DaVita HealthCare Partners Inc. — Q2 2016 Form 10-Q
Business context and period: The unaudited report covers the quarter and six months ended June 30, 2016. DaVita operates Kidney Care, including U.S. dialysis, ancillary services and international operations, and HealthCare Partners (HCP), an integrated care business. Amounts below are in U.S. dollars; financial statement figures are in millions unless noted.
Financial results and liquidity
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Net revenue | $3,717.7 | $3,434.6 | $7,298.8 | $6,722.6 |
| Operating income | $329.1 | $480.5 | $694.0 | $416.4 |
| Net income attributable to DaVita | $53.4 | $170.5 | $150.8 | $59.9 |
| Diluted EPS | $0.26 | $0.78 | $0.73 | $0.27 |
| Operating cash flow | $517 million | $31 million | $945.6 | $441.5 |
- Q2 revenue rose 8.2% year over year; six-month revenue rose 8.6%. Growth reflected dialysis treatment growth and revenue per treatment, HCP and ancillary services.
- Q2 GAAP operating margin was approximately 8.9%, versus 14.0% a year earlier. Results included $176 million of HCP goodwill impairment charges, partly offset by business-sale gains. Six-month operating income included $253 million of goodwill impairment charges; the prior-year comparison included a $495 million settlement charge.
- Management’s non-GAAP adjusted operating income was $475 million for Q2 versus $485 million in Q2 2015, and $933 million for the first half versus $915 million in the first half of 2015. These are management-defined measures, not GAAP results.
- U.S. dialysis and related lab services operating income was $449 million in Q2, up from $438 million. HCP reported a $102 million operating loss, including impairment and sale-related items; adjusted HCP operating income was $44 million versus $72 million in Q2 2015.
- At June 30, cash and cash equivalents were $1,283 million and short-term investments were $394 million. Long-term debt was $8,957 million, with another $144 million current; total debt principal was $9,189 million. The company had $1.0 billion of undrawn revolving credit facilities, approximately $91 million of which supported letters of credit.
- Operating cash flow for the first half increased from 2015, principally reflecting the prior-year $494 million settlement payment and changes in collections and working capital. First-half capital expenditures were $359 million and acquisitions used $473 million. Cash declined by $216 million from year-end to $1,283 million.
Material changes and unusual items
- HCP goodwill impairment charges totaled $253 million in the first half, including Q2 charges of $79 million for Nevada and $97 million for Florida. Nevada and Florida reporting-unit estimated fair values were 25.6% and 15.0% below carrying amounts, respectively; both remained at risk of further impairment.
- DaVita sold part of its Tandigm interest, reducing ownership from 50% to 19%, and recognized a pre-tax gain of approximately $40 million. The HCP Arizona sale produced a pre-tax loss of approximately $10 million. The income statement reported a combined net gain on business-interest sales of $29.8 million.
- The Everett Clinic acquisition closed March 1, 2016, for an aggregate purchase price of approximately $405 million. The company also had a pending agreement to acquire Renal Ventures for approximately $415 million, subject to regulatory approval and anticipated center divestitures.
- First-half share repurchases totaled approximately $249 million. The board authorized an additional $1.241 billion in July; $1.5 billion was available under authorizations as of August 8, subject to debt-agreement limits.
- After quarter-end, Khazanah and Mitsui invested an initial $100 million in DaVita’s Asia Pacific dialysis business under a three-year, $300 million commitment for a 40% combined interest. DaVita expected to deconsolidate the business in Q3 and recognize a material non-cash gain.
Outlook, commentary and risks
- Management lowered 2016 adjusted consolidated operating-income guidance to $1.785–$1.875 billion from $1.800–$1.950 billion. Kidney Care operating-income guidance was $1.675–$1.725 billion, versus prior guidance of $1.625–$1.725 billion. HCP adjusted operating-income guidance fell to $110–$150 million from $175–$225 million.
- 2016 operating-cash-flow guidance was updated to $1.600–$1.750 billion from $1.550–$1.750 billion. The filing does not provide forward GAAP operating-income guidance or a reconciliation to the non-GAAP outlook.
- Management estimated 2017 Medicare Advantage rate changes would reduce HCP rates by approximately 1%, with an estimated $25 million impact to 2017 operating income. Management cautioned that the estimate could be understated and depends on market mix and plan design.
- Principal business risks include pressure on commercial dialysis reimbursement and patient mix; Medicare, Medicaid and Medicare Advantage rate changes; HCP medical-claims costs and utilization; and the risk of additional goodwill impairment. The company also cited labor and pharmaceutical costs, competition, acquisition integration, billing and collections systems, and substantial debt.
- Government investigations and civil matters include Medicare Advantage diagnosis coding and risk adjustment, prescription-drug billing, patient transportation, and vascular-access procedures. The company is cooperating with authorities and said outcomes and potential damages could not be predicted. It recorded a $22.5 million estimated accrual in 2015 for DaVita Rx matters and a $16 million accrual in Q1 2016 for a hospice matter; additional reserves may be required. Potential consequences of adverse findings include financial penalties and exclusion from government programs.
- The company stated it expects sufficient liquidity and operating cash flow to meet obligations for the foreseeable future. Interest-rate exposure is partly hedged, but debt remains substantial; most Term Loan A variable-rate exposure was hedged, and Term Loan B was subject to a LIBOR floor and rate caps.
Key investor verification points
- Track HCP medical-cost trends, Medicare Advantage reimbursement, and whether Nevada and Florida require further impairment charges.
- Compare realized operating results with revised 2016 guidance, especially HCP and operating cash flow, and distinguish GAAP from adjusted measures.
- Monitor the status, reserves and potential financial exposure of government investigations and related claims, including whether seller indemnification for HCP matters is recoverable.
- Verify the Renal Ventures transaction’s regulatory outcome and required divestitures, and the timing and accounting effects of the Asia Pacific joint venture and deconsolidation.
- Assess debt service, liquidity, share repurchases and acquisition spending together; confirm compliance with credit-agreement repurchase restrictions.