德維特 (DVA) 2014 Q2 法說會逐字稿

Good afternoon, my name is Jenny and I will be your conference coordinator today. At this time, I would like to welcome everyone to DaVita Healthcare Partners second quarter 2014 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.

(Operator Instructions) Mr. Gustafson, you may begin your conference now.

Thank you, Jenny, and welcome, everyone, to our second-quarter conference call. We appreciate your continued interest in the Company. I'm Jim Gustafson, Vice President of Investor Relations, and with me today are Kent Thiry, CEO; Garry Menzel, our CFO; and Jim Hilger, our Chief Accounting Officer.

First I must apologize for the delay in our press release today. Our wire service messed up and didn't get it loaded in time. We will make sure this does not happen in the future.

Next, I would like to move to our forward-looking disclosure statement. 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 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 and Quarterly Report on Form 10-Q.

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 for any reason.

Additionally, we would like to remind you that during this call we will discuss some non-GAAP financial measures. The reconciliation of these non-GAAP measures to the comparable GAAP financial measures is included in our Form 8-K submitted to the SEC and available on our website.

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

Okay. Thanks, Jim. And greetings to everyone else. I have been out sick so far this week, so if there are some moments when I push the mute button it is to save you from hearing a bunch of coughing. So please bear with me.

First, our enterprise had another solid quarter, as you have seen in the press release. It consists of two parts: a strong quarter in kidney care with their OI of $402 million, and I will let Garry cover the most of those results; and then not a strong quarter in HealthCare Partners, and I will take care of discussing that.

But first, as always, we will talk about our clinical outcomes as that is what comes first. We are taking care of about 35% of the patients in dialysis centers in America. 98% of those are achieving a Kt/V of 1.2 or better. 73% have a fistula in place. In addition, there's many other complex clinical improvement programs. Among them, for example, fluid management where we decreased by 15% the number of patients with excessive fluid gain between treatments over the past 10 months, which -- for those of you that are clinically oriented, you realize is a big deal.

On the HCP front, we take care of nearly 830,000 patients on a comprehensive basis, and our 2013 ETIS clinical metrics are pretty outstanding across the board in each of our legacy markets. Right now, we will just focused briefly on California results and just talk about cancer screening and diabetes management, where we are either four- or five-star across all of our Medicare Advantage MA patients, including 80% of our patients receiving colorectal cancer screenings. That compares to a 2012 national average of 62%. And if you go back to our 2012 numbers, we were already at 80% back then, so the gap is a legitimate gap.

In addition, 64% of our diabetic patients with cholesterol scores below 100 versus a 52% national average. And, once again, our score back in 2012 from whence that national average comes, is comparable back than to today. So it is a legitimate gap.

So the clear message on both fronts is that our clinical outcomes are relatively outstanding, leading to healthier patients, higher patient satisfaction, and importantly, savings to taxpayers.

But, on to the HCP operating performance, you see that reported OI of $82 million. That overstates the performance for reasons I will get to in a second. But, within that number, there is very solid performance again in our three legacy markets, which generated $77 million in operating income and approximately $118 million in EBITDA.

And this was, of course, to some extent offset by our expenses in new markets, particularly New Mexico and Arizona. Trying to get right to the bottom line question, the overall -- the recurring normalized OI is about $55 million. Now let me do some parsing to help you understand those aggregate numbers.

The OI for the quarter benefited from the recognition of some net deferred revenues, approximately $20 million, related to the maintenance of existing physician networks in some of our new markets, of which $6 million was related to the first quarter of 2014. And of the remaining $20 million, most of it primarily related to 2013. In other words, even though we knew it was likely at the time, we couldn't realize these revenues at the time. But the first quarter of 2014 was $6 million better than we could report at that time and 2013 was nearly $20 million better than what we could report at the time.

There were also some non-period-specific items in the quarter. They effectively offset each other for a net of approximately zero. On the positive side was MA revenue. There was finalization of some of those rates and true-ups, which historically doesn't happen until Q3, and it happened in Q2.

On the other hand, we had some negative increases to our medical loss reserves for prior periods and some AR adjustments related to 2013. And, again, the net of those puts and takes was about zero, leading to that normalized Q2 OI run rate of about $55 million.

