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spk08: Good evening. My name is Michelle, and I will be your conference facilitator today. At this time, I would like to welcome everyone to the DeVita third quarter 2021 earnings call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer period. If you would like to ask a question during this time, simply press star and then number one on your telephone keypad. If you would like to withdraw your question, please press star, then the number two. Thank you, Mr. Gustafson. You may begin your conference.
spk04: Thank you, and welcome, everyone, to our third quarter conference call. We appreciate your continued interest in our company. I'm Jim Gustafson, Vice President of Investor Relations, and joining me today are Javier Rodriguez, our CEO, and Joel Ackerman, our CFO. Please note that during this call, we may make forward-looking statements within the meaning of federal securities laws. All of these statements are subject to known and unknown risks and uncertainties forward-looking statements. For further details concerning these risks and uncertainties, please refer to our third quarter earnings press release and our SEC filing, including our most recent annual report on Form 10-K and subsequent quarterly reports on Form 10-Q and any subsequent filings that we may make with the SEC. Our forward-looking statements are based upon information currently available to us, and we do not intend and undertake no duty to update these statements, except as may be required by law. Additionally, we'd like to remind you that during this call, we will discuss some non-GAAP financial measures. The reconciliation of these non-GAAP measures to the most comparable GAAP financial measures is included in our earnings press release, furnished to the SEC, and available on our website. I will now turn the call over to Javier Rodriguez.
spk03: Thank you, Jim, and good afternoon. Q3 was another strong quarter for DaVita in the face of a challenging operating environment. Despite another rise in COVID case counts across the United States and an increasingly challenging labor market, we continue to provide quality care to our patients and execute on our strategic objectives. I want to begin my remarks by highlighting an exciting milestone. We surpassed 15% of our patients dialyzing at home. This means that approximately 30,000 of our patients receive the clinical and lifestyle benefits of home dialysis. As we've explained before, to be a sustainable provider of home dialysis, it requires a comprehensive infrastructure, including convenient and easy access to a home center for training sessions and recurring visits with our care teams. Our current network of centers provides that easy access, such that 80% of our dialysis patients live within 10 miles of a DaVita home center. In addition, we continue to innovate on our platform to help make home dialysis an easier choice for patients and their physicians, and to extend the duration on home dialysis once patients have made that choice. A few highlights of note. First, We recently rolled out an enhanced education program along with supporting technology for our new patients to ensure that they receive timely and comprehensive modality education, which is tailored to each patient's individual needs. We also continue to work on additional enhancements and customizations to our education process for different communities, such as black and Hispanic patients, to improve their chance of selecting this modality and therefore improve health equity. Second, we develop a patient portal and telemedicine platform that supports remote monitoring and communications between DaVita caregivers, our nephrologist partners, and our home patients. Third, we develop a team of industry-leading home physicians to create an expert network which works closely with practicing physicians and practice leaders to help them understand the benefits of home modalities, troubleshooting complex clinical issues, and elevate their home clinical skills. Last, we're testing out our AI and other technologies to optimize PD prescriptions, alerting physicians in real time when an update prescription might be needed. We will discuss the strategic advantage of our platform in greater detail on November 16th on our Virtual Capital Markets Day. On to our Q3 results. Our business model continues to prove resilient in face of operating challenges. Q3 operating income grew approximately 9% year over year, and adjusted earnings per share grew by more than 31% over the same period. However, the ongoing COVID pandemic continues to take its toll on too many human lives in the world at large and amongst our patients. Across the broad U.S. population, the current surge driven by the Delta variant appears to have peaked in early September with new case counts reaching approximately two-thirds of the peak during the past winter. Fortunately, within our dialysis patient population, the new case counts peaked approximately one-third of the winter peak and mortality rates were relatively lower likely due to the vaccination rates amongst our patients. Incremental mortality increased from fewer than 500 in Q2 to approximately 2,000 in Q3. After quarter