DaVita Inc. (DVA) Earnings Call Transcript
May 10, 2022
Earnings Call Speaker Segments
Thank you for joining us today. It's my pleasure to be kicking off the conference with DaVita. DaVita is the largest provider of dialysis -- pure-play provider of dialysis. And with us today, we have Joel Ackerman, who's the CFO. Joel, thanks for being here.
It's good to be here.
So Joel was crazy enough to allow me to jump right into Q&A. If -- and then depending on any questions, by all means, you can ask them, but I'll start it off for sure. I guess when we think about you guys have provided this 3% to 7% OI growth estimate over time. I mean can you just kind of walk us through the building blocks. I mean a lot of things that happen around COVID and costs? And should we still be thinking about the 3% to 7% as the right number over time?
Yes. So we still feel good about the 3% to 7%, and I just want to make sure everyone appreciates. That's 3% to 7% versus 2021. And what we laid out in our Capital Markets Day in November was that 2022 is going to be a bit of a transition year. There were some well-defined headwinds that were going to bring the OI down in 2022, but we laid out a path to a big rebound in 2023. And that would allow us to remain on this 3% to 7% path from 2021 through, call it, 2025 despite the down tick in 2022. What we talked about on the call last week was a bit of an update on guidance relative to that. We maintained our views that 3% to 7% is still a good range. As we look at 2023, we are -- relative to what we said in November, we are certainly expecting more headwinds on the labor front. We're seeing about a 6% increase in labor so far this year, and we expect that to continue and that's more than 300 basis points higher than what we typically see. We've typically seen about a 250 to 300 basis point year-over-year labor increase. For 2023, what we're expecting now or we're planning for now relative to what we said 6 months ago is that, that labor increase will continue in 2023. We're not expecting another 300-plus basis points, but we are getting ready for a couple of hundred basis points. And if you think about that on a foundation of, call it, $3.5 billion, that's roughly speaking, a $70 million plus or minus headwind from labor in 2023 relative to what we had said before. We feel like we can overcome that. We've got a bunch of well-identified cost savings opportunities over and above what we had already been planning for, and with those, we feel good about 2023 being the strong rebound year and then being able to stay on the path for that 3% to 7%. The one caveat -- and again, this is relative to where we were at Capital Markets Day is really COVID. When we were sitting here 6 months ago, I think we were expecting by now to be feeling more like COVID was receding to the background and the headwind that we've been experiencing on volume would be something that we'd have more visibility on going away. Where we are today, given the Omicron surge, I'd say, we are less confident that Omicron is going to be heading into the background sooner rather than later. We don't have a crystal ball on it. We don't have any better insight on it relative to everyone else in this room, but that remains, I'd say, a question mark.
So when you think about that kind of 2022 to [ reaccelerate ] to 2023, what's driving that?
So we called out a range of $250 million to $400 million. So the middle of that range is $325 million, and let me try and build that up for you. So 2 quick things to call out. One is ballot initiatives. As you may remember, we have absorbed about a $60 million OI hit every other year related to our contribution to the industry's fight against the ballot initiatives in California. We've won that the last couple of times. We expect to win it again, but we're also baking in a number roughly of that magnitude and that goes away in 2023. So that's $60 million. We've also called out that Integrated Kidney Care, our value-based care efforts, should come up off the increased spend we're having this year. So using round numbers, say, the $175 million loss we're talking about this year should improve by about $50 million. So those 2 together get you north of $100 million. You've then got the growth in the core business, that's one. Second is the cost savings opportunities that we're seeing, that's two. And third would be a COVID tailwind. We've experienced a strong headwind from COVID over the last couple of years, largely related to mortality. When COVID mortality stops, we expect that to move not just to neutral, but actually to a tailwind as what was excess mortality should turn into lower than normal mortality and you put those 3 things together of roughly equal magnitude, and you'd get to the [ $325 million ] that we called out at Capital Markets Day. So those are the buckets to the $325 million we talked about at Capital Markets Day or for next year -- I'm sorry, the update we gave at -- on the earnings call last week was an additional headwind from labor offset by additional cost savings and maybe some better Medicare fee-for-service rates. So that's the bridge. I know it's complicated math, but that's how you get to the $325.
