DaVita Inc.

Good evening. My name is Missy and I'll be your conference facilitator today. At this time, I'd like to welcome everyone to the DaVita first quarter 2022 earnings call. All lines have been placed on a mute to prevent any background noise. After the speaker's remarks, there'll be a question and answer period. If you'd like to ask a question during this time, simply press star and then the number one on your telephone keypad. If you'd like to withdraw your question, press star then the number two. Thank you, Mr. Ackerman. You may begin your conference.

Thank you and welcome everyone to our first quarter conference call. We appreciate your continued interest in our company. I'm Joel Ackerman, CFO and Treasurer, and joining me today is Javier Rodriguez, our CEO. Please note that during this call, we may make forward-looking statements within the meeting 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 first quarter earnings press release and our SEC filings, including our most recent annual report on Form 10-K and all subsequent quarterly reports on Form 10-Q and other subsequent filings that we make with the SEC. Our forward-looking statements are based on 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. A 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.

Javier Rodriguez Thank you, Joel, and thank you all for joining the call today. It is an interesting time right now as our country and our world are facing a unique portfolio of one-time events, all happening at the same time. On the positive side, we're gathering and interacting more as communities, and in society as COVID infection rates have declined. On the more challenging side, we're dealing with new economic pressures of inflation, supply channel constraints, and the sad consequences from the war between Russia and Ukraine. As our organization works through these challenges, I think it is critical to keep in mind why DaVita exists. We are a patient-focused organization that provides life-sustaining care to over 240,000 people in 12 countries. which is why I want to start the call by sharing a clinical highlight. As you know, one of our key focus areas has been improving a patient's experience in dealing with their kidney disease. And one way to do this is through focused efforts to reduce the amount of time that our patients spend in the hospital. With our new integrated care partnerships, we have been scaling our models of care and are seeing early results of double digit percentage reductions in time spent in the hospital. which is absolutely great for our patients and for the healthcare system. These results are in line with our expectations. The improvement is primarily driven by our care management, our clinical interventions, and our focus on the quality of care of our patients. Fewer hospitalizations translates into better quality of life for our patients and more healthy days at home doing the things that they like with the people they love. We are optimistic about these early results and we'll continue to find ways to improve our patients' quality of life. Now, let me transition to our first quarter performance. In Q1, we delivered operating income of $338 million and earnings per share of $1.61. Operating income was down sequentially, primarily due to typical seasonal factors, continued volume pressures from COVID, and higher wage expenses. The mortality rate of Omicron variant of COVID has been significantly lower than prior variants, but the sheer magnitude of cases resulted in estimated excess patient mortality of approximately 2,100 in the first quarter. Therefore, our treatment volumes declined compared to the prior quarter. The good news is that patient infections and mortality rates have declined over the last couple of months, consistent with national trends. and we have not yet seen significant impact from new sub-variants. Therefore, we're beginning to see positive trends in treatment volumes in both March and April. On staffing, as we've discussed previously, we continue to experience a challenging labor market. Year over year, our first quarter field labor expense increased over 6%. The increase is due to a mix of higher than normal merit increases, higher incentive pay, increased utilization of contract labor, and lower productivity primarily due to higher training costs and inefficient staffing associated with cohorting COVID patients. While we're seeing some positive trends in our ability to fill open roles in our clinics, we expect to experience higher than normal year-over-year labor costs increases for all of 2022. With all of these challenges, we believe it's more likely that our performance will fall within the bottom half of our guidance range for 2022. However, there are scenarios in which our results could be above or below this due to the uncertainty of the environmental impact of labor costs and COVID. Looking forward to 2023 and beyond, we're preparing for wage rate growth to continue above average historical levels. To offset this impact, we will need to demonstrate continuous cost innovation. We have already identified a number of cost savings opportunities to help mitigate these inflationary pressures. These include savings from a new ESA contract, G&A efficiencies, capacity utilization improvement, clinical operation optimization, and procurement improvement. We expect to start realizing these savings in 2023 with a full run rate benefit in 2025. We believe that these anticipated savings, combined with an expectation of higher rate increases from government and private payers in the future, can keep us on a path to deliver on our long-term adjusted operating income growth of 3% to 7% and an adjusted earnings per share growth of 8% to 14%. I will wrap up my prepared remarks with some thoughts on our integrated kidney care or IKC business. As we shared in our Capital Markets Day, we continue to see significant potential for our IKC business. First, delegated patient volumes are strong and consistent with our initial modeling with some potential upside over the next 12 months. We are on track with our expected ESKD member growth via new payer partnerships, and we are trending ahead of plan on new CKD payer partnerships as payers recognize our ability to effectively collaborate with physicians on managing this patient population. Second, available cost savings may be higher than initially forecasted given strong nephrologist engagement and from the recent release 2023 MA rate increase of approximately 10%. Third, we have expanded the number of nephrologists with whom we are working with in value-based care. We are now engaged in a new value-based partnership with over 1,800 nephrologists around the country with more than 600 nephrologists using an integrated CKD electronic health record. Last, we continue to have confidence in our clinical model, which is now beginning to operate at scale. With that, I will turn it over to Joel to discuss our financial performance and outlook in greater detail.

