Q3 2023 DaVita Inc Earnings Call

Good evening My name is Jordan and I'll be your coffee.

At this time I would like to welcome everyone to Davita third quarter 2023 earnings call Today's conference is being recorded.

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After the Speakers' remarks, there will be a question and answer period.

I would like to ask a question. During this time simply press Star then the number one on your telephone keypad. If you would like to withdraw your question Press Star and then the number two.

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

Thank you and welcome to our third quarter Conference call. We appreciate your continued interest in our company.

I'm, Nick Elias and group Vice President of Investor Relations and joining me today are Javier Rodriguez, our CEO, Joel Ackerman, our CFO and Dr. Jeff Gilliam, our Chief Medical Officer.

Please note that during this call we will 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 third 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.

Thank you Nick and thank you all for your interest in Davita, we delivered another strong quarter, we began the year by making progress earlier than expected across many of our key operating priorities and that momentum has continued into the third quarter.

We have balanced our strong focus on near term operating discipline, while continuing to invest for future growth.

At the same time, we're creating a differentiated experience for our teammates and of course, delivering the highest standard of care for our patients.

Today, I will address our performance in the third quarter share our perspective on the potential impact of G. L. P. One drugs provide an update on 2023 guidance and then wrap up with some thoughts on next year.

Before we get into third quarter details I would like to start as I always do with a clinical highlight this.

At this time I will highlight our international business, which provides care for more than 40000 patients across 11 countries.

Each country is unique in terms of health status local message the practice and regulation.

Over the past five years, we have developed the universal protocols to combine our kidney care experience with local practices within each country.

Since launching this proprietary framework, we have seen consistent and meaningful improvement in clinical outcomes.

We know outperformed the clinical benchmarks of every international market in which we operate.

And at the aggregate level, all cost patient mortality across our international countries has dropped by 20% since 2020.

These results Energised, the soul of our company, which is to extend life and improve the quality of life of our patients.

Transitioning to our financial performance, we had a strong third quarter delivering adjusted operating income of $525 million and adjusted earnings per share of $2.85.

This was ahead of our expectations for the quarter we.

We continue to perform well across our key operating metrics and also had additional benefit related to seasonality and timing.

Now let me go to the next level of detail and highlight three drivers, including patient census, patient care costs, and integrated kidney care or eye Casey.

First our patient census has remained steady following the growth we saw in the first half of the year and we expect to end the year with a sense of the 1500 to 2000 patients higher than the end of 2022.

Mortality continues to decline in 2023 in line with our expectations.

Assuming these trends continue we expect to return to positive volume growth in 'twenty 'twenty four and beyond.

Second patient care costs continued to decrease during the third quarter outside of the seasonal items the conversion to Mircera for anemia management was a key driver of the decrease.

That said wage growth remains above historical trends and exceeds growth in revenue per treatment, but was below our expectations for the quarter.

Our experience on labor is consistent with recent macroeconomic trends.

Tight labor market and low unemployment has continued to put pressure on retention and training.

Offset by slight easing in the wage environment.

And finally, our I T C business had a strong quarter and is tracking ahead of our forecast for the year, we're improving patient health outcomes and reducing the total cost of care, which generates savings that are shared between davita and our partners.

We also realize that revenue associated with these savings earlier in the year than anticipated we continue to.

Invest in growth, while carefully managing our models care costs and we remain on track with our multi year plan to achieve breakeven by 2026.

Transitioning to a topic of recent focus.

Been a lot of discussion on G. L P. One drugs, including speculation on their potential impact to dialysis growth rate.

We're excited by the evidence that these drugs could improve the health of many people worldwide that said despite the evolving body of evidence about the positive impact of these drugs will have on obesity diabetes and cardiac disease. We continue to believe that the impact on dialysis volumes will be limited.

We believe this is true even if results from near term clinical trials proved to be positive in regards to progression of chronic kidney disease or C. J D.

So explain our perspective it is important to segment the population based on disease state.

In the group that is upstream from CK D stage three it is intuitive that lower be city should lead to lower incidence of diabetes and hypertension, lower incidence of chronic kidney disease and ultimately fewer people on dialysis.

This thesis is built on many uncertainties within a progressive disease, but the one area, where we can have clarity is in regards to timing.

In this population the progression to end stage renal disease is typically 15 to 20 years or longer suffice to say this scenario is beyond the horizon of our strategic plan.

Now turning to our late stage CK depopulation, we believed that there are four key factors first G. L. P. One adoption rate and CK depopulation second the impact on CK D progression third the offset impact of cardiac mortality benefit and finally.

