Earnings Call Transcript - DVA Q4 2021

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 Fourth Quarter 2021 Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer period. Thank you, Mr. Gustafson, you may begin your conference.

Jim Gustafson, Vice President of Investor Relations

Thank you, and welcome, everyone to our fourth quarter conference call. We appreciate your continued interest in the company. I’m Jim Gustafson, 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 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 fourth 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 any subsequent filings that we make with the SEC. Our forward-looking statements are based upon 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 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, Jim, and thank you all for joining today to discuss our fourth quarter performance and our thoughts on 2022. Each quarter for the last two years, I hope it's the last time that the pandemic is the start of my discussions with you, yet COVID continues to evolve and have a direct impact on our world, especially on our healthcare system. Similar to what’s been seen in the general population, COVID infections within our patient population spiked significantly in late December through January. At its peak, during the second week of January, the new case count was more than twice as high as the peak from last winter. Gratefully, the mortality rate to date, with the latest surge, has been lower than in prior surges. For the fourth quarter, we estimate that the incremental mortality due to COVID was approximately 1100 compared to approximately 1600 during the third quarter. Despite the challenges associated with COVID, I continue to be in awe of the resilience and dedication of our teammates across the DaVita Village, from our direct patient caregivers to our corporate teammates. All are unrelenting in their commitment to provide high-quality care and respond to a quickly changing environment while showing incredible compassion and support for our patients. For the balance of my remarks, I will cover five topics; transplant, labor market, our supply chain, Integrated Kidney Care (IKC), and then I will wrap up with our fourth quarter results and our outlook. First, transplants. At our Capital Markets Day presentation in November, I discussed our focus on innovation to improve the patient experience at every single stage along the patient’s kidney care journey, from delaying the progression of kidney disease to transplant and from acute hospital care to dialysis at home or in-center. Transplant is a preferred treatment option for most of our patients, and during 2021, despite the challenges posed by the COVID pandemic, we celebrated with nearly 8000 DaVita patients receiving transplants, exceeding our pre-pandemic level. With that said, the transplant process is long and complicated, with an average wait time of between four and five years for an organ. Staying active on the waitlist for such a long time is difficult. As a result, patients sometimes miss their window for a transplant. We’ve been working to address some of these challenges through our industry-leading transplant smart education program and our partnership with the NKF to help more patients find living donors. In early January, we announced the acquisition of MedSleuth, whose software enables closer partnerships and better coordination between transplant centers, nephrologists, and kidney care providers, with all three working together to support our patient transplant journey. These efforts can also benefit another meaningful goal of ours: to improve health equity. Many process and outcome results in transplant are quite inequitable, differing by race and ethnicity, economic means, and insurance coverage. We believe it doesn’t have to be this way. Removing barriers to access, making processes as easy as possible, and providing strong care coordination and support through the transplant journey can all contribute to making transplant not just more available, but also more equitable for our patients. Now, let me shift to an update on the labor market. I’ve been fortunate enough to be part of DaVita Village for over 20 years, and in all that time, across my many roles, I’ve never experienced the labor market as challenging as we face today. To help deal with the challenges, we have provided incremental pay and benefits to assist our frontline caregivers during COVID. We’ve also accelerated wage increases with a particular focus on our teammates in the clinics. As previously communicated, we expect higher than usual wage increases in 2022, which will put some additional pressure on our cost structure going forward. We believe this investment in our people will contribute to our ability to attract and retain the talent needed to achieve our long-term objectives. That said, the labor markets remain highly dynamic and will continue to be a swing factor for the year. Over the years, particularly during the pandemic and natural disasters, we have navigated many supply chain challenges. Today, our supply chain has proven very resilient. Currently, we’re working through a supply shortage primarily related to dialysate, which is a fluid solution used in hemodialysis to filter toxins and fluid from the blood. The shortage has rippled through the entire kidney care community, and as a community, we have once again come together in support of our dialysis patients and thus far have been able to provide uninterrupted life-sustaining care. We expect that these challenges related to dialysis will remain with us until the second quarter. Turning now to IKC, we now have confirmation on the market where we will partner with physicians under the federal government new five-year CKCC demonstration. These programs added approximately 12,000 chronic kidney patients and an additional 12,000 CKD patients across 11 value-based programs in different markets. We are engaging with our nephrologist partners to develop personalized care plans for each covered patient and identify opportunities to improve clinical outcomes and lower costs for each patient. Participating in these and other programs will more than double the number of patients we serve in value-based care arrangements. In light of our upfront costs of these programs and the lack of shared savings payment, as we discussed in November, we continue to expect that our operating loss in 2022 in our U.S. ancillary segments will increase by approximately $50 million, although this could increase or decrease depending on the number of new arrangements we enter into during the year. We believe that we are well-positioned for the future and, in particular, to deliver positive clinical and financial results in our IKC business over the long term. Now, let me finish with the fourth quarter results in our updated outlook. Despite the negative impact of the Omicron surge, our fourth quarter results were slightly above the midpoint of our revised guidance. This resulted in a full-year adjusted operating income increase of approximately 3% over 2020. Adjusted EPS from continuing operations grew by approximately 26% year-over-year, and we generated more than $1.1 billion of free cash flow, which we largely deployed to return capital to our shareholders. For 2022, we expect adjusted operating income guidance of $1.525 billion to $1.675 billion. The midpoint of this guidance range is $35 million below our expectation from Capital Markets Day last November, which is primarily driven by our updated views on COVID and labor costs. As we said previously, while 2022 will be a transition year due to some near-term investment and challenges that we’re facing, we continue to believe that we’re well positioned to perform across the kidney care continuum in the years to come. We still believe we can deliver long-term compounded annual growth of adjusted operating income of 3% to 7% that we discussed at Capital Markets Day.

