DaVita HealthCare Partners Inc. — Q3 2015 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2015. DaVita operates Kidney Care, including U.S. dialysis and related lab services, and HealthCare Partners (HCP), an integrated care delivery and management business. Amounts below are in U.S. dollars.
Financial performance and liquidity
| Metric | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Net revenue | $3.526 billion | $3.252 billion | $10.248 billion | $9.467 billion |
| Operating income | $509 million | $438 million | $926 million | $1.363 billion |
| Net income attributable to DaVita | $216 million | $184 million | $276 million | $515 million |
| Diluted earnings per share | $1.00 | $0.85 | $1.27 | $2.38 |
| Operating cash flow | $679 million | $848 million | $1.121 billion | $1.529 billion |
- Q3 revenue increased 8.4% year over year; operating income rose about 16%, and diluted EPS rose about 18%. Q3 operating margin was approximately 14.4%, compared with 13.5%.
- Nine-month revenue increased 8.2%, but reported operating income and attributable net income declined, principally reflecting the $495 million Vainer settlement charge. Excluding the settlement and the prior-year $17 million contingency accrual, adjusted operating income was $1.421 billion versus $1.380 billion, up 3.0%; this is a company-presented non-GAAP measure.
- Q3 dialysis and related lab services revenue increased about 6% year over year, supported by treatment growth and an approximately $7 increase in average revenue per treatment. HCP revenue increased about 12%, while ancillary and strategic initiatives revenue rose about 15% but continued to generate operating losses.
- Nine-month capital expenditures were $462 million. Operating cash flow less capital expenditures was approximately $658 million, versus $1.086 billion in the prior-year period; this simple measure does not include acquisitions, repurchases, or other investing and financing flows.
- At September 30, cash and cash equivalents were $1.047 billion and short-term investments were $923 million. Current assets were $4.738 billion and current liabilities $2.411 billion.
- Debt principal outstanding was $9.211 billion ($9.197 billion carrying value), up from $8.520 billion principal at December 31, 2014. The company reported $1.0 billion of undrawn revolving credit facilities, with approximately $40 million committed for letters of credit. It stated that available liquidity and expected operating cash flow should fund obligations for the foreseeable future.
Material changes and unusual items
- DaVita finalized a $495 million Vainer civil-suit settlement in June 2015, comprising $450 million settlement and $45 million attorney fees and costs. Approximately $494 million was paid during the first nine months; management cited about $304 million after tax. This was the primary reason nine-month reported operating income and cash flow fell year over year.
- In April 2015, DaVita issued $1.5 billion of 5.0% senior notes due 2025, using proceeds primarily to repurchase $775 million of 6⅝% notes due 2020. The refinancing resulted in $48 million of debt redemption charges.
- DaVita repurchased 5.623 million shares for $425 million during the first nine months, including 4.556 million shares for $341 million in Q3. Remaining repurchase authorization was $659 million as of October 30, subject to debt-agreement limits.
- HCP continued to face Medicare Advantage reimbursement pressure. The company estimated 2016 Medicare Advantage rates would reduce HCP’s average revenue for its senior capitated population by about 2% versus 2015, with an estimated approximately $50 million impact on 2016 operating income.
- Three HCP reporting units—California, Nevada, and New Mexico—were identified as remaining at risk of goodwill impairment. Estimated fair values exceeded carrying values by 15.2%, 8.8%, and 16.2%, respectively; further reimbursement reductions or adverse assumptions could trigger impairment.
- Ancillary services and strategic initiatives reported a $70 million operating loss for the first nine months, versus a $6 million loss in 2014, largely reflecting pharmacy-related costs and refund reserves, international expansion, and other expenses. DaVita also recorded an immaterial international goodwill impairment.
Outlook, risks, and contingencies
- Updated 2015 guidance: consolidated operating income of $1.870–$1.915 billion; Kidney Care operating income of $1.630–$1.655 billion; HCP operating income of $240–$260 million; and operating cash flow of $1.675–$1.775 billion. These projections exclude the Vainer settlement charge and related 2015 payments and are subject to significant risks and uncertainty.
- DaVita agreed to acquire Renal Ventures for approximately $415 million, subject to regulatory approval and potential divestitures; it expected closing in early 2016.
- Government investigations and subpoenas include inquiries into patient transportation and Medicare Advantage diagnosis coding and risk adjustment. The company said it was cooperating and could not predict outcomes or potential damages. It warned adverse findings could result in substantial penalties, repayment obligations, or exclusion from federal healthcare programs. Potential losses relating to historical HCP coding practices may exceed seller indemnification and escrow coverage.
- The company reported that the OIG considered it in breach of its five-year Corporate Integrity Agreement due to three implementation deficiencies; DaVita said it had remediated them and paid stipulated penalties.
- Principal business risks include government reimbursement changes, commercial payor rate and mix pressure, medical-cost estimation and collection risk, regulatory compliance and litigation, HCP’s dependence on capitated arrangements and health plans, possible goodwill impairment, high debt, and execution risks in acquisitions and international or other strategic initiatives.
Key facts for investors to verify
- Whether reported and adjusted operating results reconcile consistently, especially the treatment and cash impact of the Vainer settlement and other unusual charges.
- Whether 2015 operating income and cash-flow guidance remains achievable, and how much cash flow is available after capital spending, acquisitions, distributions, and share repurchases.
- Progress and potential financial effects of the Medicare Advantage investigations, historical coding issue, and Corporate Integrity Agreement obligations.
- HCP’s exposure to the estimated 2016 Medicare Advantage rate reduction, and whether the at-risk reporting units retain sufficient goodwill valuation headroom.
- Debt, interest-rate exposure, refinancing and covenant capacity, plus the cash demands that could arise from noncontrolling-interest put provisions.