DaVita Inc.

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 DaVita first quarter 2023 earnings call. Today's conference is being recorded. If you have any objections, you may disconnect at this time. 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 the number one on your telephone keypad. If you would like to withdraw your question, please press star, then the number two. Thank you, Mr. Eliasson. You may begin your conference.

Thank you, and welcome to our first quarter conference call. We appreciate your continued interest in our company. I'm Nick Eliasson, Group 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 the Federal Securities Law. 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, all subsequent quarterly reports on FORB 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.

Thank you, Nick, and thank you all for joining the call today. 2023 is off to a strong start for DaVita. We enter the year with a cautious balance of optimism about our ability to execute against our plan and uncertainty about treatment volume in a challenging labor market. In the first quarter, we performed well in our key metrics, and our results benefited from an improving macro environment. While some external uncertainties remain, the continuation of current trends would put us on a path to deliver strong results for the full year. Before I get into the details about the quarter, I would like to elaborate on an area of our long-term strategy, which is to connect transitions of care through solutions for our patients across each step in the kidney care continuum. That leads me to our clinical highlight around CKD education. Periodically, we have provided updates on our community education program called Kidney Smart. Raising awareness through education in the kidney care community is critical, particularly given the fact that one in seven American adults have chronic kidney disease and the majority of these people are not aware. Our Kidney Smart program is designed to help those patients understand and manage their kidney health and is frequently recommended by nephrologists as a go-to resource for patient education. To help remove the barriers to health equity, we've offered these classes in 10 different languages. In 2022, over 33,000 CKD patients attended the Kidney Smart Class, the best ever for the 12-year history of the program. Moreover, in 2022, the VITA patients who attended Kidney Smart Classes were more than twice as likely to choose a home modality in consultation with their nephrologist and care team. Transitioning to our financial performance. In the first quarter, we delivered adjusted operating income of $352 million and adjusted earnings per share of $1.58. As we discussed in prior quarters, we implemented a number of initiatives in the second half of 2022 to respond to the pressures associated with lower volumes and higher costs. These plans, combined with a strong operating rigor, translated into positive results in the quarter. And we're now seeing some of the operating metrics that impacted margins in 2022 begin to normalize. I'll start with the biggest driver of Q1 outperformance, labor. We made good progress on labor costs in the quarter, which reflected a combination of operating diligence and improvement in the overall labor environment. As we have said in the past, successful labor management requires effectively managing the interplay between wage growth, contract labor, and training costs. Our operators continue to improve on the permanent staffing levels within our clinics, which has enabled us to drive further reduction in contract labor costs during Q1. We're tracking ahead of plan in our efforts to cut our full-year contract labor expense in half relative to last year. The increase in permanent teammates combined with elevated turnover resulted in training costs in the quarter above historical norms although below the peak we saw last summer. This is in line with our expectations, and we anticipate improvement in our training productivity in the back half of the year. This will largely depend on successful teammate retention, which has historically tracked closely with the health of the broader labor market. Moving on to treatment volume. Quarter over quarter treatments per day were up approximately 1% and better than the middle of our expected range. This was driven by net census gains due to both higher admits and lower mortality. Because of the annualization of excess mortality from 2022, we still anticipate a reduction in overall treatment volume on a year-over-year basis, and we continue to assume excess mortality over the balance of this year. That said, we're encouraged by our first quarter volume results. What we saw in Q1 proves to be a trend. We would expect to finish the year in the top half of our volume forecast range of down 3% to flat relative to 2022. Transitioning to a couple of strategic topics, on April 1st, DeVita and Medtronic announced the launch of Mozark Medical, a new independent device company focused exclusively on innovative kidney health technologies. Mozark's current products and its R&D pipeline ranging from kidney access technologies to advanced home dialysis and acute therapies, are intended to improve the overall patient experience and increase access to home-based care. This investment reaffirms our commitment to realizing scale transformation in kidney care and allow us to fuel innovation in partnership with Medtronic, a global leader in healthcare technology. And finally, a note on integrated kidney care, or IKC. We continue to make progress consistent with our business plan and demonstrate that our model of care is improving the health and well-being of our patients. I'll highlight two examples of this. First, across our IKC program, more than half of our patients achieve an optimal start, which means the patient initiates dialysis treatment at home or appropriate vascular access in place. reduce costly and difficult hospitalizations, and on average, lead to a reduction in the continuing cost of care in the month and year that follow. Second, recent data continues to show an encouraging differentiation in hospitalization rates from patients in our IKC program versus our overall patient population. As we continue to scale our IKC business, which is measured by the total dollars of medical spend in our program, we will continue to focus on driving our net saving rate while pursuing a cost-efficient model of care. In summary, looking across our most important operating metrics, we're seeing progress at a faster rate than assumed in our initial forecast. Therefore, we are revising our adjusted operating income range of $1.4 billion to $1.6 billion to a range of $1.475 billion to $1.625 billion and revising our adjusted earnings per share range of $5.45 to $6.95 to a range of $6.20 to $7.30. Aside from the COVID disruption in the labor market, other important factors for the remaining of the year include continued progress against our cost-saving initiatives, which Joe will elaborate on, and of course, our continued effort to restore patient benefit protection through our advocacy efforts. I will now turn it over to Joe to discuss our financial performance and outlook in more detail.