Joel Ackerman, CFO

Thanks, Javier. As Javier mentioned, our fourth quarter results were slightly above the midpoint of our revised guidance. Q4 results included a net COVID headwind of approximately $80 million, an increase relative to the quarterly impact that we experienced in the first three quarters of the year, primarily due to the impact of the incremental mortality from the Delta surge in Q3 and some temporary labor cost increases. For the year, we experienced a net COVID headwind of approximately $200 million. As Javier said, the incremental mortality due to COVID in the fourth quarter was approximately 1100 compared to approximately 1600 in Q3. While it’s too early to accurately forecast incremental mortality in 2022, given a significant uptick in infections in January, we expect COVID-driven mortality in the first quarter to be at or above what we experienced in Q4. U.S. dialysis treatments per day were down 135, or 0.1% in Q4 compared to Q3. The primary headwind was the increasing mortality and higher missed treatments due to the ongoing COVID pandemic. U.S. dialysis patient care costs per treatment were up approximately $6 quarter-over-quarter, primarily due to the increased wage rates and health benefit expenses. Our Integrated Kidney Care business saw an increase in its operating loss in Q4, which is primarily due to positive prior period development in our Special Needs Plans recognized in Q3, and increased costs that occurred in Q4, including preparation for new value-based care arrangements effective in 2022. Our adjusted effective tax rate attributable to DaVita was 16% for the fourth quarter and approximately 22% for the full year. The adjusted effective tax rate was lower quarter-over-quarter, primarily due to a favorable resolution of a state tax issue during Q4. Finally, in 2021, we repurchased 13.9 million shares of our stock, reducing our shares outstanding by 11.5% during the year. We have repurchased, to date, an additional 1.4 million shares in 2022. Now looking ahead to 2022, our adjusted OI guidance is a range of $1.525 billion to $1.675 billion, and our adjusted EPS guidance is $7.50 to $8.50 per share. The midpoint of the OI guidance range is $35 million below the $1.635 billion that we discussed during our recent Capital Markets Day due to offsetting puts and takes. First, we have a tailwind from both higher final Medicare rates, as well as a partial extension of Medicare sequestration relief. However, this is more than offset by headwinds due to the recent COVID surge as well as incremental wage rate pressure. At the midpoint of our guidance range, we have incorporated the following assumptions related to COVID: Excess patient mortalities due to COVID of 6000. This, along with our normal growth drivers, would result in a total treatment growth range of approximately 0.5% to 1%. A year-over-year improvement to various COVID-driven costs, such as PPE, which will be largely offset by the loss of revenue from Medicare sequestration relief beyond Q2 2022. As you would expect, the high and low end of our guidance incorporates a range of COVID scenarios for 2022. There are scenarios that could lead us to performance above or below this range. In addition to COVID, the expected headwinds I talked about on the Q3 earnings call and then our Capital Markets Day remain. As a reminder, we expect to incur expenses related to DaVita’s portion of the industry effort to counter the expected ballot initiative in California. Our guidance assumes an incremental increase of between $100 million and $125 million in labor costs, above a typical year’s increase, which is $50 million higher than what we communicated at Capital Markets Day. Third, we anticipate a year-over-year incremental operating loss in the range of $50 million, as we continue to invest to grow our IKC business. And fourth, we will also begin to depreciate our new clinical IP platform, which we expect to be approximately $35 million in 2022 and we’ll begin in Q2. A few additional things to help you with our current thinking about 2022. We expect to offset a significant amount of these incremental costs with continuing MA penetration growth above historical levels and strong management of non-labor patient care costs. We are forecasting our tax rate at 25% to 27%, due to the non-deductibility of valid expenses. Regarding seasonality, remember that Q1 has seasonally higher payroll taxes and seasonal impacts of co-payments and deductibles. The vast majority of our ballot-related expenses will fall in Q3. We have historically experienced higher G&A in Q4. Looking past 2022, we continue to expect compounded annual OI growth relative to 2021 of 3% to 7% and compounded annual adjusted EPS growth relative to 2021 of 8% to 14%. Finally, we expect free cash flow of $850 million to $1.1 billion in 2022. As we communicated at the Capital Markets Day, we expect free cash flow to remain above adjusted net income, with that difference contracting over time.

