Jim Gustafson - DaVita, Inc. Kent J. Thiry - DaVita, Inc. Javier J. Rodriguez - DaVita, Inc. Vijay Kotte - DaVita, Inc. Joel Ackerman - DaVita, Inc..

Catherine Anderson - Bank of America Merrill Lynch Gary P. Taylor - JPMorgan Securities LLC Lisa Clive - Sanford C. Bernstein Ltd. Justin Lake - Wolfe Research LLC Scott R. Schaper - William Blair & Co. LLC.

Welcome, everyone, and thank you for standing by. At this time, all participants are in a listen-only mode until the question-and-answer session of this conference. Now, I would like to turn the call over to Jim Gustafson. Jim, you may begin..

Thank you, Ann, and welcome everyone to our first quarter conference call. We appreciate your continued interest in our company. I'm Jim Gustafson, Vice President of Investor Relations.

And with me today are Kent Thiry, our CEO; Joel Ackerman, our new CFO; Javier Rodriguez, CEO of DaVita Kidney Care; Vijay Kotte, Chief Financial Officer (sic) [Chief Value Officer] (00:54) of DaVita Medical Group; Jim Hilger, our Chief Accounting Officer; and LeAnne Zumwalt, Group Vice President.

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 SEC filings including our most recent Annual Report on Form 10-K. Our forward-looking statements are based upon information currently available to us and we do not intend and undertake no delay to update these statements for any reason.

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 filed with the SEC and available on our website.

I'll now turn the call over to Kent Thiry, our Chief Executive Officer..

Okay. Thank you, Jim, and welcome everyone to this quarterly call. On a summary basis, at the enterprise level, it was a solid performance in a pretty dynamic environment, as you all well know. And at this point, we are on plan to deliver within our guidance, all the normal risks associated therewith.

Before we get into any more specifics of our Q1 performance, we will start, as we always do, with our clinical performance. We are, first and foremost, a caregiving company.

First, within the DaVita Medical Group, we have a program called Ride the Wave where we attempt to reach out to each and every one of our senior members, that's 360,000 human beings and we hit our goal of just over 95% of these seniors seen at least once during the past year in 2016.

This is radically different from the level of care that Medicare patients and Fee-For-Service ever get, and radically different than many other MA plans as well. On to Kidney Care with an equally significant factoid, one-third of our commercial contracts now contain a value-based component.

And under these contracts, we typically have catheter targets. And within those targets, we had a 15% improvement in the catheter rate through our improved clinical processes in coordination with payers, et cetera.

As many of you know, patients with catheters are nine times more likely to contract a bloodstream infection, and that leads to serious hospitalizations and a lot of other bad stuff. As always, we hasten to emphasize that our quality care, a differentially high quality care not only results in healthier patients, but also drives down healthcare costs.

Now, I'll turn it over to Javier for Kidney Care..

Thank you, Kent, and good afternoon. Q1 was in line with what we expected in Kidney Care. I'll summarize the financial performance and discuss some of the key business drivers. Non-acquired growth for the quarter was 3.8%, which is within the range of our long-term expectation of 3.5% to 4.5% on an annual basis.

Our adjusted operating income was $380 million for the quarter. The decrease versus fourth quarter of 2016 was driven by both normal seasonal factors and other factors that we outlined as part of our 2017 guidance. Let me elaborate on each.

First, there were normal seasonal factors, including higher EPO utilization due to the flu season, higher payroll taxes in the first quarter of each year and two fewer treatment days. Second, we faced some swing factors that we've previously disclosed. Let me repeat them and provide some additional color. We'll start with the four headwinds.

Number one, we experienced lower enrollment on patients on the ACA plans. Number two, we continue to see an increase of clinical teammate wages. Number three, there was a decline in adjusted operating income in our pharmacy operations.

You won't be able to see this in our segment breakout for the first quarter because improvements in other ancillary businesses helped offset this decrease, but you will see the decrease in future quarters. Finally, revenue was higher in the first quarter of 2017, as our forecasted commercial rate decreases take place later in the year.

