DaVita HealthCare Partners Inc. — Q3 2014 Form 10-Q
Business context and period. This unaudited quarterly report covers the three and nine months ended September 30, 2014. DaVita operates Kidney Care, including U.S. dialysis and related lab services and ancillary businesses, and HealthCare Partners (HCP), an integrated healthcare business. Unless otherwise stated, financial amounts below are in U.S. dollars.
Financial results and liquidity
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Total net revenue | $3.252 billion | $3.000 billion | $9.467 billion | $8.701 billion |
| Operating income | $437.5 million | $377.1 million | $1.363 billion | $1.066 billion |
| Income from continuing operations | $219.8 million | $169.8 million | $612.9 million | $499.7 million |
| Net income attributable to DaVita | $184.1 million | $136.6 million | $515.1 million | $421.2 million |
| Diluted EPS | $0.85 | $0.64 | $2.38 | $1.96 |
| Operating cash flow | $848 million | $733 million | $1.529 billion | $1.419 billion |
- Q3 operating margin was approximately 13.5%, versus 12.6% a year earlier; nine-month margin was approximately 14.4%, versus 12.3%. Q3 net income attributable to DaVita was about 5.7% of revenue.
- Nine-month capital expenditures were $443.5 million and acquisitions used $218.1 million. Cash and cash equivalents were $1.527 billion at September 30, up from $946.2 million at year-end 2013; short-term investments were $142.1 million.
- Total debt principal was $8.519 billion ($8.502 billion carrying value), compared with $8.434 billion principal at year-end 2013. Current liabilities were $2.598 billion against current assets of $4.178 billion. The company had a $1.0 billion undrawn revolver, of which about $96 million supported letters of credit.
Material changes and operating trends
- Year-over-year revenue rose 8.4% in Q3 and 8.8% for the first nine months. Growth reflected dialysis treatment volume, acquired and organic expansion, HCP senior membership growth, and pharmacy and international operations.
- U.S. dialysis and related lab services revenue for the nine months increased about 5.2%; treatments rose to 18.52 million from 17.53 million, while average revenue per treatment increased to $341 from $340. The dialysis uncollectible-account provision rose to 4.25% of relevant revenue in Q3 from 3.5% in Q3 2013.
- HCP revenue grew about 11% year over year in Q3 and 10.7% for the nine months, but HCP operating income fell to $47 million from $98 million in Q3 and to $182 million from $287 million for the nine months. Management cited Medicare Advantage payment reductions, increased medical claims and member utilization, and higher costs. HCP had 836,200 capitated members at quarter-end, up from 760,000 a year earlier.
- Reported operating income includes a $17 million Q3 2014 addition to the loss contingency reserve. Excluding disclosed unusual items, adjusted consolidated operating income was $455 million in Q3 versus $482 million in Q3 2013, and $1.380 billion for nine months versus $1.414 billion. These are company-defined non-GAAP measures.
Outlook, risks, contingencies, and unusual items
- Updated 2014 guidance: consolidated operating income of $1.785–$1.835 billion; Kidney Care $1.580–$1.610 billion; HCP $205–$225 million; and operating cash flow $1.700–$1.800 billion. The company forecast 2015 consolidated operating income of $1.750–$1.900 billion and cash flow of $1.500–$1.700 billion. 2014 operating cash flow guidance excludes any potential payment relating to the physician relationship investigations.
- In June 2014, DaVita refinanced its senior secured facilities and issued $1.75 billion of 5⅛% senior notes due 2024. The refinancing generated $97.5 million of charges in the first nine months. The company reported a 4.52% overall weighted-average effective interest rate for Q3 and 4.46% as of September 30.
- On October 22, 2014, after quarter-end, the company finalized a settlement of the 2010 and 2011 U.S. Attorney physician relationship investigations: $350 million plus accrued interest, a $39 million civil forfeiture, and an agreement in principle for $11.5 million plus interest on certain state Medicaid claims. The company had accrued $414 million for the matter by September 30. The settlement also requires a five-year corporate integrity agreement, including a compliance monitor and winding down 11 joint ventures covering 26 of 2,119 clinics.
- Management identified HCP California, Nevada, and New Mexico as at risk of goodwill impairment, primarily because of Medicare Advantage reimbursement reductions. Their estimated fair values exceeded carrying values by approximately 5.3%, 11.3%, and 8.3%, respectively; no goodwill impairment was recorded in the first nine months.
- Key risks include government reimbursement and commercial-payor rate pressure, HCP medical-cost and Medicare Advantage exposure, regulatory compliance and litigation, execution of acquisitions and international expansion, patient and physician retention, and the company’s substantial debt. Management warned that future reimbursement changes or adverse operating assumptions could trigger impairment or reduce results and cash flow.
Important facts for investors to verify
- Settlement payment timing and final total, including interest and state Medicaid claims, relative to the $414 million reserve and cash-flow outlook.
- Whether HCP membership growth and risk-pool performance can offset reimbursement reductions and rising medical costs, and whether the three flagged reporting units retain adequate impairment headroom.
- Whether dialysis collection trends improve: the uncollectible-account provision increased, although management reported Q3 dialysis days-sales-outstanding of about 50 days, down from 53 in Q2.
- Progress against 2014 and 2015 operating-income and cash-flow guidance, especially the effects of the settlement, reimbursement rules, acquisition spending, and refinancing.
- Debt service, covenant headroom, and exposure to variable rates; the filing reports total debt but does not provide a clear consolidated leverage ratio in the presented text.