Thanks, Javier. I'll start with some additional commentary on first quarter results, and then I'll add detail on our expectations for the remainder of the year. As Javier said, Q1 adjusted operating income was $352 million. Adjusted EPS was $1.58, and free cash flow was $265 million. Overall, the results were at the high end of the range of our expectations for the quarter, driven roughly equally by three things. First, strong operating performance in the U.S. dialysis business. timing of certain items in our IKC results, and third, some normal positive variability in a couple of cost items that we are not forecasting to recur in the rest of the year. With that, let me provide some additional detail. First, U.S. dialysis treatments per day were up almost 1% in Q1 compared to Q4. As Javier mentioned, this was due to higher patient census. Mistreatment rates remained elevated compared to pre-COVID levels and were consistent with our expectations. Revenue per treatment was down 16 cents quarter over quarter, driven by normal seasonal impact of high patient responsibility, offset by annual increases in Medicare fee-for-services rates that begin in January, growth of MA, and seasonal increases in acute treatment. On a non-GAAP basis, patient care cost per treatment decreased by $1.18 sequentially. The biggest drivers of the change were pharmaceutical cost savings from our anemia management transition to Mercera, reductions in our contract labor spend, and positive variability in health benefits and insurance costs. These were offset by higher compensation costs and two fewer treatment days in the quarter. On a non-GAAP basis, G&A expenses were down $24 million quarter over quarter, largely due to normal variability in our G&A spend. IKC's adjusted OI for the quarter was approximately the same as Q4 and better than expected. The quarterly IKC results benefited from revenue that was forecasted to hit later in the year and the deferral of certain expense items that we expect will be recognized in Q3 and Q4. Excluding these items, IKC results were in line with our expectations. International adjusted operating income was up $12 million relative to Q4, driven roughly equally by foreign exchange and acquisition-related expenses in Brazil during Q4. Looking at our capital structure, we ended the quarter with a leverage range of approximately 3.9 times EBITDA. We did not buy back any shares during the quarter as our focus continues to be to get back to our target leverage ratio of 3 to 3.5 times EBITDA. In the last week of April, we closed on a successful $2.75 billion refinancing of our revolving credit facility and term loan A, despite a challenging capital markets environment. Looking forward, we still expect interest expense of $100 million to $110 million per quarter for the rest of the year. The April 1st launch of Mozart Medical, our partnership with Medtronic, will result in approximately $20 million of pretax losses below the OI line in Q2. This is less than previously shared due to timing shifts of certain stand-up costs. In the back half of the year, we still anticipate $15 million of negative impact on other income per quarter And as we shared previously, we expect Mozark's OI to trend towards breakeven in approximately the next three years. Regarding the savings initiatives we've talked about in the past, we're on track to realize year-over-year savings within the range of $125 to $175 million, consistent with prior expectations. This is primarily driven by a reduction in pharmaceutical costs and our ongoing facility consolidation. During Q1, we initiated our conversion to Mercera, which will continue to roll out over the remainder of the year. Additionally, in Q1, we consolidated 20 centers and currently anticipate consolidating another 40 to 50 centers over the remainder of the year. We continue to achieve high patient and teammate retention rates related to these shifts as the majority of patients at consolidated centers have transitioned to nearby DaVita facilities. That concludes my prepared remarks for today. Operator, please open the call for Q&A.

Thank you, sir. At this time, you may press star 1 on your telephone keypad to ask a question. If you would like to withdraw your question, you may press star two. One moment, please, for the first question. Justin Lake with Wolf Research. You may go ahead, sir.