Operator, Operator

Sarah James from Barclays, you may proceed.

Javier Rodriguez, CEO

Hi, Sarah.

Sarah James, Analyst

Thank you. Yes, hi. So I wanted to get a sense, as we go through Omicron and we think about the waves that are coming ahead, there seems to be more mild outcomes, like you mentioned today. And I’m wondering if that’s contemplated when we think back to your Capital Markets Day, when you talked about the $160 million to $200 million in OI drag over the next four to seven years from excess mortality. If that contemplates continuing more mild COVID trends as the years go on?

Javier Rodriguez, CEO

Well, I’ll let Joe talk about the numbers in a second, but let me just start by saying the way we’re talking about it internally in the company is that we are no longer going to speculate on how this is going to behave because we have been so surprised over time. We all had such hope when the vaccines came out and then when the boosters came out. And of course, it has resulted in milder hospitalization and mortality, but at the end of the day, I think we can all now accept that no one can speculate where this is going. Our hope is that it does become less impactful in our business and eventually, it’s something that we can deal with in the normal course of business, but that would not be a prudent thing to assume. So why don’t you go ahead, Joel, and talk about what we’ve built into the number.

Joel Ackerman, CFO

Thanks, Sarah. So as I think about how the COVID impact will play out going forward relative to a wave like Omicron or a wave like Delta, there are a whole bunch of impacts that COVID has across the P&L. And what we’ve said and remains to be true is that there are a lot of offsets in everything, except the excess mortality, and the net impact that we expect from COVID will largely be the net impact of excess mortality. What you see with Omicron is, while, yes, it is a milder disease, because it was so much more transmissible, that it still led to a big wave of excess mortality. We saw that in Q4. We’re continuing to see that in Q1. So as I think about different variants and how they might play out going forward, I think, net-net, the question is what’s the impact on excess mortality.

Sarah James, Analyst

Can you provide an update on your discussions with payers regarding whether you are considering inflationary factors for wages in future rate negotiations? I'm uncertain if this will affect the contracts for 2024.