That's helpful. I guess if I could just maybe check those numbers again. So $60 million from ballot initiatives, $50 million from Integrated Kidney Care, and then you were you're seeing core growth cost cuts in COVID tailwind each, call it, $70 million.
$70 million. Yes, call it, in that neighborhood. And then add on to that, another, call it, $75 million of cost cuts or savings to offset the labor headwind. So from my standpoint, if I were to put my investor hat on, what do you need to believe here. I think, obviously, you need to believe that IKC is going to kind of start to turn the corner. You don't have to believe anything heroic. You don't have to believe it starts becoming profitable. You just have to believe we're on an upturn. You need to believe that DaVita can manage its costs. And I'd say, if you followed DaVita over the last 10 or 15 years, managing our costs is something that we do quite well. And the third is, you have to decide on the turn of COVID and pick a sense of timing. If COVID did not turn, I think it would still be a nice uptick in OI in '23 versus 2022, but it would certainly put pressure on that range.
And how do we think about -- you mentioned slightly better Medicare rate update. Like how do we think about your ability to get pricing over time to match cost growth? Should we expect -- I think, historically, you've kind of said pricing a little bit less than cost growth. Is that the way to think about it even as costs go up? Or is there an ability to kind of match pricing costs?
Yes. So I'd divide that between Medicare fee-for-service and the vast majority of our other rates, which are negotiated with commercial health plans, whether those are commercial members or MA members. Our MA members are enrolled with the same companies, United, Kaiser, Humana, et cetera, that we negotiate commercial rates with. On the Medicare fee-for-service side, we are price takers. We don't really negotiate that. There is a methodology for how CMS decides what rate increases will be, and we would expect we will get higher rate increases, whether they will match inflation or not remains to be seen. On the commercial/MA side, we have long-term contracts with most of the big payers there. So we think it will take time until we are back at the table negotiating with them. How those negotiations play out, I think, remains to be seen. There was an interesting article yesterday in the Wall Street Journal about how hospitals are experiencing this. I don't have any inside information on that, but it felt like a lot of posturing on both sides, and we'll really only know when those new contracts get signed, then they'll probably be all over the place.
And you say, long-term contracts. Are we talking about 3-year contracts? Longer than that?
I'd say, typically about 20% of our contracts come up for renewal on any given year.
And when you think about the shift to value-based care and all of this, is that something that allows you to kind of offset this pricing dynamic? Or do you view that as a completely separate thing?
I view them both separate and intertwined. They're separate because it's a very separate business, and we report our dialysis business and the operating income from that separate from the value-based care business. They're intertwined in so far as we are trying to move away from a zero-sum game negotiation with our payers and create something that feels more like a win-win. And we think value-based care is an opportunity to bring them more than just dialysis where we are negotiating over rates, and it creates a more nuanced conversation with them about that. I'd say one other thing. This is about -- what you and I have been talking about until now is very much a bottom-up look at this. I think there's also a top-down look at it, which you have to look at it and say, the U.S. needs dialysis. It is a vital service that keeps hundreds of thousands of patients alive. There's really no opportunity other than transplant for these patients and the industry needs capacity. And in order to invest in that capacity both to either build new clinics or build home capacity or maintain the existing clinics, there just needs to be some sort of return on investment. And I think that will create another tension that will require reasonable rates over time to make sure that the industry can continue to deliver that capacity.
It looked like the MA rate for dialysis patients was actually quite strong. So how does that flow? Should we think about that number as generally flowing through to you? Or what -- how should you think about that number?