Thanks, Javier. First, let me start with some additional details on our first quarter results. The biggest driver of the operating income decline of approximately $50 million from Q4 was seasonal factors. First, there were two fewer treatment days, resulting in approximately 185,000 fewer treatments in Q1. There is negative seasonal impact on revenue from higher patient coinsurance and deductibles. Third, payroll tax expenses are higher in Q1. Now, moving on to the underlying drivers of operating income. U.S. dialysis treatments per day were down approximately 2,000 or 2.2% in Q1 2022 compared to Q4 2021. primarily due to excess mortality from COVID in late Q4 and in Q1. Higher mistreatment rates in Q1 from the Omicron surge added to the negative impact on treatments. Revenue per treatment was down quarter over quarter by approximately 35 cents, primarily due to the impact of higher seasonal coinsurance and deductibles, largely offset by increases in the Medicare fee-for-service rate for 2022, and continued improvement in both MA and commercial mix. Patient care cost per treatment was up $4.49 per treatment quarter over quarter, primarily due to higher wage rates and the impact of lower treatment volume on fixed expenses in our centers. G&A expenses were down approximately $26 million quarter over quarter, largely due to the seasonality of our G&A spend. Our Q1 operating loss for the IKC business was in line with our expectations as we continue to invest in growth. We remain on track for the incremental $50 million investment in our IKC business for the year. In Q1, we repurchased 2.1 million shares of our stock, and we've repurchased to date an additional 800,000 shares since the quarter end. Looking forward to the rest of 2022, In Q2, we anticipate a rebound in operating income as the Q1 seasonal factors fall away, partially offset by the reduction, and then the full elimination in Q3 and Q4 of sequestration relief. In Q3, we expect to incur the vast majority of the impact from ballot costs. Finally, Q4 will increase sequentially with significantly fewer ballot-related costs. Now onto our views for 2023. As we shared in our Capital Markets Day, we consider 2022 to be a transition year. We expect to see a rebound in our operating income in 2023, driven by growth in the core business, a reversal of some of the COVID headwinds, no contribution to the industry's fight against ballot initiatives in California, and progress in our IKC business. At our capital markets day, we sized this operating income rebound from 22 to 23 between 250 and $400 million. Our updated view on 2023 revolves around three of the underlying drivers. First, we are anticipating continued cost pressures in wages and from inflation that were not incorporated in our prior guidance. The magnitude of these pressures will largely depend on how the labor environment unfolds over the next few quarters. We are preparing for another year of wage pressure in 2023 that runs a couple of percent above our historic levels of growth, although not as challenging as what we're experiencing this year. We expect some offsets to these cost increases from higher RPT increases from Medicare fee for service and other payers, although our expectation is that most of our commercial and MA book will take longer to catch up because of our multiyear contracts. Second, as Javier mentioned, we've identified a number of cost-saving opportunities that we expect will begin to materialize in 2023. While we don't anticipate any significant CapEx associated with these projects, we may incur some one-time expenses associated with some of these efforts in 2022, 2023, and potentially into 2024. We have excluded these non-recurring expenses from our guidance. Finally, on COVID, our inability to predict the course of the pandemic remains a source of significant variability in our forecast. Our views of 2023 at Capital Markets Day assume the scenario in which excess mortality from COVID would be negligible and we would experience accelerated growth beginning in 2023. As Javier mentioned, although we have seen improvements in treatment volumes recently, we remain cautious about future surges. If we continue to see surges this year, and if COVID mortalities continue, if the disease remains endemic, the impact of COVID on our forecast could slip from a tailwind to a headwind in 2023. Putting this all together, while it's still early to give full guidance for 2023, particularly given the dynamic environment, we currently believe that if COVID largely subsides as a source of increased mortality this year, we feel good about the range of 250 to $400 million OII increase versus 2022. If COVID remains a headwind this year and into 2023, we would still expect a strong rebound, but are not in a position to quantify it given the uncertainty. Operator, please open the call for Q&A.