Our guidance already assumes lower margins in the second half, which mirrors historical trends, because sicker patients with higher risk scores, some of them expire in the second half of the year. And some younger and healthier patients age into MA, and so that is a natural annual trend.

Some other good news is that in terms of MA patient growth year-over-year, our three legacy markets non-acquired MA patient growth of about 12% and non-acquired MA growth across all markets, 18%, so very nice robust unit growth in the MA segment.

One other piece of good news is that is highly likely that in New Mexico and Arizona, the two most economically significant new markets, their performance in 2015 should be at least $25 million better in OI next year, maybe more so. Obviously, we can't lock and load that as a total certainty, but it is highly likely, at least $25 million better in 2015 versus 2014. And, in both cases, we have a stronger team and a better strategic position then we had 6 to 9 months ago.

On the organizational front, as many of you know, I am stepping in to run HealthCare Partners for the foreseeable future. And I will be spending a significant majority of my time there. It has been a difficult 18 months for all stakeholders, and it would be difficult for me to overstate how excited I am to step out onto the field myself and lead that wonderful physician-led organization that puts a great value proposition of coordinated care on the table.

And on that point of physician leadership, two of my key physician partners will be Dr. Tyler Jung, who is our recently named new Chief Medical Officer, who first joined HealthCare Partners in 1996 as a working hospitalist, and Dr. Chen Chuan, our new Chief Clinical Officer, who has been with HealthCare Partners since 2002 and was the primary direct report to the previous chief medical officer. So deep, deep experience on the physician side. As well as Dennis Kogod, who was, as you will recall, chief operating officer on the kidney care side and now is picking up some pretty significant tenure as COO on the HCP side.

People might ask questions about kidney care, but you see in the results that Javier Rodriguez and Mike Staffieri, currently the CEO and COO on the kidney care side, have a combined nearly 30 years' experience with DaVita Kidney Care, and are well ready to carry on the momentum that currently exists since they were some of the primary creators of that momentum all along.

If I just step back for a moment and look at the strategic position of our three businesses, on the US kidney care side, we are well-positioned from a relative performance basis. There is consistent market growth and we have consistently grown faster than the market. Our clinical outcomes are outstanding and getting better every year.

At the same time, we have got to acknowledge the substantial environmental risk, especially on the reimbursement front.

With respect to international, we are continuing to move towards establishing a solid foundation that could be a platform for years and years of risk-adjusted attractive growth for the enterprise. And, as a minor anecdotal tidbit, we will open our first center in Saudi Arabia under our big contract there within the next eight weeks.

On the HCP side, population health management, as just about everybody on the call knows, is a seemingly pervasive trend throughout America. And our value proposition is strong, our foundation is strong.

In the near-term, we may have to whether some significant reimbursement headwinds, as you all know. We will be stabilizing some of the new market performances. We're going to enhance our value proposition, including in legacy markets, and I look forward with particular eagerness in working on that with the teams there.

And then we start to grow. We have got a lot of growth opportunities. We have selected a handful. We will probably select a handful more and we look forward to having those mature in the years to come.

Now, Garry Menzel will walk through some more detail, particularly on kidney care.

Thank you, Kent. First, additional comments on our kidney care operating metrics. Non-acquired dialysis treatment growth in the quarter was 5% when normalized for days of the week.

Dialysis segment profitability was up $21 million sequentially as a result of two factors. First, there were 1.5 more treatment days in the quarter. Second, there was a seasonal decrease in payroll taxes from quarter one highs as our teammates hit annual caps.

Our international losses were $9 million for the quarter. That is in line with our forecast to lose $40 million in 2014 as we ramp up our startup costs in Saudi Arabia in the second half of the year.

Moving to the overall enterprise, our debt expense was $106 million in the second quarter, excluding the $98 million in nonrecurring refinancing charges. As previously announced, we have refinanced our bank loans and much of our on bond debt, reducing our effective interest rate and extending maturities. We expect quarterly debt expense to be approximately $100 million going forward.