Javier Rodriguez, CEO

Well, those conversations are playing out in real time. But the reality is that, as you know, and we’ve talked about for some time, our contracts tend to be longer-term in nature. And so the bulk of our contracts are not up for renegotiation. So we’ll have to, of course, assess how inflation behaves over time when each and every one of those contracts comes up. And so right now, there’s been contracts negotiated previous to seeing this ramp up in inflation.

Sarah James, Analyst

Thank you.

Javier Rodriguez, CEO

Thank you.

Justin Lake, Analyst

Thanks, guys. I wanted to go through a few things in detail. First, Joel, you talked about the first quarter being similar to the fourth quarter in terms of the mortality headwind from an OI perspective. Can you walk us through again, and I might have this somewhere, but the OI headwind by quarter, first quarter through fourth quarter in 2021?

Joel Ackerman, CFO

The OI headwind by quarter, I’m going to do this off the top of my head. It was in the 30s each of the first two quarters, so mid-30s, 55 in Q3, and then 80 in Q4. And I’m getting thumbs up in the room, so I got it right.

Justin Lake, Analyst

Okay. So 80 is the number for Q1.

Joel Ackerman, CFO

No, no, Justin, let me clarify before you go. What I said in the script was that the excess mortality in Q1 was going to be at least as large as what we saw in Q4, so that’s about the mortality. Remember, in terms of COVID impact, excess mortality has a cumulative effect. So adding another 1100 deaths or more, you would add that to what we’re seeing in the quarter. There are other dynamics, of course, but when you just focus on the excess mortality, which is the dominant dynamic, you’d expect that number to go up a bit.

Justin Lake, Analyst

Got it. So 50 to 80 might be 80 to 110, something like that, giving it a similar trajectory incrementally. Is that a way to think about it?

Joel Ackerman, CFO

That sounds a bit high, and I think that’s really a function of two things. There were a significant number of missed treatments in Q4, which has a temporary negative impact of COVID. We expect that to go down. And second, there were some non-recurring labor components to the COVID impact in Q4 as well.

Justin Lake, Analyst

Got it. I apologize if you’ve mentioned this, but is there a specific number like 200 for 2021? Is there a figure for 2022 that you believe is included in the guidance?

Joel Ackerman, CFO

It’s included in our guidance. As we reflect on the impact of COVID, we have been discussing it on a cumulative basis for the past seven quarters. However, as we move further away from the onset of COVID, it becomes increasingly challenging to estimate its cumulative effect. The baseline has changed significantly, making it difficult to address the cumulative impact. We now see the influence of COVID built into our numbers as the new normal going forward. We will keep discussing the impact we observe each quarter, but we will shift away from referring to it as a cumulative figure.

Justin Lake, Analyst

Okay. And then you talked about Medicare Advantage penetration being an offset here. Can you tell us what that was at year-end and where you are kind of after open enrollment?

Joel Ackerman, CFO

Yeah, at the end of the year, which is the most recent number I have, Justin, we were at 42.3% on MA. And I think that’s the latest one we want to show you.

Javier Rodriguez, CEO

Yeah, if we think about it for the year, I would say we would expect growth to continue to be strong but not as strong as we saw in 2021.

Justin Lake, Analyst

Okay, great. And then for my last question regarding the dialysate issue, can you provide clarity on what the issue is and its source? You mentioned that it would persist at least through the second quarter. Is there any outlook on whether this situation will improve?

Javier Rodriguez, CEO

Yes, this is a national issue affecting all providers, leading to a supply shortage. It can be attributed to supply chain disruptions, challenges with distribution centers, and labor issues. These factors have combined to create the current situation. In response, our first priority was to ensure safe dialysis through our clinical leadership. We then adjusted our usage of the product to minimize consumption and communicated inventory levels at each location to prevent excessive stockpiling. The entire community worked together on this. Currently, we anticipate a return to normal operations by sometime in the second quarter, and we will continue to maintain lower inventory levels during this period. Did that answer your question, Justin?

Justin Lake, Analyst

Yeah, thanks. I appreciate it. I’ll jump back into the queue.

