Good evening. My name is Michelle, and I will be your conference facilitator today. I would like to welcome everyone to the DaVita Fourth Quarter 2022 Earnings Call. Today's conference is being recorded. Mr. Lien, you may begin your conference.

Thank you, and welcome to our fourth quarter conference call. We appreciate your continued interest in our company. I'm Nicolaisen, 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. 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, all subsequent quarterly reports on Form 10-Q and other subsequent filings that we may 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. We start 2023 with a mix of optimism and uncertainty about the year ahead and with continued conviction in our long-term capabilities and strategy. We're grateful for getting through the winter without a surge of COVID-related mortality and like a bunch of society, wondering whether the worst of the COVID pandemic is finally behind us. I'm encouraged by the progress we've made in the recent months to improve that which is within our control, while we continue to invest in our future. That said, we're cautious in our optimism today because we're still experiencing the impact on volume and labor. For today, I'll spend a few minutes on fourth quarter results and then focus on the future with a summary of our 2023 strategic priorities and then end with our 2023 outlook. Before I dive into these topics, I'll start, as I always do, with a clinical highlight. Our most impactful clinical initiatives are those that directly improve the quality of life and vitality of our patients. There are many measures serving that important purpose. And today, I'll take a moment to recognize the successful efforts to decrease infection rates amongst our vulnerable patient population. One way we measure success is by tracking bloodstream infections, and I'm proud to share that we achieved an all-time low bloodstream infection rate for our patients as of the third quarter last year. This reflects a 20% improvement within the last year alone. These results represent just one of many efforts we have undertaken to reduce hospitalizations and mortality, which is a tremendous gift for our patients and their families. I will now pivot to our results. Our full year 2022 adjusted operating income came in at the top end of our revised guidance at $1.45 billion. Adjusted earnings per share from continuing operations for the full year 2022 was $6.60 and we generated $817 million of free cash flow. The primary driver of our fourth quarter performance coming in at the high end of our range was improvement in labor costs. The labor environment continues to be challenging across many dimensions, but the fourth quarter was certainly better than the third quarter. One particular highlight is our focus on reducing contract labor produced results earlier than expected. We still expect contract labor will be higher than pre-COVID levels in 2023 by $20 million to $40 million, but that will be a significant improvement to 2022. We continue to make progress in hiring teammates during the quarter as we work to stabilize center staffing levels and increase retention. Of note, this increase in labor capacity will continue to drive higher than typical training and onboarding costs in 2023 until retention normalizes to historical levels. We continue to expect wage pressure above historical norms in 2023 but anticipate wage growth at levels below 2022. Despite early optimism for improvement in 2023, the labor markets remain highly dynamic and will remain a key swing factor in our performance. Our fourth quarter results give us increased confidence in achieving the improvements we discussed last quarter. On to volume, overall results for Q4 were in line with our guidance from last quarter. COVID infection and mortality rates in December and January were lower than in prior years, which is a welcome relief for our patients and our caregivers. Because the winter surge has historically occurred late in December, the lack of a surge did not result in material improvement in our treatment volumes in Q4 relative to our expectations, but has reduced our expectations for total access mortality in 2023 by approximately 1,000 patients as compared to our expectations in the range provided last quarter. Last quarter, we also highlighted that patient admissions and missed treatment rates are key variables to our volume. We continue to see pressure on both of the metrics, but at the levels in line with our most recent expectations. For 2023, we continue to use a wide range of possible volume outcomes in our guidance given the uncertainty of the virus. We have shifted the range up to account for the lack of a meaningful winter surge so far but have not fully discounted the possibility of a COVID surge later in the year. Our 2023 volume guidance includes a treatment range of down 3% to flat relative to 2022. All else equal, the lack of a COVID event over the remainder of the year would move us towards the better end of our volume range. Looking forward to 2023, we kicked off the year with a robust and exciting set of priorities. We remain resolute in our commitment to pursue strategic goals that create a strong future for our patients and our company. I will highlight five of these priorities today, beginning with innovation. First, we're approaching a key milestone in our journey towards digital modernization. After years of development, this year, we're deploying our next-generation clinical IT platform. This new cloud-based system is designed to provide seamless access to patient records across locations, supporting integrated kidney care and enhancing data reporting and analytics. Rollout is well underway, and we expect the system will be live in our centers across the country in 2023. This platform will provide a superior experience for our teammates and physician partners while enhancing clinical care for our patients. Second, on policy, the Kidney Care community remains active working with CMMI to enhance innovative models that improve care coordination and advance initiatives around transplant, home care, and health equity. At the same time, we're advocating for an update to the industry bundle payment system to better reflect year-over-year cost increases. And finally, we continue working with the broader kidney community to restore benefit protection for our patients through legislative and regulatory efforts. Third, operationally, we remain committed to educating our patients and our physicians to increase adoption of home modalities where clinically appropriate. In support of our over 1,700 existing home programs, we are launching transitional care programs across the country to educate new dialysis patients on their modality options. We're also working toward a full integration of our technology platform to create a holistic information ecosystem for better home patient management. Fourth, our Integrated Kidney Care business is expected to deliver another year of significant patient growth. With the benefit of increased scale, it will be an important year for us to continue building on our capabilities for IKC to achieve its purpose of driving better outcomes for our patients, better collaborations with physicians, and economic alignment with our payer partners, particularly within the growing Medicare Advantage segment. And finally, to fuel these initiatives, we're maintaining a disciplined approach to our cost structure. For example, this includes our ongoing transition on the ESA therapy and the ongoing consolidation of our facilities footprint to align capacity with treatment volumes. This discipline is particularly important in the context of Medicare fee-for-service rates, which, as you know, have not kept pace with our increasing patient care costs. As you can see, 2023 will be a dynamic year across many of these efforts, and we remain firmly focused on the key operating drivers I previously mentioned. Now shifting out to outlook. For 2023, we're initiating guidance for adjusted operating income of $1.4 billion to $1.6 billion and adjusted earnings per share of $5.45 to $6.95. This reflects our latest views on continued moderating labor headwinds over the balance of the year, persistently volume pressures offset by the positive impact of avoiding a winter surge and the benefit of the cost-saving initiatives we have previously outlined. Looking longer term, if we continue to see diminished impact from COVID and moderating labor pressure, we would expect to return to a more normal adjusted operating income growth trajectory of 3% to 7%. I will now turn it over to Joel to discuss our financial performance and our outlook in more detail.