Next, the effective tax rate attributable to DaVita Healthcare Partners was 40.5% in the quarter, in line with our expected range of 40% to 41% for the full year 2014.

Turning to cash flow, we continue to generate strong cash flows as operating cash flow was $262 million in the second quarter and $1.77 billion over the last 12 months.

Finally, I would like to address our outlook. Our updated enterprise operating income guidance is now $1.755 billion to $1.840 billion. This includes, number one, reducing the high end of our HCP guidance so that the range is now $205 million to $240 million. This includes the onetime Q2 revenue benefits that Kent discussed earlier, and number two, increasing kidney care guidance of $1.55 billion to $1.60 billion.

We still expect operating cash flow to be between $1.45 billion and $1.55 billion in 2014, excluding any payments associated with the potential PRA settlement with the government. As always, these guidance ranges capture a majority of probable realistic outcomes, but we could be above or below this range.

With that, operator, let's go ahead and open it up for Q&A.

(Operator Instructions) Justin Lake, JPMorgan.

First question, Kent, maybe you can give us some color as to what drove the decision-making on the leadership change at HCP. And then, can you give us also some color on what your -- how much of your day-to-day time is going to be spent at HCP going forward versus what it was over the last 6 to 12 months.

On the second question, I will be spending a significant majority of my time on HealthCare Partners. The first question, as you know, historically, we don't typically comment on personnel issues. So I think I would just stay away from that and reiterate how excited I am to step into that role after the last 18 months of some difficulty, as you know.

Sure. Maybe, Kent, a better way to ask it is just that maybe you can lay out for us the two or three or four things that are on the top of your agenda to get accomplished as a change agent coming in there.

I think some things that I mentioned, and they are going to sound awfully generic, but hopefully they will emerge in a very substantive and non-generic way. But it is to deepen the value proposition in existing markets with respect to MLR management and patient loyalty, ability to attract and retain physicians, et cetera. So it is sort of power alley, fastball down the middle improvements of the value proposition in legacy markets.

It's to stabilize -- continue to stabilize and improve things in the two new markets that have consumed the most economic resources. And it is to selectively grow. And, as I mentioned, we have already identified a handful of very promised opportunities and are in various stages of execution on those, and are picking from a bunch more for the next handful. So I think about is kind of the trilogy of focus, if that is helpful. I recognize it is quite generic at this point.

Okay. And then last question, just on HCP again, the one you mentioned that you expect $25 million of improvement. I didn't watch what was driving that. And then, secondly, in terms of the startup losses or the new market losses, can you give us a reason on what trajectory as to when you think you can get them back to breakeven? Thanks.

On the first question, Justin, I don't think we want to break out the $25 million, because it is a couple of different markets. It is a lot of different variables. I think the important news for shareholders is just that we are doing good at -- at least a year-over-year, $25 million pickup which is a very significant amount, especially in two markets where we have a nontrivial market position to build from.

And then, as to exactly what their net economic status is and when they hit it, I don't think we want to get into that level of detail. And, in part, there is decisions in each place and we may decide to have losses go on longer because of the returns we think we will ultimately get. It is really too difficult to predict. So unfortunately, I've got to stay away from that.

Darren Lehrich, Deutsche Bank.

This is Dana Nentin in for Darren. Just as it relates to HCP, on the new market entry strategy, can you just discuss progress with Tandigm Health JV in Philly and then maybe update us on any similar types of relationships you have?

Tandigm -- the short answer is it is going well. But, of course, it that has to be qualified by the fact it is still in the early stage. We hit our target of 300 primary care physicians who signed up to work with Tandigm, which is exactly what we wanted. They are the physicians we were hoping would join. They are physicians that are committed to moving forward with IVC as a big payer, and us, in order to start to improve managed care in that community.

And so, without at all underestimating the business challenges to come, so far it is right on track. We have got the right partners and we have got the right tools. We have got the right momentum. But there is a lot of work ahead of us and time will tell.

Okay great.

And then I guess, Dana, the other question, might there be others, the short answer is yes. It is a model that has attracted a lot of interest. We just have to decide how many we want to do at what pace. We don't want to get ahead of ourselves in terms of our capabilities.

