Business context and reporting period
DaVita HealthCare Partners Inc. filed this unaudited Form 10-Q for the quarter and six months ended June 30, 2015. Its two principal divisions are Kidney Care, including U.S. dialysis and related services, and HealthCare Partners (HCP), an integrated care and management business. Unless noted, amounts below are in U.S. dollars.
Financial performance and liquidity
| Metric | Q2 2015 | Q2 2014 | Six months 2015 | Six months 2014 |
|---|---|---|---|---|
| Net revenue | $3,434.6 million | $3,172.5 million | $6,722.6 million | $6,215.3 million |
| Operating income | $480.5 million | $484.3 million | $416.4 million | $925.5 million |
| Net income attributable to DaVita | $170.5 million | $147.7 million | $59.9 million | $331.0 million |
| Diluted EPS | $0.78 | $0.68 | $0.27 | $1.53 |
| Operating cash flow | Not separately stated for Q2 in the cash flow statement; MD&A reports $31 million | MD&A reports $262 million | $441.5 million | $681.5 million |
- Q2 revenue increased 8.3% year over year, while operating income was nearly flat; reported operating margin was approximately 14.0%, versus 15.3% in Q2 2014. Q2 diluted EPS rose from $0.68 to $0.78.
- First-half revenue increased 8.2%. GAAP operating income and attributable net income declined substantially, principally reflecting a $495 million Vainer settlement charge recorded in Q1 2015. Excluding that charge, first-half operating income was $911 million, down from $926 million in 2014.
- Cash and cash equivalents were $933.7 million at June 30; short-term investments were $942.1 million. Total debt principal outstanding was $9.225 billion, versus $8.520 billion at year-end 2014. The company had $1.0 billion of undrawn revolving facilities, with approximately $93 million committed for letters of credit.
- First-half capital expenditures were $290.9 million. Operating cash flow declined from $681.5 million to $441.5 million, largely reflecting settlement payments and working-capital and tax-payment timing.
Material changes and operating drivers
- U.S. dialysis and related lab services revenue increased 6.4% in Q2 year over year, supported by treatment growth and an approximately $8 increase in average revenue per treatment to $348. First-half average revenue per treatment rose approximately $7.
- HCP Q2 revenue increased 8.9% year over year to approximately $966 million, but operating income fell 12.2% to $72 million. Higher medical utilization and corporate growth costs weighed on results.
- Ancillary services and strategic initiatives revenue increased 21.9% year over year in Q2, but the segment recorded a $26 million operating loss, versus a $2 million loss a year earlier. The filing cites pharmacy costs and reserves, international expansion costs, and an asset write-down among the drivers.
- In April, DaVita issued $1.5 billion of 5.0% senior notes due 2025 and used proceeds in part to repurchase $775 million of 6⅝% notes due 2020. It recorded $48.1 million of related refinancing charges.
Outlook, commentary, risks and unusual items
- 2015 guidance was raised at the low end: consolidated operating income of $1.825–$1.925 billion and Kidney Care operating income of $1.600–$1.650 billion. HCP operating income guidance remained $225–$275 million. Operating cash flow guidance was increased to $1.600–$1.750 billion. These projections exclude the Vainer settlement charge and related 2015 payments.
- The Vainer civil suit settlement totaled $495 million, comprising $450 million plus $45 million in attorney fees and other costs; most was paid in June. The company also reported ongoing federal inquiries, including subpoenas concerning Medicare Advantage diagnosis coding and risk adjustment. Outcomes and potential losses were not estimable from the filing.
- HCP estimated 2016 Medicare Advantage rate changes would reduce its average Medicare Advantage revenues by approximately 2% versus 2015, with an estimated approximately $50 million impact to 2016 operating income. Three HCP reporting units remained at risk of goodwill impairment, with estimated fair-value cushions of 9.9%, 7.4%, and 2.0% over carrying values.
- The OIG notified the company it considered it in breach of its Corporate Integrity Agreement because of three implementation deficiencies. The company said it remediated them and paid stipulated penalties.
- Key disclosed risks include commercial reimbursement pressure and changes in government rates, medical-cost estimation and utilization, regulatory compliance and investigations, HCP coding and risk-adjustment exposure, high leverage, and execution and profitability risks in ancillary and international businesses. Management stated it expected sufficient liquidity and operating cash flow to meet obligations for the foreseeable future.
- Management concluded disclosure controls were effective and reported no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Track progress against 2015 operating-income and operating-cash-flow guidance, including the stated exclusion of settlement impacts.
- Monitor HCP Medicare Advantage reimbursement changes, member mix, medical utilization, and possible goodwill impairment.
- Assess the status and potential financial consequences of Medicare Advantage coding investigations and compliance obligations.
- Reconcile cash generation and capital allocation with debt levels, refinancing, repurchases, and the $863.1 million fair-value liability for noncontrolling interests subject to put provisions.
- Evaluate whether growth in dialysis, HCP, pharmacy, and international operations is translating into sustainable operating margins and cash flow.