Thanks. Appreciate all the color. Joel, maybe you could talk a little bit about what you're seeing. You talked about higher turnover and lower, you know, temp labor costs. What's going on with turnover there? What are you expecting for the rest of the year? and how are labor costs tracking versus kind of the headwind that you had laid out for us? And then maybe given the upside in the quarter, what are you projecting for the rest of the year relative to Q1? And if you do hit these numbers, when do you think you get back to kind of your target leverage ratio and therefore, you know, the potential to buy back shares? Thanks.

Okay. Well, there's a lot in there. So let me just pull up for a second and then Joel can answer some of your follow-up questions. Justin, this is Javier. First, on labor, we started to give a little more color when we had more volatility in some of the underlying metrics. But I think it's a good time right now to pull up, as you asked, which is a bigger number. But just so we're clear on all of the metrics, when you talk about SWBs, you take into account wages, productivity, benefits, training and contract labor within wages. There's obviously you can double click on that. You've got overtime shift differential and other things, but let's stay with those five. Uh, in the third quarter of 2022, we had a spike in training and contract labor that we called out because they were outliers to our historical numbers. But then as we fast forward to today, we worry that people aren't facile enough with the math to calculate the interplay between the five. So let me see if I get to your number, and if not, you can follow up a question. So from 2018 to 2022, we had a CAGR of roughly 2% in SWBs. In 2022, which of course had that outlier that we were just talking about, that number went to roughly 8% growth. And in 2023 over 2022, we expect that number that incorporates all those variables to be more in the 4% to 5% growth. So does that answer the question on labor, or do you want to ask a follow-up on that?

Yeah, just mostly on labor, what I'm trying to figure out is versus that 4% to 5%, if you continue at this pace, where do you think you end up?

I'd say, Justin, we're thinking we're about $25 million ahead of where we thought we would be on the total labor cost. So if you think of our guide increase at the middle of the range of of $50 million, I'd say half of that is labor and half of that is volume. And that's how I get to $25 million.

And is that just for the first quarter, Joel? And I'm kind of trying to think about, like, if this continues, does that mean you're 100 better?

Well, In the labor line itself, there were some items that we don't think will recur. They were good guys in lines like benefits and workers' comp that I'd strip out as you think about annualizing things. So the 25 would be a full year number. In terms of where we need to go from here, we're expecting continued wage pressure as the year presses on. There will be a little bit of improvement in contract labor, but we've seen most of the improvement in contract labor that we're likely to see because it just happened faster than we thought. And on the productivity side, we haven't seen much. We're off the peak that we saw in the middle of last year, but we're still well above pre-COVID levels. And what we're currently building in is some progress in the back half of the year, but ending the year still above pre-COVID levels. And that's really driven largely by the turnover that we're seeing.

That's helpful. I'll take the rest of my questions offline, Joel. Thanks.

Thank you. Our next caller is Kevin Fishbeck with Bank of America. You may go ahead, sir.

Hi, this is actually on for Kevin. Thanks for taking the question. Just another quick question on labor. You said you expect continued wage pressure in the year. What are you assuming for wage inflation this year, and how does it compare to last year and pre-COVID levels? Thanks.

Yeah, I think, you know, it was really answered a little bit with Justin, so let me make sure we're asking the same thing. So we just basically said that if you take all of the variables into account, that we think that SWBs will be 4 to 5% higher at 23 over 22. Does that answer your question?

Yes, thank you. And that's all. Thank you. Thank you. Our next caller is Andrew Mock with UBS. You may go ahead, sir.

Hi, this is Thomas on for Andrew. Thanks for taking the question. Star, could you walk us through the underlying drivers of the treatment growth beat in the quarter, as well as provide an update on how mistreatment rates are tracking sequentially? Thanks.

Sure. Thanks for the question. So, I like to use the treatment per day number, and you'll see that that number is up about 90 bps quarter over quarter. That is largely driven by census increases, and that's the result of admissions increases in Q1 offset by continued excess mortality, which is way down relative to prior years, but remains higher than it was pre-COVID. In terms of mistreatment rates, It continues to trend well above the pre-COVID number. It can move around from one quarter to the next. There's a lot of seasonality and other impacts in it. But we are still seeing it running roughly 100 basis points higher than what we saw pre-COVID.

Got it. That's helpful. And a quick follow-up. I wanted to ask about the ESA switch to Mercera, specifically, Are there any KPIs you can share to track the transition? And do you have any update on the cadence of the rollout?

Thanks. We do not have any disclosures on it. All I can tell you is that the rollout is going as well as we expected and that from a clinical perspective, we are seeing the results that we wanted. So it's going as planned. Great. Thanks again. Thank you.