Yes. So it was very strong. It was 9.6% for the year. Most of our value-based care contracts, whether it's MA or government, have some form of either shared savings or full risk. So we would benefit on the MA side from better rates. The question is, what happens to the medical cost trend. And in an environment where medical cost trend is going up 9.6%, it doesn't really help on the bottom line. You're just -- your revenue is keeping in line with your cost and a medical cost trend environment where that's lower than that 9.6%, yes, it would be beneficial.
Okay. So your view is that's supposed to represent a trend, and so that's really never -- I guess over time, the bigger that you're trying to manage, the more savings there would be or opportunity there would be.
Potentially, yes. But I think your statement is right. I don't think CMS sat back and said, we really want to value-based care providers in dialysis to make more margin.
Okay. Because I think for a while the industry was arguing that the rate for dialysis was inappropriate. And I wasn't sure whether you felt like this was kind of a catch-up towards appropriate or where this is something that was an actual underlying trend.
I've heard nothing from CMS or Washington that would say they were trying to catch up for a low rate. So my sense would be, it was more about trend.
All right. Can we talk a little bit then about the IKC business?
Sure.
You're growing that very rapidly this year into next year, but you're still going to have -- it feels like the growth slows off after '23, but the profitability kind of ramp. So can you talk a little bit about that path from [ minus 175 today to 125 ] to -- so basically, a breakeven, I guess, in [indiscernible].
Yes. So look, I think there's uncertainty about the growth path. The growth this year was a bit faster than we were expecting. So that feels good. There are a couple of dynamics about why we're generating the magnitude of losses we are. One is, it takes time for the model of care that we have to generate the cost savings that we expect. You generate some in year 1, but that builds over time. So -- and so far as that's really what generates revenue and profit that cost savings, it will take time for that to continue to build. Second is revenue recognition. We have generally taken an approach to recognizing revenue when we feel strongly that the model of care has kicked in and the shared or the full risk savings will be realized. If you look back at the ESCOs, it's why we never had a write-down with the ESCOs. We never had revenue problems. It's because we didn't recognize the revenue until it was real. So you take those 2 things, you put them on top of a fixed cost business, if you will, and it takes time for that number for the bottom line number to realize. So that's really the way we're thinking about it.
And so that ramp and that improvement in the margin, where do those savings come from?
I mean the biggest opportunity is on the hospital side because it is the biggest single source of expense for dialysis patients. So keeping patients out of the hospital is probably job one on the value-based care side. We feel good about our capabilities there. One is, especially on the ESKD side, we have a lot of interaction with these patients. They come to our clinics typically 3 times a week, if they dialyze in-center. If they dialyze at home, they'll still come once or twice a month. So chasing these patients, finding them, looking for ways to engage them is not a challenge. Obviously, we've got a relationship with them. We've got a relationship with their physicians. Our care teams and the clinics know these patients. They can keep an eye out for things that might be leading to hospitalizations, a number of which are dialysis related. And so that's number one. We've also got programs around pharmacy, around end of life, about ER diversion, around home care. So there are opportunities across the spend, but hospitalizations is #1.
And can you just remind us on the ESCO performance, how you did, and then is there anything about this structure that says, that is or isn't a good base?
Yes. So we saved about kind of 10-ish percent low double digits on cost -- on non-dialysis cost savings. And we're using that as a -- kind of as a starting point for thinking about what we can generate in this next generation. ESCOs are different and reality is all the plans we provide today are different. The government models, what we call, CKCC, which are Medicare fee-for-service patients tend to be very local, so there's dense scale. The MA contracts tend to -- and the commercial contracts tend to be spread out more. So there are different models of care there and different levels of scale we can bring. But I think our opening views, and Javier mentioned this on the call, is that on the path to scaling a model of care that we felt good about, we're seeing some early successes.
Great. And then how should we think about the growth here? Is that basically going to level off in 2024? Or is there an opportunity to keep growing that, whether it's through MA or some other?
I think there is opportunity to continue growing after 2023. If you think about the P&L and what the impact will be, I think there'll be a lot more impact from these early boluses of lives that we've assumed risk for kind of moving along the stages I talked about and starting to see the revenue recognition and seeing the model of care kicking in. I think that will be a bigger driver of OI improvements in the near term then more topline growth, although we are expecting more members under management.
