DaVita Inc.

Thank you for standing by. My name is Colleen, and I will be your conference facilitator today. At this time, I would like to welcome everyone to the VITA fourth quarter 2018 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 session. At that time, to ask a question, please press star followed by the number one on your phone, and to cancel your question, press star followed by the number two. Mr. Gustafson, you may begin your conference.

Thank you, Colleen, and welcome, everyone, to our fourth quarter conference call. We appreciate your continued interest in our company. I'm Jim Gustafson, Vice President of Investor Relations, and with me today in the room are Ken Theory, our CEO, Joel Ackerman, our CFO, Javier Rodriguez, CEO of Davida Kidney Care, Jim Hilger, our Chief Accounting Officer, and Leanne Zumwalt, Group Vice President. Please note that during this call, we may make forward-looking statements within the meaning of the federal securities laws. All of these statements are subject to known and unknown risks and uncertainties that could cause the actual results to differ materially from those described in the forward-looking statements. For further details concerning these risks and uncertainties, please refer to our fourth quarter earnings press release and our SEC filings, including our most recent annual report on Form 10-K and quarterly report on Form 10-Q. 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. Additionally, we'd like to remind you that during this call, we will discuss some non-GAAP financial measures. A reconciliation of these non-GAAP measures to the most comparable GAAP financial measures is included in our earnings press release, submitted to the SEC, and available on our website. I'll now turn the call over to Ken Ferry, our Chief Executive Officer.

Thank you, Jim. As you probably already noted, we had solid fourth quarter results that were consistent with prior communications. And, of course, JR and Joel will discuss those in greater detail a little bit downstream. But we are first and foremost a caregiving company. And so, as usual, we will start by talking about a clinical highlight today, antibiotic stewardship. As many of you know, dialysis patients are highly prone to to infections. We have continued to get better at supporting evidence-based prescribing of antibiotics, which has a couple of benefits, including reducing harm to patients from excessive antibiotic use and also preventing the emergence of antimicrobial resistance. This is something that all caregivers should be doing across American and global healthcare, and we're proud that we're getting better. In fact, in 2018, Among patients with symptoms of bloodstream infections, we actually decreased IV antibiotic starts by 12% while maintaining all clinical quality. This is important not only in terms of what we did this year, but we continue to collect data to improve our ability to do even better in the future. Now a quick update on the DMG transaction. We are working closely with Optum to obtain FTC approval, which of course is necessary. The timing of the process was very negatively impacted by the government shutdown, as it was for so many other transactions, and we cannot speak definitively to timing for all the reasons we haven't been able to do that up to this point and all the same reasons that other companies involved in other transactions cannot, but everybody's working very diligently to move that ball forward. In addition, some good news is that in 2019, the DMG financial performance will improve, is expected to improve, significantly. There are a number of very tangible reasons for this. One, for example, is significantly better Medicare Advantage rates than in prior years. Number two, the elimination of the health insurer fee is a dollar-for-dollar significant pickup. Number three, the dollar-for-dollar elimination of considerable consulting expenses incurred in 2018 that will be gone in 2019. And fourth, the number of operating improvements and investments that we made in prior years that are bearing So the net is that 2019 NDMG will be significantly better and is expected to be significantly better than 2018. Now over to Javier for a summary of our kidney care business.

Thank you, Kent, and good morning, everyone. Today I will cover two topics. First, I'll provide a recap of our financial performance, and second, I will discuss the legislation recently introduced in California. For the fourth quarter of 2018, our results are in line with our guidance. Adjusted operating income was $370 million for the quarter and $1.513 billion for the full year. Our 2018 operating cash flow from continuing operation also came in line with guidance at $1.48 billion. Related to cash flows, our 2018 CAPEX spend came in better than our guidance and we're guiding to a lower spend in 2019. There are several drivers of this declining CAPEX spend, two of which are worth calling out, as they should decrease the CapEx spend on new centers in the next couple of years. First, we continue to focus on driving the right modality for our patients. For many of them, dialyzing at home may be the best option. Now that we have a more secure supply on PD products, we anticipate more patients will be able to choose home dialysis. In fact, in 2018, we trained and educated over 13,000 new home patients. As you know, home growth has an incremental benefit of being more capital efficient. Second, as we mentioned earlier this year, some recent data suggests that ESRD industry growth may be slowing. While we don't know whether this is a short-term impact of increased transplantation availability or whether there is a long-term implication, in the immediate term, we plan to build fewer centers to keep pace with patient demand. Next, as many of you know, Q4 includes open enrollment decisions for many of our patients. Overall, we observe stable results from open enrollment, which is consistent with our expectations. In the individual markets in particular, we saw slightly higher re-enrollment than we experienced over the last couple of years. We believe that these results set us up to deliver on 2019 guidance we shared last month, which Joel will cover later. Now, let me transition to a legislative update in California. a member of the Assembly has reintroduced effectively the same legislation as last year's SB 1156, which was vetoed by the Governor because of the potential harm to patients. This new bill, AB 290, seeks to impose rate cuts on dialysis providers for their support of premium assistance charities and impose restrictions on charitable premium assistance for patients with preexisting conditions and end-stage renal disease. Our coalition of dialysis patients, physicians, and caregivers in California will, of course, fight to defeat this ill-conceived bill. Finally, let me finish by saying that we continue to build our integrated care capabilities, which are helping us care for patients in a more holistic way. Let me provide a couple of examples. First, we've developed a predictive model that incorporates lab data, dialysis treatment data, and claims data to determine which patients are at a highest risk of hospitalization over the following month. Second, we now have a team of nurse practitioners dedicated to addressing a broad range of primary care needs on a more real-time basis for our patients. We believe that these capabilities will improve the quality of life of our patients while reducing costs to the system. And, of course, we look forward to providing this coordinated care to many more patients in the future. So in summary, overall, solid quarter, and we continue to focus on delivering high-quality care for our patients. Now on to Joel for financial details on our results.

