Earnings Call Transcript - DVA Q1 2024

Operator, Operator

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 2024 Earnings Call. Thank you. Mr. Eliason, you may begin your conference.

Nic Eliason, Group Vice President of Investor Relations

Thank you, and welcome to our first quarter conference call. We appreciate your continued interest in our company. I'm Nic Eliason, 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 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, 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, Nic, and thank you all for joining our call today. Through the first quarter, we continued building on the momentum generated through 2023, demonstrating operational discipline while continuing to find opportunities to invest, innovate and, most importantly, deliver clinical excellence. Today, I will cover our first quarter results, provide color on our expanding international business and wrap up with an update on Change Healthcare claim disruption. Before we get into our first quarter performance, I'll start as we always do with a clinical highlight. One of our strategic goals is to provide solutions for patients at every stage along the kidney care journey, including helping to support transplantation. Our aspiration is to enable as many patients as possible to receive this life-changing gift. Let me highlight three ways that DaVita is helping to address the systemic challenges of kidney transplant. The first is patient referrals to transplant centers. We recently achieved our highest monthly rate with more than two-thirds of DaVita patients under the age of 75 years old being referred for transplant. The second is living donation. The number of living donors in the United States has essentially been flat over the past two decades. To encourage more living donors, we partnered with the National Kidney Foundation on its Big Ask, Big Give campaign to educate the community on living donation. We also offered patients a range of resources to support them through the conversations about living donation. And finally, because there is a gap on transplant rates across race and ethnicity, we created a new Health Equity Learning Lab. By deploying transplant navigators, we're testing novel approaches to drive a more equitable distribution of patients succeeding on their quest to receive a transplant. Through these and other efforts, more than 8,000 DaVita patients received a kidney transplant in 2023, the highest number of annual transplants in our history. Unfortunately, the largest challenge continues to be constrained organ supply. You may have seen recent stories about compassionate care cases involving genetically engineered pig kidneys. This is an exciting first step as society aspires to a future where organ availability is no longer a constraint for patients living with kidney disease. It is still in its early days for this technology as human trials will take some time. In the meantime, we will continue to invest in transplant and participate in innovations that will improve access to this life-changing outcome. Transitioning to our first quarter performance. Adjusted operating income was $463 million, and adjusted earnings per share from continuing operations was $2.38. We had a strong quarter across our core financial trilogy with treatment volume and patient care costs performing in line with our expectations and incremental upside driven by revenue per treatment. Our Q1 performance provided increased confidence in our full-year expectations, and therefore, we're raising the bottom of our adjusted operating income guidance putting our updated range at $1.875 billion to $1.975 billion. Within these consolidated results, our international business is a growing piece of DaVita's portfolio. As a reminder, our international strategy is focused on three primary principles: first, identify markets that enable us to invest in clinical differentiation and provide excellent standards of care to our patients; second, operate in countries where we have a path to achieve meaningful scale led by strong local management teams; and finally, hold ourselves to the same discipline of capital-efficient growth and attractive risk-adjusted returns that we use for all of our business segments. Following these principles, in March, we signed an agreement to invest $300 million to expand our operations in Brazil and Colombia and enter Chile and Ecuador through the acquisitions of high-quality centers in those four markets. The Chile acquisition has closed and the transaction in Ecuador, Colombia, and Brazil remains subject to each country's respective antitrust and regulatory approval process, which we expect to be completed at various times throughout 2024. Opportunistic transactions such as this one are consistent with our overall enterprise capital allocation strategy. Going forward, we will continue to monitor the market for acquisition opportunities that meet our investment criteria and we otherwise expect international investment to be roughly consistent with our historical levels. Upon completion of these transactions and combined with our existing business, we would be the largest dialysis provider in Latin America. Once these acquisitions close, we will provide care in 13 countries outside the United States with more than 500 centers treating approximately 80,000 patients and employing nearly 20,000 health care professionals. In 2024, we expect international growth to contribute approximately $20 million or about 1 percentage point to DaVita's overall enterprise growth in adjusted operating income. Most importantly, our international clinical outcomes continue to excel. We outperformed the clinical benchmarks of every international market in which we operate, and we have reduced hospitalizations across all countries by 11% since 2021, which has driven a reduction in unnecessary health care expense and represents a meaningful improvement to our patients' lives. Finally, let me cover our experience with the Change Healthcare outage and where we stand today. Historically, the vast majority of our U.S. dialysis claims went through the Change platform. Similar to many providers, this presented a challenging situation in the back half of Q1 as we were unable to submit claims through this channel. As reflected in our first quarter balance sheet, the increase in our days sales outstanding and borrowing on our revolving credit facility were entirely related to the Change outage. Joel will provide more detail, but to summarize, we have resumed billing activity, and we're collecting cash well in excess of our typical levels as we catch up from the claims backlog. As of today, we believe that the operational impact from the Change Healthcare disruptions is largely resolved.

