DAVITA INC. quarterly report, Q2 FY2010

DaVita Inc. — Q2 2010 Form 10-Q

Business and period: Unaudited results for the quarter and six months ended June 30, 2010. DaVita’s principal business is dialysis and related laboratory services, supplemented by pharmacy and other ancillary services.

Financial performance and position

Metric	Q2 2010	Q2 2009	Six months 2010	Six months 2009
Revenue	$1,586.9 million	$1,519.0 million	$3,146.3 million	$2,966.7 million
Operating income	$242.4 million	$236.0 million	$485.0 million	$456.6 million
Net income attributable to DaVita	$107.9 million	$105.8 million	$217.3 million	$202.0 million
Diluted EPS	$1.04	$1.02	$2.08	$1.94

Q2 revenue rose 4.5% year over year and operating income rose 2.5%; six-month revenue and operating income each increased about 6.1%. Q2 operating margin was approximately 15.3%, versus 15.5% a year earlier; the six-month margin was approximately 15.4% in both periods.
Q2 dialysis treatments increased 5.5% year over year to 4.46 million, while average dialysis revenue per treatment declined 1.7% to $335. For the first half, average revenue per treatment was $339, flat year over year.
Operating cash flow was $296 million in Q2 versus $212 million a year earlier; first-half operating cash flow was $557.8 million versus $346.6 million. First-half investing cash use was $169.8 million and financing cash use was $352.7 million. Cash increased to $574.7 million from $539.5 million at year-end 2009.
At June 30, total debt principal was $3.382 billion, down from $3.630 billion at December 31, 2009. Current debt was $96.6 million and long-term debt carrying value was $3.288 billion. Total current assets were $2.265 billion and current liabilities $1.119 billion.
Undrawn revolving facilities totaled $250 million, with about $52 million committed for letters of credit. A significant portion of secured credit facilities matures in 2012; management expected to refinance when conditions permitted and cautioned that future rates could be higher.

Material changes and notable transactions

Growth was driven mainly by treatment volume, including acquisitions and non-acquired growth. Lower revenue per treatment—reflecting pharmaceutical intensity, commercial-payor mix, EPO reimbursement and seasonal lab revenue—partly offset volume gains. Pharmacy services supported ancillary revenue growth.
Patient care costs were 70% of revenue in Q2, versus 69% a year earlier. Management cited higher pharmaceutical and labor costs, partly offset by productivity improvements and lower benefit costs.
On June 7, DaVita redeemed $200 million of 6⅝% senior notes due 2013, incurring a $4.1 million pretax redemption charge. First-half debt expense declined to $88.2 million from $95.4 million.
DaVita repurchased 1.587 million shares in the first half for $100.0 million, averaging $63.04 per share; approximately $400 million remained under the authorization at June 30.
In the first half, the company acquired 24 dialysis centers and opened 39. Acquisition cash outlays were $91.7 million. Capital expenditures were $99.4 million.
After quarter-end, DaVita acquired land for approximately $11 million for a planned Denver headquarters, with estimated construction cost of $90 million. A July 22 NxStage agreement continued discounted equipment and supply purchases and provided potential warrants tied to home-patient growth targets.

Outlook, risks and contingencies

2010 operating income guidance was narrowed to $970–$1,020 million. Operating cash flow guidance was raised to $725–$825 million from $675–$725 million. Management cautioned that actual results could differ materially; the filing does not state the prior operating-income guidance range.
Key reimbursement risks include pressure on commercial rates and patient mix, and the Medicare ESRD bundled-payment system scheduled to begin in 2011. The filing discusses the July 2010 final rule and uncertainty around payment adjustments, documentation, costs and implementation.
Federal inquiries and subpoenas concern, among other matters, pharmaceutical utilization and billing, physician relationships and joint ventures. The company said it was cooperating and, to its knowledge, no proceedings had been initiated; adverse findings could result in significant penalties, program exclusion or criminal penalties.
Other disclosed exposures include commercial-payor billing claims, a class arbitration demand, wage-and-hour litigation and potential government audits. Management said the ultimate outcome of pending ordinary-course proceedings was not expected to materially affect the company, while noting that certain outcomes could not be predicted.
Noncontrolling interests subject to put provisions were valued at $347.4 million. The company changed its valuation methodology during Q2 by removing an annual inflation factor and identified the estimate as judgmental and potentially subject to significant fluctuation.
Other risks include pharmaceutical pricing and utilization, labor availability and costs, regulatory compliance, collections and revenue-estimation uncertainty, interest-rate exposure, acquisition competition and substantial leverage. Interest-rate swaps covering $350 million of debt expired by September 30, 2010.

Important facts for investors to verify

Progress toward 2010 operating-income and operating-cash-flow guidance, including the assumptions behind treatment growth and revenue per treatment.
The expected economics and operational effects of the 2011 Medicare bundled-payment rule, including final reimbursement adjustments and required systems or documentation changes.
Commercial-payor rate and patient-mix trends, and changes in pharmaceutical utilization, EPO reimbursement and costs.
Refinancing plans and terms for the substantial 2012 debt maturity, along with future interest expense after the swaps expire.
Developments in government investigations, payor claims and the valuation of noncontrolling-interest put obligations.
Whether acquisitions, center openings, share repurchases and the planned headquarters investment remain consistent with liquidity and capital-allocation priorities.