DaVita HealthCare Partners Inc. — Q3 2013 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2013. Unaudited results; dollar amounts below are in millions unless noted. DaVita operates U.S. dialysis and related lab services, HealthCare Partners (HCP), and ancillary and international businesses. HCP, acquired November 1, 2012, is included in 2013 results but not the comparable 2012 periods, limiting year-over-year comparability.
Financial performance
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Net revenue | $2,999.6 | $1,945.9 | $8,700.8 | $5,708.4 |
| Operating income | $377.1 | $340.9 | $1,066.0 | $909.0 |
| Operating margin | 12.6% | 17.5% | 12.3% | 15.9% |
| Net income attributable to DaVita | $136.6 | $144.7 | $421.2 | $380.2 |
| Diluted earnings per share | $0.64 | $0.75 | $1.96 | $1.98 |
| Debt expense | $108.4 | $70.5 | $322.3 | $192.6 |
For the nine months, operating cash flow was $1,419.2 million, compared with $900.6 million in 2012. Investing cash outflow was $577.1 million, including $399.5 million of property and equipment additions and $234.8 million for acquisitions. Cash and cash equivalents were $970.7 million at September 30, versus $533.7 million at year-end 2012.
At September 30, total debt principal was $8,459.8 million ($8,441.2 million carrying value); current and long-term debt on the balance sheet totaled $8,441.2 million. Undrawn revolving facilities totaled $350 million, with approximately $99 million committed for letters of credit. Current assets were $3,381.4 million and current liabilities $2,453.1 million.
Material changes and unusual items
- Revenue increased 54.2% year over year in Q3 and 52.4% for the nine months, primarily because HCP contributed $802.7 million in Q3 and $2,367.5 million year to date. U.S. dialysis revenue also grew, supported by treatment-volume growth, acquisitions, and higher revenue per treatment.
- Q3 HCP revenue was $802.7 million and operating income $97.9 million. U.S. dialysis segment operating income was $309.0 million in Q3, versus $366.8 million a year earlier; the reported figure includes the legal reserve described below.
- DaVita recorded a further $97 million Q3 charge for the estimated reserve relating to federal physician-relationship investigations, bringing the reserve to $397 million. Management’s adjusted operating income, a non-GAAP measure excluding specified unusual items, was $482 million for Q3 and $1,414 million for the nine months. These figures exclude the reserve and other specified items and should not be confused with GAAP operating income.
- Other notable items included a $7.7 million reduction of an HCP acquisition-related tax asset, which reduced operating income but was offset by lower income tax expense; a $57 million favorable contingent earn-out adjustment in Q2; and a $13.4 million after-tax gain on the February sale of HomeChoice Partners. The company also completed a two-for-one stock split in September; presented share and per-share figures reflect the split.
Outlook, risks, and contingencies
- Management narrowed 2013 operating income guidance to $1.88–$1.92 billion consolidated, $1.50–$1.52 billion for dialysis and related ancillary businesses, and $380–$400 million for HCP. Operating cash flow guidance was raised to $1.60–$1.70 billion. Guidance excludes the $397 million legal reserve and specified other items, and cash-flow guidance excludes any payment of the reserve.
- Management cited strong treatment growth and HCP contributions, alongside higher labor, benefits, pharmaceutical, professional-fee, and medical-claim costs. It also noted pressure from commercial payor rates and changes in payor mix.
- The proposed 2014 Medicare ESRD payment update was projected to reduce payments by 9.4%; the final rule was expected in November 2013. The 2% Medicare sequestration reduction had taken effect in April 2013, with management estimating an impact of about $20 million per quarter. HCP estimated that 2014 Medicare Advantage rate changes would reduce average senior-member revenues by 6%–9%; contractual pass-throughs were expected to offset about 10% of that reduction, with other offsets uncertain.
- Federal civil and criminal inquiries into physician relationships and joint ventures remained under discussion with regulators. The company said the reserve could require further adjustment and that settlement terms could include operational restrictions; it could not predict timing or outcome. Potential consequences identified include financial penalties, changes to practices, exclusion from government programs, and possible criminal penalties.
- Other material risks include government reimbursement and regulatory changes, commercial-rate and patient-mix pressure, HCP medical-cost and Medicare Advantage exposure, integration and acquisition risks, and substantial indebtedness. Management stated it expected liquidity and operating cash flow to fund debt service and other obligations for the foreseeable future.
Important facts for investors to verify
- Track the resolution, final cost, and any operational conditions associated with the $397 million physician-relationship investigation reserve.
- Compare final 2014 Medicare ESRD and Medicare Advantage rates with the proposed changes and management’s estimated revenue impacts.
- Assess whether treatment growth, commercial reimbursement, and HCP membership and medical-cost trends support the stated guidance.
- Reconcile GAAP results with management’s adjusted operating income and confirm which unusual items are excluded from guidance.
- Monitor debt service, refinancing needs, interest-rate exposure, and the availability of revolving credit after letters of credit and other commitments.