And I guess that in 2023 kind of number, is there way to think about that? Is that like you're covering 70% of your population or...
Much lower than that.
But what is the -- where is that top number that you can get to?
Hard to tell. I mean thinking way out, I don't see why 50% isn't reasonable. I think part of it will depend on how the market develops and how much of these lives payers want to subcapitate, if you will, or attribute who else is in the market trying to get those lives, but I think 50% is not an unreasonable number in the out years.
And so then [indiscernible] what number are you at now?
We're at about 40,000 lives, so that would put you at about 20%. 40,000 on a basis of 200,000.
Total lives, not Medicare.
Total lives under management, yes. And if you wanted to bucket those, you'd say, about 1/3 are Medicare ESRD, 1/3 -- I mean Medicare fee-for-service ESRD, about 1/3 are Medicare fee-for-service CKD and about 1/3 are MA. Those are very rough numbers. We have value-based care with commercial lives. We have other government value-based care lives, but at a very high level, those would be the 3 biggest buckets.
Fair. We could then pivot back to the labor side for a minute. This year is worse than you thought. Next year, better, but still worse than you would have been long term. Is 2024 also going to be a year where we -- is there going to be a new normal? Or do you think that 2.5%, 3% is the right number? It's just going to take a year to get back to that level?
I think that's an environmental question rather than a DaVita question, and the answer is, I don't know. I think what we are doing is less trying to predict how this is going to evolve and more ensuring that we are ready. If there is a new normal out there either for 2 years, 3 years or forever, that we've got a plan in place. And the dynamics in the short term are very different than the dynamics in the long term. In the short term, we've got cost savings we can realize, and a lot of our costs are not influenced by inflation in the short term. If you think about our rent depreciation, a lot of our procurement, our pharma costs and our supply costs, our medical director fees, these are all well contracted for a number of years. So we don't experience inflation in those. But as I said before, there are rate increases that are going to take time to materialize because those are long-term contracts. So on some level, you've got long-term revenue contracts and some long-term expense contracts. And so in the short term, you're really talking about Medicare fee-for-service and labor. Those are the big dynamics. As you go out a few years, we would expect more opportunity on the revenue per treatment to catch up with inflation, but some of the costs that are relatively fixed over the next year or 2 or 3, rent comes up for renewal as does all these other costs. So over the long term, we might see more inflation in some of the other cost lines, but more of an opportunity to offset that in revenue per treatment. That's it. Look, I think there's an important long-term perspective to recognize, and I'm not talking about the last 2 or 3 years or 4 years, I'm talking about the last 10, 12, 15 years. The dialysis industry, and DaVita is no exception, lived with 1% revenue-per-treatment increases. And there's -- I think some people have this misperception that because of the structure of the industry, somehow we've got these outsized rate increases for a very long period of time. It's just not the fact. If you went back and looked at our publicly reported RPT, you'd see roughly 1% growth over 10, 12, 15 years. And that's been an environment of labor increases of 250 to 300 basis points, call it. So what we have done well and this is kind of the underpinnings of my comments about, we've done a nice job of managing costs, we have been very effective at looking for opportunities to continue to drive down costs in the context of continued clinical improvements, just great quality. And that's really been the story over the last 10 or 12 years, and I think we can continue that story. We can continue to deliver on our margins and our return on capital and our free cash flow story in the context of a wage pressure and inflationary environment that is north of what we will realize on RPT. And just because we've been good at saving costs in the past, it doesn't mean there are no longer any cost to save. It's not like we've squeezed every penny out, now we're cutting into muscle, it's that new times, new opportunities, new context, new environment leads to new cost savings opportunities. So new machines come out and that can help us with productivity. Our new information system, we've called out this [indiscernible] as a driver of higher depreciation. A modern clinical technology in the clinics, as you would expect, will allow us to drive down costs. On the procurement side, drugs go generic competition comes out that helps drive down costs as well. So just because we've been so good at driving down cost doesn't mean we've run out of opportunities.