The impact on payer mix due to any changes in the average patient age.

For the purpose of building a conservative forecast, we assume robust adoption and long term adherence supported in part by the possibility of strong uptake by those who may take G O P. Once for obesity.

Rather than for the CK D benefit.

We also looked at a wide range of possible clinical impact from current and future clinical trials.

Stimulating across these assumptions the mid point of our model reflects a neutral impact on 10 year dialysis growth rates with a small but immaterial impact on payer mix.

We recognize this may not sound intuitive, which is why we must consider several misunderstood characteristics about kidney disease.

If we look at the approximately 16 million people in the U S. Today with CK D stage, three and beyond over the next 10 years, approximately 75% will pass away before reaching end stage kidney disease.

This compares to less than 10% of those individuals who will ultimately progressed to dialysis.

Since major adverse cardiac events are the single largest cause of this mortality the positive impact of reduced cardiac event has a much larger population to influence than the effect of timing from slower disease progression.

To better quantify the downside case on dialysis growth. We also modeled the scenario in which efficacy is found across all kidney endpoint in each of the flow and select trials with zero.

Offsetting cardiac mortality benefits this scenario, which should be clear, it's not something we expect reflects a 0.5% annual growth headwind over the same 10 year period based on our model.

This would equate to approximately 25 million of operating income headwind per year.

Let me wrap up by acknowledging the disconnect between our view and what we believe is a market perspective.

To be clear the disconnect is not related to the popular G. L. P one or their numerous health benefit.

But specific to the impact on kidney care.

Because of this we have pressure tested our analytics with external epidemiologists and consultants with extensive review available research and across a wide band of assumptions.

We are focused not on the mid point, but on the downside scenario on volume and incorporated possible financial headwinds from lower commercial mix in.

In the in our conclusion based on what we know today is that strong adoption of these drugs will not prevent us from achieving our long term operating income growth target in the next 10 years.

This is a complicated topic and we're happy to elaborate or answer any questions on our assumptions.

Transitioning topics looking forward to our fourth quarter, we are revising our 2023 adjusted operating income guidance range of 1.565 billion to 1.675 billion to a new range of 1.65 billion to 1.725 billion.

We're also updating our adjusted earnings per share range of $7 to $7.80 per share to a new range of $7.80 to $8.30 per share.

It's too early to give guidance for next year, but we expect 'twenty 'twenty four to be a year of positive growth in volume and adjusted operating income Despite continued cost pressures and our ongoing commitment to invest in our teammates we expect a mid point of our 2024 adjusted operating income guidance will fall within our long term target growth rate.

3% to 7% driven by continued progress on our operating initiatives, we will provide more detail during our fourth quarter call.

With that I will now turn it over to Joel to discuss our financial performance and outlook in more detail.

Thanks, Javier I will walk through the strong performance in the quarter provide some detail about how we're thinking about the fourth quarter and give an update on capital deployment.

Starting with volume.

Q3 was in line with our expectations U S dialysis treatments per day, and sensus were approximately flat to the second quarter.

For the first time since the pandemic began we've now experienced three sequential quarters of year over year growth in admit trail.

Trailing 12 month mortality rate continues to decline we are now approaching pre pandemic levels of mortality rate as we once again improved quarter over quarter.

Revenue per treatment was up $3.60 versus Q2.

This increase was the result of continued improvements in our revenue cycle performance as well as normal contracted rate increases and an uptick in private pay mix for the full year, we expect to be near the top end of the 2.5% to 3% year over year. Our P. T range that we shared last quarter.

Looking ahead to 2020 for the Medicare P. P. S final rate for ESR D was released last week.

Despite CMS acknowledging that the 2022 forecast error was larger than originally calculated the net rate update finalized for 'twenty 'twenty four was only 2.1% which is still below what we believe is appropriate given continued forecasting errors current inflation.

And other rising costs that said, we continue to find ways to expand margin. Despite RPT increases below current inflation trends.

non-GAAP patient care cost per treatment was down $2.30 sequentially as Javier mentioned. This was the result of a number of items, including the conversion to Mircera for anemia management.

In Ik see quarter over quarter results improved by $50 million due to two factors first we recognized approximately $45 million more of shared savings revenue in the third quarter than in the second quarter.

It is important to note that this is higher than our forecast, but the difference is primarily timing as we had anticipated this revenue in the fourth quarter.

Second we had $15 million of positive adjustments from reconciliations from our special needs plans in the quarter.

These revenue increases were offset by approximately $10 million of higher costs.