end, COVID infections continue to decline with our new case count during the week ending October 16th down by approximately 60% relative to the recent Delta peak. Switching to vaccines. Approximately 73% of our patients have now been vaccinated. In addition, we've started to roll out vaccine boosters for eligible patients in accordance with CDC guidelines. We're hopeful that any future COVID surges and breakthrough infections will be more limited relative to what we saw in the peak of last winter. Shifting to cost. Cost management continues to be strong in the quarter. although we are facing the same competitive dynamics in the market for healthcare workers as other companies have mentioned. Despite these challenges, I'm pleased with how our frontline leadership team has been responding. It has long been a key part of our mission to be the employer of choice. How we live this aspect of our mission has been evident throughout the pandemic, as our team has retained relentless focus on the safety and care of our patients, as well as one another. As we have discussed in past calls, we continue to offer a safe and fulfilling work environment and have provided incremental pay and benefits to help our frontline caregivers during this challenging time. These efforts are ongoing. Given the current environment, we expect to provide our teammates with higher annual compensation increases than in typical years. This will put additional pressures on our cost structure, but we believe This will help us attract and retain the talent needed to achieve our long-term objectives. Just as critical, it aligns with our mission and builds on our history of investing in our people. Finally, I would like to say a few words about Integrated Kidney Care, or IKC. Last quarter, we shared details on our planned investment in IKC and long-term opportunity this creates for patients, payers, and our shareholders. At the end of Q3, we now have over 22,000 patients in some form of integrated care arrangements representing $1.7 billion of value-based care contracts. Next year, we expect to approximately double the size of our IKC business, driven primarily by our participation in the federal government's new CKCC program. While it is still early and contingent on successful execution, We believe that the investing in IKC represents a new and potentially meaningful earnings opportunity for us in the coming years. This is another area we plan to discuss in detail at our upcoming virtual capital markets day. With that, I will turn it over to Joel for more details on the quarter.
spk02: Thanks, Javier. Despite the operating challenges Javier referenced, we delivered another quarter of strong results. Operating income was $475 million and earnings per share was $2.36. Our Q3 results include a net COVID headwind of approximately $55 million, an increase relative to the quarterly impact that we experienced in the first half of the year. As Javier mentioned, the latest COVID surge resulted in excess mortality in the quarter of approximately 2,000 compared to fewer than 500 in Q2. We're also anticipating the mortality in Q4 to be higher than it was in Q2, although we've seen a decrease in the last few weeks that we hope continues. Our current view of the OI impact of COVID for the year is worse by approximately $40 million compared to our expectations from last quarter. For 2021, we now expect a total net COVID impact of approximately $210 million. Treatments per day were down by 536 or 0.6% in Q3 compared to Q2. The primary headwind was the increase in our estimated excess mortalities and higher mistreatments as a result of the COVID surge. In addition, the quarter had a higher ratio of Tuesday, Thursdays, Saturdays, which lowered treatments per day for the quarter by approximately 300. In light of the current Delta surge and the compounding impact of mortalities on our year-over-year growth, we believe that the timing of a return to positive NAG will now be delayed into 2022. Revenue per treatment was essentially flat quarter-over-quarter. Patient care cost per treatment was up approximately $5 quarter-over-quarter, primarily due to higher teammate compensation and benefit expenses. This is the result of higher wages, additional training costs associated with an increase in our new hires, and seasonality in health care benefit expenses, which we expect to continue into Q4. Our integrated kidney care business saw an improvement in its operating loss in the quarter, which is due primarily to positive prior period development in our special needs plans. We continue to expect increased costs in Q4, especially in our projected CKCC markets as we ramp up staffing in preparation for 2022. DSOs for our U.S. dialysis and lab business increased by approximately three days quarter over quarter, primarily due to fluctuations in the timing of billing and collection. Other loss for the quarter was $7.6 million, primarily due to a $9 million decline in the mark-to-market of our investment in Miro Matrix. The value of this investment at quarter end was $14 million. Now turning to some updates for the rest of the year and beyond. As I mentioned on the Q2 earnings call, we excluded any impact of a significant surge in COVID from