Thanks, Javier. Let me first share a few more details on Q4 performance and then I'll add some color on 2023 guidance. For Q4, we delivered $317 million of adjusted operating income and $1.11 of adjusted earnings per share from continuing operations, which resulted in the full year coming in right at the top of the updated guidance range we provided last quarter. For the U.S. dialysis segment, treatments per day were down 1.3% compared to the third quarter in line with our expectations. This was the result of lower patient count due to excess mortality and a higher seasonal missed treatment rate. Adjusted patient care cost per treatment was up $1.78 sequentially. There were three primary drivers of this increase: seasonal flu expense, year-end benefits, and lower fixed cost leverage because of the decline in treatment volume. These were offset by lower contract labor costs in the quarter. Adjusted G&A was down $24 million quarter-over-quarter. This decrease was primarily driven by the $28 million of California ballot initiative expense in Q3. Turning to our other segments. For our IKC business, operating income was roughly flat quarter-over-quarter. International adjusted operating income decreased $15 million quarter-over-quarter. This is primarily driven by $7 million in foreign exchange headwinds and an expense related to acquisitions in Brazil. This acquisition expense has an offsetting decrease in taxes, so there's no net impact on the P&L. During Q4, we did not repurchase any shares. As we communicated on the Q3 call, our primary deployment of the excess capital will be to pay down debt to return to our target leverage ratio of 3x to 3.5x EBITDA. Turning to 2023. Let me add some more detail on our guidance. Our 2023 adjusted operating income guidance is $1.4 billion to $1.6 billion. Compared to our comments on the Q3 call about our expectations for 2023, the only significant update to our expectations is higher treatment volume due to the lack of a winter COVID surge. To give some more color, let me run through our latest expectations on the three drivers of the U.S. dialysis business in 2023. First, we expect the year-over-year change in treatment volume to be between 0 and negative 3% due primarily to the annualization of excess mortality in 2022 and continued excess mortality through 2023. Second, we anticipate revenue per treatment will increase approximately 2% to 2.5% year-over-year, driven roughly two-thirds by rate increases and one-third by higher Medicare Advantage and commercial mix. And third, we expect patient care cost per treatment to increase approximately 2% to 2.5% driven by wage rate growth and inflationary pressures, partially offset by savings from our new anemia contract and other cost-saving initiatives. A few additional things to help your thinking about 2023, each of which is incorporated in our guidance. Year-over-year adjusted operating income is benefited by approximately $50 million due to the absence of the ballot initiative spend in 2023. Regarding timing of adjusted operating income in 2023, we expect Q1 adjusted operating income to be approximately $75 million to $100 million lower than the average of Q2 to Q4 due to typical seasonal factors impacting, among other things: RPT, treatment days per quarter, and labor. Regarding our previously disclosed agreement with Medtronic, we anticipate the transaction will close in the first half of this year. Our initial cash investment will be approximately $300 million at closing. On the P&L, we expect approximately $60 million of pretax losses below operating income in 2023, which assumes approximately $30 million in the second quarter and $15 million per quarter over the remainder of the year. The EPS impact of this will be approximately $0.47 in 2023. For IKC, we expect operating income to be flat to slightly down in 2023 relative to 2022. This is driven by additional growth expenses, offset partially by increased shared savings. Our interest expense assumption for the year is $405 million to $425 million. For income tax, we anticipate an effective rate of 25% to 27%. On cash flow, we expect free cash flow from continuing operations of $650 million to $900 million. And finally, we anticipate our leverage ratio at the end of 2023 to be in the range of 3.6x to 3.9x 2023 EBITDA. That concludes our prepared comments for today. Operator, please open the call for Q&A.