Because of the concentration of the shared savings revenue in Q3, we are forecasting a decline in Ik see operating results in Q4 compared to Q3 as.

As we have said in the past results in the Ik C business are likely to be somewhat volatile from one quarter to the next so focusing on annual results remains the better way to understand our performance.

I K C business continues to make progress and we now expect our full year 'twenty twenty-three Ik see adjusted operating loss of approximately $110 million, which is slightly ahead of our prior 2023 guidance.

Turning to Q4, our updated operating income guidance implies fourth quarter adjusted operating income of $380 million, a sequential decline of approximately $145 million.

The vast majority of the Delta is due to two factors I K C and seasonality.

In Ik see fourth quarter results will be lower due primarily to timing as previously noted the.

The fourth quarter will also have typical seasonality driven by several factors, including higher Ms treatment rates around the holidays higher spend on health benefits for our teammates increased G&A and other year end costs in the fourth quarter.

The magnitude of this seasonality is higher than what we would normally see in the fourth quarter of this year.

We closed or consolidated 15 clinics in the third quarter, bringing our year to date number to 51, we will continue to evaluate our footprint in light of utilization trends.

On taxes, we now expect our full year 2023 tax rate to be approximately 23% to 24%, which is below our previous range for the year.

The updated range is reflective of larger benefits recognized for stock based compensation and forecasted tax credits.

Transitioning to the balance sheet, our capital allocation strategy remains focused on capital efficient growth as we have said in the past we target maintaining a leverage ratio of three to three and a half times EBITDA over the long term and had paused our share repurchase program one year ago as part of our.

Goal to return to this range.

Accordingly, we did not repurchase any shares this past quarter and we ended the quarter with a leverage ratio near the middle of our target range.

As a result, and after considering our typical set of capital allocation principles, including our view of intrinsic value relative to current market price of our stock we intend to resume purchasing shares this quarter.

We expect to fund share repurchases using a combination of excess cash flow and capacity within our revolving credit facility.

As a reminder, we upsized our revolver earlier this year to provide us with more liquidity and flexibility in our capital structure.

We continue to manage our exposure to rising interest rates approximately half our debt is long term notes with very attractive fixed rates, while the other half of our debt is floating rate we have implemented interest rate caps to manage the majority of this exposure through the end of 'twenty 'twenty fives that concludes <unk>.

My prepared remarks for today operator, please open the call for Q&A.

Thank you we will now begin our question and answer session. If you would like to ask a question over the phone lines. Please press star one from your phone to withdraw your question Press Star two.

First question comes from Peter Chickering with Deutsche Bank. Your line is open.

Hey.

Good afternoon, guys. Thanks for taking my my questions I guess, a couple from me here I guess on year over year patient care costs. You guys works is a pretty pretty big reductions sort of year over year and sequentially you sort of talked about changes you know within in looking to imagine, but can you just help us sort of think about.

Sure what were the drivers and bridge those drivers to US and then why not talking about 2024, you've done a pretty amazing job this year controlling costs I guess.

Do you still see the same opportunity going into next year.

Yes. Thanks for the question. So if you think about.

Patient care costs.

The right way to think about it is continued wage rate.

of the adult population. Clearly we've seen a notable increase in diabetes in lock and depth, but at least the estimated prevalence at the.

big estimate because there are so many undiagnosed patients, but the estimated prevalence of CKD has really been pretty flat over that time period. Any thoughts on why that may be the case? I'm just thinking if that obesity rate even potentially pulls back and what the relationship will be with CKD.

Yeah, most of the estimated prevalence comes from physicians coding CKD as a diagnosis through what's called ICD-10 codes. And so as physicians focus on other things, cardiovascular risk factors and cancer-type risk factors and things like that, CKD in the early stages, especially CKD 1 and 2 and early CKD stage 3, just isn't top of priority in some cases. And so we're just not seeing at least the documented prevalence of those with CKD stage 3 rise.

Okay, thanks for that.

Thank you, Lisa.

Our next question comes from Peter Chickering with Deutsche Bank. Your line is open. Thank you.

Hey guys, so I'll volunteer the couple sort of just quickies here SGA a lot of moving parts this quarter including I think a funding of charity groups just you know curious if you can sort of bridge this for moving parts in 3q And I was you think my gna for 4q

Yeah, I don't think there's a lot to call out on G&A overall, quarter over quarter. There's really nothing that jumps out. In terms of Q4, I would expect a modest uptick from seasonality, but nothing major.

Okay, revenue for treatment had a nice pickup sequentially as well. Is there any makeshift here or is that just more of a seasonality thing at this point?