Okay. Got it. And then, continuing on HCP, could you just discuss medical cost trends in the quarter and whether your margin outlook has changed given the utilization environment?

I don't think we have anything material to say on that. There hasn't been anything dramatic going on one way or the other within the quarter. And so it is sort of business as usual, which is not to say it is a smooth line, but there is nothing noteworthy, I think, in the quarter itself.

Okay that's all I had. Thanks.

Kevin Fischbeck, Bank of America Merrill Lynch.

I guess I just want to understand how the offsetting dynamics in the quarter that you mentioned at HCP works. You are saying that the Medicare rates you don't expect to happen in Q3 happened in Q2. Maybe it was net neutral to this quarter, but is it still in that negative when you think about the yearly guidance?

Well, certainly, it means that Q3 will be missing that incremental boost. It would have already happened, but that reality is incorporated into our total guidance for the year. And so it doesn't change our guidance, the fact that it moved from Q3 to Q2.

Okay, then just to understand the guidance, then, because you basically got $20 million of out of period revenue, but you took -- you kept the low-end the same, you took the high end down by $20 million. So did you really take the low-end down by $20 million and the high end down by $40 million on a 2014 kind of earnings base, then?

Could you repeat the question, please?

Your guidance for HCP, I believe, kept the low-end of the range and reduced the high end by $20 million. But you say you got $20 million of out of period revenue and theoretically operating income. So if you are just trying to focus on what you actually earned in 2014, did you essentially take the low end down by $20 million and the high end down by $40 million?

No we did not. This is Jim Gustafson. Because we had already incorporated the probability-weighted impact of this into our guidance, so that had already been incorporated in the guidance.

Okay. So the potential to kind of pick up prior year revenue for things like this is something that we should expect to happen and therefore -- not every year and therefore not to adjust out of the operating income even though it is related to the prior year?

Let me take a stab at that. There is a certain amount of puts and takes in an IB&R intensive business that happen all the time. And so what we try to highlight for you is when there is an unusual number of them, which we have had a time or two in the last 18 months, and when it is more than normal offsetting puts and takes.

Does that help answer? There is no black and white answer. You never expect a year in this kind of business without some prior period adjustments, but you also don't expect too many of them. Is that answering the question?

Well, I guess maybe the better way to ask it is, when you talk about next year being better by $25 million, do you mean off of this current guidance rather than off of the 2014 actual earnings in the current period?

Okay. I get the question now. I apologize for missing it before. The comment on $25 million in improvement was focused on the two significant new markets of New Mexico and Arizona. That, in those competitive arenas, we are confident of a year-over-year $25 million OI improvement. That $25 million then would become a factor in the aggregate HCP performance, which we are not commenting on now. We were just highlighting a delta in those two new markets.

Okay. But I guess I think you said that the network of that network $25 million number was mostly new market. Is that right? So, even with that extra new market income this year, you're going to do $25 million better than that next year.

That is correct.

Thanks for clarifying that. And then, I guess when we think about -- you mentioned that a number of things that you are analyzing now -- there are number of things you are -- kind of got in the hopper for the next round of things. How do you think about the competitive landscape?

I guess there was recently an article about how there is a record number of ACOs, and doctors and hospitals competing for physician alignment and things like that. Do you, as a Company, look at this and say, we have to kind of do more than maybe we are ready for in the next 12 to 24 months, because if we wait five years, all the partners who were the strongest partners will have done something? How do you balance that as you analyze the opportunity set?

Yes, very fair question. In general, on the one hand, there is increased supply of competition, more and more people trying to do population health management. On the other hand, there has been a proportional increase in demand for the same. And so I don't think there has been any fundamental change in the demand/supply relationship, which is what really matters, and nor are things going to happen quickly. Or I should say there will not be a lot of successes quickly.

An awful lot of the people who are getting into this space or who have gotten into it the last year or two or three are failing, if not on an absolute basis, on a relative basis. And so I think from a strategic point of view, the important thing is to maintain a differentiated, better product. And in that context, there will be no shortage of opportunities for the next 5 to 10 years.

Kevin Ellich, Piper Jaffray.