the Delta variant in our revised guidance. but noted that a wider range of outcomes was possible, depending in part on how a fourth surge would develop. Now that we've seen the impact of the Delta surge, we are increasing our estimate of COVID impact for the year by $40 million. Given where we are in the year, we are now incorporating this COVID impact into our revised adjusted OI guidance of $1.76 billion to $1.81 billion. We are also narrowing our guidance for adjusted EPS to $8.80 to $9.15 per share. And we are maintaining our free cash flow guidance of $1 billion to $1.2 billion, although there is some chance that our free cash flow may fall below the bottom end of the range depending on the timing of our DSO recovery. Our revised OI guidance implies a decline in our Q4 financial performance relative to Q3. This is partially explained by the incremental COVID mortality impact and by expected higher salaries and wages for existing frontline teammates. Our guidance anticipates Q4 operating income to be negatively impacted by approximately $75 million of seasonally high or one-time items, including certain compensation expenses, elevated training costs, higher health benefit expenses, and G&A. Looking ahead to 2022, The three expected headwinds I talked about on the Q2 earnings call remain. As a reminder, we expect to have added expense related to DeVita's portion of the industry effort to counter the ballot initiative in California. We anticipate a year-over-year incremental investment in the range of $50 million as we continue to grow our IKC business. And we will also begin depreciating our new clinical IT platform, which we expect to be approximately $40 million. A few additional things to help you with our thinking about 2022. COVID remains a big uncertainty. We are anticipating the end of the temporary sequestration suspension, which would be a $70 million headwind for the full year. We also expect that some of the costs that spiked during COVID, in particular PPE, may not return as quickly to pre-COVID levels due to the challenges of the global supply chain. Finally, COVID's impact on mortality next year remains a large swing factor. Another winter surge would negatively impact treatment volume and could delay the timing of achieving positive NAG. If the recent surge proves to be the last significant COVID surge, then we would expect a tailwind from lower than typical mortality, which could result in treatment growth higher than pre-COVID level. In 2022, we expect net labor costs will increase more than in typical years as a result of market pressures. Our current estimate is a net headwind of 50 to $75 million. We expect to offset a significant amount of these incremental costs with continuing MA penetration growth above historical levels and strong management of non-labor patient care costs. From an operating income growth perspective, we expect 2022 will be a transition year with some significant but largely temporary headwinds to get through, after which we expect our platform to continue to support strong profit growth. While the range of potential outcomes for 2022 is broad, a reasonable scenario could result in an OI decline of $150 million from our 2021 guidance. This includes the impact from the expected ballot initiative, IKC, and the increased depreciation. This scenario also includes a modest headwind from COVID although there are scenarios where the impact of COVID could be significantly worse. Looking forward to 2023, we anticipate a reversal of the net impact of these 2022 headwinds, plus incremental operating income growth, such that we expect 2023 operating income to show a low to mid-single-digit CAGR from the midpoint of our updated 2021 guidance. which would be in line with the multi-year outlook we have shared historically. We expect this to be the result of the lack of ballot initiative-related costs, the recognition of savings in IKC, an improved COVID situation, and continued growth of the core business. We'll have more to say about long-term guidance at our Capital Markets Day in a couple of weeks. During the third quarter, we repurchased 2.7 million shares of our stock, and in October to date, we repurchased an additional 1.2 million shares. Operator, please open the call for Q&A.
spk08: Thank you. At this time, if you would like to ask a question, you may press star followed by the number one. To withdraw your questions, you may press star two. One moment, please. Justin Lake from Wolf Research. You may go ahead, sir.
spk01: Thanks, and thanks for all the color here. Let's start on the fourth quarter. You're talking about, you know, it sounds like most of the $40 million of incremental COVID costs are actually happening in the fourth quarter. Is that correct?
spk02: um most yes but there was some in uh in q3 as well so i would think of q3 is 55 million and if you take the number we gave for for covet for the full year what would be left is about 85 million for q4 okay and then can you help us on the mortality side what you're seeing there and
spk01: You know, how much of that $40 million or, you know, maybe we even talk about the $75 million that you talked about in terms of higher costs, how much of that's coming from mortality?
