual and fourth-quarter comparisons include a significant change in the company’s business mix.
Business context and major transaction
DaVita operated two primary businesses: U.S. dialysis and related laboratory services, and HCP, an integrated medical group and managed-care provider. At year-end, DaVita served approximately 153,000 U.S. dialysis patients through 1,954 outpatient centers and provided dialysis services in about 970 hospitals. HCP had approximately 724,000 managed-care members and a broader fee-for-service patient base.
DaVita acquired HCP for approximately $4.70 billion: $3.64 billion in cash, net of acquired cash, and $1.06 billion in DaVita stock. Up to an additional $275 million is payable if performance targets are met. The acquisition was financed in part with $3.0 billion of new term loans and $1.25 billion of 5.75% senior notes.
Financial and operating results
| Metric | FY 2012 | FY 2011 | Change or context |
|---|---|---|---|
| Net revenue | $8.186 billion | $6.732 billion | Up 21.6%; includes two months of HCP |
| Operating income | $1.297 billion | $1.155 billion | Up 12.3%; reported margin approximately 15.8% versus 17.2% |
| Adjusted operating income | $1.414 billion | $1.155 billion | Company non-GAAP measure; excludes $86 million legal settlement expense and $31 million HCP transaction expenses |
| Net income attributable to DaVita | $536 million | $478 million | Up approximately 12.1% |
| Diluted net income per share | $5.47 | $4.96 | FY 2012 includes acquisition-related share issuance |
| Cash from operations | $1.101 billion | $1.180 billion | Down $79 million, primarily reflecting higher tax payments and working-capital timing |
| Capital expenditures | $550 million | $400 million | Includes $278 million for new centers and relocations |
| Cash and cash equivalents | $534 million | $394 million | At December 31 |
| Working capital | $861 million | $1.128 billion | At December 31 |
| Long-term debt, carrying value | $8.327 billion | $4.418 billion | Excludes current portion; acquisition financing drove increase |
U.S. dialysis revenue was $7.095 billion, up 12.7%; treatments increased 12.5%, and average revenue per treatment rose to $332 from $330. Dialysis operating income was $1.380 billion, including the $86 million settlement charge; the segment’s reported operating margin was approximately 19.4%. Medicare and other government programs represented 66% of dialysis revenue, while commercial payors represented 34%. Management stated that nearly all dialysis profits are generated by commercial payors.
HCP contributed $477 million of consolidated revenue and $67 million of operating income for November and December. For calendar 2012, HCP reported approximately $2.7 billion of operating revenue, $3.6 billion of care dollars under management, and $524 million of adjusted operating income; those full-year figures are not included in DaVita’s consolidated results. Other ancillary and strategic businesses generated $642 million of revenue and an operating loss of $66 million.
Fourth-quarter 2012 net revenue was $2.478 billion, operating income $388 million, net income attributable to DaVita $156 million, and diluted EPS $1.51. Fourth-quarter 2011 figures were $1.794 billion, $330 million, $148 million, and $1.56, respectively. The revenue comparison is not like-for-like because HCP was included only in 2012.
Cash flow, debt, and liquidity
- Operating cash flow was $1.101 billion. Cash interest paid was approximately $258 million and cash income taxes paid were approximately $322 million.
- Acquisitions used $4.294 billion of cash, including the HCP transaction. The company reported $4.833 billion of net cash used in investing activities.
- Total debt principal outstanding was $8.576 billion at year-end, before discounts; scheduled 2013 debt principal was approximately $228 million. The company also reported $2.208 billion of future operating lease commitments.
- DaVita reported a $350 million undrawn revolving facility, with approximately $115 million committed for letters of credit, and a separate HCP line of approximately $16 million, with about $1 million committed. Management said liquidity and operating cash flows should be sufficient for foreseeable obligations.
- Debt includes floating-rate exposure. A hypothetical 100-basis-point increase in rates was estimated to raise annual interest expense by approximately $6.7 million on specified exposed debt. Interest-rate swaps and caps partly hedge exposure.
Changes, outlook, risks, and unusual items
- Acquisition and comparability: HCP materially expanded reported revenue, assets, goodwill, debt, and shares outstanding. Year-end assets rose to $16.0 billion from $8.9 billion; goodwill rose to $9.0 billion from $4.9 billion. HCP’s internal controls were excluded from management’s 2012 internal-control assessment, as permitted for an acquired business.
- Management outlook: Management described 2013 as challenging, citing integration and execution risks from HCP, expected Medicare sequestration reductions, commercial-payor mix pressure, and continuing investment in international expansion. The filing provides no specific numerical 2013 revenue or earnings guidance.
- Reimbursement risk: Management identified potential Medicare payment reductions as a key concern. A 2% sequestration cut to Medicare provider payments was scheduled to take effect March 1, 2013 absent further congressional action. Legislation also directed CMS to adjust the dialysis bundle beginning in 2014 to reflect lower drug utilization; oral-only ESRD drugs were delayed from inclusion in the bundle until 2016.
- Payor and operating pressures: Commercial dialysis rates are generally substantially higher than government rates, and a continued decline in commercial coverage or rates could materially pressure earnings and cash flow. Labor, supply, EPO costs, collection performance, and evolving bundled-payment documentation requirements are additional risks.
- HCP-specific risk: Capitation places HCP at risk if medical costs exceed fixed member payments. The filing also highlights health-plan concentration, Medicare Advantage reimbursement changes, risk-adjustment documentation and claims estimates, and regulatory uncertainty around corporate practice of medicine and global-risk arrangements.
- Legal and regulatory matters: The Woodard EPO-related matter was settled and dismissed in December 2012; the $86 million charge included a $55 million settlement and related costs. The 2005 U.S. Attorney investigation closed without charges or payments. Other physician-relationship and Medicaid inquiries and private civil suits remained unresolved; the company said outcomes and potential damages could not be predicted.
- Other items: HomeChoice was sold on February 1, 2013 for $70 million cash, subject to adjustments; DaVita expected to receive approximately 90% of proceeds. The business’s results were classified as discontinued operations. No shares were repurchased in 2012, and DaVita had no current plan to pay dividends.
Important facts for investors to verify
- Separate acquisition-driven growth from organic dialysis growth and evaluate HCP’s contribution on a comparable, full-year basis.
- Track commercial-payor mix, contracted rates, patient transitions to Medicare, dialysis revenue per treatment, and bad-debt provisions.
- Assess post-acquisition leverage, debt maturities, interest-rate exposure, and cash generation after capital spending and contingent payments.
- Monitor implementation and financial impact of Medicare sequestration and the future dialysis bundled-payment adjustments.
- Review HCP medical-cost trends, health-plan concentration, risk-adjustment documentation, and the resolution of regulatory and legal matters.
- Confirm final HCP purchase-price allocations, contingent earn-out amounts, integration progress, and the effect of the HomeChoice divestiture.