Joel Ackerman, CFO

Thank you, Javier. First quarter adjusted operating income was $463 million. Adjusted earnings per share was $2.38, and free cash flow was negative $327 million. Our Q1 results reflect strong core operating performance as well as the impacts from delayed submission and payment of claims due to the Change Healthcare outage, which I will expand on shortly. With that, let me dive into the detail for the quarter. U.S. dialysis treatments per day were slightly lower in Q1 as compared to Q4, consistent with our expectations for the quarter. Q1 was our fifth consecutive quarter of year-over-year new-to-dialysis admissions growth, although mortality remains elevated relative to pre-COVID levels. For the full year, we maintain our expectations of 1% to 2% treatment volume growth. Revenue per treatment was down approximately $2 quarter-over-quarter. This is primarily due to typical seasonality related to patient coinsurance and deductibles offset by typical rate increases, contracted escalators and mix improvements. We continue to see strength in revenue per treatment as the result of revenue cycle improvements and we're trending towards the top of our original revenue per treatment range of 2.5% to 3% growth year-over-year. Non-GAAP patient care cost per treatment declined $8 sequentially, down from the seasonally elevated fourth quarter. As a reminder, Q4 seasonality was higher than typical and we see this reflected in the sequential quarterly change. International adjusted operating income increased $15 million sequentially, a return to normal from a low in Q4 related to higher bad debt reserves. Additionally, Q1 benefited from foreign exchange tailwinds. As Javier mentioned, this quarter, we announced acquisitions in four Latin American countries, including our entrance into Chile and our anticipated entry into Ecuador. These acquisitions are expected to close at various points during 2024 and we anticipate that their partial-year operating income in 2024 will largely be offset by expenses related to the acquisitions. Transitioning to cash flow and capital allocations. As you'll see in our quarter-end numbers, U.S. dialysis days sales outstanding increased by 19 days. And at the end of the quarter, we had drawn $765 million on our revolver, reflecting an increase in our leverage ratio to 3.3x at the end of Q1. As Javier noted, these increases are directly attributable to the Change Healthcare outage. Since the Change platform has come back online, these metrics have improved dramatically. We have caught up and are now current on primary claims submission. Cash receipts are catching up and we have fully paid down the $765 million of revolver draw through a combination of strong April cash flow and interest-free funding from UnitedHealth Group, Change's parent company. By the end of Q2, we expect the majority of the DSO increase to have reversed. In Q1, we repurchased 2.1 million shares, but out of an abundance of caution, we temporarily suspended our share repurchases in March in light of the Change disruption. Given where we are today, we expect to resume share repurchases subject to our typical capital allocation considerations. As we look to full year 2024, we are updating adjusted operating income guidance to $1.875 billion to $1.975 billion, a $25 million increase in the midpoint relative to our previous guidance. We are also updating EPS guidance to a range from $9 to $9.80. That concludes my prepared remarks for today. Operator, please open the call for Q&A.

Andrew Mok, Analyst

Treatments per day. I want to follow up on those comments. I think they're in line with your expectations. They were down sequentially and the normalized growth was up 40 basis points year-over-year. So one, trying to understand if there was any impact, whether it's weather or other seasonal impacts on the quarter? And two, any confidence on your levels to get back to 1% to 2% treatment growth for the year? Like what sort of visibility do you have on that? And what's going to drive that from here?

Joel Ackerman, CFO

Yes. Thanks, Andrew. So the big difference between the year-over-year number on treatments per day versus the normalized number is actually day mix. So Q1 in '24 had an extra Tuesday and it also had New Year's Day on a Monday, and what happens then is about half the volume gets pushed to Sunday. Those two things combined can lead to more than 0.5 points of volume swing. So I think of Q1 year-over-year as a positive number of 40 or 50 basis points of year-over-year growth, but as you highlighted, below the 1% to 2% range. As I think about how to bridge the range of 1% to 2% versus the Q1 number, I'd point to two things. First is clinic closures. The timing of clinic closures in the back half of 2023, and the pattern we're expecting for '24 is a drag on volume early in '24, but much less so towards the next three quarters. That would be one. The second is there's a lot of seasonality, both in new-to-dialysis admits as well as mortality, and that could move from month to month. And just looking at the pattern of what we saw in '23 versus what we're expecting in '24, we still feel good about the 1% to 2% growth, but we think it's going to come a little later in the year than anticipated. So I'd emphasize again, Q1 was in line with what we were expecting, the general pattern of new-to-dialysis admits being strong, offset by continued challenges on mortality. None of that has changed, and we feel good about the 1% to 2% for the year.