Thank you. Once again, if you would like to ask a question, you may press star 1. Our next caller is Pito Chickering from Deutsche Bank. You may go ahead.

Hey, good afternoon, guys. So follow up here on Justin's question. On the $50 million operating income raise, you said half was labor and half was better volumes. You added almost 60% new lives into IKC. I guess any changes on how that is tracking versus your previous guidance? And then on the guidance raise, can you walk us through what $50 million of operating income It's transitioning into $100 million of free cash flow. Is that just working capital or anything else in there?

Let me take the first part of that, and Joel can take the second part of that. On IKC, as you can imagine, it is a growing business. And while we're making really good progress, it is clearly in the investment phase of the business. And so there is no change in what we see the full year. We had a bit of timing in there, so the number looks a little better today. on a quarter of the day than it will on an annualized basis. We're still on target to what we've said.

Yeah, Pito, on the free cash flow, as you pointed out, obviously an increase in OI helps that. The other two things are, one, cash taxes are trending better than we expected, and the second is working capital. You see the DSOs were down considerably, so we think we'll get a bit of a tailwind to that as well for the year.

Okay, and then just to signify Casey for a second, realizing that when you add on 50, almost 60% new lives, that's going to be sort of a drag as you guys think about those coming online. But any sort of color and sort of how the medical trends are tracking for your people that you had coming into the year? I mean, we've seen spikes of utilization in other areas of health care, just curious kind of how that class of 2022 was tracking during the first quarter.

Yeah, as you said, we agree it's a little hard to say because we have so much noise and volatility because of COVID. And so there's not a lot to report. What we're seeing is that the savings are coming in line to where we expect. The model of care is a little less efficient than we want. We need to build more scale and we need to standardize a whole bunch of these things that right now are manual. So we're still a work in progress. We're growing a lot of things that we want to be, and we're still expecting to be breakeven in 2026.

Okay. And then, sir, one last question here, which won't shock you. Looking at the NAG growth, you know, sort of flat year-over-year, definitely a lot better sort of trending than we've seen sort of in the last, you know, several quarters. Back, sir, was talking about sort of similar normalization of utilization. I guess any comment you can give us on how many patients you guys added and this quarter, how did that sort of track versus, say, 2022 versus pre-COVID? And then any more call you can give us on, you know, where mortality is tracking on the current patient base today.

Yeah, so let me walk you through some numbers, Pito, here. So the net census growth in Q1 was about 1,350 patients. If you compare that to what it was in Q1 of 22, that was negative almost 500 patients. So in almost 2,000 patients swing, most of that is explained by the change in excess mortality, although some of it is also the result of a better admit quarter this quarter than we saw last year. So on both the mortality side, and the admit side, uh, we saw, we saw progress.

So on the admin side, I guess it gives the color of sort of, you know, the one Q 23 new ads and how that was say one Q 19, just as some comparison on a pre COVID.

Um, if you were to look at this excluding excess mortality, um, I don't have the numbers in front of me, but I can tell you, um, it was definitely higher this quarter. than it was Q1 of 2019. That said, I would be cautious before we start extrapolating this out. This is one quarter of data. This metric historically has been variable quarter to quarter, and I'd want to wait to see what happens for a few more months before we're ready to really declare a trend here.

So, I mean, just a last question on that one. Sorry to sort of keep going there, but you're looking at the USRDS data. We go back, you know, for many years, the incidence rate of end-stage renal disease has been fairly consistent for, I mean, nearly a decade. Are all signs you're seeing that we are returning to normalization of incidence rates, and it's just too soon simply to call it at this point?

It's a little too early to call it. We've been studying and evaluating all different data sources, and we're not ready to draw any conclusions. But, you know, there's a lot of movement upstream on the CKD population, in particular with COVID. And so we will look because, as you know, there's some things that are making progression slower on the other hand. There's things that are expanding life expectancy, and so our math is not leading to any conclusion at this point.

And then last piece there, I promise I'll stop here, at least for now, is on mortality. I guess any comments on where the normal mortality was and excess mortality, and sort of how we should think about both of those continuing into the back half of the year, and I'll stop there.

Yeah, so... Excess mortality was about 900 patients in the quarter. We have brought down slightly our expectations of excess mortality for the balance of the year, but we're still looking at a number somewhere between 2 1⁄2 and 3,000 patients in terms of what's built into the middle of our guidance range. Great. I'll stop there.

Thank you. Thank you. Our next caller is Gary Taylor-Lacowen. You may go ahead, sir.