Yes, sir. If you'd like to ask a question over the phone, again, that's star followed by one. Please make sure your phone is unmuted and record your name clearly when prompted. If you wish to withdraw your question, you can press star two. Our first question comes from Kevin Fishback with Bank of America. Your line is open.

All right. Great. Thanks. I guess when it comes to Q1, you missed the consensus estimates by a decent amount, but you're kind of reaffirming the guidance. It's a low end of the guidance, which kind of implies that the rest of the year is going to play out the way you thought, even though it sounds like these cost initiatives won't help until next year, just trying to figure out why the pressure in Q1 isn't going to hurt the back half of the year the same way it hurt Q1?

Yeah, Kevin. So Q1 was really dominated by two seasonal impacts that totaled about $60 million of pressure on OI. One relates to treatment days. There were two fewer treatment days during the quarter. And the second, and that's about half the impact. And the second one is about the seasonal patterns related to co-insurance and deductible, and that's worth about another $30 million. So if you back those things out, there are a bunch of other things that played through in the quarter that will kind of be puts and takes for the rest of the year. But you back out that seasonality, and I think that explains most of the delta.

And maybe the way to ask the question is, did Q1 come in the way that you thought it was? Because those two are seasonal things that you would have known. Is it just the street didn't model those things correctly? Is that what you're saying?

I'd say that's the bigger piece. But Q1 was behind where we expected, and it was mostly around volume. Mortality was higher than we expected. And while we're not changing our view on mortality for the full year, it came in earlier than expected. and the mistreatment rate was higher than expected. Q1 is typically a higher mistreatment rate quarter because of flu seasonality, but it was even higher than we would have thought, and that's largely due to COVID.

Okay. And then I guess to the point about the rate opportunity over the next few years to offset these costs. How is the commercial environment? I mean, you guys have talked about relatively low net rate updates historically. And so that leaves me wondering whether you feel like you really do have the bargaining power with commercial over time. How do you feel about that ability? Is it that when inflation is going up, you do have that power? Or should we still think about weight or overall rate growth probably being something less than what you think cost growth will be, even though it'll start to catch up.

Yeah, Kevin, this is Javier. Thanks for the question. The short answer is it's too early to tell because, as we've told you, we are comprehensively contracted and most of our contracts are multi-year. So on any given year, you probably have only 15% to 20% or so being negotiated. And so it's a little early to tell. As it relates to your question on who's got power, the reality is, as you know, is the payers have more market share than we do in any given market. And so it's a good conversation. What we're all trying to do now is see if we can align our incentives to get more progressive contracts to save costs to the overall system. And so it's a bit early to tell. There's a lot going on in revenue, as you're well aware, since you've tracked us for a long time. because you've got, of course, mix and rate and a lot of other variables. But we continue to think that the foreseeable future, at least, that the yield will continue to be in that 1% to 2% range.

Let me just ask a question. I guess the RPT has been aided by the shift into MA. I guess where do you think we are in that shift? I guess we all love the baseball analogy, what inning are we in? Would you expect to get similar type lifts in 23 or 24, or are we largely, you know, getting to the steady state here? Thanks.

Yeah, I don't know what inning we're in, but I think the biggest jump has happened. We went from obviously being subpar in the market to being roughly at market. We continue to see our new patients selecting MA at a higher rate than Medicare. And so we think that it'll just continue to be more incremental, but slightly higher than the MA market overall. Thanks. Thank you.

Thank you. Our next question comes from Justin Lake with Wolf Research. Your line is open.