Now let me shift to a couple of the tailwinds. As discussed previously, we have temporarily decreased our compensation accruals in 2017 due to a switch from profit share programs to a 401(k) match program, and we benefited from lower EPO pricing from our recent renegotiated contract with Amgen.

The primary adjustment to our Kidney Care adjusted operating income in the first quarter of 2017 was a government settlement that we previously disclosed. As a reminder, we received $538 million in March. Next, we're happy to announce the closing of the acquisition of Renal Ventures effective May 1. We acquired 38 centers in six states.

As part of the deal, we had to divest seven centers. The partial year financial impact of this acquisition is already incorporated into our 2017 guidance. Keep in mind that we'll incur some one-time costs to integrate the business.

Finally, we just executed an extension to our partnership with Humana to provide integrated care services to approximately 7,500 Humana members with late-stage CKD and ESRD. The ESRD industry continues to move in the direction of integrated care due to the number of comorbid conditions that ESRD patients have.

Our strong clinical performance improves the quality of life for patients and puts us in a good position to partner with payers to reduce costs to the healthcare system. As to outlook, we're reaffirming our 2017 Kidney Care adjusted operating income guidance of $1.525 billion to $1.625 billion.

As Kent mentioned on our last earnings call, we're in a period of greater uncertainty than is usual for our Kidney Care business given the efforts around repeal and replace and the impact those efforts will have on healthcare in our country and on our business.

We will continue to monitor political landscape and represent dialysis patients in those discussions. Now, on to Vijay Kotte to discuss DMG..

first, $10 million of expected rate headwind; second, nearly $7 million of previously described accelerated non-cash brand amortization for the transition from HCP to DMG; and third, $50 million of depreciation and amortization expense in the quarter.

Finally, reflected in our performance were some higher-than-expected medical expenses in the quarter, driven in part by a more intense flu season in both California and Florida. These expenses were partially offset by composite results from true-ups to existing shared savings pools.

As we look at the full year, it is too early to make any changes to the operating income guidance range of $110 million to $150 million, though it is more likely than not to be in the lower half of the range.

We'll have more to say about this during the second quarter earnings call after we have visibility from the prior year and the mid-year revenue true-ups that typically occur during summer. Looking beyond 2017, in April, CMS issued the final Medicare Advantage rate notice for the 2018 payment year.

Our analysis results in projected rates to be flat from 2017 to 2018. As you may recall, during our Capital Markets Day last year, we communicated an expectation that Medicare rates would track with medical expenses trend over the long term.

As a result, we expected approximately 1.5% improvement or $30 million in rate increases for 2018, which we no longer expect to materialize, though we will do our best to mitigate some of it. We will go into further detail regarding our longer-term expectations at our Capital Markets Day later this month.

Now, to Joel to discuss international and some other financial items..

Thank you, Vijay. To everyone on the phone, as you probably know, this is my first earnings call, and it is a pleasure to be here. I look forward to meeting many of you at Capital Markets Day in a few weeks. First, I will address our international operations. The adjusted operating loss from our international business was $11 million.

This result includes a $3.5 million currency loss within the Asia Pacific joint venture. A $6 million non-cash gain on the creation of our Asia JV has been excluded from the adjusted operating income. We continue to expect adjusted international operating losses to be approximately $20 million in 2017, excluding any currency gains or losses.

We are also excited to welcome Robert Lang as the President of our International Operations. He started with us in April. Robert joins us with extensive experience growing international healthcare and insurance businesses. Next, a few financial details for the enterprise.

In the quarter, we generated strong operating cash flow of $865 million, positively impacted by the settlement payment received from the government. Our operating cash flow guidance for 2017 remains $1.75 billion to $1.95 billion. Our adjusted tax rate attributable to DaVita, Inc.

was 40% in the quarter, after non-GAAP adjustments highlighted in the press release. We continue to expect our adjusted effective tax rate attributable to DaVita, Inc. in 2017 to be in the range of 39.5% to 40.5%. We, like other U.S.-centric healthcare service providers, pay among the highest tax rates in corporate America.

Finally, our debt expense for the quarter was $104 million. Now over to Kent for a few closing comments..

number one, this is a controlled adventure; and number two, the long-term growth upside is really quite striking.