Hi, good evening. I think just two quick numbers. For me, Joel, you had mentioned, or at least in the release, some favorable items in G&A, including an advocacy refund. Just wondering if you could size that for us. And then on I know there's a ton of moving parts there, but I was just trying to sort of foot how the revenue was down $4 million sequentially from 4Q, but you said you had some early revenue there and some delayed expense, so just trying to sort of foot down but still including some early revenue recognition.

Sure. So $6 million is the ballot number you're looking for. In terms of IKC, we saw about $20 million, roughly half in the revenue line, half in the expense line, that we were expecting. We were just expecting it later in the year. In terms of the timing of the revenue, we generally view IKC revenue to be back half of the year loaded. As you think about the claims lags filling up or maturing, and then ultimately the calculations on shared savings being done, that usually happens in the back half of the year, and that's when we'll recognize the shared savings dollars. That's why you see the decline from Q4 with still a, call it a positive timing surprise.

Got it. Perfect. Thank you. Thank you, Gary.

Thank you. Our next caller is Pito Chickering with Deutsche Bank. You may go ahead, sir.

All right. Sorry, guys. I just had a couple ones I want to come back to you on. So revenue for treatment sort of, you know, sort of flattered sequentially primarily due to sort of the seasonal co-pays. Just curious, two questions, I guess. What are you seeing from managed care on cost of living updates? And how should we think about revenue for treatment sort of going for the rest of the year?

Yeah, thanks, Peter. A couple of things. We're not seeing anything to report on from the managed care negotiations. And just to refresh you, we've talked about our contractor multi-year. In any given year, we negotiate roughly about 20% or so of our portfolio, and we're not seeing anything different in this year. What we've talked about in Q4 last year is that we said that we would get a revenue per treatment increase year over year of from 2% to 2.5%, 23 over 22.

Okay, great. And then, so on the efficiencies from closing centers, you have sort of close 20 this quarter. You talked about consolidating another 40 to 50 centers. I guess, how much of a savings do you think you're going to realize in 23 from those center consolidations just solely on that line? And how much of that then should trend through for 2024?

Yeah, so we haven't quantified the number. We've always said it'll be part of the 125 to 175, but not the biggest piece. The biggest piece of that is Mercera. So that'll be in 23. There'll still be some amount that'll roll over into 24, but we'll get most of it in 2023.

Okay, and then sort of last one here for me. Maybe I missed it, but what was the contract labor dollars this quarter? What are you seeing for the rest of the year? And then any color on what your hiring was and net hiring was in the first quarter?

Yeah, so I think what we said was that in the year, last year, remember, contract labor was running around $100 million, and we said for the year this year we'd be half of that, and now today we moved that. that we are moving better at a better pace, that number will be more like 35. But again, I would point you to the beginning of the conversation where we said the most important part is the interplay between all the variability of all those metrics because, of course, training, productivity, wages, benefits, and contract labor are all intertwined. But that's the number.

And I guess the second part is just can you quantify for us the number of hires you had in the quarter and what the net hires was after turnover and how that should trend throughout the year? Because you mentioned about lower training costs as this bachelor comes online. Just a helpful thing you can quantify that for us.

Yeah, so here's the way I'd think about the training costs. They peaked last year as a result really of two things, higher turnover and combined with the need for us to net add staff. And those combine to a high training level. As we sit here today, the turnover remains elevated. It's gotten better with some classes of labor than others, but it still remains elevated. So we're expecting continued high training levels. Until that comes down, we're modeling the back half of the year. but we are much closer or at fully staffed. So some of the training associated with getting the staffing levels back up is now done, and that will mitigate some of the training costs relative to the peak we saw in Q3 last year.

So when you talk about sort of the 4% to 5%, you know, increase of SMB, I guess, how much of that is sort of more of a want? It comes from the training costs that are embedded within the guidance that should sort of roll off as I think about 24.

Not a lot. The change in contract labor is a much bigger tailwind relative to 22 than the training productivity, and that's, you know... It's partly because we're not going to see the training productivity improve until the back half of the year. It's also partly because in the beginning of 2022, training productivity was still low. So we saw the spike in Q3, but that was only one quarter.

Okay, great. Thanks so much, guys. I appreciate it.

Thank you.

Thank you. And at this time, I am showing no further questions.

Thank you, Michelle, and thank you all for the questions. As I hope you've heard today, we have some positive momentum to start the year. The results of Q1 proved to be a sustainable trend. We're excited about the implications for our patients, our teammates, and our financial performance in 2023 and beyond. Thank you all for joining the call, and be well.

Thank you. This concludes today's conference call. You may go ahead and disconnect at this time.