Javier Rodriguez, CEO

No, no, no. If it was entirely clear as to this whole notion of why we don’t want to go back to this baseline because it’s so far. Just to put a finger on something that we are all experiencing is travel and entertainment, which we, of course, are one quarter over another. You could say we used to have a run rate, as the world actually changed in travel and entertainment, it is going to be completely different. Then we had benefits, which we told you we had a run rate, but the benefits have changed and the run rate. So that’s why it starts to get a little harder to go into that, and as Joel said, we want to go now into sort of, let’s call it, the new normal and go off of that. Hopefully, that made sense here.

Justin Lake, Analyst

Got it. Thanks.

Javier Rodriguez, CEO

Thank you.

Pito Chickering, Analyst

Good afternoon, everyone. I have a few questions. Regarding the OI guidance for 2022, I understand it's down $35 million. Can you confirm that there's an additional $50 million in labor costs compared to the Analyst Day? Also, is it correct that you now expect 6,000 excess mortality in 2022 due to higher COVID impacts? This seems like a significant number of headwinds against your guidance of a $35 million reduction, so I would like to know what the tailwinds are compared to your previous guidance.

Javier Rodriguez, CEO

Yeah, Pito, I’d point to two tailwinds. One is the final Medicare fee-for-service rate came in at 1.9%, which was above our estimate, and the second is we got partial sequestration relief for the year, which is about $25 million. So those two offset those, and you wind up with a net $35 million decline.

Pito Chickering, Analyst

Okay. And on the excess mortality, I understand that it’s impossible to forecast at this point. Like 100 for the first quarter, it’s a little unclear so what the incidence rate is for new patients entering dialysis. So any chance you can give us sort of the color of how many patients you guys had at the end of the third quarter? How many have at the end of the fourth quarter? And where that’s tracking sort of at this point in the first quarter?

Javier Rodriguez, CEO

Yeah, so the patient count is relatively flat. In terms of the underlying drivers that drive the new to dialysis admits, we really haven’t seen any changes there. It continues at the pattern that we saw pre-COVID, and there are really only two dynamics if you’re looking at treatment count or treatment volumes or treatments per day between Q3 and the end of the year, and that’s one, the continued excess mortality that we talked about, and the second is the dynamic of missed treatments. So if you’re asking about the pipeline of new to dialysis patients, that remains quite healthy.

Pito Chickering, Analyst

Okay. And then from another perspective, as you think about the first quarter sequential treatment versus the fourth quarter, we already had the excess mortalities, sort of the time lag between different quarters, and then the lost treatments that we had during the fourth quarter due to patients that were in the hospitals. So would we be modeling first quarter down a little bit versus fourth quarter or relative flat sequentially?

Javier Rodriguez, CEO

It will depend a lot on missed treatment rates. There is also the factor of an acquisition we made in Q4, which was for about 750 patients. This will contribute positively in Q1 as well. However, for the entire year, based on the COVID figures included in our forecast, we anticipate treatment volume to grow by somewhere between 0.5% and 1% for the year; of course, this number could change as situations with COVID evolve.

Pito Chickering, Analyst

Okay. And then on the IKC, I think at the Analyst Day, you guided to sort of $50 million to $75 million of incremental costs in 2022. On the script, I think you said, $50 million. I just want to see if the economic costs for IKC have changed versus what you told us at the Analysts Day.

Javier Rodriguez, CEO

Yeah, I think that the number hasn’t changed, Pito, so it is the $50 just to clarify, incremental $50.

Pito Chickering, Analyst

Perfect. I have one more question regarding IKC. Can you provide insight into the class of patients you enrolled in the first quarter of 2021, specifically in relation to the losses reported at the beginning of that quarter compared to those at the end of the fourth quarter of 2021? I'm looking for clarification on how this class of patients has experienced loss progression throughout the year.

Javier Rodriguez, CEO

Yeah, not yet, Pito. Remember, in the first year, we generally drive no revenue. So it’ll really be sometime in 2022 where we’ll start to see that playing through in the financials.

Pito Chickering, Analyst

Okay. And then two more super quick ones here. What were your home treatments at the end of the fourth quarter? How should that progress through 2022?