spk02: Yeah, so what we've seen in mortality is a pickup in Q3 to about 2,000 excess mortality. Remember, we were below 500 in Q2, and there's no doubt the Delta surge has came on significantly. bigger than we expected, and we expect that to continue in to Q4 a bit. So if you look at, if you're trying to triangulate in on growth, what you see for the quarter, Q3 over Q2, is treatment growth per day that's down a bit. That's largely the result of the excess mortality. There were more Tuesday, Thursday, Saturdays than Monday, Wednesday, Fridays, and that was about a 300% treatment per day headwind in the quarter as well so that's the those are the numbers behind it in terms of the the financial impact from covid what you're seeing is definitely uh the excess mortality that hits in q3 it hits even harder in q4 you're also seeing some increase in mistreatments which we've seen in prior surges and we're anticipating in Q4 again. And then you also see some increased labor costs associated with cohorting and stuff like that. So that's how I'd lay out the impact of mortality and other things on COVID in Q3 and Q4.
spk01: Okay. And then in terms of the – You know, this $75 million, is any of that, you know, it sounds like some portion of that's one time. So is this not, you know, the kind of implied Q4 OI? Is that a reasonable run rate or is there, you know, to kind of jump off of? Or is there some one-time cost within that $75 million that kind of jump you off a bigger basis?
spk02: Yeah, so I would think of the 75 as coming in two forms, either one-time or seasonal pickups. The one-time things I'd call out are some comp bonus type stuff, and then training is up when we hire new teammates. That tends to lead to a higher training number. So those are the one-time things in the 75s. And then there are some seasonal items. There's a seasonal benefit impact in Q4 and also a seasonal increase in G&A. Those are things we tend to see in most years, and they're a bit exaggerated this year as a result of the patterns resulting from COVID. But to get to your fundamental question of what's a good jumping off point for next year, I think the full year number is for 2021 is a reasonable baseline off of which to jump off for next year. If you took Q4 and adjusted for the $75 million, you'd get to about the same spot.
spk01: Got it. If I could squeeze in one more, you talked out to 2023, and a lot of this stuff makes sense in terms of kind of transitory costs, but you talked about two pieces here, IKC savings Right. So you talked about 2022, you're going to have $50 million of incremental losses. How much better does IKC, you know, what's the tailwind in 23 there? And then you talked about improved COVID. Can you talk about the tailwind there in terms of sizing that? That'd be really helpful.
spk02: Sure. So I'll start with a caveat that 2023 is a long way away. And we're, we're, we're even cautious about talking about 22, given the uncertainty that, So I wouldn't think of this as guidance, but just some reasonable estimates to help you think things through. So on IKC, I think a $50 million reversal of the headwind we're seeing in 22 is a reasonable way to think about 23. So basically winding up in 23 about where we are in 21. COVID is really, really hard to think about. That said... If you assume that COVID disappears at some point next year, I think the right way to think about it, and now I'm bridging basically from 21 to 23, is we've got a $70 million sequestration suspension that becomes a tailwind, right? We're getting all of that in 21 years. That goes away in 22 and stays away forever. So there's a $70 million headwind there. We've got roughly a comparable number of net expenses associated with COVID. Think about labor. think about the increased spend on PPE with some offset related to T&E primarily. And that net number is a $70 million number today. So as that dissipates, what you've really got is effectively a tailwind from that that offsets the headwind from sequestration. And what you're left with is mortality. And Mortality today is on a run rate basis somewhere in the $240 million number, and what we would expect is over some long period of time, four, five, six, seven years, for that number to go to zero. So as that $240 million headwind we've got today dissipates, then... you would see that coming back into earnings over time. So that's the COVID story. Thanks for all that.
spk03: Great. Thank you. And then I'll just add one thing. As you're finishing your bridge, Justin, don't forget that there's a $60 million California ballot that's going to be in 22. Sorry, yeah, in 22. It won't be in 23. That's another... A helpful number to bridge, too. Thank you. Thank you. Okay, Michelle.
