DaVita Inc. — 2016 Form 10-K Summary
Reporting period: Fiscal year ended December 31, 2016. The filing is an annual report, not a standalone fourth-quarter filing. DaVita operates U.S. dialysis and related services, DaVita Medical Group (DMG), and ancillary and international businesses.
Financial and operating performance
| Metric | FY 2016 | FY 2015 |
|---|---|---|
| Net revenue | $14.745 billion | $13.782 billion |
| Operating income | $1.895 billion | $1.171 billion |
| Operating margin | 12.8% | 8.5% |
| Net income attributable to DaVita | $880 million | $270 million |
| Diluted EPS | $4.29 | $1.25 |
| Cash from operations | $1.963 billion | $1.557 billion |
FY 2016 revenue increased 7.0%. The reported increase in operating income and EPS was heavily affected by unusual items in both years; adjusted operating income, a company-defined non-GAAP measure, was $1.849 billion versus $1.898 billion, a decrease of about 2.6%. Operating cash flow less capital expenditures was approximately $1.134 billion.
- U.S. dialysis: Revenue was $9.138 billion, up 5.7%; segment operating income was $1.777 billion. Treatments rose about 4.5%, while average revenue per treatment increased $4 to $352. Patient care cost per treatment rose $5 to $226. The company operated or managed 2,350 U.S. outpatient centers and served approximately 187,700 patients.
- DMG: Revenue was $4.114 billion, up 7.2%, partly due to the acquisition of The Everett Clinic (TEC). GAAP operating loss was $104 million; adjusted operating income fell to $135 million from $240 million. Management cited lower Medicare Advantage and Medicaid reimbursement, medical costs, and other expenses.
- Ancillary and strategic businesses: Revenue was $1.621 billion, up 17.3%. Adjusted operating loss narrowed to $48 million from $78 million. Reported segment income was lifted by the APAC joint venture gain.
- Liquidity and debt: Year-end cash was $913 million and short-term investments were $310 million. The company had a $1.0 billion undrawn revolving facility, approximately $95 million of which supported letters of credit. Working capital was $1.284 billion, compared with $2.104 billion a year earlier. Debt principal outstanding was $9.192 billion; reported debt expense was $414 million. About 53% of debt had fixed interest rates, and the year-end effective rate was 4.52%.
Fourth-quarter context: Unaudited Q4 2016 revenue was $3.716 billion, operating income $381 million, net income attributable to DaVita $158 million, and diluted EPS $0.80. Q4 2015 revenue was $3.534 billion, operating income $245 million, and net loss attributable to DaVita $6 million.
Material changes and unusual items
- FY 2016 included $281 million of goodwill impairment charges ($253 million in DMG and $28 million in vascular access) and a $15 million impairment of a minority investment.
- Reported results included a $374 million non-cash gain on the APAC joint venture ownership change and a $40 million gain on the sale of part of Tandigm, partly offset by a $10 million loss on the sale of DMG Arizona. The APAC gain was described as non-taxable.
- DaVita accrued $38 million for potential pharmacy-related damages and liabilities and $16 million for the DMG Nevada hospice matter. It said additional reserves may be required. A separate $31 million reduction in a DMG acquisition-escrow receivable was offset by a corresponding tax-expense reduction.
- FY 2015 included a $495 million private-litigation settlement charge and approximately $210 million of impairment charges. These items make reported year-over-year profit growth an incomplete measure of underlying performance.
- Capital expenditures rose to $829 million from $708 million; acquisition spending increased to $564 million from $96 million. DaVita repurchased 16.6 million shares for $1.072 billion during 2016.
Outlook, risks, and contingencies
- Management expected 2017 operating-cost increases in U.S. dialysis to outpace net Medicare rate increases, with labor, supplies, turnover, and inflation among the pressures. CMS projected a 0.73% increase in total ESRD facility payments for 2017; the Medicare sequester’s 2% payment reduction was extended through 2025.
- DaVita estimated that 2017 Medicare Advantage rate changes would reduce DMG rates by about 1%, or approximately $25 million of operating income, subject to uncertainty. The filing also cites medical-cost trends and reimbursement pressure as risks to DMG.
- Commercial dialysis payors are particularly important to profitability: commercial plans represented 36% of U.S. dialysis revenue, while government programs represented 64%. The company warned that lower commercial rates, loss of commercial coverage, or restrictions on charitable premium assistance could materially affect results.
- The company remained subject to a five-year HHS OIG Corporate Integrity Agreement following its 2014 settlement. It reported that the OIG had identified three implementation deficiencies, which DaVita said it remedied; stipulated penalties were paid.
- Government inquiries and litigation include Medicare Advantage diagnosis coding and risk adjustment, pharmacy billing, charitable patient assistance, and other matters. The filing says outcomes and any losses beyond recorded accruals may be difficult to estimate. A securities class action and a derivative suit were filed in February 2017; DaVita disputes the allegations.
- In January 2017, DaVita reached a $538 million resolution of its VA underpayment lawsuit and expected to recognize it in Q1 2017. The filing also describes a proposed approximately $360 million acquisition of Renal Ventures, subject to FTC review and anticipated divestitures, with closing expected in mid-2017.
- DaVita entered a six-year EPO supply agreement with Amgen in January 2017, requiring purchases to cover at least 90% of its ESA requirements. Supplier concentration, clinical staffing, regulatory compliance, medical-cost estimation, and interest-rate exposure are additional risks.
Important facts for investors to verify
- Whether commercial dialysis reimbursement and patient mix remain sufficient to support per-treatment revenue and profitability.
- DMG’s performance against medical costs and the expected impact of Medicare Advantage and Medicaid rate changes; monitor remaining goodwill impairment sensitivity.
- Resolution and potential financial exposure from the pharmacy, Medicare Advantage coding, American Kidney Fund, and other legal or regulatory matters, including whether recorded accruals prove adequate.
- Timing, terms, and accounting for the $538 million VA settlement, and the closing and FTC-required divestitures for the Renal Ventures transaction.
- Debt service, liquidity, put-provision obligations, and the returns on elevated capital spending, acquisitions, and share repurchases.
KPMG issued an unqualified opinion on the consolidated financial statements and internal control over financial reporting as of December 31, 2016.