Javier Rodriguez, CEO

Yeah, the home penetration rate was in the low 15% range. Home grew about 3% in the year versus in-center, which shrunk 2%. So our continued path to grow home and be a leader in that modality continues strong. We’re not guiding specifically on that number for next year.

Pito Chickering, Analyst

And then to Justin’s question on the dialysate supply shortage, is there any inflationary cost pressures, if you have to hit a spot market to get the dialysate required, or are those under those contracts? Thanks so much.

Joel Ackerman, CFO

Yeah, thanks, Pito. On the dialysate, in particular, it is contracted, so no is the answer to that one.

Pito Chickering, Analyst

Great, thanks so much.

Joel Ackerman, CFO

Thank you.

Kevin Fischbeck, Analyst

All right. Great, thanks. I guess not 100% clear to me what you guys are signaling about the 2023 outlook. I know so far out, but you gave us some comments last quarter about what 2023 would look like. And it seems like some of the headwinds here might persist into 2023 as far as maybe higher labor costs or mortality being a little bit higher from a starting point perspective, but some of the tailwinds like sequestration delay would not. But at the same time, you’re also kind of saying your growth rate of 2021 hasn’t changed. In fact, 2021 is a little higher, which would point to a little bit higher 2023 number. I’m just trying to think directionally, how should we think about 2023 versus your prior comments?

Javier Rodriguez, CEO

I would like to highlight a few points. First, you are correct that labor and COVID are significant uncertainties for 2022 and possibly 2023. However, the growth we discussed during Capital Markets Day for 2023 is something we are very confident about. If I were to categorize the factors that will likely drive this growth compared to 2022, I would point out a few key items. First, the elimination of the ballot initiative, which is not present in odd years. Second, we expect IKC to start generating revenue in 2023 from a large group of patients added in 2022. Third, we have several cost initiatives that we are implementing across our financials. These are areas where we have clear visibility. The aspect we are less certain about is the unwinding of COVID. We believe that as COVID becomes less prominent in the future, it will serve as a positive force for us, not just in terms of uncertain costs but more importantly, in driving patient growth. Our outlook on these factors remains unchanged, and if I had to provide a rough estimate, I think these opportunities could easily total around $200 million, in addition to the normal growth we would anticipate in a typical year.

Kevin Fischbeck, Analyst

But your current outlook for COVID mortality feels a little bit higher. So I would think that would kind of maybe delay kind of that re-utilization of that $200 million, which might make how much you recapture in 2023 less than what you would have thought a few months ago?

Javier Rodriguez, CEO

Well, it will depend on the timing, and we don’t profess to have a crystal ball about COVID. We wanted to be crystal clear about what we built into our forecast and obviously, it could be better, it could be worse. Depending on how the timing plays out in 2022, there are different scenarios about what this number could look like in 2023.

Kevin Fischbeck, Analyst

Okay. Now, that’s fair enough. And then, I guess, in the quarter, it looks like you closed 30 centers, which I think is like, as many as you’ve ever closed in a year, like for the last decade plus that I’ve been covering DaVita. So I wanted to understand what was driving those closures in Q4? I guess the year number is twice what you’ve ever done in the year before.

Javier Rodriguez, CEO

Yeah, thanks for the question. It is a little higher than normal, although we always have some center closures and consolidations, etc. I think the best way to think of our footprint is we have three lenses. The very first one is, of course, access to patients, ensure that patients are safe and have the right access. The second lens would be what is the mix of home and in-center and how that changes over time. The third is utilization, which is we’ve had, of course, because of this excess mortality, we’ve had some utilization decrease. And then the last is sort of you think of the local market dynamics. We want to be really careful and want to be very thoughtful that if you were going to say what’s the net takeaway is that we continue to think that we will build less to de novos and more home centers over time.

Kevin Fischbeck, Analyst

Okay. If you're referring to recapturing the COVID-related challenges, then I would suggest that the low volume this year means those sites are unlikely to remain open as they aim to regain that business. Is it primarily the shift to home that is driving this change?

Javier Rodriguez, CEO

If you look at our utilization over time, we actually started to grow less pre-COVID than we had during COVID. So the compounding of that actually has our footprint having less usage than we’ve had historically. We just want to make sure that we have the right modality in the right market, so we continue to assess that in every market.