Andrew Mok, Analyst

Got it. And then I think on that mortality comment, I think you said mortality remains elevated relative to pre-COVID levels. Any trends on how that's been tracking kind of year-over-year or quarter-to-quarter post-COVID?

Joel Ackerman, CFO

It has generally come down significantly since its peak. It does move around from quarter to quarter, and it's frankly, still a little early to know exactly where Q1 landed. As you know, we don't find out mortality until a few months after the period. So we're keeping a careful eye on it. It's, as I said, it's come way down, but remains elevated.

Andrew Mok, Analyst

Got it. Okay. And maybe just one more on patient care costs. Costs per treatment were down another 1% year-over-year, and I think 3% sequentially. Anything in particular to call out there that helped drive the strong results?

Joel Ackerman, CFO

Yes. So sequentially, it's a lot about the higher seasonality we saw in Q4 that we called out. Year-over-year, wage pressure continues, as we've said, it's offset versus Q1 of '23 by lower contract costs and also a productivity pickup in the quarter.

Pito Chickering, Analyst

Revenue per treatment was quite strong in the quarter. Was that influenced by HIX enrollment or any other one-time factors? Typically, it increases by about $4 to $5 sequentially as we work through copays and deductibles. Is that the correct way to view it for the remainder of the year?

Joel Ackerman, CFO

Yes. I think that is right. The seasonality of, call it, $5 a treatment that we typically see in Q1, we saw this quarter. So we'd expect to pick that up in revenue per treatment in Q2 and the rest of the year. In terms of anything unusual in the quarter, nothing that I would highlight. I think the Q1 number is a pretty clean number off of which to model the rest of the year.

Pito Chickering, Analyst

Okay. So that's tracking above your guidance. If we look at where you are guiding revenue per treatment, you're essentially projecting nearly mid-single digits, which is above the 3% range, and this trend appears to be continuing.

Joel Ackerman, CFO

We're right around the high end of the range, right around the 3%. If you think of the guide as being up $25 million at the midpoint, and you attribute that to revenue per treatment, which is, I think, a fair way to think about it, that would put you right around 3% year-over-year.

Pito Chickering, Analyst

Was the market miscalculating the first quarter operating income considering the adjusted operating income beat of $39 million and the $25 million increase? It seems you did not raise the upper limit of the range. I'm just wondering if there is an oversight. Also, is there any reason why you can't analyze the first quarter operating income at around 23% to reach about $2 billion? Assuming trends remain the same, why wouldn’t that be a reasonable way to think about potential outcomes if the first quarter trends persist?

Joel Ackerman, CFO

Yes. Seasonality shows clear patterns, but it varies from year to year. The revenue per treatment increase from Q1 is probably the strongest indicator of our seasonality. Wage pressure tends to rise throughout the year, and this pressure is generally higher as well. Additionally, we often see an increase in expenses in Q4 due to year-end costs and other factors. As observed in '23, there has been significant negative seasonality in Q4, particularly concerning U.S. dialysis. Identifying trends for IKC is more challenging; we usually perform better in the latter half of the year, although this can fluctuate annually. Therefore, annualizing Q1 may not provide an accurate projection. If you annualize our operating income, you might find it slightly below our defined range. It's essential to account for the revenue per treatment and the seasonal weakness in Q4 to arrive at a figure within our range.

Pito Chickering, Analyst

Okay. Great. And then one quick numbers question. Can you quantify the number of new patients to dialysis in this quarter versus where that was this time last year?

Joel Ackerman, CFO

I don't have a specific number for you. Typically, that number increases in line with our historical volume growth figures, and I believe it's consistent with that trend this quarter as well.

Kevin Fischbeck, Analyst

Great. I guess it does kind of seem like going back to the revenue per treatment that it feels more like you're raising the guidance for the outperformance in the quarter on that rather than a continuation of that higher rate sustaining? Is that true? Or you're saying the guidance now assumes that this higher rate is actually sustained throughout the rest of the year?

Joel Ackerman, CFO

We're not raising it, assuming that this beat persists throughout the year. The quarter came in better than expected, but I don't think you can multiply that by four to get to the new number.

Kevin Fischbeck, Analyst

So why is that? It seems like you're suggesting there is something unusual about it. Why isn't it the typical seasonal growth for the space, and why doesn't that carry through every quarter?

