DaVita Inc. — Q1 2017 Form 10-Q
Reporting period: Three months ended March 31, 2017; compared primarily with Q1 2016. Dollar amounts below are in millions unless stated otherwise. DaVita operates DaVita Kidney Care, including U.S. dialysis, and DaVita Medical Group (DMG), an integrated healthcare business.
Financial performance and liquidity
| Metric | Q1 2017 | Q1 2016 |
|---|---|---|
| Net revenue | $3,697 | $3,581 |
| Operating income | $888 | $365 |
| Net income attributable to DaVita | $448 | $97 |
| Diluted EPS | $2.29 | $0.47 |
| Operating cash flow | $865 | $429 |
- Revenue increased 3.2% year over year. DMG revenue rose about $98 million, while U.S. dialysis and related lab revenue rose about $44 million; ancillary and strategic-initiative revenue declined about $13 million.
- Reported operating income included a $527 million net gain from the Veterans Affairs settlement. Excluding the settlement and other specified unusual items, adjusted operating income was $392 million versus $458 million in Q1 2016. Management attributed the decline to lower adjusted results in U.S. dialysis and DMG and higher adjusted losses in ancillary businesses.
- Reported operating margin was approximately 24% versus 10% a year earlier, substantially reflecting the VA gain. Adjusted operating income was approximately 10.6% of revenue versus 12.8% in Q1 2016.
- U.S. dialysis average revenue per treatment was $349, down about $2 year over year; treatment volume increased. Management cited a lower commercial-payor mix, including exchange payors, as a source of revenue-per-treatment pressure. Adjusted dialysis operating income was $415 million versus $440 million.
- DMG revenue increased 9.9% year over year, but adjusted operating income was $12 million versus $36 million. Management cited higher utilization and labor costs, lower commercial and Medicaid membership, and lower Medicare Advantage rates, partly offset by senior membership growth and other factors.
- Cash and cash equivalents were $1,472 million at quarter-end, up from $913 million at December 31, 2016; short-term investments were $313 million. Operating cash flow benefited materially from the VA settlement. Capital expenditures were $215 million and acquisition spending was $77 million.
- Debt principal outstanding was approximately $9,165 million; balance-sheet debt, net of discounts and financing costs, was $9,089 million. The company had $1.0 billion of undrawn revolving facilities, with approximately $94.6 million committed for letters of credit. Overall weighted-average effective interest rate was 4.64% at quarter-end; about 53.1% of debt had fixed rates.
Material changes, outlook and management commentary
- The VA settlement generated a $538 million cash receipt and a reported $527 million net gain; the filing states the net effect increased operating income by approximately $530 million when related entity gains are included. This is a significant nonrecurring item behind the quarter’s reported earnings and cash flow.
- DaVita recorded a $24 million goodwill impairment for vascular access and a $15 million asset impairment related to restructuring its pharmacy business. Management said continued reimbursement-driven operational reviews at vascular access could lead to further impairment charges.
- 2017 guidance was maintained: adjusted consolidated operating income of $1.635–$1.775 billion; Kidney Care operating income of $1.525–$1.625 billion; DMG operating income of $110–$150 million; and consolidated operating cash flow of $1.750–$1.950 billion, including the net benefit of the VA settlement. The company does not provide corresponding forward-looking GAAP operating-income or effective-tax-rate guidance.
- Management cited continued pressure on commercial dialysis mix and rates, reimbursement uncertainty, DMG medical-cost utilization and Medicare Advantage rates, and losses in certain ancillary and international operations. It expects to continue investing in ancillary services and international markets.
- On May 1, 2017, after quarter-end, DaVita acquired Renal Ventures for approximately $360 million in cash, subject to adjustments. The business operated 38 centers; DaVita was required to divest seven centers as part of the transaction.
Risks, contingencies and other notable disclosures
- DaVita operates in a highly regulated sector and disclosed continuing government inquiries, subpoenas and litigation, including matters concerning Medicare Advantage diagnosis coding, prescription-drug billing, charitable patient assistance, and a securities class action. The company disputes allegations in the shareholder suits and says it is cooperating with government inquiries. The VA vascular-access qui tam matter was settled for an immaterial amount and dismissed with prejudice in April 2017; a transportation-related complaint was dismissed without prejudice in April 2017.
- Recorded accruals for legal and regulatory matters, net of anticipated recoveries, were approximately $69 million at both December 31, 2016 and March 31, 2017. The company cautioned that actual losses could differ materially and that some possible losses cannot be estimated.
- Goodwill reporting units identified as at risk include DMG Nevada, Florida, New Mexico and Washington, and vascular access. Further reimbursement reductions, medical-cost increases, or adverse changes in assumptions could trigger additional impairment.
- Other principal risks include dependence on government reimbursement and higher-paying commercial patients, the effect of healthcare policy changes, DMG’s exposure to medical-cost risk under capitated arrangements, substantial debt and variable interest rates, and the possibility of additional legal or regulatory consequences.
- Management concluded disclosure controls and procedures were effective as of quarter-end and reported no material change in internal control over financial reporting during the quarter. The filing also notes a prior-year segment-asset disclosure misclassification; management concluded it was not materially misleading in the 2016 financial statements and provided corrected segment disclosure here.
Important facts for investors to verify
- How much of reported earnings and operating cash flow reflects the one-time VA settlement, and how results compare using the company’s adjusted measures.
- Whether commercial-payor mix and revenue per dialysis treatment continue to decline, and whether treatment growth offsets that pressure.
- DMG medical-cost trends, membership changes, Medicare Advantage reimbursement, and performance relative to the $110–$150 million 2017 operating-income outlook.
- Progress and potential financial exposure from government investigations, shareholder litigation, and other contingencies beyond the recorded $69 million accrual.
- Potential further impairments at vascular access and at-risk DMG reporting units, plus the impact of the Renal Ventures acquisition and required divestitures on debt, cash flow and guidance.