DaVita Inc. — Q3 2016 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2016; unaudited. Unless noted, amounts below are in U.S. dollars and millions. DaVita operates Kidney Care, including U.S. dialysis and related services, and DaVita Medical Group (DMG), an integrated care business.
Financial performance
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Net revenue | $3,731 | $3,526 | $11,029 | $10,248 |
| Operating income | $819 | $509 | $1,513 | $926 |
| Net income attributable to DaVita | $571 | $216 | $722 | $276 |
| Diluted EPS | $2.76 | $1.00 | $3.48 | $1.27 |
- Revenue grew 5.8% in Q3 and 7.6% for the nine-month period. Growth reflected dialysis treatment volume and revenue per treatment, acquisitions, and ancillary and international business growth.
- Q3 reported operating margin was approximately 22.0%, versus 14.4% a year earlier; nine-month margin was 13.7%, versus 9.0%. These reported comparisons include significant unusual items. Excluding specified items, adjusted operating income was $472 million in Q3 (about 12.7% of revenue) versus $509 million (14.4%) in Q3 2015; nine-month adjusted operating income was $1,405 million (about 12.7%) versus $1,425 million (13.9%). These are company-presented non-GAAP measures.
- Q3 U.S. dialysis and related lab revenue increased 5.6% year over year; average revenue per treatment rose about $5 to $353. Patient care cost per treatment increased about $6 year over year, reflecting labor, benefits and other direct costs. Nine-month treatment volume increased to 20.27 million from 19.34 million.
- DMG revenue increased 2.7% in Q3 year over year, but adjusted operating income fell to $33 million from $83 million. Nine-month adjusted DMG operating income declined to $113 million from $215 million. The filing cites reduced commercial and Medicaid membership, risk-sharing revenue changes, reimbursement pressure, and higher costs, partly offset by acquisitions and growth in fee-for-service and senior capitated revenue.
- Operating cash flow was $536 million in Q3 versus $679 million in Q3 2015. For nine months, it was $1,481 million versus $1,121 million, with the increase reflecting the prior-year settlement payment and working-capital timing. Capital expenditures were $575 million and acquisition outlays were $497 million. Operating cash flow less capital expenditures was approximately $906 million.
- At September 30, cash and cash equivalents were $913 million and short-term investments were $659 million; current assets were $4,261 million and current liabilities $2,639 million. Debt principal outstanding was $9,209 million ($9,125 million net of discount and financing costs). The company had $1.0 billion in undrawn revolver capacity, of which $91.6 million supported letters of credit. Cash declined $586 million from year-end 2015.
Material changes and unusual items
- DaVita recognized a $374 million non-cash, non-taxable gain after deconsolidating its Asia Pacific dialysis joint venture (APAC JV) on August 1. Khazanah and Mitsui each initially invested $50 million for a combined 40% interest, with further investment commitments over three years. DaVita retained an equity-method investment.
- DMG recorded $253 million of goodwill impairment in the first half of 2016, related to Nevada and Florida reporting units. Nevada’s estimated fair value was 27.8% below carrying value; Florida’s was 1.5% below. Further reimbursement or medical-cost deterioration could cause additional impairment.
- Q3 2016 operating results also included a $27 million reduction in a DMG acquisition-escrow receivable, offset by a corresponding reduction in income tax expense. Other 2016 items included a $40 million gain on sale of part of Tandigm, a $10 million loss on sale of DMG Arizona, and a $16 million hospice-related accrual. The comparable 2015 nine-month period included a $495 million settlement charge.
- DaVita acquired The Everett Clinic (TEC) in March for approximately $394 million net cash, plus assumed liabilities; acquisition cash outflows for the period were $497 million in total. It repurchased 9.93 million shares for $656 million during the first nine months, and repurchased a further 3.37 million shares for $212 million after quarter-end through October 31.
Guidance, management commentary and risks
- Updated 2016 guidance: adjusted consolidated operating income of $1.810–$1.870 billion; Kidney Care operating income of $1.695–$1.725 billion; adjusted DMG operating income of $115–$145 million; and operating cash flow of $1.750–$1.850 billion. The company does not provide a forward GAAP reconciliation for operating-income guidance because certain items cannot be predicted without unreasonable effort.
- Management cited continuing labor and benefit cost pressure, lower productivity, commercial and Medicaid membership declines, shared-risk utilization and Medicare Advantage reimbursement as operating challenges. It stated that it expected sufficient liquidity and operating cash flow to fund debt service and other obligations for the foreseeable future.
- CMS’s 2017 Medicare Advantage rates were estimated to reduce DMG operating income by about $25 million. DaVita also warned that restrictions on charitable premium assistance or marketplace-plan eligibility could materially affect dialysis revenue and cash flow. It estimated annualized operating-income reductions of up to $140 million for a restriction affecting Medicaid patients seeking ACA coverage, with up to a further $90 million impact under a broader restriction. On October 31, DaVita announced it would suspend support for applications by patients with minimum essential Medicaid coverage seeking additional 2017 ACA-plan coverage.
- Key legal and regulatory exposures include federal investigations involving Medicare Advantage diagnosis coding, prescription-drug billing, transportation, and vascular-access services; the Swoben case was revived by a Ninth Circuit panel, with rehearing requested. The filing says outcomes and potential damages are not presently predictable. The company also remains subject to a Corporate Integrity Agreement.
- Interest-rate swaps expired September 30. Interest-rate caps cover portions of debt, but approximately 52.8% of total debt was fixed-rate at quarter-end; the company reported a 4.49% overall effective interest rate as of that date. Floating-rate exposure, substantial debt, put obligations for noncontrolling interests, and government reimbursement changes remain relevant risks.
Important facts for investors to verify
- Reconcile reported earnings and margins to the APAC JV gain, DMG impairment, and other adjustments; assess the sustainability of adjusted operating performance.
- Track CMS and commercial-payor decisions on ACA coverage and charitable premium assistance, and compare realized impacts with management’s stated estimates.
- Monitor DMG membership, risk-sharing results, Medicare Advantage rates, and goodwill headroom, especially in Nevada and Florida.
- Review cash generation against capital spending, acquisitions, share repurchases, debt service, and the expected Renal Ventures acquisition of approximately $360 million, then anticipated in early 2017 subject to regulatory approval and possible divestitures.
- Follow the status and potential financial consequences of the disclosed government investigations and litigation; the filing does not provide a clear estimate of ultimate exposure for several matters.