Earnings Call Transcript - DVA Q1 2022

Operator, Operator

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. Thank you. Mr. Ackerman, you may begin your conference.

Joel Ackerman, CFO

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 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 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, CEO

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 society as COVID infection rates have declined. On the more challenging side, we’re dealing with new economic pressures of inflation, supply chain 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 clinical highlights. 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 health care 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. Pure hospitalization 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 the 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 subvariants. 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 due primarily 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 cost 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 improvements. 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 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.

Joel Ackerman, CFO

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 2 fewer treatment days, resulting in approximately 185,000 fewer treatments in Q1. Second, 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 $0.35, 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 on to our views for 2023. As we shared at 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 2022 to 2023 between $250 million 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 offset 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 nonrecurring 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 assumed a 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 million to $400 million OI increase versus 2022. If COVID remains a headwind this year and into 2023 we’d still expect a strong rebound but are not in a position to quantify it given the uncertainty.

Operator, Operator

Operator, please open the call for Q&A.

Kevin Fischbeck, Analyst

All right. Great. I guess when it comes to Q1, you missed the consensus estimates by a decent amount. But you’re kind of reaffirming the guidance at the 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.

Joel Ackerman, CFO

Yes, Kevin. So Q1 was really dominated by two seasonal impacts that totaled about $60 million of pressure on operating income. One relates to treatment days. There were 2 fewer treatment days during the quarter, and that’s about half the impact. And the second one is about the seasonal patterns related to coinsurance and deductibles, 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.

Kevin Fischbeck, Analyst

I guess maybe the way to ask the question is, did Q1 come in the way that you thought it would? 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? Or...

Joel Ackerman, CFO

I would say that is the main issue, but Q1 did not meet our expectations, primarily due to volume. Mortality rates were higher than anticipated. While we are not altering our full-year outlook on mortality, the rates came in sooner than we projected, and the mistreatment rate was also above our expectations. Typically, Q1 has a higher mistreatment rate due to flu season, but this year it exceeded our assumptions, largely because of COVID.

Kevin Fischbeck, Analyst

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 that when inflation is going up, you do have that power? Or should we still think about overall rate growth probably being something less than what you think cost growth will be even though it will start to catch up?

Javier Rodriguez, CEO

Yes, 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 multiyear. 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.

Kevin Fischbeck, Analyst

Maybe just last question. I guess the revenue per treatment has been aided by the shift into MA. I guess where do you think we are in that shift? I guess we all have the baseball analogy. What inning are we in there? Do you expect to get similar type lifts in ‘23 or ‘24? Or are we largely getting to the steady state here?

Javier Rodriguez, CEO

Yes. 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 will just continue to be more incremental but slightly higher than the MA market overall.

Justin Lake, Analyst

Maybe we can stay on revenue per treatment for a minute. So you said that the seasonality around copays and stuff hurt you by about $30 million. That’s a little over $4 a treatment. So revenue per premium would have been up sequentially about 1%. Given what Medicare rate is doing, plus MA, plus you said commercial mix got better, is there some other piece we’re missing here besides that on revenue per treatment?

Joel Ackerman, CFO

No, Justin, there’s nothing that you’re missing. I think you pointed out the right factors, and they generally balance out. There are a few minor variabilities, as always, but there’s nothing else to the story.

Justin Lake, Analyst

Remind me, what was Medicare rate again year-over-year?

Joel Ackerman, CFO

It’s in the high 1s, somewhere in the 1.7% to 1.9% range.

Justin Lake, Analyst

Right. That alone would have given you a bit over 1% by itself. Additionally, you mentioned that the commercial mix improved, which would have brought your $4 back. Since you said the commercial mix is better, could you provide that number? Also, how did the commercial mix perform sequentially, and what was the sequential change in MA penetration?

Joel Ackerman, CFO

Yes. 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 mix 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.

Justin Lake, Analyst

Okay. Can you tell me what Medicare Advantage and commercial mix did from the fourth quarter to the first quarter?

Joel Ackerman, CFO

MA mix came out at just under 45% for the quarter, and commercial mix was 10.5%, just under 10.5% for the quarter.

Justin Lake, Analyst

And what were those numbers in Q4?

Joel Ackerman, CFO

Hold on one second. MA mix was 39% and commercial was 10.38%.

Justin Lake, Analyst

Okay. And then getting back to the sequential earnings, when you said Q2 is going to rebound...

Joel Ackerman, CFO

Sorry, I gave you a bad number. Q4 on MA was 42%.

Justin Lake, Analyst

You mentioned that Q2 is expected to rebound after Q1 faced some seasonal challenges. Are you anticipating a recovery that matches the levels seen in the fourth quarter? When you refer to a rebound, should we expect it to align with the fourth quarter's performance, or even surpass it? Any insights you can provide would be appreciated.