Operator, can we move on to Q&A, please?.

Thank you. We will now begin the question and answer session. Our first question comes from Kevin Fischbeck. Kevin, your line is now open..

Hi. This is Catherine Anderson on for Kevin. You highlighted a $100 million headwind to guidance from commercial pricing. The last quarter, you indicated that you think it wouldn't continue into 2018.

Can you talk a little bit about your managed care contracting over the past few months and how confident you are that it's a one-time reset?.

Yeah, Catherine, let me see if I get the – what you're going for in your question. The short answer is you have not seen the hit because they're in the back end of the year.

And how we're feeling about the environment is that the environment is very active on the one topic of charitable premium assistance, but the relationship with our payers continue to be what they have been for years. And as you see from the announcement on Humana, we continue to negotiate all of our contracts.

And actually, we are in a situation where right now we are as contracted as we've been for quite some time. I don't believe we said $100 million in headwind is incorporated in our guidance. So, we'll have to check that..

Okay.

And then in your guidance, were you assuming that all of the Medicaid-eligible patients who moved out of exchange funds, they were going into Medicaid this year? Has that been working out? And how much of your commercial revenue is getting support from the AKF today?.

Yeah. On the first part of your question, yes, those patients have gone back to Medicaid. And as to the second part of your question, I'm not going to provide any additional details than what we've already provided..

Okay. Thank you..

Thank you..

This is Jim Gustafson. I just want to confirm, we have not given a number to the commercial rate headwind. It's incorporated in our guidance, but we didn't say $100 million..

Okay..

Thank you, Catherine..

Thank you. Our next question comes from Gary. Gary, your line is now open..

Hi Jim, (14:48) it's me..

Hi, Gary..

Hi. So I guess, maybe just to follow-up on the last question, Javier, regarding the commercial pricing.

Is the expectation still that the pressure is going to be on the small number of, I guess, out of network rates that you expect to see decreases on?.

Yeah, Gary. As you know, there's a wide distribution of rate. And what we want to do is make sure that we do what's right for the long term. So sometimes, we have some of their outliers that we need to bring in, and we do have a small set of out-of-network rates, and so those are sometimes the one we're discussing here..

Okay. And then maybe you mentioned EPO, I guess, utilization being up a little bit in response to flu.

Can you discuss, to whatever extent that you're willing, kind of impact it had in the quarter? Or is the new contract in place? And, I guess, are you seeing the benefit from it as you would have expected?.

Yes. We are seeing the benefit as we expected. And of course, we had to go down, wind down some inventory that we had, but we are experiencing the contract as we anticipated. As it relates to the spike on the seasonal, of course, it's very hard to predict and isolate because of the flu season, it's sort of a moving target, if you will.

And with the prescriptions the way they are, meaning every physician gets to make their own, it's almost impossible to diagnose a number. But if you had to put it in a range or you had to bracket it, I'd put it anywhere from $5 million to $15 million or so..

Okay.

And then is there any way to give us any color on how the inventory issue, I guess, will benefit you to a greater extent in future quarters?.

On that, it's just basically we're winding down from inventory that was purchased at the previous contract. So, it's probably not worth worrying about..

Okay. Thanks a lot..

Thank you..

Thank you. Our next question comes from Lisa. Lisa, your line is now open..

Hi. I just wanted to get some clarification on the current guidance with regards to the premium support issues. So the 2,000 patients who are Medicaid-eligible, as the question earlier alluded to, so it's my understanding those have disappeared, so that's a $140 million headwind.

But then you also gave guidance for another $90 million headwind from the non-Medicaid patients on the exchanges who have premium support and then also the non-Medicaid patients off the exchanges who have premium support.

I'm just wondering particularly in between those two buckets, have you seen further erosion of the exchange-based book in addition to those 2,000 Medicaid-eligible? And then also separately, has there been any impact on the off-exchange individual plans?.

Yeah. So, I'll try to give you as much as I know and then let me know if that answers the question. We did see those 2,000 patients that you alluded to, which is $140 million.

It's probably not worth going to the detail on the $90 million, but at the end of the day, we did some handicapping as to what would happen, and the number worked out to be in the right range. And so as opposed to the journey, the destination ended up being the right one.