Thanks, Javier. Let me walk you through some components of our U.S. dialysis and lab segment. First, growth. Our treatment per day growth in Q4 was 3.1%, and normalized non-acquired growth was 2.6%. as we continue to see a decline in volume growth. We continue to expect non-acquired growth to range between 2.5 and 3.5 percent in 2019. Next, on revenue. Revenue per treatment was down 65 cents from Q3 to Q4. If you exclude the impact of calcium emetics, revenue was up a little more than $1 per treatment sequentially. To give some perspective on this for the full year, Commercial RPT for the year was down approximately 1% as we shifted out of network business to in-network, which offset commercial rate increases that we've achieved across much of the portfolio. For the year, commercial mix was down approximately 10 basis points, from 10.5% in 2017 to 10.4% in 2018. We believe that our decline in mix was consistent with the demographic headwinds that we have previously outlined. Finally, on revenue, our strategic initiative revenue was negatively impacted by our previously announced wind-down of DaVita Rx. DaVita Rx revenue was down approximately $100 million quarter over quarter, and Q4 is reflective of the go-forward run rate. On costs, patient care cost per treatment was up $1.26 quarter over quarter, primarily due to an increase in professional fees. Dialysis and lab segment G&A was down quarter over quarter approximately $4 per treatment, $2 driven by a decrease in advocacy spend, and the remainder due to normal quarterly spending fluctuations. For international, we achieved a slightly positive adjusted operating profit for the quarter, excluding the FX impact of our joint venture in Asia. We expect positive operating income from international operations in 2019, excluding any FX impacts, which is incorporated in our enterprise guidance. For the fourth quarter, our effective tax rate on income attributable to DaVita from continuing operations was 24.3%, and for the year it was 29.2%. The effective tax rate was unusually low for Q4, as a result of the positive quarterly true-ups for our federal, state, and international accruals. It's unusual that all of these moved in the same direction in one quarter. Now on to cash flow. Operating cash flow from continuing operations was $307 million for the quarter and $1.48 billion for the year, in line with our previous guidance. I'll conclude by reiterating our 2019 guidance. We expect operating income to be between $1.54 and $1.64 billion. As a reminder, the first quarter has seasonally low operating income as the quarter is shorter with 76.6 treatment days, meaning lower treatment volumes and fewer treatments over which to absorb the fixed costs. Q1 has higher seasonal payroll taxes. Our 2019 guidance includes the following expectations. Three to four percent U.S. total treatment volume growth, zero to one percent U.S. revenue per treatment growth, and one half to one and a half percent U.S. cost per treatment growth. We are initiating 2019 guidance for operating cash flow from continuing operations for the year to be $1.375 to $1.575 billion. In 2019, we expect $800 to $840 million in CapEx from continuing operations. This range includes CapEx for self-developed real estate projects that are offset by proceeds from the subsequent sale-leaseback transactions. We expect approximately $100 million of proceeds from self-developed projects in 2019, leading to net spend of approximately $720 million at the midpoint. For comparison purposes, in 2018, our CapEx firm continuing operations was $902 million, and we received proceeds from sale-leaseback transactions of $45 million, for a net of $857 million. You can see the historical detail in Section 6 of our supplemental financial data in our earnings release. Finally, we expect our effective tax rate on income attributable to the VITA from continuing operations to be 28.5 to 29.5 percent. As always, our guidance captures a majority of probabilistic outcomes although there are scenarios in which we could end up above or below the estimates provided. Now I'll turn it over to Kent for some closing remarks. I'd like to just make a few comments.

Number one, please be reminded that the next few years, Medicare year-over-year fee-for-service rate increases will be better than the almost zero increases over the last few years. Second, the international business now has a foundation on which we can expect year-over-year OI contributions rather than offsets. Number three, we continue to generate strong cash flows, and they are, in fact, incrementally better than some of the prior years. And four, we are very well positioned to be a differentiated, high-value-added provider of integrated care for these needy and expensive patients. Operator, let's switch to Q&A, please.

Thank you. We will now begin the question and answer session. To ask a question, please press star followed beta number one on your phone. Unmute your phone and record your name clearly when prompted. And to cancel your request, press star followed beta number two. The first question comes from Kevin Fishbeck, Bank of America. Your line is now open.

Great. Thanks. I guess we want to start off with DMG as a question. I appreciate that you can't say exactly when it's going to close, but I didn't hear a comment from you that you're still confident that it's going to close. I just want to make sure that, from your perspective, everything is still on track and it's just a matter of timing at this point?

Yes.

Okay, great. And then I wanted to talk a little bit more about the slowdown in growth that you're seeing and expecting from a treatment perspective. I think you mentioned something about factors that may or may not be temporary. Can you talk a little bit about what those factors are and if there's anything else that you're thinking about when thinking about what organic growth should look like?

Yeah, thanks, Kevin. This is Javier. We started to see a bit of a slowdown on new starts in the back end of the year, and that's why when we provided guidance, you saw the number came down to 2.5 to 3.5 of non-acquired growth Some of the factors that are still in play are what's happening upstream with other comorbid conditions and how that is impacting how many patients have ESRD. And another dynamic is how many organs are going into the transplant pool as the number of organs has picked up due to the opioid crisis with many people being young and having healthy kidneys. So there's a lot interplay, many dynamics upstream, and so we're trying to see if they're short-term or if they're going to be longer-term.

Okay. But from your perspective, the new starts that you're doing over the next year, is that going to position you for in-line industry growth, market share gains, market share losses? How are you thinking about that?

I'm sorry, are you asking how we're positioned within that growth?

Yeah, so your guidance of 2.5% to 3.5%, does that mean that you expect to gain share, or are you going in line with what you think the market overall should be growing?