Okay. That's helpful. That's going to be the next question because I always think of you as well-run from a cost perspective. Always seem strange when you say, we have $75 million of new cost cuts that we're going to do next year, it's like...
Yes, it's fascinating. There's an example I'd like to give where there's a new machine that can start itself in the clinic in the morning. And the result is 2 patient care technicians don't have to come in early -- an hour early to start the new machines. And it's easy to sit there and say, really? That doesn't sound so impactful. If you think of 2 hours of labor across almost 3,000 clinics 6 days a week, it's tens of millions of dollars of savings. And this is only available because of this relatively incremental new technology available through these machines, and there are countless examples of things like that.
And then you mentioned the free cash flow dynamic of the business. So right now, it seems like you're buying back stock. Is that the way to always think about it? Is there some other tangential use of capital for M&A that might become meaningful overtime?
Yes. So we've been pretty disciplined, right? We came out in middle of 2019 after the DMG deal was done. For those who weren't around, we owned a large physician business that we ultimately sold. We closed on the deal in June of 2019, and we talked about this concept of capital-efficient growth. And in my mind, that's about finding the balance between continuing to be a growth business, continuing to look for innovation and ways to grow both the top line and the bottom line, but doing it in a capital-efficient way. And I think we've -- over the last few years, we've delivered better on the capital efficiency side than on the growth side. I think that's largely due to the result of COVID. Ex-COVID, I think we were delivering on both sides of it, and that's the path we're going to continue on. We do look for opportunities to invest capital in growth and in innovation around the core business, and that core is U.S. dialysis, both home and in-center, it's IBC, it's our international business. We generally are not looking for things that can't touch 1 of those 3 businesses in a real way. But I think given the magnitude of what we are looking out, share buybacks will remain a very important component of our capital allocation strategy over the next few years.
Yes. So as long as you're able to grow OI 3% to 7%, no rush to get into something else to boost your growth, is kind of a...
Right. And I think what -- the way we think about it and what we've heard from investors is, if we can deliver 3% to 7% OI growth and continue to return capital then that feels like the right balance for us.
And how do you think about dividend versus share repurchase?
We've generally shied away from dividends. I have yet to see any evidence that it is a better path for us and it will accomplish anything different. I think there was certainly a time where investors were wondering, were we serious about returning capital to shareholders who we're really going to follow through on what we had talked about. I feel comfortable. Anyone who's watched this carefully over the last few years has realized we are serious about this, we are not shy about returning capital. We don't do it in a perfectly smooth way, and we do think about stock price, although I cannot sit here and tell you I have a crystal ball and can predict when the stock is going to go up and it's going to go down. We are -- we have a methodology around intrinsic value that we stick to. And for all those reasons, it seems like our path of returning capital through share buybacks is working, and there's -- we haven't been seeing a reason to shift towards dividends.
Maybe the last question home dialysis. I guess how is that going versus your expectations? Is this a solution potentially to the labor problem? It seems like this is going to be a good thing based on what we're seeing right now.
Yes. So we continue to grow. We continue to be the largest provider of home dialysis. COVID has been tough on home dialysis. Patients don't just miraculously go home. They need a lot of training. There's a lot of education. And in a labor-constrained environment when you -- job one is to staff a clinic for the patients who are coming in that day, there are certainly times where you need to take a home training nurse and have them work the floor, and that is a constraint. Over the very long term, it is a lower labor intensity model. It actually is a higher nurse intensity model. You save hours on patient care technicians, but you actually use more nursing hours. That said, I think the opportunities for growth certainly could help labor over the long term, but I don't think it's going to happen. I don't think it's going to have a real material impact over the short term.
All right. Great. I think that's all we have time for. So thank you for joining us.
Thank you, Kevin. It's a pleasure to be here.
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