spk08: Thank you. Kevin Fischbeck from Bank of America. You may go ahead, sir.
spk05: Great. Thanks. I want to maybe follow up on that last question. That mortality number, Joel, I guess you're talking about, you know, four to maybe seven years getting that back. I guess that might be a little bit longer than I might have thought of a time period to think about that number coming back. I mean, why wouldn't it be something more like three years rather than four to seven?
spk02: Yeah, so, Kevin, first of all, you might be right. And I think there's likely to be a tail to it, right? And we don't know how long that tail is. But there is certainly a very reasonable scenario where most of that bounce back comes back quicker, certainly quicker than seven years and potentially quicker than four years. So it probably doesn't come back evenly over whatever number you choose. And I think there's reasonable logic to say you get more early on in that period and the tail gets a little thin towards the end. So- I'd say you could be right in terms of getting most of it in three years.
spk05: Okay. That's helpful. And then I think you mentioned that because of the COVID spike, you now don't expect NAG to get back to positive until next year. I forget what, I guess maybe I don't remember if you said that you thought it was going to happen by year end or not, but I guess that's, Is that how we should think about it, that you had the last spike in Q1 and then you thought you might have been able to get back to positive by year end, and now that we have one in Q3, maybe three-quarters later, we'll get to positive NAG? Is that the right waiting period?
spk02: I think that's a good start for thinking about it, although the size of the spike also impacts how long it takes us to get back to positive. a positive NAG because if the spike is lower, our natural growth can kind of overcome that in a shorter period of time. As I've said, I think, on prior calls, I've found thinking about quarter-over-quarter treatment-per-day patterns to be a much easier way to think about what's going to happen to our volumes and then ultimately revenue over the next few years NAG can be a little bit of a clunky number when in times like this where there's so much volatility.
spk05: Okay. And then the last question you mentioned kind of doubling the size of IKC. And, you know, it's not like a big portion of that with the government program. I guess, is there a way to break out, you know, your view about growth in MA versus the new programs?
spk03: Sure. Well, right now what we're seeing is that more patients are reviewing their insurance and selecting MA. And so if you were to look at the broader population, I think the last number I saw in non-kidney is around 43% of patients are choosing MA. Our number is now getting close to that. We're roughly around 41%. And so as MA grows, of course, that's likely to be a big feeder into the risk because those plans are coming to us and wanting the contract. As it relates to the government, we are in the final stages here of sizing the practices that are really going to enroll and therefore attribute their patient. But our estimates have been both doubling roughly from what we have now. And we'll give you information as it plays out.
spk05: Okay. Again, so if MA is already kind of at penetration, the doubling then is from just moving contracts with MA plans that you already have from a fee-for-service to an IKC-type structure? Yes.
spk03: Yes, so more plans are wanting to have IKC-type structures. Correct. Correct.
spk05: Okay. And then this last question on that, unless then, um, is there anything different or these contracts coming together, you know, quickly? So we think about timing of all this stuff, you know, this, this year is the first year. So I could see a lot of companies dragging their feet. Would you expect to largely have penetrated that contract opportunity with an MA plans or, you know, what percentage of your MA contracts would be this type of arrangement? you know, next year? And when would we expect to see, you know, the vast majority of them do that type of arrangement?
spk03: Yeah, I think it's specific by payer. It's quite customized. As we all know, payers have different strategies and different cadences as to where they put their focus. Again, the range of contracts and structures from anywhere from fee-for-service, paid-to-performance, gain-shared, shared-risk, all the way to full-risk. is basically customized by payer. So the cadence is really customized. We're ready to go, and so we're talking to them, and there's nothing really interesting to report on timing, per se. It's steady and constant.
spk05: Okay, so it's not like a huge jump next year. It's constant growth and increasing that number is the way to think about it.
spk03: We're not forecasting any drastic change. Perfect. Thank you. Thank you.
spk08: Our next question comes from Pito Chickering from Deutsche Bank. You may go ahead, sir.