Joel Ackerman, CFO

I think part of it is how we were modeling it for the year, and the pattern came in a little bit different than we expected.

Kevin Fischbeck, Analyst

Okay. So you had a higher year-end number and you're just getting there faster according to what you've seen in Q1. Okay. And then, I guess, just on the IKC business, obviously, there's a lot of focus on cost trend within Medicare Advantage companies seem to be all over the place on another year. Your experience is going to be a little bit different to Medicare Advantage broadly, but just love to kind of hear how you're seeing utilization play out under your managed programs there?

Javier Rodriguez, CEO

Yes. Let me grab that one. I think the question that comes often is why are the MA players in kidney saying different things. The reality is the utilization in the broader MA population has more volatility. Our patients, while having many comorbid conditions, are more predictable, so we have less volatility. In addition, as you know, broader MA had some coding changes that didn't apply to our population. And so that, again, removes some of the volatility that they're experiencing. And so our trends are a lot more stable in our population. Does that answer your question?

Kevin Fischbeck, Analyst

Yes, it does. You're saying that it's coming in line, neither higher nor lower than what you were predicting so far in Q1.

Javier Rodriguez, CEO

Correct.

Kevin Fischbeck, Analyst

Okay. And then maybe just last question. International business acquisition, it sounds like you guys are really excited about it. We always just kind of wondered that sometimes like when one large-scale player exits an asset and another large-scale player comes in? Like how do you think about what you can add to those assets? Or how do you just think about what the opportunity was there, if someone else in theory had similar optionality felt like it was time to get out?

Javier Rodriguez, CEO

It's a great question, and we're not arrogant enough to say that we're better operators. What we're looking at is that there's some efficiencies to be gained by economies of scale. We were present in these countries, and we had offices that we could leverage. So in essence, the fixed part of the business was leveraged in a more meaningful way. And I think that's how one entity can exit and the other entity, you can see, is an attractive asset. But as we said in the beginning, we look at our normal filters of clinical differentiation. We wanted to scale and help them with the scale, and we thought we could get to a good attractive risk-adjusted return.

Dean Rosales, Analyst

This is Dean Rosales on for Justin. Any color you can share on wage inflation? What are you assuming for the year? And my second question would be any update on how mistreatment rates are tracking sequentially compared to yearly trends? Any trends there?

Joel Ackerman, CFO

Yes. So on wage inflation, we called out at the beginning of the year, we were expecting something around 5%, and it's tracking pretty consistent with what we were expecting. In terms of mistreatment rate, it's doing what we had largely expected, which is slowly improving year after year post-COVID, not a lot to call out. It's a pretty small magnitude. We think we'll get back to our historical mistreatment rate over a few years. So in any given year, it's not really a significant number.

Javier Rodriguez, CEO

Thanks, Dean. I think the number will be somewhere in the 30 or so closures sort of net; that would be the right number to have on the net build and closures.

Gary Taylor, Analyst

Maybe just to follow up on that last one. That's a 30 net for the next three quarters or that's the full year number?

Javier Rodriguez, CEO

That's a full year number.

Gary Taylor, Analyst

I wanted to ask, first, I want to commend you for producing margin growth significantly beyond what analysts expected. This marks the third consecutive quarter where you've achieved 30% to 50% operating income growth alongside 6% to 8% revenue growth. It's impressive cost management and productivity that you all have demonstrated. As we approach the latter half of 2024, are there still strong reasons to believe that this operating leverage can be maintained at levels above your long-term operating income guidance of 3% to 7%? What would be a couple of key factors that might lead to continued optimism regarding operating margin leverage?

Joel Ackerman, CFO

Yes. So first, thank you, Gary, for those kind words. As we look forward, I don't think we're changing our long-term operating income growth number from 3% to 7%. So I'd start with that. That said, I also don't think we're running out of opportunities to continue to run the business well and deliver high-quality clinical care to our patients and continue to improve our bottom line and potentially our margins. We've done this not just on the back of cost cutting, I would highlight, right? We've done a lot on the revenue side that has kicked in nicely. But I think there are other opportunities as well. Continued progress on IKC would be on the list. I think capacity utilization improvements would be another important one that I would point to. I think there are other components of our cost structure, which could be productivity, could be other things non-labor-related that we can continue to manage. So I don't feel like we're running out of ideas. That said, we're also not ready to raise our long-term operating income guidance above 3% to 7%.

Gary Taylor, Analyst

Maybe last one for me. I just want to maybe understand tender consolidations a little bit. When we look at average patients per center, certainly multi-year highs. And just in the last couple of years, I think patients per center is up 9% in a couple of years and your margins improved nearly 300 basis points as that's happened. Some of that is the consolidation; some of that is the expansion of your home programs driving that. Is this still a key lever going forward or beyond the 30 centers Javier talked about?

