DaVita HealthCare Partners Inc. — Q1 2014 Form 10-Q
Reporting period: Three months ended March 31, 2014; interim financial statements are unaudited. Unless otherwise noted, amounts below are in U.S. dollars and rounded to millions. The company’s principal businesses are U.S. dialysis and related lab services (Kidney Care) and HealthCare Partners (HCP), alongside ancillary services and international operations.
Financial performance and liquidity
- Revenue: Net revenue was $3.043 billion, up 7.5% from $2.830 billion a year earlier, but down 0.7% from Q4 2013. Year-over-year growth reflected dialysis treatment volume, HCP senior membership, pharmacy services, and international operations.
- Profit: Operating income was $441 million versus $167 million in Q1 2013; attributable net income was $183 million versus $30 million, and diluted EPS was $0.85 versus $0.14. The prior-year comparison includes a $300 million legal contingency charge. Excluding that charge, Q1 2013 operating income was $467 million, so Q1 2014 operating income was lower by about $26 million.
- Margins: GAAP operating margin was approximately 14.5%, compared with 5.9% in Q1 2013; the prior-year margin excluding the contingency charge was approximately 16.5%. Q1 2014 net income attributable to DaVita represented approximately 6.0% of revenue.
- Segment performance: Kidney Care operating income was $387 million, compared with $59 million in Q1 2013, which included the $300 million reserve; excluding that charge, Kidney Care operating income was approximately $359 million. HCP operating income fell to $54 million from $108 million, despite higher revenue, as medical claims costs and lower Medicare Advantage reimbursement weighed on results. Ancillary and strategic initiatives reported $2 million of operating income, versus a $15 million loss.
- Cash flow: Operating cash flow was $419 million, up from $379 million. Capital expenditures were $127 million and acquisitions used $68 million; cash increased by $162 million to $1.108 billion.
- Debt and liquidity: Debt principal outstanding was $8.381 billion ($8.364 billion net of debt discount), including $292 million current. Cash less debt principal was approximately $2.273 billion net debt. The company reported $350 million of undrawn revolving facilities, of which approximately $83 million supported letters of credit. Current assets were $3.707 billion and current liabilities $2.566 billion.
- Interest and collections: Debt expense was $106 million; the weighted-average effective interest rate was 4.89% for the quarter and 4.87% at quarter-end. The dialysis bad-debt provision rose to 4.0% of relevant revenue from 3.5% in both comparison periods, primarily due to additional non-covered Medicare write-offs. Consolidated receivables were approximately 47 days of revenue, versus 46 days at year-end.
Material changes and management commentary
- Compared with Q4 2013, revenue fell by about $20 million, principally because Q1 had three fewer dialysis treatment days. Dialysis revenue per treatment increased by approximately $1, while HCP revenue grew with senior membership; HCP operating income nevertheless declined because of Medicare Advantage rate reductions and higher medical claims.
- Compared with Q1 2013, dialysis revenue growth was driven mainly by additional treatments, while average dialysis revenue per treatment was flat. Management cited rising pharmaceutical unit costs, greater prescribed pharmaceutical intensity, higher labor and benefit costs, and increased uncollectible accounts as pressures on underlying operating income.
- Dialysis treatments totaled 5.976 million, up from 5.629 million in Q1 2013; average treatments per treatment day increased to 78,215 from 73,579.
- Management estimated that the 2014 Medicare Advantage rate structure would reduce HCP’s average senior-member revenue by approximately 8% versus 2013. It estimated the 2015 rate structure could increase that average revenue by up to approximately 0.5% versus 2014. Management said it expected to offset part of the 2014 decline through provider-network pass-throughs and other revenue and cost initiatives, without assurance of success.
Outlook, risks, and contingencies
- 2014 guidance: Consolidated operating income guidance was revised to $1.725–$1.840 billion from $1.725–$1.860 billion. Kidney Care guidance increased to $1.520–$1.580 billion from $1.475–$1.550 billion; HCP guidance decreased to $205–$260 million from $250–$310 million. Operating cash flow guidance remained $1.450–$1.550 billion. Cash-flow guidance excludes any potential payment related to the physician relationship investigations.
- Legal settlement: The company had agreed to a framework for a global resolution of the 2010 and 2011 U.S. Attorney physician relationship investigations, including an approximately $389 million payment, a corporate integrity agreement, an independent compliance monitor, business restrictions, and unwinding a limited set of joint ventures. Specific terms remained under negotiation. A $397 million reserve had been recorded in 2013; no additional reserve charge was recorded in Q1 2014. The filing does not establish a final settlement date or final terms.
- Other proceedings: In April 2014, the company reached an agreement in principle to resolve a separate Medicaid investigation; settlement terms remained under negotiation. The Vainer qui tam case remained active, and an appeal was pending in the Swoben case after HCP’s claims were dismissed with prejudice.
- Regulatory and operating risks: Major exposures include Medicare and Medicaid reimbursement changes, continued sequestration-related payment reductions, commercial payor rates and mix, HCP medical-cost estimates and Medicare Advantage rates, pharmaceutical costs, government investigations and compliance obligations, and the company’s substantial debt. The filing also identifies risks from acquisitions, international expansion, labor availability, collections, and reliance on health plans and provider networks.
- Management stated it expected sufficient liquidity and operating cash flow to fund debt service and other obligations for the foreseeable future, including the next 12 months. It cautioned that projections involve significant risks and actual results may differ materially.
Most important facts for investors to verify
- Final terms, timing, and cash impact of the physician-investigation settlement; reconcile the approximately $389 million proposed payment with the $397 million accrued reserve.
- Whether HCP can manage medical claims costs and mitigate the Medicare Advantage reimbursement reduction, given the sharp decline in segment operating income.
- Dialysis revenue quality: treatment growth, commercial-payor mix and rates, per-treatment revenue, and the rising bad-debt provision.
- Progress toward revised 2014 operating-income and operating-cash-flow guidance, noting that cash-flow guidance excludes a potential investigation-related payment.
- Debt-service capacity, refinancing and interest-rate exposure, and any calls on liquidity from put provisions or other commitments.