Kent, just wanted to kind of follow up on the ACO questions. What are your updated thoughts on the care coordination model and even maybe greater use of certain physicians, maybe even in hospital medicine?

Can you elaborate a little further on the question? I think I would be groping if I answered now.

Sure. So, one of your big competitors recently made its entry into the hospitalist industry. And it was kind of an interesting move. Obviously, a lot of hospital medicine is used in the ACO integrated care model. I'm wondering if you guys could look to expand into that area, specifically, in terms of improving the coordination of care between acute and post acute patients.

Okay. Let me take a stab at it, and you let me know if I am not responding. We have some of the best hospitalist operations in America now embedded within our existing markets. And up to this point, have opted not to try to create what we might call a vertical and take certain capabilities outside of our legacy markets and sell them, market them, implement them on an isolated vertical basis.

However, strategically, that is something that we talk about regularly. Just up to this point, we have never opted to do it.

That's helpful. That's helpful. And then, going back to your comments about population health management, just wondering, what do you think are the keys to driving improvement in outcomes within population health management? And then, also, do you think there are any hot button issues in that category as well?

Well, I think one of the primary tenets of our answer to that question, and one of the ways in which we are highly differentiated, is that we believe putting the physicians in the spot of operating leadership is critical. And that is part of the legacy of HealthCare Partners. It is part of why we have been as successful as we have been. So I think that, and investing in technology over the next three, five, seven years, those are the two of the primary components of the answer.

Okay. That's helpful. And then lastly, actually two questions, thoughts on biogenerics coming in on the ESA front like Micera, do you have any pilots our plan to have any pilots were you could use new ESAs? And then could you prioritize uses of capital? Thanks.

Okay. On the biogenerics, we of course, like any customer, like it when our suppliers, whether they be vendors or partners, have competition. And so, no surprise, we are in favor of their being new entrants into all products and drugs and biogenerics that we have to purchase. We are wildly in favor of that. And we will work with some companies bringing new stuff to the market if the terms make sense. And, at the same time, we value very highly our historical relationship with Amgen and the clinical value of the drug that they provide.

On the capital allocation, I think the way we have answered this best, historically, is to have people look in the rearview mirror and see that over 15 years we have done a lot of different things in terms of our leverage ratio, in terms of buying back stock, in terms of paying down debt, in terms of changing the nature of our debt, in terms of investing in acquisitions, and et cetera, et cetera, et cetera. So I think we bring a pretty open mind to what is the right way to think about capital allocation that is very time specific, fact specific, et cetera, always trying to manage the risk-adjusted upside for our shareholders.

Gary Lieberman, Wells Fargo.

Could you talk a little bit about how you view the change of the risk adjusters next year on the Med Advantage business and how significant of a positive that could be to HCP?

I would just say our expectations on that are baked into our guidance for this year. And next year we have not provided guidance for, and certainly whatever the government decides to do -- well, I guess -- can you repeat the question? Are you talking about 2015 or 2016?

2015.

Well, there, we have the positive of some adjustments to what they were doing on risk adjustments versus the negative of reductions to the underlying rates. And so, as we provide you with guidance for 2015, there will be a netting of those two effects.

Okay. And then how are you thinking about 2016?

Who knows? I mean, it is just so hard to predict what the government is going to do. If they compress acuity scoring, that hurts us because we have a lot of high acuity patients. And we think it would be a big mistake for the Medicare program to do that, because you want to attract investment in the ill people and make them healthier. That is when the whole system works that is when the whole system works in a virtuously reinforcing way, clinically and economically.

So if they compress acuity scoring, that's bad. On the other hand, of course, if they leave that the same, but drop underlying overall rates, that is bad too. So we kind of have to wait and see where they come out.

Okay. And then your comments regarding new markets on HCP, it sounds somewhat more bullish than maybe you have been in the past. I guess in the past you have talked about entering -- refresh my memory -- two or three markets this year with a couple more next year and a lot more the year after that. Is that still the way to think about that, or could that be accelerated somewhat?

I would not presume any acceleration. In fact, in the last quarter, I, if anything, nudged expectations towards deceleration. But I think the difficulty here is sort of the unit of measure.