In the last couple of years, actually not the last couple of years, maybe the last couple of decades, we've outperformed a non-acquired growth. We believe that there's nothing in the data that would say that we would not do that. And so right now we're just looking more at the market dynamics overall.

Okay. And then maybe last question for now. On the commercial mix, I think you said that, you know, mix was down 10 basis points year over year in line with kind of what you would expect in all demographic trends to kind of argue for. But I think your guidance assumes that actually mix will be relatively flat. So I'm not sure. if the demographics point to a decline each year, how you're thinking about being flat in 2019?

So, Kevin, it's Joel here. The demographics are certainly a headwind, about 10 basis points a year. We see opportunities to offset the headwind through upstream education of patients as well as helping them with their insurance once they've come on dialysis. So we see opportunities to offset the headwind, but we do see the headwind persisting.

Okay. All right. Great. Thank you.

Thank you, Kevin.

Thank you. And our next question comes from Justin Lake, Wolf Research. Your line is now open.

Thanks. Good morning. First, let me follow up on Kevin's question around the deal close. I understand the government shutdown delayed everything, but the last thing you had talked about was expecting the deal to close in the first quarter. So with the government shutdown about 30 days, that would take us out to end of April. Is that still kind of where you would expect, or do you feel like the first quarter, even after the government shutdown, things have changed?

Yeah, so Kevin, it's Joel here. We are certainly still trying for Q1. That is a real possibility, but the government shutdown has certainly lowered the odds of that happening.

Is there anything new besides the shutdown that would change that trajectory?

Justin, there's always a lot going on. So to say nothing new would suggest that nobody's doing any work, nobody's asking any questions, but Joel's answer still applies. We're hard with the goal that he cited.

Okay. And then on the California legislation, just given this is the second time they're coming here and they've got a governor that might be more likely to actually sign this legislation if it gets passed, I'm curious if you can help us put a range around the potential financial impact that we should think about for 2020 if this legislation does pass.

Yeah, Justin, as you can imagine, the legislation moves and there's different ways to interpret. And, of course, you can never predict how it'll play out. But to try and be constructive and give you a range, I think it would be useful to have somewhere in the $25 to $40 million as a range.

That is helpful. I will jump back in the queue. Thanks, Chris. Thank you.

Thank you. Our next question comes from Steve Tunnell, Goldman Sachs. Your line is now open.

Thank you, guys. Good morning. Good morning. I guess just on the slower normalized nonacquired treatment growth in the quarter at 2.6, is any of that attributable to a pickup in home dialysis, or is that capturing that?

That is captured in there. The home growth is in the 2.6. Got it. Okay.

Okay. And how are you thinking about home hemo? Just the comments on sort of growing in the home and making that more available, is that with some of the new sort of technologies in the market, are you guys planning for growth in that business, or how should we think about that?

We've been leading in home for as long as I can remember, and we will continue to do what's appropriate for the patient and the right modality for each patient. So we, of course, assess technology's There's a lot of talk of innovation, but if you really look carefully, there's a lot of smoke in that innovation. It really is a lot of the same, and people are just trying to talk up their products. But we, of course, love it when there's something that's good for the patients, and we will pursue whatever is best for them.

Okay, got it. Then just on the slower de novos, can you give us a sense for what you're planning for 2019 and how you're thinking about sort of the number of openings longer term at this point?

Sure. So I'll preface the answer by highlighting the fact that there is a lag between the slowing of growth and the slowing of the de novos. De novos that are coming on now are decisions that were made. They're leases that were signed a year or two ago. So With that said, we are looking at a significant slowdown in de novos in 2019, and we think that will continue going forward. I'll highlight that it's a function of two things. One, it's a function of the slowing nag. It's also a function of the growing home. And, you know, as more and more patients are dialyzing at home, our need for the traditional in-center dialysis de novos comes down.

Understood. Okay. Got it. And just lastly for me, just on the RPT side and calcium emetics, I think you'd mentioned it was a $1 sort of headwind sequentially. So calcium emetics in total added about $17. I think it was $18 in Q3, if I recall correctly.

Yeah, that's about right.

Got it. Okay. Thank you.

Thank you, Steve. And our next question comes from Pito Checkering, Deutsche Bank. Your line is now open.

Good morning, guys, and thanks for taking my question. Two questions. First one on the revenue per treatment. You talked about bringing more revenues from out-of-network to in-network. We sort of estimate about 3.4% of revenues now out-of-network for your book of business. Is that in the ballpark, or can you talk about that?

I think that question's been asked for many years, and I think we are not going to change our stance today to give more clarity on that. We try to be as useful as we could in January to provide some of the trends over the long haul, and Kent talked about sort of a nine-year trajectory of that number coming down, and I think that's as much as we can do right now. All right. Fair enough.

And then on the weaker growth in the quarter. Can you sort of talk about any impact from wildfires or weather? And then because it varied so much in fourth quarter versus what we saw through the rest of the year, is there any way of giving us any sort of monthly numbers just so we can get a better feel for sure what was the core growth rate and also what you guys exited January in?

Yeah, so nothing to point out relating to wildfires or any sort of one-time stuff like that. In terms of monthly numbers, I don't think we're going to we're going to go to that level of granularity.

Okay, fair enough. And then last question, from a leverage perspective, as the DMG business hopefully gets sold, think about the next three years, what's the right leverage ratio that we should be thinking about you guys running?

No real change to our thinking around that three to three and a half times is the range we expect to generally be in, although we have gone above that for a variety of reasons. Obviously, we're well above that right now. But I think the three to three and a half times is still the range to think about.

Great. Thank you so much.

Thank you.

Thank you. Our next question comes from Patrick Feely, Barclays. Your line is now open.

Hey, good morning. Thanks for taking the question. You've mentioned in the past that as an industry, you'd be looking to introduce some proactive legislation in California. Can you just provide some color on what that legislation might look to do?