How many patients are on and off exchange? We're kind of combining them, and there's approximately 2,500, which is, of course, give or take, half of the 3,000 plus 2,000 that we alluded to last year.

Does that answer your question?.

Okay. I'm a bit confused, because I thought there are 2,500 on exchange, 2,000 of whom are Medicaid eligible. So that leaves you with 500 who are on exchange. And you would know by now whether they've re-enrolled or not. And then there was about 1,000 who are off exchange in individual plans with premium support.

At least that was my understanding of what the numbers looked like.

So clearly, bucket number one, the Medicaid eligible goes away but then the others, if it's still a $90 million headwind, does that also include the impact from any rate pressure on your sort of broader private book of business?.

Yeah. I think the confusion might be – we did not, to my recollection, provide detail on, on and off exchange. We basically just said that there was 5,000 patients on the exchanges. And so maybe that's where the confusion is coming from. And so we have not disclosed any additional detail.

And so what I am telling you is that we have 2,500 patients that are both the addition of on and off exchange..

Okay..

Thank you. Our next question comes from Justin. Justin, your line is now open..

Hi, Justin..

Hi. Good afternoon. A bunch of questions here. So I'll just ask a few and jump back into the queue. So first, just to follow up on a couple of numbers. The commercial contracting pressure, Javier, can you repeat what you said there? I apologize. I thought I caught it.

But did you say that most of that hasn't actually developed yet, and that it's more of a back half of the year issue?.

I did. And we did not provide additional detail on the numbers. We were just clarifying a number that was thrown out. That wasn't a number that we had cited in the past..

Okay.

So, you haven't actually agreed to any rate cuts on these out of network? It's just something that you anticipate could happen given what's going on in the world?.

There are some that are handicapped, which we always do for you. We try to give the best stab in anticipating what's going to transpire during the year. And then there are some that have been agreed to and have an effective date that hasn't been incorporated in Q1..

Got it.

So effectively, the stuff that's been agreed to at least, that's going to be in the back half of the year, would be an incremental headwind to 2018 as they are annualized (21:43)?.

Correct, it will be in our run rate. Correct..

Okay. And then remind me the patients that you had, the 5,000 patients on exchanges.

Can you tell me the number of patients that were in Medicaid? Was that number 2,000?.

Yeah..

Okay. And then the patients that made up the $90 million that you expected also to lose.

Can you give me that number out of the 5,000?.

Let me see. I don't think I could give you any additional detail on that, Justin..

Okay. I figured I'd take a shot.

So then, while we're on commercial, can you update your commercial mix now?.

What have we disclosed?.

We're still at 11%, Justin..

You're still at 11% even after losing 2,500 patients that had commercial individual insurance?.

So at the end of the fourth quarter, we were rounding down to 11%, now we're rounding up..

Okay, so it's down about 100 basis points.

And if you were to exclude what happened in the individual market, can you give me the underlying trends?.

The trends on what, Justin?.

I'm sorry, if you were to exclude this one-time change in the individual market, right, if we were to call it that..

Yeah. What we....

If you pull those numbers out, did commercial mix improve or moderate, Q4 to Q1?.

Yeah, we're seeing it moderate, I guess, to use your word, flat..

Okay. And then, last question before I jump back in. Just the international segment, international and other, I should say, together lost $25 million.

Can you give us an idea of what you expect that – I mean I know you told us $20 million on international, can you give us a number or ballpark in the other segment for the year?.

Give us one second, Justin, or maybe let's move on and we'll come back to it. That's not a number we typically are prepped on.

I mean, of course, it's incorporated within our guidance and we try to do the additional service of carving out international here for the last several quarters, but the other number you're asking for is not something we've classically calculated and forecasted, so let us reflect a little bit..

Got it.

Is that mostly Part D? And is that like a reasonable run rate to think about at least, this quarter is at a reasonable run rate then? You can't give us the guidance for the year?.

Yeah. I don't think we want to throw out a spontaneous answer because again, you're asking for a parsing we've never done..

Okay..

So, give us a little time to stare at it. It's not an unreasonable question. It's just not something we've ever parsed that way before..

