DaVita HealthCare Partners Inc. — FY 2014 Form 10-K
Reporting period: Fiscal year ended December 31, 2014. The filing also presents unaudited fourth-quarter results. The company operates Kidney Care, including U.S. dialysis and related services, and HealthCare Partners (HCP), an integrated care and management business. KPMG issued an unqualified opinion on the consolidated financial statements and internal control over financial reporting.
Financial and operating results
| Metric | FY 2014 | FY 2013 | Change |
|---|---|---|---|
| Net revenue | $12.795 billion | $11.764 billion | +8.8% |
| Operating income | $1.815 billion | $1.550 billion | +17.1% |
| Operating margin | 14.2% | 13.2% | Expanded |
| Net income attributable to DaVita | $723.1 million | $633.4 million | +14.1% |
| Diluted EPS | $3.33 | $2.89 | +15.2% |
| Operating cash flow | $1.459 billion | $1.773 billion | Declined |
| Long-term debt | $8.383 billion | $8.141 billion | Increased |
At year-end, cash and cash equivalents were $965 million and short-term investments were $337 million; working capital was $1.788 billion. The company had a $1.0 billion revolving facility, with approximately $95 million committed for letters of credit. Capital expenditures were $641 million and acquisition spending was $272 million. Operating cash flow included approximately $410 million of settlement-related payments (about $269 million after tax); cash flow also reflected higher income tax payments, partly offset by improved collections. U.S. dialysis days sales outstanding improved to 50 days from 55.
Fourth quarter: Revenue was $3.328 billion versus $3.063 billion in Q4 2013; operating income was $452.1 million versus $484.2 million. Net income attributable to DaVita was $208.0 million versus $212.3 million, and diluted EPS was $0.96 versus $0.99.
Business segments
- U.S. dialysis and related lab services: Revenue was $8.211 billion, up 5.8%; treatments increased 5.7%, and average revenue per treatment rose to $342 from $340. Segment operating income was $1.638 billion, including a $17 million legal accrual. Excluding the comparable legal charges, adjusted segment operating income increased by $58 million, with growth and productivity improvements partly offset by higher pharmaceutical costs and a $72 million increase in the provision for uncollectible accounts.
- HCP: Revenue was $3.502 billion, up 9.6%, while operating income fell 44.2% to $215 million. Senior capitated membership increased by approximately 45,500 to 310,500, but lower Medicare Advantage reimbursement, higher medical utilization and expenses, and fewer commercial members pressured profitability. HCP had 837,300 capitated members overall.
- Ancillary services and strategic initiatives: Revenue was $1.139 billion, up 33.7%, primarily reflecting pharmacy and international growth. The segment operating loss narrowed to $25 million from $39 million.
Material changes, outlook and risks
- FY operating income growth benefited from the comparison with a $397 million 2013 legal accrual. Excluding specified unusual items, adjusted consolidated operating income decreased 3.5% to $1.832 billion, mainly due to HCP’s lower operating income, higher pharmaceutical costs, increased HCP medical claims expense and higher dialysis uncollectible-account provisions.
- In October 2014, DaVita settled federal physician-relationship investigations, paying $350 million plus interest, a $39 million civil forfeiture, and $11.5 million plus interest for state Medicaid claims. It entered a five-year Corporate Integrity Agreement (CIA), including compliance oversight and restrictions requiring unwinding 11 joint ventures covering 26 clinics. The company had accrued $414 million for the matter.
- The company refinanced debt in 2014, issuing $4.5 billion of new term loans and $1.75 billion of 5.125% notes due 2024; it recorded $97.5 million of debt-refinancing charges. Debt carries interest-rate exposure, partly mitigated by swaps and caps. The filing reports $8.520 billion of total debt principal outstanding at year-end.
- Management expected 2015 operating-cost increases, including labor and supplies, to outpace Medicare rate increases. The 2015 dialysis payment update was estimated at 0.3%–0.5% for most facilities, while a 2% Medicare sequestration reduction continued through 2015; scheduled market-basket reductions were described for 2016–2018.
- HCP faces reimbursement uncertainty. Based on CMS’s preliminary 2016 Medicare Advantage rate notice issued after year-end, management estimated a potential 4% HCP rate reduction and approximately $100 million impact to 2016 operating income; final rates and geographic effects were not yet known. HCP California, Nevada and New Mexico goodwill valuations had limited headroom, creating possible future impairment risk if results or assumptions deteriorate.
- Other significant risks include dependence on commercial dialysis reimbursement (33% of dialysis revenue, while commercial patients were about 10% of dialysis patients), government payment and regulatory changes, physician referrals, labor and pharmaceutical supply costs, billing-system implementation, and HCP’s exposure to capitation medical costs and concentration in three health plans.
- Unresolved matters included the Vainer private civil suit, a Medicaid investigation for which settlement terms were not finalized, and the Swoben appeal. In February 2015, the company also disclosed subpoenas relating to a government investigation of patient transportation medical necessity. The filing states DaVita does not provide or bill for transportation.
Important facts for investors to verify
- Whether dialysis commercial rates, commercial patient mix, and collections remain sufficient to support dialysis profitability as government-covered patients grow.
- Final 2016 Medicare Advantage rates and the realized effect on HCP earnings, alongside HCP medical-cost trends and membership mix.
- Cash costs and business restrictions under the CIA, status of the remaining investigations and litigation, and any further settlement or compliance liabilities.
- Debt repayment capacity, covenant headroom, interest-rate exposure, and potential cash requirements from noncontrolling-interest put provisions, estimated at $830 million at year-end.
- Progress on billing-system implementation, uncollectible-account estimates, and HCP goodwill impairment headroom.