spk06: Hey, good afternoon, guys. Let's take my questions. I follow up to Justin's questions. And forgive me, there are a lot of numbers sort of on this call. If we take the midpoint of OI guidance for 2021 and put a 4% CAGR on that, for 2023, you get to that $1.93 billion mark. of operating income, how much that comes from IKC versus core dialysis, and how does IKC change the low to minimal digit category of OI going forward?
spk02: Yeah, so in terms of how much of the OI in 23 comes from IKC, again, with all the caveats about uncertainty and everything else, you're really going to see no change in OI and IKC from 21 to 23. That's, again, that's a reasonable scenario from where we are. So if you think about OI growth, you know, total OI growth 21 to 23, you basically see a zero in that scenario from IKC.
spk06: Okay, so that sort of 4% OI growth sort of tagger for the next two years, that is 100% coming from core dialysis at this point.
spk02: Yeah, I think, you know, the right way to think about it is it's largely coming from core dialysis. We've called out a bunch of headwinds and tailwinds. The ones from ballots and IKC kind of offset each other, so they're a net zero. The the depreciation from our new clinical IT system stays with us, and you'll have a tailwind from COVID.
spk06: Okay, so let me just work these numbers for a second. If I take, again, the OI from this year, that's embedding $120 million of losses from IKC. You're saying that by 2023, we'll still run $120 million of losses through the P&L on the IKC?
spk02: Right. What we're effectively saying is the 120 in 2021 goes to 170 next year, and that's one of the big headwinds for next year, and that reverses itself in 23.
spk06: Okay, so the full 170 reverses or just the 50 reverses?
spk02: No, just the 50. Okay, got it. Ultimately, our expectation would be the full 150 would reverse itself and the business would become profitable, but it wouldn't happen all in 23.
spk06: Okay. And then from a labor side, as you sort of think about 3Q and 4Q, cost for treatment, how much of this is transitory from premium labor versus wage inflation, which will continue in 2022? And can you remind us sort of what your normal wage inflation was and kind of what we should be thinking about for 3 and 4Q?
spk02: Yeah, so the numbers in Q3 and Q4, there is some wage inflation, but where you're really going to start seeing that is next year. And I know I went through a lot of numbers quickly in the script. What we called out at the beginning of the call was a 50 to 75 million net labor headwind next year. And that would be wages, it would be training, and there could be potential offsets from benefits or productivity and stuff like that. But I think the right number for next year is a net headwind, given the challenging labor environment, of $50 million to $75 million.
spk06: Okay, fair enough. For IKC, will you plan to break out sort of the revenues and costs per patient at some point so we can help model out how that's tracking?
spk02: Yeah, I think we're on a bit of a path to continue to create a disclosure package around IKC that'll give shareholders the visibility they need into our progress.
spk06: Okay, and then the last question for me, you know, there's a billion dollars of cash sitting in the balance sheets right now. How much cash do you guys need to run the core dialysis and now, you know, the new IKC that grows in 2022? and how much we think about that going back to the repo at this point. Thanks so much.
spk02: Yeah, so I would think about us typically needing somewhere around $300 million of cash on the balance sheet just to run the business. I don't think that number will change significantly with IKC. We're not a regulated entity. We don't have statutory capital requirements.
spk06: Okay, so then it's fair to think about, you know, $700 million of excess cash being used for share repo sooner rather than later.
spk02: I'd say yes on the $700 million of excess cash. Look, we've clearly been buyers of the stock. We bought more than usual since the last earnings call. As we've said in the past, we're not agnostic on price. If we like the price, we will buy more.
spk06: Great. Thanks so much.
spk08: Thank you. Sarah James from Barclays, you may go ahead.
spk07: Thank you. And I appreciate all of the color about 22 as a whole, but I'm hoping that you could give us a little bit more on the cadence of how the year will roll out. So some of those headwinds, are they starting at the beginning of the year or later on? And then on the labor cost side, we've heard some of the acute guys talking about labor costs improving in the back half of the year and just wasn't sure if that's what you were anticipating in your guidance as well.