Joel Ackerman, CFO

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

Justin Lake, Analyst

Okay. Then you’d given us a number on wages. I think it was $100 million to $125 million that you had put incremental to typical in the operating income guide. Do you want to give us an updated number there?

Joel Ackerman, CFO

Yes. 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 the high end of that range.

Justin Lake, Analyst

Okay. Lastly, many of us have reviewed the hospital rates that were released, and we are puzzled as to why the labor pressures and overall inflation were not more apparent. I know you frequently engage with CMS. Your rates haven’t been released yet, so when will that happen? Do you anticipate that we will see CMS incorporating some inflation into dialysis rates for 2023?

Joel Ackerman, CFO

Yes. So look, I think the 2022 number was higher than normal, and 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 for 2023 until late June, early July.

Javier Rodriguez, CEO

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 2 years old, and so there’s going to be a bit of a lag is the point.

Justin Lake, Analyst

That’s the issue. Okay. That’s what I was trying to get a little smarter on, Javier. 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 2 years ago. So their 2023 rate is based on 2021 inflation.

Javier Rodriguez, CEO

That’s our understanding, Justin.

Pito Chickering, Analyst

Going back on the first quarter treatments, I understand the increase in mortality and the mistreatments seasonality. Previously, you guided sort of 2022 treatments to be growing to 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 Q2?

Joel Ackerman, CFO

Yes, we believe that year-over-year treatment growth will be down compared to the previous estimate of 0.5% to 1%, and a figure closer to zero is a more accurate model now. We observed a significant decline throughout the quarter. From memory, the treatment numbers were above 1,500 in January, a few hundred in February, and around 150 in March. The excess mortality figures have decreased considerably. Regarding how to model Q2, there is much uncertainty. If historical trends continue, we would expect to see daily treatment growth in Q2, with the next surge likely occurring in the summer, although it is unclear if those historical patterns will persist.

Pito Chickering, Analyst

So I mean could you give us just any range with what you guys see on your treatments or where it’s tracking? I guess, in April, sequentially, should we be growing 50 basis points from Q1 to Q2? I mean there’s more treatment days, but then you also had the excess mortality if they’re not in that round. So I guess just you can help quantify for us treatment growth in Q2.

Joel Ackerman, CFO

Yes. First of all, I would focus on modeling treatments per day because that will give you a clearer number with the number of treatment days. I think I can confidently say it’s going to increase. However, I’m not sure I’m ready to provide a specific figure yet.

Pito Chickering, Analyst

Okay. And Justin’s question on revenue per treatment. I guess there’s a lot of moving parts with mix and copays, et cetera. Normally, from Q1 to Q2, we add in sort of $5, $6 from the first quarter, I guess, around 367 for 2Q revenue per treatment. Is that the right way of thinking about it?

Joel Ackerman, CFO

I think your number is right for a normal year. I would remember that we are getting about $17 million of sequestration suspense dollars in Q1. That number gets cut in half for Q2. So we’ll lose, call it, $8 million or $9 million of revenue as a result of that. So that will cost us a little bit more than $1 of treatment.

Pito Chickering, Analyst

Okay. So sort of 366 is the right way of thinking about it in Q2?

Joel Ackerman, CFO

I think that’s a good starting point, yes.

Pito Chickering, Analyst

Okay. And then for the last question, regarding the IPF Group, did you receive the true-ups from your managed care partners for 2021? I'm interested in understanding how the patients performed in 2021 compared to your expectations. Additionally, could you provide some insights on the losses of the patients who joined in the first quarter of 2021 versus those in the fourth quarter? How did those losses change? Lastly, I noticed your IKC losses decreased sequentially to $370 million in Q1 from $300 million in the fourth quarter. I expected that number to increase with more patients coming on board. If you could clarify all of this, I would appreciate it.

Joel Ackerman, CFO

Yes. 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 significantly different. In terms of the 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.

Pito Chickering, Analyst

Okay. When do you get the true-ups from your managed care partners for last year?

Joel Ackerman, CFO

It varies among different partners, but I would expect that most will come in the latter half of the year. Keep in mind that you need to wait for the claims to fully run out before you can accurately assess the numbers.

Pito Chickering, Analyst

Got it. Just to confirm, your guidance is at the low end of the range for 2022, but you're still maintaining the $240 million to $400 million. So that means we should expect our 2023 models to be around 1875 for that year?

Joel Ackerman, CFO

Yes. So I build the $250 million to $400 million 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.

Operator, Operator

I’m showing no other questions in queue at this time.

Javier Rodriguez, CEO

Okay. Thank you. Well, let me end with a couple of closing comments. Patient outcomes and improvements to the quality of life for 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.

Operator, Operator

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