Thanks. Maybe we can stay on revenue for treatment for a minute. So you said that... the seasonality around co-pays and stuff hurts you by about $30 million. That's a little over $4 a treatment. So revenue per treatment would have been up sequentially about 1%. Even with Medicare rates doing plus MA, plus you said commercial rates got better. Is there some other piece we're missing here besides that on revenue per treatment?

No, Justin, there's nothing that you're missing. I think if you look at the I think you've called out the right things, and they roughly balance out. There are a few other little things, as there always is a little bit of variability, but there's nothing else to the story. Remind me, what was Medicare rate again? It's in the high ones, somewhere in the 1.7% to 1.9% range. Right. So that alone would have gotten you –

My math is a little fuzzy, but it would have gotten you a little over 1% alone. Plus, you said commercial mix got better, so that would have gotten you your $4 back. The commercial mix is better, you said, so can you give us that number? What did commercial mix do sequentially, and what did MA penetration do sequentially?

Yeah, so I think the government rate number you're a little high on. There's some Medicare bad debt you have to take into account there. There's some mixed changes within government. There's flu shots. So there's a bit of noise in there, which is, I think, preventing you from getting your numbers to tick and tie.

Okay. Can you tell me what Medicare Advantage and Commercial Mix did for the first quarter?

MA Mix came out at just under 45% for the quarter, and Commercial Mix was just under 10.5% for the quarter. And what were those numbers in 4Q? Hold on one second. MA Mix was... 39%, and commercial was 10.38%. Okay.

And then, you know, getting back to, you know, the sequential earnings, when you said 2Q is going to rebound.

I'm sorry, I gave you a bad number. Q4 on MA was 42%.

Okay. Thanks for that. So then you said 2Q is going to rebound after Q1. That's a couple of seasonality issues. Are you saying rebound to like fourth? We just want to try to get consensus and models in line with what you're thinking at least. So is that going to be kind of in line with the fourth quarter? When you say rebound, is it going to be to the fourth quarter level? Is it going to be beyond that? Anything you can help us with there?

Yeah, I'm really reluctant to start giving quarterly guidance, so I'm going to stay away from that question.

Okay. Then you've given us a number on wages. I think it was $100 million to $125 million that you would put incremental, the typical in the OI guide. Do you want to give us an updated number there?

Yeah, I think we're now thinking about the high end of the range for that. Q1 came in about 6% up year over year, and you can, I think, model that on a base of about $3.5 billion, and we're now looking probably somewhere just below 6%. We're now looking somewhere around 6%, maybe a smidge above that for the full year. But that would get you a number consistent with a high end of that range.

Okay, and then just lastly, a lot of us kind of looked at the hospital rates that came out, and we're scratching our heads as to why some of this labor pressure and inflation in general didn't seem to be reflected. I know you guys spend a lot of time talking to CMS. Your rates I don't think have come out yet, but when do we – When does that start to occur? Do you think that in dialysis rates, for instance, for 2023, that we're going to start seeing CMS start embedding some inflation there? Yeah.

So, look, I think the 22 number was higher than normal. And, you know, I don't know that we have a whole lot of insight more than you do about why, but I'd say inflation is probably a good assumption. We're not going to see the preliminary rate increase. for 2023 till late June, early July.

Okay.

But remember, Justin, the formula is not as straightforward as one would think. So you would think that they would grab some kind of either past experience or future experience that was literally tailored to our specific financials. That's not the case. They literally grab a basket update and do some future modeling, and then they apply some kind of productivity index, and then they come out with the number. So it's labor-based on hospitals, and it's two years old. And so there's going to be a bit of a lag is the point.

That's the issue. Okay, that's what I was trying to get a little smarter on, Avi. I appreciate that. So you're saying that. What Medicare is building in, in terms of whatever inflationary pressure there is on wages, or whatever inflation is happening on wages, is coming from two years ago. So their 23 rate is based on 21 inflation.

That's our understanding, Justin.

Okay. All right, guys. Thanks for all the call. Thank you. Missy?

Operator?

Our next question comes from Pito Chickering. Go ahead. Your line is open.