Yes, thank you, Patrick. Of course, we are trying to make sure that we educate the legislators to understand all the dynamics that are going on in an ecosystem that is not something that they normally are discussing. And so in our legislation, what we want to make sure is that whatever guardrails are needed so that everybody understands that the right patients that have continuity of care are getting access to charitable premium assistance. And so it's clarity on that is what we're trying to do, as opposed to the bill now, which goes beyond that.

Got it. And the other thing is I can't have heard you speak recently about desire to get more involved with the predialysis CKD population. Any color on what kind of investment you may look to make there? Why you think there's opportunity for DaVita? Is this something that could better enable you to provide integrated care once patients are transitioning onto dialysis and better address the cost of the patients outside the clinic? Just any color around that would be helpful. Thanks.

We will be able to add significant really impressive clinical and economic value if we're allowed to move upstream and help take care of people who have kidney disease but have not yet experienced kidney failure. And by intervening with those patients in different ways, we'll be able to delay the onset of dialysis, in some cases prevent it, and not only delaying it but also having people be healthier and have a healthier start to their dialysis. All of these improvements have big clinical and economic implications, but there's a bunch of regulatory work to be done as well as contracting work to get there, and we're making some nice incremental progress. Nothing to bake into any forecasts yet, but we're working hard.

Got it. Thank you.

Thank you. And our next question comes from John Ramson, Raymond James. Your line is now open.

Hi. Good morning. I went back and looked at some of the qualitative comments about commercial contracting all of last year, and it seems like we ended up in a place in 2019 that was a bit below at least what I was expecting. So was the thought that you would always end up here, or did we get some kind of late-breaking news that caused the needle to move?

John, obviously I don't know what's in your assumptions, but it came in line with what we were seeing. And, of course, on any given time there's pluses and minuses, but for the year it was in line with what we expected.

I was specifically talking about the five to six large contracts being redone, and you were pleased with the increases. And I guess I was thinking zero to one wouldn't be – what she'd be shooting for, but that's what I was referring to. Okay, that's it for me. Thank you. Thank you.

Our next question comes from Gary Taylor of JP Morgan. Your line is now open.

Hi, good morning. Just a few quick ones. For 2019, is the expected advocacy spend still in the $30 million range?

Gary, that is the additional spend from our regular advocacy spend. Gotcha. Yes.

Okay. That's compared to the 93 extra last year, right?

Correct.

And I just want to make sure I understood in response to Justin's question on the California legislation, the equivalent of 1156. So you're saying if If every CPA patient in California moved to the Medicare rate, it would be a $25 million to $40 million revenue and OI hit, or are there some offsets between revenue and OI?

I'm glad you're asking, Gary, because basically we didn't provide much detail because there are so many assumptions that go into it around a lot of dynamics. And so what we're trying to do is just be useful and give you the top line, which is basically There is a range of 25 to 40, but we're not going into the specific dynamics.

And that would be every CPA patient going to Medicare, right?

Like I said, patients and the way the system will work is yet to be seen, so it's probably not good to assume anything, rather be constructive and give you the range of all of the dynamics going in there.

Okay. Last one is for CapEx. Can you tell us, and I apologize if it is on that last page, but CapEx for new centers in 2018 and what you think that looks like for 2019 and 20? You talked about pure new center openings. I was trying to get a sense of the impact on annual CapEx.

Gary, so We can't give you a specific number. There's a range built into that as we watch over the course of the year exactly how many de novos get built, where they get built, what the cost per de novo is. But it is safe to assume part of that significant decline from 2018 to 2019 will be the result of fewer de novos getting built. Let me jump in and just correct something I said before. There was a question about calcium emetics, RPT, and I think what I confirmed was a number of $17. Just to be clear, 17 was the number for the year. The number in Q4 was about $16 of RPT.

That's it for me. Thank you. Thank you.

And our next question comes from Whit Mayo, UBS. Your line is now open.

Hey, thanks. On the commercial book, how much of your book is set to reset in 2019? I guess I'm just trying to get a sense of you know, what your expectation is for renewals in 2019 and what the expectation is for revenue per treatment. Thanks.

Thanks, Whit. We don't disclose how many contracts are up on any given year, and so can't give you that. What we guided to at JPM was that the commercial book would be down 1% to up half of a percent. For 2019? Correct.

Okay. Looking at the deceleration in treatment growth, I know that we're all speculating and guessing on a lot of the contributing factors, whether it's better insurance management, transplants, or whatever. But have you been able to size maybe internally what you think some of these contributing headwinds are just to maybe help frame up for us how to get from point A to point B?

Yeah, so we spend a lot of time on that. It's challenging because the data bounces around, and a lot of the data we're using comes on a really long lag. So how to assess kind of current numbers is more challenging than we like. So I don't think we can be particularly helpful in trying to break down how this works. how the deceleration comes about from the different components.

I think we're all trying to do the same exercise. Looking at G&A in the fourth quarter, if we exclude the $30 million of advocacy costs in California, it would have been around $180 million. And I know that they're quarter-to-quarter fluctuations, but it still stands out a little bit lower than I would have expected. And I guess I'm just trying to think about the starting point. into 2019? Is this the new run rate? You know, just any color to put the G&A trends for this year into perspective.

Yeah, it does bounce around, as you pointed out. I don't think there's anything major that we would call out for Q4 or in the year-over-year numbers, so roughly flattish would be a reasonable number. expectation for 2019. And just be clear, that's on a per treatment basis.

On a per treatment. Maybe two other quick ones. I don't know if you've disclosed this metric before, but any idea how much of your total treatment mix is Medicare Advantage today? Or maybe another way to get a more responsive answer is I think CMS is sized the industry around 20% of total treatments. Any reason that you'd be, you know, different one way or the other? And I guess I'm trying to sort of gain some insight into 2021 and maybe where you think that that mix can go over time.