Kevin Fischbeck, Analyst

Okay. And then just maybe the last question, the higher labor costs that you’re building in now versus the previous guidance, are these underlying wage increases that kind of increase the base going forward or is there some component of that? I think last time you talked about increased training and things like that. Is there some of that that would go away or is this $50 million kind of added to the base going forward?

Joel Ackerman, CFO

Yeah, it’s interesting. We were just talking about that because, of course, there has been a bit more turnover, and we’re working on how to get training to be a bit more efficient and effective, but the bulk of the number will stick with us.

Kevin Fischbeck, Analyst

Okay, great. Thanks.

Joel Ackerman, CFO

Thank you.

Gary Taylor, Analyst

Hey, good evening. A couple of small questions and then a larger one. The comment about the increase in commercial mix sequentially that’s playing out, is that still just the mortality impact the primary driver there?

Javier Rodriguez, CEO

Yes. And the consistent thing that the patients are really valuing choice of keeping the commercial insurance. It has really demonstrated through the pandemic resilience in value of the patient wanting to keep their insurance, and then the excess mortality coming, as you said, from a bigger number of Medicare patients.

Gary Taylor, Analyst

The release mentioned that part of the sequential revenue growth was from the flu vaccine, which I understand is seasonal for your company. How significant is that? Is there a larger increase this year that could be considered substantial, especially given the heightened awareness?

Javier Rodriguez, CEO

Oh, sorry. I thought you were done, Gary. The number is immaterial and it’s actually offset on the cost line items. So it’s basically a service that we offer to our patients because it’s good and convenient for them, as opposed to thinking of it as an economic one.

Gary Taylor, Analyst

Yeah. Last question. I just want to get your view. I haven’t heard you guys talk about the Supreme Court case on ERISA plans that have made changes to dialysis payments and benefits structure. I think the oral arguments are coming up on March 1 and presumably a ruling this summer. I think I understand your view would be that it’s discriminatory practices, and I guess that’s what the court’s going to decide. But what do you think the implications are if the Sixth Circuit is overturned and the Ninth Circuit sort of upheld and it gives ERISA plan some leeway to pursue cost containment strategies for lack of a better word?

Javier Rodriguez, CEO

Thank you for the question. It’s a complex issue, especially for those not closely following the details. At the core of this matter is Medicare in the Secondary Payer Act, also known as MSPA, which aims to protect patients from discrimination. The key question here is whether there’s a difference between dialysis patients and what the statute defines as ESRD patients. While it may seem like a minor distinction, it’s quite significant. So, how did we arrive at this situation? Essentially, small employer groups, influenced by third-party benefit designs, have limited benefits for dialysis patients, which has effectively pushed them toward Medicare. This issue has been taken to court, leading to differing rulings from the Sixth and Ninth Circuits, with the Supreme Court expressing interest in the case. While I won’t speculate on the outcome, you’re asking what the ramifications would be if we were to lose. Naturally, I prefer to focus on winning. However, if we do lose, there are several potential scenarios. The Supreme Court’s decision could be nuanced, resulting in a narrow ruling with minimal impact, or they could provide broader clarity. If it’s a broader loss, we would need to assess its implications, but predicting the court’s plans and their consideration of reputation risks and legal obligations under the ADA and ACA is extremely challenging. Even if we argue one aspect, the other legal protections could be robust enough that the loss may not affect us significantly, but we lack certainty. We will continue to fight vigorously for our patients' rights, whether through litigation or legislative means. The most important thing for us is ensuring that our patients can access care just like individuals with any other condition, and we are committed to being aggressive on both legal and legislative fronts because we believe our patients deserve that advocacy. I’ve shared a lot on this topic; are there any follow-up questions?

Gary Taylor, Analyst

No, I think investors are trying to understand how to measure the potential for a loss, and I find that challenging as well. I also tend to agree that it would be a significant shift to assume that many plans would change their behavior drastically. For now, I appreciate what you have shared.

Javier Rodriguez, CEO

Thank you.