We are going to do some new things and then probably more new things next year and more the year after, and so on. If you just use that as sort of the crude metric, those words are probably still true. However, the math on a lot of those things is going to be quite small in the early years, just like Tandigm is not something that is going to have a huge, immense impact for a whole bunch of reasons tied to our strategy with our partner.

And so the number of things we do might be quite significant, but the math of it is very hard to predict and is probably not going to be as significant as the unit number.

Okay. And then, finally, maybe just an update on the recovery in Albuquerque.

I don't think it is a good idea to go into a huge amount of individual market detail. Again, we did want to convey that in the two new markets that have been consuming the most resources, we are looking at a very nice year-over-year improvement 2015 over 2014. And the odds that that will happen are very high, and probably just leave it at that.

As you do know, the government approved the acquisition by Blue Cross Blue Shield of the MA plan. And that is a good thing for us, because it puts us back in network and our number of lives -- our MA lives has gone up in a very nice fashion since then. But to start slicing and dicing it, I don't think is a good idea. The aggregate math is probably the best way to characterize it.

Margaret Kaczor, William Blair.

A few for me. First, you guys haven't talked about the number of international patients you have right now in a while. What is that number today?

Between 5000 and 6000 at this point.

Okay. And then, at what point really does that become material? Because I think that is about 100% growth year-over-year. Is that right?

Offhand I don't know, but it must be something in that ballpark. We have not provided a forecast of patient growth internationally for a reason. That is because it would be too wide a range of outcomes at this point.

We have been very pleased with the growth. It has exceeded our expectations. And so I think we just have to stop there and keep on reporting it, but there is too much uncertainty right now, as you divide it across the 10 countries that we are operating in, to allow us to give you a high confidence forecast.

Okay. Can you talk a little bit about the growth in home dialysis? Are you guys still investing in that? Is there still opportunity in PD or HHD? Or is it kind of penetrated now with the bundle?

Home dialysis continues to grow and we think that trend will continue.

Okay. And then, one more from me. Can you give any update on kind of the dual eligible contracts that you have seen right now in California? Is it something that you have been kind of walking away from right now or still kind of in negotiations? When should we hear something about that? Thank you.

We are quite excited about dual strategically. And we have one contract buttoned up and signed and a few thousand lives already signed up. And at this point we would estimate, in that contract alone, we might very well end up with 10,000 or so.

In addition, we are still in discussions with a couple of other parties, but even with this one contract we are very excited that we are going to get an opportunity to develop new more muscles and demonstrate the power of some old ones. And so, so far that is playing itself out very, very nicely and hopefully going to lead to a lot of growth in the future.

Matthew Borsch, Goldman Sachs.

Thank you. Just wanted to ask on HCP, if you can talk at all about how your payer contracts have evolved, if at all. I imagine with all the changing reimbursement, is that a place where you have had intense negotiations over the last year? Or has it been sort of steady-state on that front?

Yes, there have been intense negotiations. And as we have said consistently, the portfolio of contracts will be amended over time. And in general, where we come from, is making them more and more partnership oriented with aligned upside and downside as opposed to confrontational upside, downside, or whatever is the opposite of aligned.

And some payers are very philosophically open to that. Others are not. And, in either case, there is intense negotiations as to what that means. So we made some nontrivial progress, but the portfolio will take a while to resolve itself.

And some parts will never be aligned, just like in kidney care when we stated that we wanted to move more towards bundled contracts in the private sector. We did so over five years, but still to this day are not to the point where every private contract is bundled.

And given some of the challenges that you had with HCP, has that made you think more or less about the possibility of offering HCP as its own plan, if you will, either on your own or in some form of partnership? Is that something that you have any changing interest in, in the last two years?

No. It hasn't changed our views on that at all, which is to say strategically we are open to being a plan if at any point that makes strategic sense. And if we have the right relationships and contracts with existing plans, that may never be necessary.

And there are no further questions on the phone at this time.

Okay. Thank you all for your interest in DaVita Healthcare Partners. And we will do our best for you over the next three months. Have a good day.

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