DaVita Inc. (DVA) reported fourth-quarter net operating income of $111.9 million, or $1.13 per share, exceeding the Zacks Consensus Estimate by a penny. DaVita also posted net operating earnings of $451.1 million, or $4.38 per share in fiscal 2010, which exceeded the Zacks Consensus Estimate by two cents.
DaVita also surpassed the earnings of $109.7 million or $1.06 per share in the comparable quarter of 2009 and $422.7 million, or $4.06 per share in fiscal 2009.
The operating results exclude after-tax debt refinancing and redemption charges of $42.9 million and $45.4 million in the fourth quarter and final year 2010, respectively.
Including one-time charges, net income reported was $69.0 million or 70 cents in the fourth quarter, and $405.7 million or $3.94 per share in fiscal 2010.
Net operating revenues for the reported quarter climbed 5.2% year-over-year to $1.65 billion, but lagged the Zacks Consensus Estimate of $1.66 billion. In fiscal 2010, net operating revenue increased 5.6% year over year to $6.45 billion, while it missed the Zacks Consensus Estimate of $6.46 billion.
Segment wise, revenues from the Dialysis and related Lab Services segment for the quarter came in at $1.55 billion as against $1.48 billion in the prior-year quarter. Operating income for the segment increased to $268 million in the reported quarter from $253 million in the year-ago quarter.
Ancillary services and strategic initiatives generated revenues of $105 million as against $85 million in the year-ago quarter. The segment suffered an operating loss of $2 million in the reported quarter as against the loss of $5 million in the year-ago quarter.
DaVita’s quarterly consolidated operating income, including stock based compensation and equity investment income climbed approximately 6.7% year-over-year to $255 million.
Operating income margin for the reported quarter stood at 15.5% as opposed to15.2% in the year-ago quarter. Total operating expenses and charges for the quarter climbed 4.9% year-over-year to $1.39 billion.
DaVita provided administrative services across 1,612 outpatient dialysis centers serving approximately 125,000 patients as of December 31, 2010. DaVita acquired 7 centers, opened 14 new centers, closed 5 and sold 2 centers during the reported quarter.
Total treatments for the reported quarter came in at approximately 4.7 million. This represents a per day increase of 6.8% over the year-ago quarter. The growth of non-acquired treatment in the quarter stood at 4.4%.
The company’s effective tax rate was 30.2% in the reported quarter. The third party owners’ income attributable to non-tax paying entities impacted the effective tax rate. The effective tax rate attributable to DaVita in the reported quarter was 36.5%.
Evaluation of Financial Strength
DaVita‘s operating cash flow stood at $840 million for the year ended December 31, 2010 and free cash flow stood at $597 million. In the reported quarter, operating cash flow was $121 million and free cash flow was $36 million. The total long-term debt at the end of December 31, 2010 jumped to $4.23 billion from $3.53 billion in the year-ago period.
Capital expenditures from routine maintenance for the reported quarter came in at $62.1 million as opposed to $35.1 million in the year-ago quarter, up 76.9% y/y.
Development and relocations expenditure in the reported quarter surged 31.3% year-over-year to $44.5 million, and acquisition expenditures rose to $50.9 million from $23.6 million in the year-ago quarter.
DaVita repurchased a total of 5.88 million shares for $420.0 million, or an average price of $71.38 during the reported quarter. At the end of December 31, 2010, DaVita repurchased a total of 8.92 million shares for $618.5 million, or an average price of $69.35.
Further, the company did not repurchase any additional shares of its common stock subsequent to December 31, 2010, and as a result of these transactions, the remaining board authorization for share repurchases of DaVita is currently $681.5 million.
On October 20, 2010, DaVita also completed its $4.55 billion debt refinancing transactions.
Acquisition
On February 4, DaVita agreed to acquire its competitor DSI Renal, Inc. (“DSI”), for approximately $690 million, subject to customary closing conditions. DaVita expects to complete the deal by the second or the third quarter of 2011.
DaVita will require the Hart-Scott-Rodino antitrust clearance to complete the deal. In addition, DaVita believes that it will have to divest some of its centers as a condition of the transaction. Credit Suisse Group (CS) will act as its financial advisor in the deal.
Outlook
DaVita did not provide any specific guidance for fiscal 2011 due to the uncertainties of operatons under the new Medicare bundled payment system and the ongoing uncertainties associated with the payor mix.
Our Recommendation
Overall, the headwinds from the DaVita’s debt refinancing coupled with the ongoing concerns related to payor mix and the uncertainties of operating under the new Medicare bundled payment system continue to raise caution on earnings volatility in the near-term.
Nonetheless, with strong expected free cash flow from DaVita, the potential for meaningful mergers and acquisitions and the longer-term benefits of the bundle, we believe a downside from current levels is likely limited.
Moreover, we believe the acquisition of DSI to bring in new areas of work for DaVita in the Midwestern, Southern and some Western states, which will continue to improve the quality of life of DSI’s patients and provide high quality care.
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