DaVita HealthCare Partners Inc. — Q2 2013 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2013. The company operates U.S. dialysis and related lab services, HealthCare Partners (HCP), and other ancillary and strategic businesses. HCP’s results are included from its November 1, 2012 acquisition, so consolidated year-over-year growth is not directly comparable with the prior-year period.
Financial performance and liquidity
Amounts below are in millions of dollars except per-share data. Q2 and six-month comparisons are with the corresponding 2012 periods.
| Metric | Q2 2013 | Six months 2013 |
|---|---|---|
| Net revenues | $2,871.7; up 50.1% | $5,701.3; up 51.5% |
| Operating income | $522.0; operating margin 18.2% | $688.9; operating margin 12.1% |
| Adjusted operating income, company-defined non-GAAP | $465 million | $932 million |
| Net income attributable to DaVita | $254.4, versus $95.3 | $284.5, versus $235.5 |
| Diluted net income per share attributable to DaVita | $2.37, versus $0.99 | $2.65, versus $2.46 |
| Operating cash flow | $307 million, versus $202 million | $686.0, versus $534.0 |
- Revenue drivers: Q2 dialysis and related lab services revenue rose about 9.1% year over year, driven mainly by treatment-volume growth and approximately $6 higher average revenue per treatment. HCP contributed $761 million of Q2 revenue. Six-month dialysis treatments increased to 11.50 million from 10.77 million.
- Margins and unusual items: Q2 GAAP operating income included a $57.0 million gain from reducing the HCP contingent earn-out liability. The prior-year Q2 included $78 million of legal settlement expense and $10 million of HCP acquisition transaction costs. Q1 2013 included a $300 million reserve for physician-relationship investigations. Excluding the specified items, Q2 adjusted operating income was approximately flat sequentially ($465 million versus $467 million); the six-month adjusted comparison was $932 million versus $662 million.
- Cash investment: Six-month capital expenditures were $258.4 million and acquisitions used $152.1 million. Operating cash flow less capital expenditures was approximately $427.6 million; this is a simple subtraction, not a company-reported free-cash-flow measure.
- Balance sheet at June 30: Cash and cash equivalents were $617.9 million; current assets $3,131.8 million and current liabilities $2,214.9 million (working capital approximately $916.9 million). Debt principal outstanding was $8,496.2 million, with $8,234.3 million classified as long-term debt. Debt expense was $213.9 million for the first six months, versus $122.1 million.
- Funding access and interest: Undrawn revolving facilities totaled $350 million, with approximately $113 million committed for letters of credit. The company reported a 4.85% overall weighted-average effective interest rate at quarter-end and used swaps and caps to hedge portions of variable-rate debt.
Material changes versus the prior period
- Reported consolidated revenue grew sharply, largely because HCP was acquired and consolidated; it generated $1,564.8 million of first-half revenue. The six-month comparison therefore includes HCP in 2013 but not in 2012.
- Six-month GAAP operating income declined to $688.9 million from $568.1 million despite the increase in reported revenue; the comparison reflects the $300 million 2013 reserve and the different legal and acquisition-related items in 2012. Company-defined adjusted operating income increased to $932 million from $662 million.
- HCP’s Q2 revenue declined to $761 million from $804 million sequentially, and operating income fell to $81 million from $108 million. Management cited seasonal lower premiums for senior members and Medicare sequestration.
- The company sold HomeChoice Partners on February 1, 2013 for $70 million cash, subject to adjustments, and recognized a $13.4 million after-tax gain in the first half. HomeChoice was classified as discontinued operations.
- Cash rose to $617.9 million from $533.7 million at year-end 2012, while total debt principal declined to $8,496.2 million from $8,575.9 million.
Outlook, management commentary and risks
- Raised 2013 guidance: Consolidated operating income of $1.83–$1.93 billion, excluding the $300 million loss contingency reserve and contingent earn-out adjustment; dialysis services and related ancillary businesses operating income of $1.45–$1.50 billion; and consolidated operating cash flow of $1.40–$1.50 billion. HCP operating income guidance was lowered to $380–$430 million. The filing cautions that projections involve significant risks and may differ materially from actual results.
- Reimbursement pressure: Medicare sequestration reduced dialysis and Medicare Advantage payments by 2% beginning April 1, 2013. CMS proposed a 9.4% net reduction to the 2014 ESRD payment rate. Management estimated the 2014 Medicare Advantage rate structure could reduce HCP’s average revenue for senior capitated members by 6%–9%; contractual pass-throughs and possible benefit-design changes may offset part, but not necessarily all, of the decline.
- Legal contingency: The company accrued $300 million in Q1 in connection with ongoing federal investigations into physician relationships and joint ventures and settlement discussions covering civil, administrative and criminal matters. The amount could change; timing, resolution and any operational restrictions remain uncertain. The filing says criminal proceedings are possible. Other investigations and private litigation are also described. Separately, HCP’s motion to dismiss the Swoben claims was granted with prejudice on July 30, 2013.
- Business and regulatory risks: Management highlights commercial-payor rate and patient-mix pressure, government reimbursement changes, compliance and billing risks, competition, labor costs, HCP medical-cost and provider-network risks, Medicare Advantage dependence, and risks from integrating HCP. The company stated that commercial payors generated about 34% of Q2 dialysis revenue and Medicare about 48%.
- Liquidity and debt: Management said it expected operating cash flows and available liquidity to fund scheduled debt service and other obligations for the foreseeable future, including the next 12 months. Substantial indebtedness, refinancing needs and interest-rate exposure remain risks.
Important facts for investors to verify
- Track final 2014 ESRD and Medicare Advantage reimbursement decisions, and the realized effects of sequestration on dialysis and HCP revenue and margins.
- Monitor resolution of the physician-relationship investigations, adequacy of the $300 million reserve, potential settlement restrictions, and any related proceedings or additional charges.
- Reconcile reported results with company-defined adjusted operating income, especially the $57 million earn-out gain and the $300 million reserve; review the definitions and exclusions used in guidance.
- Assess HCP’s membership, senior-capitated premiums, medical-cost experience and ability to offset projected reimbursement reductions; HCP total capitated membership was 733,300 at June 30, down from 742,000 at March 31.
- Monitor debt reduction, interest expense, operating cash flow, capital spending and the availability of revolving credit after letters of credit and other commitments.