spk02: Sure. So on labor timing, I don't think we have a particular view about the macro economy and the labor market and how that's going to play out. So I don't have anything to add there. IKC, I think you'll see a lot of that starting in the beginning of the year. You'll actually start seeing some of that in Q4, but it's certainly – could build up over the course of the year. If the ballot initiative is similar to what we've seen historically, it plays out largely in Q3, although there can be pieces in other quarters. The depreciation number I've talked about is probably likely to be more of a back half of the year event. You might see some in Q2, but it'll be back end loaded. And COVID is complicated. The sequestration, assuming it goes away, will happen on 1-1, so there'll be a big hit related to that starting in January. How exactly the other costs roll out, hard to predict, although net-net, you'd probably see that improving as the year goes on, although not that big a number. And I'm not sure how to even help you with the mortality figure. Historically, even when mortality comes down, it still accumulates. Next year, if there is no winter wave and COVID overall begins to go away, I think you'd expect to see that starting to improve over the course of the year. I hope that helps.
spk07: No, that's very helpful. Thank you. And just one more here on labor. Can you give us any more color on where you're seeing that labor pressure most acutely? So is it in a certain skill level or type of position that you're seeing it? And then how material is that class of employee to your overall SWB expenses?
spk03: Sir, I wish we could point to one, but the reality is while it is more acute in certain geographies, it is very widespread and across most of our clinical teammates. And so it is wide and many geographies.
spk07: Got it. Thank you very much.
spk03: Thank you.
spk08: Thank you. And as a reminder, if you would like to ask a question, you may press star one. To withdraw your question, you may press star two. Our next caller is Lisa Clive from Bernstein. You may go ahead.
spk09: Hi there. Two questions for me. Just on the wage inflation. So Medicare is obviously inevitably delayed in how their rate updates come through. Could you just give us some information on the rate adjusters in your private contracts? Is it similar to Medicare where they're set once a year and are looking at metrics that are somewhat backdated? And then the second question on integrated care, you know, the $120 million of losses still in 2023. I'm just trying to understand this and really sort of thinking about scaling up that program. CKCC is obviously one major driver. How big do you envisage that program getting and I suppose what does the ramp up look like?
spk03: Let me grab the first part and then Joel can supplement. First, in case it's useful, Medicare has a basket update and the way it's calculated is not looking at pure dialysis and what's happening to cost either retrospective or prospectively, rather, there's an economic firm that forecasts inflation, and then they subtract what they call a productivity adjustment, which in essence is a 10-year average that's trying to measure the efficiency of the economy. So as you can imagine, that's got some complexity. As it relates to the commercial business, the way it's done is usually through a negotiated process. way, and so every single one of them is negotiated individually, and the timing tends to be effective whenever the contract was signed. And so if you think of a contract that was signed in February, usually the annual escalator would be done in February of the next year. That's the most traditional way of doing it. Of course, there can be other ways that have a pay-for-performance or other mechanisms. But in general, that's how that works. As it relates to your second question on CKCC, the short answer is we don't know. For right now, it's a CMMI pilot, and so it's authorized for two years. Of course, the intent is to try it out and see if it's effective and if it works for the system. and if we're doing well by the patients and then I would assume that then Medicare would try to extend it. We try to think of a world where hopefully you get to somewhere in the 30,000 patients in one way or another being through MA or a CMMI vehicle, but we will see.
spk08: Thank you for that.
spk03: Thank you, Lisa.
spk08: And our next caller is Pito Chikering from Deutsche Bank. You may go ahead, sir.
spk06: Hey, guys. Thanks for the follow-up here. I sort of want to go back to the IKC losses in 2023. I'm just struggling a little bit on the $120 million of losses you guys are assuming that we'll have there. When the ESCO program you guys have been running showed savings right out of the gate, help me understand why we'll still see $120 million in IKC three years out when ESCO is profitable on year one. Thanks so much.