Yeah, thank you. We have not disclosed our MA mix and we're not going to disclose our MA mix. But as you try and look out what happens in the future, It's difficult to predict because, as you can imagine, individuals will make their own decisions. But maybe one reasonable assumption could be that it's in line with the overall market, which is around 35%. But as you know, in individual decisions, there's going to be a consideration on co-pays and deductibles and out-of-pockets and coordination of care. They're going to try to see if the physicians are in their network, etc., So to try and guess that on a total population is hard. So we, of course, have done some modeling. And right now, a reasonable assumption is that it will be in line with the overall market.

Okay. And just one last one. Joel, you cited increased professional fees. Any more color there? Thanks.

Really nothing interesting there. Some legal stuff is probably the biggest component of that, but really just kind of normal fluctuations up and down.

And that's in your professional fees? Is that flowing through G&A? No. It's in the cost number, patient care costs?

It's in both. I think my recollection, and I'll get an answer for you in a second, is that most of the swing up is in the patient care side.

Okay. So nothing in the ancillary segment that would be allocated? No. Okay. Thanks, guys.

Thank you. Thank you. On your neck. And our next question comes from Jeff Gates, or Gates Capital. Your line is now open.

Yeah, I'm looking at the U.S. dialysis segment margin, and if I exclude the so-called incremental advocacy costs, and if I exclude the calcimetric revenue, and then if I move $25 million per quarter out of 2017 numbers, if I add it back because of removing the 401K benefit, I'm showing that underlying comparable U.S. dialysis margin was actually up for the year, and I just wanted to confirm that that math was approximately correct.

Yeah, I'd suggest we kind of take this offline. I'd be happy to walk it through with you. I'm not 100% following your math, so why don't you reach out to Jim Gustafson, and we'll follow up on this.

Thank you, and our next question comes from Justin Lake, Wolf Research. Your line is now open.

Thanks for taking another question. I just got a few more here. Commercial price, so just trying to come at this another way, you said 60% of the outlier rates have normalized over nine years. Maybe you could tell us how much more normalization you're kind of assuming for 2019, kind of where would we end this year at?

Justin, I think talking about it year by year is just, not reflective of reality, which is why we gave you the long-term data. We pledged many years ago to work down the outlier part of the book in a constructive way. And in some cases, that can be easy because you've got a payer that's got some really high rates and some really low rates, and so you move everything to the middle on sort of a net neutrality basis. In other cases, it's not so simple. That's why we cited the historical data, so that people know that over a period of many years, it has not led to any material disruption, although there have been good quarters and bad quarters, or good years and bad years. It's quite unpredictable. Once again, we give you the empirical data, so you can see that it is relatively predictable over the long term, but not over the short term. So guessing and giving you a guess on a single year, we just think could be really a lot more noise than data. We do, however, commit to our belief that over the next five, six, seven years, this trend towards fewer outliers will continue, and there'll be some bumps that are positive and some bumps that are negative along the way, but it shouldn't be anything fundamental.

Right. I guess I'm sure you can understand investors are trying to figure out the potential impact. And, you know, this year there was, you know, you have zero kind of built in for commercial rate growth, give or take. So, you know, given you normally get increases in contracts, as you said, we're just trying to figure out, like, is this what we should consider a normal year over the next five to six that you talked about? Or is this a, you know, a bigger year of these outlier rates moving to normal?

Yeah, I don't think we can say. We've put a lot of work into giving the guidance for this year. We're going to put a lot of work into providing the three-year outlook at our upcoming capital markets in 2019. But I just spontaneously trying to figure out whether or not the word normal applies to that particular number in the particular year of 2019. I don't think I want to say, we don't want to say either yes or no to what exactly is normal. Hopefully we've really helped you understand that clearly there's some offsets in 19 that are offsetting the fact that in a lot of our book we're getting nice rate increases. So that is going on, and we've done our best job of calibrating it for you, but I wouldn't want to characterize it as either normal or abnormal. If you look over the last eight, nine years, it's It's not an outlier. It's just a tough year.

Okay. And then just switching over to volume, obviously you've got a ton of medical directors who are nephrologists, and I assume they're seeing upstream to pre-ESRD patients. And so I'm curious what they're telling you in terms of this slowdown in patient growth. Are they saying that, you know, people are sticking on, you know, are taking longer to, you know, they're able to prevent the kidneys from fully failing, so that's why it's slowing, or are they seeing an actual slowdown in growth in pre-SRD? Because I would have assumed that would be something that you would be able to, you know, see coming from a pretty long distance.

It's a fair question, and as you know, there's a wide distribution of sophistication of of the way that the practices are ran from very small practices to large practices. With the people that I'm talking to, Justin, they have not seen their CKD practice slow down in any significant way, but one can never put too much stake in that because the reality is that many of these practices are not that sophisticated, that their practice is busy and they don't segment as well as a sort of a Fortune 500 would. But at the end of the day, there's nothing that they're picking out.

And, Justin, it's worth throwing out a few numbers to help explain why JR's answer is the appropriate one. You just take a typical nephrology group and say there's three doctors and say they've got 100 dialysis patients each. That's 300. And then there's a 13% mortality rate, let's say. So that's 39 patients to replace the ones that passed away. And then you have 3% growth, and so you add another nine patients on. And so you're talking about 48 new patients per year spread across three doctors. When you have a 1% change in the organic population, you're talking about two patients difference over the course of an entire year. And so whether or not a group has 48 new patients or whatever number spread across 12 months or 50 or 46, that is not something a practice can notice because year by year they're going to have those fluctuations. It's not going to have anything to do with aggregate CKD incidence or advancement. And so that's why JR has answered that the practice wouldn't pick up on this unless it was way, way, way more than 1%. For us in aggregate, and for you, we pay a lot of attention to 1% because there's some incremental EPS math attached to it. but it's highly, highly incremental and not discernible at the practice level with rare exceptions.