Lisa Clive, Analyst

Hi there. I have two questions. First, could you provide the percentage of your Medicare eligible patients that are currently in MA? The last figure you mentioned was around 41% in your Q3 results. Secondly, regarding labor costs, is the increase primarily due to wage inflation, or are staffing shortages also a significant factor? It would be helpful to understand how these aspects are divided.

Javier Rodriguez, CEO

Yeah, so quickly on the MA, it’s a little north of 42% of our total Medicare patients are on MA. On the labor side, it’s generally wage inflation that we’re talking about.

Lisa Clive, Analyst

Okay. So you don’t have a lot of vacancies or needing to use agency staff, that sort of thing?

Javier Rodriguez, CEO

No, we do, but we’re pretty good at that being kind of short-term. So I think we’re answering to be as helpful as possible, as you’re saying, is this a good stepping stone to go into the future, and the fact is that it is, even though we’re struggling. One of the things that we do when we have labor shortages is sometimes leadership, which is fixed salary, will step into the floor because we have a lot of our facility administrators that are nurses. That’s not something we want to do for a long period of time; it’s unsustainable, but that’s very helpful when you’re short-staffed. So there’s a lot of dynamics, as you know, and interplay when you’re looking at staffing, but I think if you’re going to say what’s the bulk of that number, it is inflationary in the wages.

Lisa Clive, Analyst

Okay, great. And one last question just on home dialysis, how has the growth rate changed, if at all, over the last year or two? I guess, there may be more interest in it, but are you also having more sort of bottlenecks around being able to train patients because of stretched staff? That would be helpful to understand how that’s going?

Javier Rodriguez, CEO

Yeah, I think COVID, of course, creates some air pockets as it relates to growth and we’ve talked a lot about during the call, excess mortality. If you were going to step back and look at the mix overall, in the last couple of years, we’ve basically gone from a little over 12% to 15% of our patients being in some kind of a home modality. So the modality was driving double-digit growth for quite some time, and then COVID occurs. What happened during the year is we were between 2% and 3% growth during the year, but then again, our in-center shrunk. The modality is still thriving, people are still picking it, we continue to create the best home suite out there, surrounding patients with all kinds of things so that they can get on to the modality. As it relates to training, of course, COVID has added some challenges and also has had some tailwind in the sense that people say, 'Gosh, if this happens again, maybe I want to dialyze at home.' Still, it is not an easy answer, but hopefully, those trends give you a sense of the appetite for the modality.

Lisa Clive, Analyst

Great, thanks very much.

Javier Rodriguez, CEO

Thank you.

Pito Chickering, Analyst

Hey there, guys. Thanks for taking my last follow-up here. Just a really quick question here, and I understand it’s impossible to model excess COVID mortality from COVID just because basically it is impossible to predict. But could you give us some sensitivities around operating income impact, if excess mortality is 3000 versus 6000, you guys are assuming?

Javier Rodriguez, CEO

I think the rough math on that would be about a $30 million delta.

Pito Chickering, Analyst

So basically –

Javier Rodriguez, CEO

And that uses a mid-year convention.

Pito Chickering, Analyst

Yep. So to assess that differently, if you guys hadn’t taken your excess COVID mortality of up to 6000, that probably would have been almost a delta between the guidance you provided at the Analyst Day versus today.

Javier Rodriguez, CEO

Yeah, I think that math works, Pito.

Operator, Operator

And at this time, I’m showing no further questions.

Javier Rodriguez, CEO

All right. Well, thank you, Michelle, and thank you all for your interest in our company. As you can see, like many other companies, the short term is a tough one with the macro landscape being quite complex and dynamic, particularly in the labor markets. That said, hopefully, you hear from our voices that in the long term, we continue to build a differentiated capability, and we are very positive on how we are positioned to deliver integrated care for our patients, deliver world-class outcomes, and bring savings to our payers. I would be just remiss if I don’t finish by saying that this is all possible because of the resilience, the passion, and the dedication of the DaVita team that wakes up every single day to deliver life-sustaining therapy. So thank you for your time, and we’ll talk again next quarter. Be well.

Operator, Operator

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