I just take my questions. Going back on the first quarter treatments, I understand the increase in mortality and sort of the mistreatments, you know, seasonality. Previously, you guided sort of 2022 treatments to be growing, sort of 1 to 1.5%. I guess, any changes to that assumption? And then, can you sort of quantify the treatments you saw in March and April? And what should we be modeling for sequential treatment growth into 2Q?

Yeah, so... We are thinking that the year-over-year treatment growth will be down relative to the kind of half to 1% that we had talked about in the past. And I'd say somewhere closer to zero is a better way to model it now. We did see a dramatic decline over the course of the quarter. This is from memory, but the numbers were something north of 1,500 in January, a few hundred in February, and then I think 150 in March. So the excess mortality number did come down significantly. In terms of how to model Q2, again, a lot of uncertainty here. If historical patterns hold, you'd expect to see treatment per day growth in Q2 and the next surge really come in the summer, it's not clear whether historical patterns will hold.

So, you know, could you give us just any range, you know, with what you guys see on your treatments or where it's tracking, I guess, in April, you know, sequentially? Should you be growing 50 basis points from 1Q to 2Q? I mean, there's more treatment days, but then you also have the If there's mortality, they're not around. So I guess just you can help quantify forest treatment growth in 2Q.

Yeah. So first of all, I'd focus on modeling treatments per day because you'll just get a cleaner number with the number of treatment days. I think I'm comfortable saying it's going to go up. I'm not sure I'm ready to quantify it yet.

Okay. On Dustin's question on revenue for treatment, you know, I get that there's a lot of moving parts with mixing COBEs, etc. Normally, from 1Q to 2Q, we add in sort of $5, $6 from the first quarter. I guess around $3.67 for 2Q revenue for treatment. Is that the right way of thinking about it?

I think your number is right for a normal year. I would remember that we are getting about $17 million of sequestration revenue sequestration suspense dollars in Q1, that number gets cut in half for Q2. So we'll lose, call it eight or nine million dollars of revenue as a result of that. So that'll cost us a little bit more than a dollar of treatment.

Okay, so 366 is the right way of thinking about it to Q. I think that's a good starting point, yes. Okay, and then last question here. On the IKF group, do you guys get the true-ups from your managed care partners for 2021? Just curious if you could give us some color on sort of how those patients did in 21 versus your expectations, any color on the cadence of losses, so the patients you had that joined you in the first quarter of 21 versus the fourth quarter of 21. I guess what sort of, you know, how did those losses sort of change? And then the last question is, I saw your IKF losses are down sequentially. to 37 million in one queue from 39 million in the fourth quarter, just, you know, I thought that would have gone up considering, you know, you're bringing more pages online. So if you can sort of tie that all up for me, that'd be great.

Yeah. So, so first on the 2021 true ups, they'll come much later in the year. We haven't really seen much on that. So we've got no reason to believe anything is, is significantly different in terms of the, uh, IKC losses, they're down a little bit in Q1. I think we got some payments in Q4 of last year, but it's really mostly just normal variability. I don't think there's anything big to call out there.

Right. When did you get the true-ups from your management partners for last year?

It varies in different partners, but I would expect most of them will be in the back half of the year. Remember, you've got to let the claims run out for quite a while until you really know what the numbers are.

Got it. And then just last confirmation, you know, you got answers for the low end of the range for 2022s, you know, but you're still maintaining the 240 to 400. So does that mean that we should have our 23 models around 1875 for 23?

Yeah, so I'd build the 250 to 400 off of the new number we gave you. So, I mean, I'm just doing the math in my head. I think you're in the right zip code with the 1875. Okay, great.

Thanks so much, guys.

Thank you. I'm showing no other questions in queue at this time.

Okay, thank you. Well, let me end with a couple of closing comments. Patient outcomes and improvement to the quality of life of our patients continue to energize our 65,000 professionals. Because of COVID and inflation uncertainty, the short term continues to have materially less visibility than usual, in particular, as we discussed in volume and wage rates. We are deploying a lot of energy to innovate and reduce our cost structure to mitigate some of these uncertainties, and we continue to feel very confident that the investments and capabilities that we're building will position us to outperform in the years ahead. I thank you for your time and investment in DaVita. Be well.

That does conclude today's conference. You may disconnect at this time, and thank you for joining.