Our first caller is Andrew Mok with UBS.

To start, you delivered the high end of the revised guide this quarter, but you're leaving the operating income growth for 2023 unchanged. And so can you help us understand those dynamics a bit better? Because it sounds like labor costs and volumes are both trending better, which would presumably lead to a better operating income outlook for 2023?

Yes, Andrew, I'll take that one. So I'd say relative to the guidance we gave on the Q3 call, we've really learned two things. One is, as you highlighted, the quarter came out at the high end of our range, largely as a result of labor. And the second is we didn't have a winter surge. As we looked at guidance for the year, we incorporated the volume improvement from no winter surge. We looked at the labor dynamic and ultimately, we concluded to leave our labor guidance for 2023 unchanged, really for two reasons. One, we did see improvement in Q4, but some of that was improvement that we really anticipated in the front half of 2023. It just came in earlier than expected. So you wouldn't expect that to change 2023. The second is we're in a really dynamic labor environment. And given all the moving pieces, we ultimately concluded one quarter's worth of outperformance wasn't enough yet for us to change our views. So for that reason, we kept labor where it is, and the improvement in the guide for next year is really the result of better volume because of no COVID surge in the winter.

Got it. Do you have the number for contract labor costs in the quarter?

Yes. Contract labor costs in Q4 were down about $14 million relative to Q3.

Okay. And then in the prepared remarks, you noted that you would expect to return to a more normal operating income trajectory of 3% to 7% if COVID normalizes. Can you help us understand what level of visibility you have into incidence rates for new patients to drive the confidence in that restored growth rate should COVID normalize?

Sure. I'll grab that one. In essence, when we think of growth, we think of it in two categories. One is what's within our control and the other is the macro factors. Within our control, as we said, in the fourth quarter, we've made some progress, and we will continue to make progress on being staffed and ready to accept new patients. On the macro, which is sort of the question that many are asking, what is upstream new patient looking like, there are some questions that we still can't quantify. Some variables that we still can't quantify. That said, there is nothing we've seen that leads us to conclude that there is a permanent change to new starts. And so the best assumption at this juncture is to assume that after COVID plays out, that admissions would revert to the roughly 2% that we experienced historically.

Got it. And just a follow-up. I wanted to ask about the ESA switch from EPOGEN to Mircera. What sort of cadence are you expecting with respect to transitioning patients? What have you done so far? And when do you expect that transition to be complete?

Yes. The cadence is obviously done very carefully with the coordination of all the physicians making their independent decisions as to what's right for each patient. It will roll out throughout the year, and we should be done by the end of 2023.

Sticking with the incidence for a few minutes. It's pretty delayed, but looking at the U.S. incident count the first half of 2022 is down sort of 5% versus '21. I guess, can you guys help quantify sort of what your new adds were sort of quarterly throughout 2022? You guys sort of assume that to be in 2023?

Yes. So our admission rate in 2022 was lower than what we've seen prior to COVID-19. We called that out. And I think that's really one of the big drivers of why what I'd call organic volume or organic growth is down. That's been persistent. It's kind of picked up through the back half of the year, and we haven't seen it come down, which is why our guide for 2023 continues basically to track what we saw in 2022. We haven't built in any material improvement to that. That said, as Javier noted, we expect that to revert back to what we saw pre-COVID once the direct and indirect impacts of COVID are done.

Okay. So looking at the press release, you had added about 1,200 patients sequentially. I guess, you actually can't quantify for us the 6,000, 3,000 adds with the delta being sort of mortality. I mean, just any color just sort of you can quantify what the new adds were in the fourth quarter?

