DaVita Inc. — Q3 2017 Form 10-Q
Business context and reporting period. DaVita provides kidney dialysis and related services through Kidney Care and integrated healthcare services through DaVita Medical Group (DMG). This unaudited report covers the quarter and nine months ended September 30, 2017; comparisons are with the corresponding 2016 periods unless noted. Dollar amounts below are in millions, except per-share data.
Financial performance and liquidity
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Net revenue | $3,922.8 | $3,730.6 | $11,497.6 | $11,029.4 |
| Operating income (loss) | $(192.5) | $819.2 | $1,074.0 | $1,513.1 |
| Net income (loss) attributable to DaVita | $(214.5) | $571.3 | $360.2 | $722.1 |
| Diluted EPS | $(1.14) | $2.76 | $1.86 | $3.48 |
| Operating cash flow | $553 (quarter) | $536 (quarter) | $1,564.5 | $1,481.3 |
- Revenue and mix: Q3 revenue rose 5.1%; nine-month revenue rose 4.3%. Q3 growth reflected higher dialysis volume and DMG revenue, partly offset by lower ancillary/pharmacy revenue. DMG’s reported growth also reflects conversion of contracts from shared-risk to global-risk accounting presentation.
- Profitability and margins: Q3 GAAP operating margin was approximately (4.9%), versus 22.0% a year earlier; nine-month margin was 9.3%, versus 13.7%. Q3 included $601 million of goodwill impairment, principally DMG. Management’s non-GAAP adjusted operating income was $399 million for Q3 versus $472 million in Q3 2016, and $1,227 million for nine months versus $1,405 million. These adjusted figures exclude specified unusual items and are not GAAP measures.
- Cash flow and investment: Nine-month operating cash flow increased 5.6%, helped by receipt of the VA settlement, partly offset by higher days sales outstanding and working-capital timing. Investing outflows were $1,107 million, including $640 million of capital expenditures and $727 million of acquisitions. Financing outflows were $530 million, including $349 million of share repurchases.
- Balance sheet at September 30: Cash and cash equivalents were $846 million; short-term investments were $137 million. Current assets were $4,034 million and current liabilities $2,875 million (current ratio about 1.40). Debt principal outstanding was $9,166 million; reported current and long-term debt carrying amounts totaled approximately $9,099 million. Equity was $4,969 million. Noncontrolling interests subject to put provisions were $1,027 million.
- Debt and access to liquidity: Overall weighted-average effective interest rate was 4.78%; approximately 53.7% of debt had fixed interest rates. Undrawn revolving facilities totaled $1.0 billion, with about $94.6 million committed for letters of credit. Management said it expects operating cash flow and available liquidity to meet obligations, including over the next 12 months.
Material changes and operating developments
- DMG impairment and performance: Q3 goodwill impairment was $601 million, including $561 million in DMG California; nine-month impairment totaled $686 million, compared with $253 million in 2016. The California impairment included a $218 million deferred-tax benefit, leaving an estimated $383 million net-income impact. Management cited reimbursement pressure, rising medical costs, weaker-than-expected commercial membership, lower expected California Medicaid rates, and the persistent gap between Medicare rate increases and medical-cost increases. DMG reported a Q3 operating loss of $588 million; adjusted operating income was a loss of $5 million.
- Dialysis operations: Q3 U.S. dialysis and related lab revenue increased 2.0% year over year, principally from treatment growth, while average revenue per treatment fell about $7 to $346, primarily due to lower commercial mix. Q3 operating income was $443 million, down $9 million. Treatment volume was affected by hurricanes; the company also cited higher labor and other direct costs.
- VA settlement: In Q1, DaVita received $538 million related to its VA settlement and recognized a $527 million consolidated gain; including its share of joint-venture gains, operating income benefited by about $530 million. This one-time item materially boosted nine-month cash flow and reported dialysis operating income.
- Acquisitions, ownership changes and repurchases: DaVita acquired Renal Ventures for about $362 million net cash in May and acquired Magan in July, recognizing a $17 million non-cash gain on its previously held interest. It repurchased 5.6 million shares for $349 million in the first nine months. After quarter-end it repurchased a further 5.9 million shares for $353 million and authorized an additional $1,253 million of buybacks; $1,228 million remained available as of November 7, 2017.
- Working capital: Dialysis receivables days sales outstanding rose to 60 days from 56 at June 30, reflecting acquired receivables, hurricane-related billing delays, and collection-process changes. Management expected DSO to decline 3–4 days over the next few quarters.
Outlook, risks and contingencies
- No company-wide earnings or revenue guidance is provided in the supplied filing text. CMS projected the 2018 ESRD bundled payment rule would increase payments to facilities by 0.5% overall. DaVita estimated 2018 Medicare Advantage rates applicable to DMG would be nearly flat versus 2017, below the stated industry-average increase of about 0.45%.
- Management is evaluating strategic alternatives and mitigation opportunities for DMG challenges; their timing and likelihood are uncertain. Further reimbursement reductions, medical-cost increases, utilization changes, or adverse valuation assumptions could trigger additional goodwill impairments. DMG California, Florida and New Mexico had no reported carrying-value cushion at their latest assessments; Washington had 17.1% coverage.
- Key business risks include dependence on government reimbursement and higher-paying commercial dialysis patients, commercial rate and membership pressure, Medicare Advantage and Medicaid rate changes, medical-cost and claims-estimation risk at DMG, competition, labor availability and costs, acquisitions/integration, and interest-rate exposure.
- DaVita disclosed ongoing government inquiries involving Medicare Advantage diagnosis coding and risk adjustment, prescription-drug billing, and charitable patient assistance, among other matters. A securities class action and consolidated shareholder derivative suits were also pending. The Swoben suit against DMG was dismissed without prejudice in October 2017; a separate Solari matter was settled for an immaterial amount. Accrued legal and regulatory liabilities were approximately $51 million, net of anticipated recoveries; possible additional losses could not be estimated clearly in some matters.
- Other obligations and uncertainties include $1,027 million of puttable noncontrolling interests, operating leases, and commitments to suppliers. The filing states that adoption of the new lease standard is expected to materially affect the balance sheet, but not materially affect results or liquidity.
Most important facts for investors to verify
- Whether DMG’s reimbursement, membership and medical-cost trends stabilize, and whether further goodwill impairment is required.
- How much reported earnings and cash generation depend on the nonrecurring $530 million VA settlement gain.
- Whether dialysis commercial mix, revenue per treatment and DSO improve as management expects.
- Developments, potential financial exposure and any indemnification recovery related to government investigations and shareholder litigation.
- Debt service capacity and capital-allocation plans, including subsequent repurchases, put obligations and available revolver capacity.