Okay. Just a few other numbers questions here. You mentioned international as getting to profitability. Can you give us any kind of trajectory there, maybe a margin kind of target over the next few years that you think would be a reasonable range to think about where this business can operate?

Yeah, Justin, we're no longer going to call out specific guidance for international. We will continue to report on it every quarter, but given the magnitude in the context of the whole company, we don't think guiding on it as a specific number is something we're going to do.

But we will add, just to try to be a little responsive without going into too misleading detail that we've had three consecutive years of improving the EBITDA margin by 2% per year. So just to give you a sense of the incremental operating improvements and mixed improvements. So things are moving in the right direction. We can say that right now.

Okay. But no even target margin?

I don't think that would be a good idea right now, given the different country mix. I mean, it's heavily influenced by which countries grow the most, and sometimes you might have a lower margin country, but, in fact, it's got higher return on capital. And so I don't think it wouldn't yet be a useful number for you, Justin.

Okay, and then two more here. The CapEx... It was asked before where your CapEx can go, and, Joel, you said CapEx could materially decline over some period of time if your de novo is moderate. Can you give us an idea of what kind of – if you had to look today, and obviously this takes years to kind of play out because of how far you have to plan them ahead, but two or three years from now, given the growth you're seeing in the business, what kind of CapEx moderation – do you think can happen here from that net, you know, seven and change number that you're reporting for this year?

David Morgan It's hard to predict, Justin, and we're just not in a position right now to give kind of multi-year guidance on this. It will depend on a bunch of things, including growth. And depending on what happens to the growth, whether this decline is temporary or not, as well as what happens to home penetration and other things, there can be some real impact on that number, but we're not in a position to give longer-term guidance.

No, I apologize, but I thought you'd said it was material. It could be a material decline if the growth continues and you continue moving towards home, which it sounds like you're trying to, so I'm just trying to get some order of magnitude. I understand if it were to re-accelerate, you'd have to spend more money, but just at this growth rate, in both of those factors, where do you what would you call material?

Yeah, Adam, we're not in a position to quantify what exactly that would mean right now.

Okay, last one on Medicare Advantage. I know to Whit's question, it was helpful to say that you think you can get to an industry average over time in Medicare Advantage penetration, but obviously The starting point is pretty important. And I just recollect you guys having said 10% to 15%. That was kind of the range of where you were today. Am I wrong in picking that number up?

We're looking around the table, Justin. No one remembers ever having shared that number, which is not to say it didn't happen, but there's just a bunch of blank stares across the table.

Okay, Bill. Then I'll come out of it a different way. Obviously, we've talked about this being a potential meaningful positive. But to get and getting those 35%, 40% where the industry is going to be a few years from now is obviously could be significant. But not understanding where the starting point is, there's no way to say whether that's even going to be a benefit or not unless we understand the starting point. Is there any way you can give us – even a round number, 10%, 20%, 30% of where you are today?

Hey, Justin, how about if we do this? Because we weren't prepared to do that for today, but you're making a fair point. So this is obviously a multi-year issue, and we do expect our MA to grow in a non-trivial way, and it's going to be great for patients, and we think great for the system because we'll also bring down total costs. But none of that is responsive to the specific starting point question. So if you just let us not make a spontaneous decision here and instead think about it, and then maybe next quarter we'll provide that number.

Appreciate it. Thanks for all the questions.

Yeah, thanks, Justin.

Thank you. Our next question comes from John Ramson, Raymond James. Your line is now open.

Hi. Let me just go back one more time on something. you mentioned wanting to get more involved in free ER, excuse me, free CSRD and it would involve some contracting. Is it, you know, the commercial payers only being on the hook for 18 months and then Medicare being kind of slow. Are we talking probably the Medicare advantage payers would be most receptive to some different type of contracting that would actually incentivize you to keep people from crashing in the dialysis or is it, or am I thinking about that wrong?

No, you're thinking about it correctly. We're already doing that work with some payers, and both they and we believe we're having quite an impact clinically and economically, and so we would expect that to increase over time. However, right now, there's not math associated with it that's exciting enough for you to bake it into any near-term forecast. Hopefully, as the future rolls on and we get better and better at it and have more data to prove how good we are at it, it'll be more relevant to your model.

And is this part of the tuition from DMG? Does this accelerate your learning curve in some of these risk-based type of contracts?

Yes, there was some very good learning in both directions where DaVita Kidney Care was able to help DaVita Medical Group do better on kidney care patients, both dialysis and predialysis. And similarly, And DMG was able to help to be the kidney care, do better in managing down the total cost and managing the economics of our dialysis patients. So it was a good mutual, and it continues to be, a good mutual learning highway.

The other question I had is, our D.C. folks think that CMMI might do some different payment structures for home dialysis patients. So two questions. One, are you hearing any of that, number one? And then number two, let's just wave a wand, for example, and say three years from now you've got a set of 12% of your patients at home. Let's say it's 25%. How do you think about that at a high level from a return on capital, a contribution margin, total economic to the enterprise? Thanks.

Yeah, I'll take a stab at it. Number one, CMMI is great. looking at a bunch of kidney care stuff, including eliminating some of the obstacles to home and PD growth. And we are supporters of that, and we're in regular, constructive conversations with them about the best way to do it. We've had a series of meetings. They've also talked with other people. And so we applaud a bunch of the stuff that they're looking at and hope that they go ahead and put it in and that there's a good chance that they will. And then second, if you wave that wand, that is a good world in a couple of different ways. One, it just significantly reduces the capital intensity of our business. Number two, there are some patients in America who would be happier or healthier on home that are not on it today because of local practice patterns, nephrology group preferences, etc., And we've been growing home steadily. Javier referred to the fact that we've been the leader for a long time in this and intend to remain the leader. But that doesn't mean that every single patient that should be on home or might be happier on home is on it now. And so implication number one is that outside of capital intensity, excuse me, would be happier and in some cases healthier patients. Having said all that, right now when people walk around saying that, home is almost uniformly a better form of care for dialysis patients is factually incorrect. And so for a lot of patients, it leads to a better life. For a subset of patients, it leads to better clinical outcomes, but not for every one. And what you tend to have is that the type of people who take the initiative and have the desire to dialyze at home are a fundamentally different type of patient on average than those who stay in the center. So it's very, very difficult to do an apples to apples clinical comparison because of the type of population you have that is willing to take on the burden and responsibility and risk of dialyzing at home.