Javier Rodriguez, CEO

I want to clarify because some of the numbers didn't resonate, but I believe it’s important to focus on the utilization of our centers. Before the excess mortality issue, we were operating at about 65% utilization, and now we are around 58%. This means we have more capacity available and are less likely to need to invest in building new centers. While our home performance has improved, it hasn't seen significant growth, with around 15% of our patients receiving care at home. I hope this clears up some of the points.

Joel Ackerman, CFO

Yes. And Gary, just to add one thing on to what Javier said, we can improve capacity utilization without closing any more centers. We're just absorbing treatment growth in our existing footprints.

Albert Rice, Analyst

Thanks, everybody. First, maybe just to ask on the trajectory on IKC, I know you were forecasting for '24 a loss of about $50 million. And I think in the first quarter, you're at $26 million. I know there's seasonal factors and a variety of things going on. But I just wonder if you would say you're on track? Are you running a little better? Or how should we put that in perspective?

Joel Ackerman, CFO

Yes. I would say we're largely on track. There's a lot of seasonality in this business. And obviously, you learn more as the year progresses, but there was nothing surprising to us in the Q1 results.

Albert Rice, Analyst

Okay. So coming off the fourth quarter, I believe we estimated that you are expecting share repurchases to be in the range of $1 billion to $1.5 billion for '24. Given your comments about the first quarter, do you think you'll still reach something close to that? Or should we assume that the share repurchase activity in the first quarter has concluded and you'll continue at the previous rate for the last three quarters?

Javier Rodriguez, CEO

I think we still aspire to that goal. There's obviously a timing component to it, and we'll watch it, but we're still aspiring to get it all done.

Albert Rice, Analyst

Okay. And just lastly, a follow-on question and comments about the international acquisition. I guess, it sounds like that is, in your mind, more of an opportunistic deal that came along that allows you, like you said, to leverage in certain markets and enter some new ones. Is there anything that's happening on the international front that makes you think that the pace of activity there could step up?

Javier Rodriguez, CEO

No. I think you've got it in the right light, which is we are opportunistic, and we're always looking for a transaction that meets the criteria that we've outlined. And if we don't find it, we don't execute. And if we find it, we do. And so there's no urgency or rush but rather just doing business with discipline and according to our plan.

Lisa Clive, Analyst

A few questions for me. On the utilization figures that you mentioned, that's just looking at your in-center population, right? I'm just trying to think about how to layer in whole patients on top of that, assuming that population continues to grow faster than your in-center patients, whether essentially that improves the number of patients per clinic, but then in terms of utilization, you just think of the in-center. And then second question, could you tell us what percentage of your patients are on MIRCERA today? Just trying to understand how much more costs you could potentially squeeze out from that transition. And then lastly, do you have any preliminary thoughts, comments on online hemodiafiltration? I assume in your European centers you use that technology. It obviously remains to be seen how quickly FMC can launch those machines and ramp up scale to be able to sell them in the U.S., but just would love your thoughts on that.

Javier Rodriguez, CEO

Sure, let me address them in order, and please remind me if I overlook anything. Regarding utilization, the figure pertains to chronic center utilization, and it's important to remember that bringing in new patients is much easier and requires significantly less capital when it comes to home care. You are correct that the utilization figure provided refers to in-center patients. As for MIRCERA, nearly all of our patients are now using it. On the topic of hemodiafiltration, it will be interesting to see its development in the United States since it's already permitted in various countries. The data we have indicates considerable variability; in some regions, most patients are receiving it while in others, it's only a small fraction. Although there are a few studies suggesting potential advantages due to the removal of mid-molecules, there are many weaknesses in those studies that must be taken into account. We’ll need to observe how this evolves. Furthermore, while the FDA has approved the machine, we still lack any reimbursement guidance. Ultimately, we will need to integrate what doctors and patients prefer, as the treatment may require more time, and we need to overlay the economic implications. There are too many undefined variables for us to accurately gauge the potential market size at this time.

Operator, Operator

And at this time, I'm showing no further questions. Speakers, I'll turn the call back over to you for any closing comments.

Javier Rodriguez, CEO

Okay. Well, thank you, Michelle, and thank you all for your questions and interest in DaVita. As we discussed on the call, we're off to a strong start of the year. And of course, we'll continue to work hard to stay on this trajectory. First and foremost, we remain vigilant in providing great clinical care for our patients. Thank you all for joining the call, and be well.

Operator, Operator

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