DVA

DaVita Inc. 2008 Annual Report (10-K) Summary

Business Context and Reporting Period

Company: DaVita Inc.
Reporting Period: Fiscal year ended December 31, 2008.
Business Overview: DaVita is a leading provider of dialysis services in the United States for patients with end-stage renal disease (ESRD). As of December 31, 2008, the company operated or provided administrative services to 1,449 outpatient dialysis centers in 43 states and the District of Columbia, serving approximately 112,000 patients. The company also provides acute inpatient dialysis services in approximately 700 hospitals and related laboratory services. Dialysis and related lab services accounted for approximately 96% of consolidated revenues, with ancillary services and strategic initiatives accounting for the remaining 4%.

Key Financial Metrics

Revenue Mix (2008): 65% from government-based programs (primarily Medicare) and 35% from commercial payors. Approximately 30% of dialysis revenues are derived from the administration of pharmaceuticals, with EPO accounting for approximately 20%.

Material Changes vs. Prior Period

• Revenue Growth: Net operating revenues increased by 7.5% ($396 million) compared to 2007. This was driven by a 5.9% increase in treatment volume and growth in ancillary services (pharmacy, VillageHealth, infusion therapy).
• Operating Income Decline: Operating income decreased by 4.6% ($40 million) to $822 million. This decline occurred despite revenue growth and was primarily due to rising labor costs, increased pharmaceutical costs (specifically heparin), the absence of a Medicare rate increase, and commercial rate compression. The 2007 period included a non-recurring $55 million valuation gain on a product supply agreement and a $7 million insurance settlement, which were absent in 2008.
• Revenue Per Treatment: Average dialysis revenue per treatment remained flat at $334, down slightly from 2007 due to commercial rate compression and decreased pharmaceutical intensities, offset by mix changes.
• Debt Service: Interest expense decreased to $215 million in 2008 from $243 million in 2007, primarily due to lower LIBOR-based variable interest rates.

Guidance, Outlook, and Risks

2009 Guidance: Management projects 2009 operating income to be in the range of $820 million to $880 million. The company expects to generate approximately $500 million to $550 million in operating cash flow for 2009.

Key Risks and Contingencies:

• Government Investigations: The company is subject to multiple subpoenas and inquiries from the U.S. Attorney's Offices (Georgia, Missouri, New York, Texas) and the Office of Inspector General regarding pharmaceutical utilization (EPO, Zemplar, Hectorol), billing practices, and relationships with physicians and joint ventures. Negative findings could result in substantial penalties or exclusion from Medicare/Medicaid.
• Medicare Payment Reform: The Medicare Improvements for Patients and Providers Act of 2008 introduces a bundled payment system effective January 2011. The initial bundled rate is set 2% below historical fee-for-service rates, with future adjustments based on a market basket index less 1%. This poses a significant risk to future margins.
• Commercial Rate Pressure: Approximately 35% of revenues come from commercial payors, which generate nearly all of the company's profits. Continued downward pressure on these rates could materially adversely affect earnings.
• Pharmaceutical Supply and Cost: The company relies on a single supplier (Amgen) for EPO. Additionally, a recall of heparin by Baxter Healthcare left only one supplier for this critical drug, leading to significant cost increases with no separate Medicare reimbursement.
• Regulatory Compliance: The company operates under a Corporate Integrity Agreement (CIA) for centers acquired from Gambro Healthcare, requiring strict compliance and annual audits.

Investor Verification Checklist

• Government Inquiry Status: Verify the current status of the federal subpoenas regarding EPO utilization and billing practices, as these represent significant contingent liabilities.
• Commercial Payor Mix: Monitor the percentage of patients covered by commercial insurance versus Medicare, as the shift to lower-paying government plans directly impacts profitability.
• Medicare Bundled Rate Impact: Assess the company's preparedness and cost-control measures for the 2011 transition to the bundled payment system, which is projected to reduce reimbursement rates.
• Pharmaceutical Costs: Track the cost trends of heparin and EPO, given the lack of alternative suppliers and the impact on operating margins.
• 2009 Operating Income Target: Compare actual 2009 results against the $820-$880 million guidance range to evaluate management's ability to navigate cost pressures.