All right. Thanks guys..

Thanks, Justin..

Thank you. Our next question comes from Margaret. Margaret, your line is now open..

Hey, guys. This is actually Scott Schaper on for Margaret.

I wanted to ask just briefly, anything going on in the rumored new push for healthcare reform and do you see that could help or hurt DaVita and its patients?.

Well, there's just so much speculation, Scott. I think we could talk about what's been talked about yesterday, but it will probably be different tomorrow. And so I think it's not good to speculate..

Okay. And you closed a deal this morning in the DMG group. Maybe just talk about the changes the team has made over the last two years or so in identifying quality assets that can contribute to that group.

And maybe if you could, you could touch on a number of quality assets that you currently view as compelling in the way you see that going?.

Okay.

Scott, could you just repeat the question so I don't ramble around?.

Yeah.

It's just basically, what have you guys done from a management team perspective that you can point to towards identifying quality assets that can contribute almost immediately or in the near term in the DMG group versus historical where it's taken sometime or have not been great purchases at least at the start?.

Yes. Well, I guess, I'd give a two-part answer, and then you can come back for more. Number one, we said, think about a year ago that because we were still digesting some of the acquisitions we had made in the prior year-and-a-half that we were going to have a tighter filter on doing any new market large deals. And since that time, we haven't done any.

There's always a chance that over the next year, we will do one, but there's also a very good chance we won't do any because we've got a bunch of opportunities in our existing markets and we want to focus on those. The second dimension of looking for quality assets is in our existing markets.

And here, we are looking at a nice steady space of what we call tuck-in deals where we're buying or merging in small practices or medium-sized practices and attaching them to some of our existing assets. And that process is moving along quite nicely..

Okay.

So that's how we should think about it, kind of smaller tuck-ins versus anything that's done on larger scale, at least for the near term?.

The odds are that that's the case. Again, every now and then, the quality new asset and a new market that's big pops up. In general, we're not price competitive on those. But you never know, maybe one day, we'll get one..

Okay. And then just quickly for – probably for Javier. Last quarter, you guys said I think it was $10 million included in OI for Renal Ventures.

Is that still how you guys are thinking about that for the remainder of the year?.

It's in the range but as we disclosed, it's not a very significant number for the year..

Okay. Thank you..

Thank you..

Our next question comes from Lisa. Lisa, your line is now open..

Hi. Thanks for giving me the follow-up question. I was just going back to my numbers, and one thing that you did disclose in your October 31 press release was that out of that 5,000, you had 2,000 Medicaid eligible. But then of the remaining 3,000, about 1,500 were on some sort of premium support.

So I suppose my question is, given that the regulations are on premium support haven't actually changed, are you seeing losses from those patients because insurance companies are successfully denying acceptance of premium support? And is there any difference in their sort of ability to do that whether it's an on-exchange or off-exchange individual plan?.

Yeah. It's really hard to parse through what's going on. And so why patients are doing what they're doing with plans, exiting and other things around it. So instead of giving you a specific answer, let me just give you the total. We're at 3,000, and we're at 2,500.

And so we can't parse through with clarity as to why the number changed, but that's probably better just to give you where it ends – well, where it is as opposed to where it ends..

Okay. That's fair enough. And then I suppose just on the disclosure generally, because it's ultimately just up to the patient whether they're getting the premium support and buying the private insurance or not, so you don't really have much visibility on the ins and outs of it.

Is that fair?.

It's fair. Yes..

Great. Thanks..

Thank you..

Thank you. Our next question comes from Justin. Justin, your line is now open..

Thanks. So a few more here. I'll just follow up here to see if I could try this one more time, this individual stuff. Just going through the numbers, it does seem interesting. So the 2,000 Medicaid lives that you said were on individual plans are now – are back on Medicaid, right? And that costs $140 million.

Is that the correct way to think about those?.

Let's just be clear about one thing. It's important. They never left Medicaid..

No, I apologize. You're right..

So they lost supplemental coverage, which in most cases, was a beautiful thing for improved coverage and care. And they lost that in the midst of all the controversy, but they were never off of Medicaid..