We haven't provided a number for new additions in the past, and I'm reluctant to do so now. There are various ways to calculate it, so I'm unsure about an exact figure. That said, it remains low, as we observed in Q4. This metric does experience seasonality and usually improves in the first half of the year. Therefore, we are anticipating an increase in the first half of 2023.

Yes, if you were going to use really high-level math, and I'm just trying to help get the direction going, and you say, we guide it to negative 3 to 0, but I would give you a midpoint of negative 1.5. And if you just do the math of the excess mortality starting off in 2023, that's a sort of a negative 2. There's other variables going into it, but that would get you to a plus 50 basis points for new admissions, give or take. And there's other dynamics, but that gives you direction.

Okay, which actually is a segue in, I mean, I guess prior to COVID, 2018, you saw a sort of generally about a 17% sort of mortality rate gets you to just under sort of 6 years or on average. And during 2020, it was 20-plus percent mortality rates sort of sub-5 years. I guess as you're looking at the fourth quarter, are we seeing sort of mortality rates sort of go back to previous levels? There's expectation at one point that it would be extended. Just from a pull forward due to customer tell COVID in 2021 seeing if that number is starting to extend back again.

Yes. So if you just look at the numbers just to make sure because there's new people to the story is in 2020, we announced roughly 6,800-or-so excess mortality, and we're guiding roughly to 3,000 in 2023. So it is coming down quite aggressively. And I think, again, we don't have visibility exactly as to when that would revert. But as COVID unwinds, it looks like it should go with the visibility we have back to normal.

And Pito, just to add to that, to help you with your modeling, the excess mortality number in Q4 based on what we know now, and these numbers get updated as the data catches up, was roughly 900. You want to compare that to Q4 of 2021, that number was somewhere around 1,500. So Q4 over Q4, the numbers come down significantly. And we would expect similarly Q1 '23 over Q1 '22 because of the lack of the surge.

Okay. One quick follow-up. Can you sort of talk about the nurse turnover? Has that sort of stabilized at this point? And then on the contract labor, what was contract labor running sort of in 2019? Just as we think about this normalizing out kind of where we are to expand your contract labor in pre-COVID?

Pre-COVID was roughly a little below $20 million. When we got to a high, we got to roughly $100 million last year. And what we've told you is that we would run roughly $20 million to $30 million higher in 2023. So that would put you right around $50 million or so. So trying to get halfway through, if you will.

A couple of quick questions. Going back to Integrated Kidney Care. 42,000 full risk patients. What is the guidance or what's built in for 2023? How much patient growth?

I'd say 50% is a good number to use there, Gary.

So I mean 50% patient growth and then you're saying the loss is going to be fairly similar to slightly better than that 1 25, right?

I think the way to think about that rough numbers is a $50 million improvement in shared savings revenue, and that's driven by the shared savings in 2023 that we get for patients that we were at risk for in 2022, and that's offset by roughly $50 million of costs associated with that growth that we're going to see in 2023.

That makes sense. And I think I understand the accounting you do for that, but the $378 million of revenue you booked this year for that segment, you've got about $3.5 billion of spend. I know that's not all ratable necessarily. But that implies like your net savings that's going into our revenue numbers, like 11% of the spend. Is that the right way to think about the results you're achieving so far?

I believe it's challenging to make that calculation. The $377 million in revenue for 2022 can be divided into two components. $300 million comes from SNPs, which I would describe as gross revenue, similar to how a health plan accounts for the total medical costs as part of revenue. The remaining $76 million is from shared savings revenue, where we only record the actual amount of shared savings and not the total medical costs. If you want to look at a number, you would consider the gross margin related to that $377 million. This is not an accounting gross margin but rather a financial metric we would calculate that would not comply with GAAP. You would then take that number, let's say it's around $100 million, and divide it by the previous year's medical spend or the dollars under management from the prior year because that shared savings revenue relates to the prior year. This ratio would provide what I would refer to as a net savings number.

Got it. Following that. Appreciate it. Last one. Javier, you talked about...

Gary, I'm sorry, just a quick correction. I think you said that '23 would be flat to slightly better than '22, and I agreed with that. What I said in the prepared remarks, it would be flat to slightly worse. So I just wanted to clean that up.

Okay. I just want to go to Marietta for a second, Javier, I mean, Fresenius is talking about having a lot of confidence in regulatory or legislative, and you suggest that you're still active there. I guess, is there anything else you can share on where you think that relief is more likely to come, CMS making a regulatory language change or the legislation that was introduced last year? And then in the last part of it would just be any evidence at all any of the regional TPAs are doing anything with this yet? It sounds like not, given your commercial mix guide for '23, but I just want to see.