So thanks for that. And last one for me, just at a very high level for home, how much of the relatively minor mix in your opinion, as qualitative factors around physician practice patterns versus quantitative and clinical factors?

Could you say the question again, please?

Probably not, but I'll try. So what we have been told is that some of the shortfall and the growth has been kind of tiny, 20, 30 bps a year. And what we've been told is that some of that is just physicians not being trained physicians, not being in the rhythm of thinking about home, and just the default answer is the clinic. And, you know, whereas others is, you know, some patients don't belong at home, as you mentioned. So if you had to guess, if we normalize physician practice patterns across the country and everybody was thinking about it, like this is the first option, let's send the patient home if we can, where can the mix go to just with qualitative physician decision-making and versus some of the other factors around the payment structures and clinical obstacles.

John, this is Javier. I think when we look around and we see the most, let's call it home champions, the most dedicated physicians that have a good education program and are really trying to champion the right modality for the right patient, you get into a low 20 or so mix. Maybe you get it up to 25 if they're really, really good, but that's on the high end. And as you look around the world, that's probably also a good number to use.

Thanks. That's great. That's all for me.

Thank you.

Thank you. Our next question comes from Kevin Fishbeck, Bank of America. Your line is now open.

Hey, just a few more for me. I guess I might have missed it, but did you say that the guidance for 2019 includes additional advocacy costs, or is that included in the normal run rate spent?

No, it includes this $30 million, which is consistent with what we've said before, and think of it as... you know, 60-ish million less than the 90-something that we had in 2018. The point I think Javier was trying to make is that we've always had advocacy costs built into our cost structure. It went up significantly in 2018 as a result of the California stuff. This 30 is kind of the remnant of that California piece that we'll roll through. There's other stuff that's always been in there, and that hasn't changed.

Okay, great. And then just on the home health commentary, obviously home health is something that you guys have talked about from time to time and been supportive of, but this feels a little bit more of a discussion than I'm used to hearing from you guys. Is there anything, so obviously lower capital intensity is good. It's good for some subset of the patient, so that's good. Probably better for a kind of commercial patient, so that's good. But is there anything that you have to worry about as you move to home hemo? Because one of the things that just structurally I would think that you and Fresenius have, you know, there's some barrier to entry in that you guys already have, you know, bricks and mortar across the country to the extent that we create and push towards a less capital-intensive model, broadly speaking, does that create the potential for disruption or more competition? So, A, am I off based on that concern? And, B, is there any downside that you can think of, if not that, towards Home Hero getting bigger?

Yeah, so one of the most important things to remember is that our patients are big consumers of the entire healthcare system. And by definition, when your kidneys fail, you are fragile and you're quite sick. And so one of the things that's not discussed when discussing home is that the peritoneal cavity, A, there's high infections, and two, that sometimes it doesn't last. And sometimes is probably not the right word. And most times, it actually gives within two years or so. And so if you were to look at a patient of ours, They are, A, hospitalized. Home patients are hospitalized. And, of course, Davida and Fresenius serve in the acute setting. And then number two is approximately 85% of patients that treat at home will have to use an in-center at some point in their care. And so having the entire suite, meaning the hospital, the clinic, and the home service, is a very important part of the value proposition for a patient. because they want the continuity of care. They want their doctor to go from the hospital to the center to the clinic, and then, of course, home. So is that responsive to your answer?

Yeah, no, that's good. So that presence of the person motor is always going to have an important role, even if home hemo becomes a bit bigger than what it is now. All right. And then the other question, I want to understand a little bit more about the sale-leaseback dynamic. Are you signaling that you plan on owning fewer homes as a percentage going forward through these saley specs, or is this more just a method of financing that destruction and that you wouldn't expect to be leasing a higher percentage of their facilities going forward?

So, Kevin, there's no real change in the amount of real estate we're planning on owning, which is extremely low. The dynamic here is that we have found rather than having someone else build the center for us and us leasing it, it is more cost effective for us, both in terms of the capital and the ultimate lease expense, for us to build the center and then sell the already constructed center. So the impact on our cash flow is that we have an increase in CapEx as a result of this, which flows through the normal CapEx line. There's a net benefit which doesn't flow through the CapEx line, but is effectively economically an offset to our CapEx when we sell this, when we sell the center. So, no real change in how the ultimate ownership of the center but it does create a little noise on our cash flow that we wanted to really clarify, and that's why we've added over the last few quarters how this plays out in Table 6, what the net kind of bring back against the CapEx is. We understand it's a little bit confusing, but we thought it was important to lay it out to make sure everyone has the clearest view of what the real capex and cash flow the business is.

All right. Great. Thanks.

Our next question comes from Whit Mayo, UBS. Your line is now open.

Thanks. Just had a couple quick ones. There's some numbers kind of moving around versus my notes, so just want to make sure I've got the correct headwinds and tailwinds written down. On the tailwind side for this year, I've got DaVita RX losses reversing to be a $25 million tailwind. I think, Joel, you cited now a net $60 million-ish tailwind in California on advocacy, and then maybe a $35 million pickup on Medicare rates. Are those the big buckets? Are those the right numbers? Are we missing anything?

I think the sizes are about right. The Medicare is actually a headwind. I'm getting...