Okay. I'll move on from the subject. If we could just talk a little bit about DMG, you talked about there was – you had expected a $30 million improvement in rates for 2018, and now it looks like you're not going to get those.

Given the rates looked pretty benign at least on the high-end, I know there is rate changes at the accounting level as well from rebasing.

Can you just tell us what changed in your mind that took that $30 million to zero?.

Yeah, Justin, I think the basic premise is that we expected over time that the rate setting process with CMS would more or less have the rates track with the market medical expense trend in the markets that we operate in.

And we didn't know if we would have them one year, two years or what the longer timeframe would be, but we expected it to track more or less. And the bottom line is that we now know the 2018 rates will not do that because they're going to be relatively flat.

And it's about 0.5% difference versus what CMS expected overall, and that is the geographic differential. But ultimately, the $30 million is a headwind because we do expect the medical expense trend next year, and it won't be covered through rates..

Got it.

So when you think about that, does it put a risk on your ability to hit that $250 million target that you put out there for 2019 for DMG?.

Yeah. No doubt, the $30 million is a headwind, and we're going to work with our payers and our providers to do our best to mitigate as much of that as possible. But on the other hand, I do think that we are more confident about our ability to increase the savings and efficiencies in administration between now and then..

But Justin, Kent Thiry here. It was an assumption we had that turned out to be incorrect. And so it's definitely a reduction. And now the challenge becomes how many other places can we find anything incremental for a partial offset..

Got it. And then you mentioned this Humana contract on Integrated Care, certainly sounds interesting.

Can you give us any more color in terms of how this is set up? For instance, this is a full capitation, or is it risk sharing on these numbers?.

Sure. It is a mix of both of those. So we have some set fees, and we have some things that relate against value based, in particular, in CKD. And so there's a whole bunch of things that are trying to reward good transitions into ESRD and savings around the transition around that..

Okay. And so you had talked about obviously the opportunity for Medicaid to actually make a profit in Medicare by offering these capabilities to managed care. And I think you had even talked about there's a number that's been thought of in terms of the potential upside versus just providing a Medicare treatment.

Is it fair to think of the economics here as similar to that upside that you typically have in Medicare Advantage in terms of what you get paid for in treatment? Or is it better or worse than that?.

Well, Justin, I'll go first on this one. It varies all over the map and not only by a private payer does it vary by contract, but also even within Medicare and Medicare Advantage, it differs geographically and it differs by what the baselines are that you start with. So it's a wide distribution curve..

Right. I can see that must be tough to nail down. Okay. I will leave it there. Thanks for all the questions, guys. Appreciate it..

Thanks, Justin..

Thank you. Our next question comes from Gary. Gary, your line is now open..

Thanks. Maybe just – on a similar topic. At the end of last year, the industry, it sounded like felt pretty good about moving some legislation or trying to get some legislation moved through Congress that would make it easier to move towards an accountable care model.

Any comments on what you think the chances are for something to get attached in the current Congress?.

I'd make two points. First, a generic one, that in a world where Congress is passing very little of anything, it makes it very difficult to find a vehicle to attach to because there's lots of people with lots of attachments and very few vehicles, and so that's an environmental problem that exists for us and others.

Second, as to the particulars of our Patient Act that we have a real shot. You never know how this works, you would never say the odds are on your side, because in a world where little is being passed, you just can never say that. But it's a highly respected piece of legislation with broad bipartisan support.

I'll remind everyone that we passed the House Ways & Means Committee late last fall with one dissenting vote in a year when that virtually never happened in any piece of substantive legislation in the House. Having said that, it's a real battle each new year to try to rise above the noise.

And so, I think, I just have to leave it as we have a real shot, and we're working hard and it would be a tremendous victory for both patients and the taxpayers and that's increasingly known and increasingly attractive, but that doesn't mean it's in the home stretch..

Great. That's very helpful. Thanks a lot..

You're welcome, Gary..

We show no further questions on queue at this time..

All right. Thank you all for your continued interest in DaVita, and we will do our best for you between now and Capital Markets in a few weeks. Thank you..

That concludes today's conference. Thank you for your participation. You may disconnect at this time..