Yeah, the biggest impact on RPT quarter over quarter was continued progress on our collections efforts. We're really proud from an operational standpoint of what our team has been able to accomplish there. We talked about it last quarter. We got a little bit more this quarter. And I would say for the time being we've probably gotten the vast majority of that, so I'm not anticipating a whole lot more of that in the next few quarters. We did see a commercial mix uptick in the quarter, but we also got the benefit of some just negotiated rate increases as well.

What are the COLAs that you're getting at this point from commercial bears?

Sorry, what was the question?

What are the, I guess, the rate increases that the Medicare payers are giving you at this point?

You know, as we've said in the past, our contracts are multi-year, so in any given year, you don't have that many at bat. What we've seen up to now is a lot of regional accounts, and it's fair to say that the increases have reflected the environment that we're in, i.e., an inflationary environment. So they've been a bit higher than pre-pandemic, and we will see what next year brings as we have a couple of the larger ones up for a null.

Okay, on IKC, I guess things got a little bit worse there for the year, I guess, what was driving that if I heard that right? And then, you know, you talked about sort of 2024 OI in the 47% range. How much that is coming from improvements of IKC versus from kidney?

Yeah, so, you know, I think you misheard their IKC has gotten a little bit better. We have lowered the loss.

since our prior guidance.

So, we continue to see improvement over the course of the year. In terms of 24, it's too early to give guidance. Javier talked about 3 to 7% as being where we think the midpoint of the range will fall. Again,

Too early to quantify where that will come from. I'd say it's fair to say some of it will come from IKC, but that will not be all of it.

Okay, and the last question here for me, just to follow up on Kevin's question, specifically on third quarter, what were the new patient ads in the third quarter? How did that compare versus where we were pre-COVID, and specifically, what was the mortality in the quarter, and how did that compare versus sort of pre-COVID? Just curious, you know, the interplay between incidence of new patients versus extension of mortality to help figure out treatment growth.

Yeah, so, um...

for the quarter, volume came in right where we expected it. The new ads were consistent with kind of a pre-COVID type number. Excess mortality, I'm gonna peg it at 400.

I think it.

The excess mortality number is a number that we're probably going to start phasing out as a metric.

It's getting so close to pre-COVID levels. It's getting within the error band of what you consider as our...

Pre-COVID number and that number moved year to year pre-COVID. So...

for consistency with what we've called out historically, the number is 400, but I think...

I would expect that number to continue to decline and ultimately, like contract labor, it was something that was important for a period of time but is no longer important. So we're going to try and move away from that number going forward....

Okay, great. That's it for me, guys. Thanks so much. Thanks, Peter.

Our next question comes from Lisa Clive with Bernstein. Your line is open.

Hi, I just wanted to squeeze in some questions on home dialysis while I can.

Do you have any statistics you could give us about what proportion of your

incident private patients are still employed versus on COBRA and how that looks if there's any difference in your home dialysis patients and how we should think about that mix going forward.

I actually don't know the mix between COBRA and private, but I know that that number is pretty steady when there's full employment. That usually just moves in recessionary periods. So we can look at that, but I don't think it's a meaningful change if that's what you're going for. And as it relates to home, it does have a higher mix.

We have now roughly 15% change of our patients at home, and that number has been stable. We've continued to work hard to get more patients on it. But we have not seen any shift in insurance as it relates to the cohorts.

Okay, I guess I was really just wondering.

for those private patients.

that managed to go on home dialysis, whether more of them can stay employed, because my understanding was for the patients that are on COBRA, a lot of them won't make it through the full sort of 33 months. Could you just comment on whether I'm right on that?

whether that, you know, whether greater home dialysis could mean to...

of more patients employed for longer.

Yeah, we've looked at that number and it's not an easy piece of analysis because you can run into the trap of correlation without causation and you wind up with a number that looks good but ultimately doesn't really drive any better financial results as your home dialysis rates go up. So I would put that down as inconclusive. That's it.

And Lisa, one of the things that is important for the last decade or so, people assume that patient would go home, they would have more flexibility, and they would keep their ability to work. But the reality is that the dropout rate on dialysis at home has continued to be incredibly high. So roughly about half of the patients that are on therapy would rather be taken care in-center or have to be taken in-center because of a medical condition. So that makes trying both adults and patients more reliable andtheir Psychos PROC. And going out to the hospitals I think about over 20,000 a day before you are doing the actual surgery.

Okay, that's helpful. Thanks. Okay.

Thank you.

And we have no additional questions in the queue.