Yes. Thanks for the question, Gary. Won't speculate as to how it will come or if or when it will come. But we continue to work very diligently with the kidney community and disability groups to restore our protection for our patients. As it relates to what are we seeing, we have not seen any significant uptick, but we wouldn't expect it given the time of the year we're in because there's a lag in claims and payment. So right now, it's going as expected. But one of the things that we're working with the congressional champions is that they've asked that we produce examples because they're very interested in protecting patients. So that's all we have at this juncture.

This is Austin on for Justin. Appreciate the question here. Joe, I guess I wanted to start real quick just on sort of the leverage outlook in that 3.6 to 3.9 that you were speaking to. And just kind of curious what sort of needs to happen to reach both ends of that range? And then off of that on the share repo thinking, is there any timing or outlook embedded in the '23 guidance when that might resume? Or like alternatively, what do you guys kind of need to see on the debt side to start to reserve resume the repurchase activity?

Yes. So we have not built any share repurchases into our guidance for next year. We just think that's the prudent way to model things out. The range is largely driven by the range in operating income, which translates into a range in EBITDA. So that's what drives the range there. In terms of what we need to see, look, we need to see a very clear path to getting back into the range before we shift our capital allocation priorities back to share repurchases.

Okay. Great. And then on the follow-up, kind of on the clinic closures, you guys did 44 last quarter, 58 this quarter. I guess we think ahead to '23, is there kind of like a point-in-time number that you guys are kind of targeting in terms of further clinic consolidation? And then off of that, just kind of an update on how the patient retention is tracking off of that.

We don't have a specific target. It's a serious process for us to ensure that patients and the community are well cared for, and we consider many factors. It appears that the number of clinics will likely be between 50 to 70 in 2023, with prospects for further consolidation. Patient retention plays a role in this calculation, and we continue to observe strong retention rates as patients choose to remain with DaVita.

Great. And then just one last one for me kind of on an IKC follow-up, the number of Ares patients bounces around a little bit during the year. I'm just wondering what are the drivers of that in terms of attribution to you guys? And then is there an expectation like patient mortality in a certain sense, is sort of showing up there? And then on the med cost under management, just I guess what are the expectations for cadence and how that moves through 2023?

Yes. So there's nothing I'd call out in terms of the movement on the lives over the course of the year. Contracts go up or down, the number of lives in our SNP plans can move around a little bit. Some of it, I think this quarter was more around rounding than any major moves. In terms of medical spend under management. I think for next year, we expect that number to end somewhere in the $5 billion range with a lot of that growth coming at the beginning of the year.

Great. And then sorry, let me squeeze in just 1 more here. You guys mentioned the commercial mix in MA. Just wondering kind of where that tracked in 4Q and then what's kind of embedded for year-end '23, just on the mix side.

We ended the year with a mix of 10.4, and we don't usually give forward guidance on mix, but that's where we ended the year.

Great. I guess last quarter, you mentioned a lot about the missed treatment dynamic. Is there any update there? It sounds like you're saying it came in line with seasonality. I think it's back to normal? Or back as you would have expected based upon how things played out in Q3 plus Q4 seasonality.

Kevin, on the missed treatments, we just highlighted that it was trending higher than it had historically by 1 percentage point. We also said that this is a dynamic that's going to take some time to, a, understand and then, b, fix. And so in our guidance, we do not have any significant progress in there until we can really understand the dynamic and lower it. So it came in line in the sense that it wasn't modeled to improve in any dramatic way.

And so you're assuming that in your 0% to 3% to down 3% on guidance, it just stays stable?

Correct.

Okay. Regarding the Medtronic joint venture, it appears to be around $15 million per quarter for the remainder of this year. When do you expect it to break even? Is that something that can be projected reliably for the upcoming year?

Yes, I'd say ratable to 2026 is a reasonable estimate.

Okay. And so if you're still going to be at 3.6% to 3.9% leverage, I guess, going back to earlier point, is it safe to assume that there probably won't be share repo in the first half of next year or two? Or if you feel like there's core growth going on, you could potentially see that pathway to deleveraging that would allow you to start repo before you are kind of right at that range?

I think it's a little early to speculate, but we certainly want to retain the optionality to start the share repurchase program before we get there. I'm not saying we will, but we'd want to know that we've got a clear path to getting there.

Thank you, Michelle, and thank you all for your questions and for your continued interest in DaVita. I'll finish where I started with optimism for the year ahead. Although we will continue to stay away from any COVID predictions, I'm encouraged by our recent progress. As outlined today, we will continue to pursue our strategic priorities to create the best long-term capabilities and outcomes for our patients, teammates, and shareholders. Thank you all for joining the call today, and be well.

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