I guess I was thinking more just on the rate update.

Oh, on the rate update, yes. I thought you were talking about the Medicare bad debt issue.

No, I'm going to get to that.

Positive revenue.

Yeah, okay. Is that in the ballpark, though, $35 million just net incremental tailwind from the rate update? That's about right. Okay. And then on the headwinds, as you mentioned, you've got a $36 million increase. headwind from the Medicare bad debt recoveries, and then maybe a $17 million reversal from DaVita Health Solutions. Any other major headwinds, and are those the right numbers?

Those are about right. DHS, I wouldn't call it a reversal in an accounting standpoint. It was a positive.

Lack of a tailwind.

Yeah, it's the lack of, yeah. Yeah.

Okay. Okay.

And so that implies... The one other thing I would point to was the retirement cost that we had in Q3. The number was roughly $25 million, $23 million precisely. Got it. Okay.

Add that to the tailwind category. Yep. Yep. Got it. Okay. And... One last one, just the calcium emetic landscape is like fairly fluid right now, some drugs coming on off of the market. Just what's the expectation for 2019? And I'll get all six.

Yeah, so I think you're exactly right. It is a very fluid situation. It is one of the largest components of the the swing in our 100 million of OI guidance given the different ways it could play out. But roughly speaking, kind of if you think about the middle of the range, it's not a big change year over year. But again, a lot of variability in terms of how it plays out.

So what would be the scenarios that would play out that would get you towards the low end versus the high end? Is there any way to share that? what would have to happen with calcinomatics to be within that range?

The couple of dynamics that you'd have to consider are, one, prescription patterns. In there you have, does oral come down or go up, or do physicians prefer IV or oral? So there's a mix in there. In addition, then you have to consider whether more generics come into market, So if it's one player versus five players, and what happens to pricing? And so then, of course, you have a calculation on ASP that has got a lag, and it's got a six-month lag in that. So those are the dynamics in play.

Okay, one last one just on ASP. Can you comment how ASP has trended? the last six to 12 months and what that implies for the next six months. And I promise I'm off now.

ASP is trended down. And then as it relates to prediction, you can't have one because of all the things I just went through.

Thank you. And the next question comes from Gary Taylor, JP Morgan. Your line is now open.

See what happens when you move your call to the morning. Nobody knows how to get off the phone. Everybody's double dipping. I just had a quick one. I just wanted to go back to while I had you, you know, kind of this question about slower growth in the industry and looking at the U.S. RDS data, and maybe there's a good reason why it's not good or comprehensive, but if you look at prevalent data, Population growth before 2000, it was in the fives. From 2010, it was in the fours. Since 2010, it's been in the threes. It's a couple years lag, but it looks like it's poised to drop into the twos. So when we look at kind of that bigger picture of the industry maturing, you're saying you're seeing something that looks more – step function-ish than sort of that long decline we've seen over the last 30 years?

No, I would say the opposite, probably, that the data is quite clear that nothing dramatic happens quickly, and yet that the trend is the trend, and we're not predicting any significant change in either direction off the trend. but recognize that there's an awful lot of dynamism underneath that number. On the one hand, treatment for diabetes and hypertension, some of the primary causes of kidney failure, are getting better. So you could argue that that would lead to a reduction in dialysis patients. On the other hand, the African-American and Hispanic populations are growing significantly in America, and they're far more likely to have kidney disease and kidney failure. So that pushes exactly the opposite direction. And I could cite two or three or four other variables. So under the surface of that long-term trend, which we think may very well continue without any significant discontinuity up or down, but underneath that are a lot of basic fundamental forces in American healthcare and American demographics. And so it's very difficult to get too confident Because if any of those underlying trends change, that would, in fact, create some sort of discontinuity in the trend. It just hasn't for the past 25 years.

Gotcha. Yeah, I just thought the opioids transplant commentary was perhaps suggesting you thought you were seeing something more onerous or steeper. So I appreciate the clarification. Thanks.

Let's stay on that for one second because that is a perfect example of a new discontinuity, but we would also predict probably a relatively temporary one in that we would say that five years from now, the incidence of opioid abuse and people getting to the point where their kidneys fail because of a lack of treatment are going is going to be reduced dramatically because already the leading indicators for that, things like prescription patterns, prescription limitations, prescription oversight, clinic availability to help these people, all of that is fundamentally changing throughout America and is quite well funded in many cases. So that's a classic example of a new thing that has had a negative impact in some ways on us in the short term. but will probably, on a relative basis, become an incrementally positive one over the next five, six, seven, eight years. But it's, once again, very difficult to quantify and calibrate because it has to do with fundamental demographic issues and fundamental healthcare system issues.

Understood. Thank you.

Thanks.

Our next question comes from Peter Chikering, Deutsche Bank. Your line is now open.

Hey, thanks, and thanks for taking all the, you know, extra questions here. I want to take another crack at the organic treatment growth that you guys are, you know, what you guys have guided to versus what we did in fourth quarter. The 2.6 in the fourth quarter, guidance of 2.5 to 3.5 for 2019. So the midpoint of the guidance is applying an upside versus what you're just reporting and effectively calling fourth quarter as what the bottom, what the ranges can be. Can you give us any additional color in terms of sort of why this should improve to the midpoint of your guidance for 2019?

I'll take a crack at that, although I don't think I've got much to add. You know, the number does bounce around a bit, and we tend to look at things, you know, some things purely on a quarterly basis, other, you know, with a little bit of a blending over time. So I'd say we're blending the Q4 data point with some prior data and our go-forward models, so we come up with something that's in that 2.5 to 3.5 range.

All right. It's worth a try. Thanks so much.

And speakers, we show no further questions at this time.

All right. Thank you all very much for your interest in DaVita. We look forward to talking to you again next quarter.

Thank you, speakers. And that concludes today's conference. Thank you all for joining. You may disconnect at this time.