spk03: Well, let me just grab the high level, and then, Joel, you can supplement with numbers. The best way to think of the ESCOs is actually not that they were profitable, but what the non-diosis savings were actually quite good. But then, of course, you have to apply the operating model, and then you have to load the GNA. And now, in the models that we have, we also have to share with partners. And so that's how the number sort of trickles down. And you have to get to scale. And so a good way of thinking is that once you do all that and you go through all those iterations, you probably will get to a low single digit OI number. And depending if you're grabbing non-dialysis, I would think of it somewhere in the three-ish percent or so. If you're thinking of the entire number, it's one and a half or so because it's It's roughly half dialysis and half the other non-dialysis costs. But in the ESCOs, when you fully load them, we didn't make money. Rather, people were measuring whether it was effective at reducing non-dialysis costs.
spk02: Yeah, Peter, the thing I'd add there, Javier paints kind of the end game there. The question is, how do you get there? And the thing I would remind you is in The costs all come up front. You're paying for the model of care to deliver the savings. You're paying for the G&A. You're building capabilities. The revenue is delayed, and we won't see any revenue in year one. Year two, we'll start to see some, but the number will grow over time as the effectiveness of the shared savings continues to grow. there is not a good matching of revenue and cost, especially in the end years. So part of it is the investment and the scale that Javier talked about. Part of it is the delay in the revenue.
spk06: Okay, thanks.
spk08: Thank you. Gary Taylor from Cohen, you may go ahead, sir.
spk00: Hey, good afternoon. Just three quick ones. Joel, did you ever give us the quarterly step-up in depreciation that you've mentioned a few times, but I don't know that I have it quantified for the credit system?
spk02: Yeah, it's $40 million is the annualized number, Gary, and it'll probably start sometime in Q2, but you'll see most of it in Q3 and Q4. Okay.
spk00: Just making a note. The other is, anything happening on, you cited commercial, favorable commercial mix a couple quarters in a row. Is there anything happening there besides the Medicare mortality that's changing that, that's worth calling out?
spk03: No. I think there's been a very much an appreciation during the pandemic that people want to keep their insurances and they value it, and so it's been very resilient and constant.
spk00: Got it. And then my last one is going back to, Joel, going back to 2023. So if we take 2021, we walk it down $150 million, but then we're getting back to low to mid-single-digit CAGR and towards 2021, towards that 1.9 and change for 2023, that's about a $300 million step up from 22 to 23. So the parts of that would be an incremental $50 million IKC, $60 million reduction advocacy spend, some low to mid-single digit organic, and then the rest of that whole would be some portion of this gross COVID mortality and direct expenses coming down? Is that the other big part? You got it exactly right. Okay, perfect. Thank you.
spk08: Thank you. Lisa Clive from Bernstein, you may go ahead.
spk09: Heather, I just wanted to follow up on the private contracting. In terms of the structure of how the rate increases work, so if you have a, say, four-year contract, are the rate adjustments for all four years fully fixed at the outset, or is there any ability for those rate adjustments to increase if there is higher inflation, as you're clearly experiencing now, or are they just fully set as a percentage increase and that's that over the course of the contract?
spk03: Most of them are fixed, Lisa. Some of them you have to earn your way to them so they can fluctuate year over year depending on performance, but most of them are fixed.
spk09: Okay, but they would vary based on performance, not on your underlying cost structure.
spk03: Correct. Sometimes you could have, of course, something that's linked to an index or something like that, but in general it's defined. and understood. Okay, that's clear. Thanks. Thank you.
spk08: And at this time, I'm showing no further questions.
spk03: Thank you, Michelle. Well, we've covered a lot, so let me just try to summarize as cleanly as I can three takeaways. Number one, our core business is strong. Number two, 2022 will have a lot of temporary OI decreases that will correct back to historical OI in 23. And then point three, our teams are working really hard on innovation to deliver on the integrated care dream. We look forward to discussing our strategy in more detail on November 16th during our capital markets day. and talk to you then. Be well, everyone.
spk08: And thank you. This concludes today's conference call. You may go ahead and disconnect at this time.
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