德維特 (DVA) 2003 Q3 法說會逐字稿

At this time I would like to welcome everyone to the DaVita third-quarter 2003 conference call. All lines have placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer period. (CALLER INSTRUCTIONS) Mr. Whitney, you may begin your conference.

Thank you and welcome, everyone, to our third-quarter conference call. We appreciate your continued interest in our company. I have with me today Kent Thiry, our Chairman and CEO, and LeAnne Zumwalt, our Vice President of Investor Relations. I'd like to start with our forward-looking disclosure statements. Certain statements included in today's presentation, as well as in our press release and related supplemental information dating November 3, 2003, are forward-looking statements. These forward-looking (technical difficulty) and we do not have any current intentions to update forward-looking statements, forecasts or guidance whether as a result of changes to underlying factors, new information, future events, or otherwise.

Additionally our press release and related disclosures include certain non-GAAP financial measures which we believe provide useful information to investors. These measures should be considered in addition to the results prepared in accordance with GAAP and should not be considered as a substitute or superior to GAAP results. Also included in the press release is a reconciliation of these non-GAAP measures to the most comparable GAAP financial measures. I will now turn the call over to Kent Thierry, our CEO.

Good morning and good afternoon. As you've already seen, we had a great quarter. Every now and then things work the way you want them to. Both our clinical outcomes and our financial performance were very strong and, while some of the drivers of the profit increase are unlikely to be sustained over the long-term, it was still a very strong quarter. We would like to answer three questions. Number one, what drove our strong incremental profit performance? Number two, how do the next several quarters look? And number three, how does the longer-term look? I'll come back to answer that question after Rich discusses the quarter in more detail.

First, question number one, what drove our strong incremental profit performance? There were five primary factors, two cost, two revenue, and one volume reflecting the broad-based performance of the quarter. On the cost side, number one was improved labor productivity and number two was lower G&A expense per treatment, straightforward but both big parts of the cost structure. On the revenue side, factors three and four were some recent private placing victories, and forth, some changes in pharmaceutical intensities, in particular related to improved anemia management for new patients in their first 90 days on dialysis. The fifth and final driver was simply higher treatment volume than what we had expected. So two cost drivers, two revenue drivers, and one volume.

Second question, how do the next several quarters look? At this point we are happy to say they look similarly strong, although we will probably experience our normal early year dip in margins in Q1 and Q2 of 2004. In general over the next few quarters we expect volume growth to offset the impact of margin compression. Specifically we expect Q4 2003 operating income will be comparable to the third-quarter, and for 2004 are we now targeting operating income to be between 360 and 385 million.

Before turning it over to Rich, there are two other specific areas that I would like to discuss, the first being clinical results and the second being a government update. With respect to our clinical results, we'll provide the same two scores that we have provided in the past. First, adequacy, which is essentially how well we're doing in removing toxins from peoples' blood. 93 percent of our patients had a Kt/V greater than 1.2 in the third-quarter, which demonstrates very strong relative performance to our own past as well as to other participants in the industry.

The second measure, anemia management, the percentage of our patients with hematocrits greater than or equal to 33 was 83 percent, consistent with our performance in the earlier quarters of this year. And once again, although it's difficult to be sure that you're applying apples-to-apples comparisons with other members of the industry, the numbers suggest that we compare very favorably.

As for the happenings in Washington, D.C., as you all already know, the congressional countries are still hammering away. The situation is so fluid day-to-day that in my mind there is no value in handicapping the ultimate outcome, at least not by us. Suffice it to say that we continue to lose money on Medicare patients, but we don't like having to close centers when there are not enough private patients to subsidize the inadequate government reimbursement, and that we are worried about some of the structural reimbursement changes they are considering. In the meantime, we hope we get a rate increase, in particular if they give one to hospitals. Rich will now take you through more detail regarding the quarters financial results.

Thanks, Kent. As Kent mentioned, we had a very strong quarter financially. I'd like to start with a few key points about Q3 performance. And please note that these numbers exclude refinancing costs as well as income from lab recoveries. Q3 operating income or OI was 95 million, up 15 percent versus the prior year quarter. Year-to-date OI is 257 million, up 8 percent. Q3 net earnings were 48.5 million, up 29 percent versus the prior year quarter. And year-to-date net earnings were 123 million, up 11 percent versus the prior year.

Q3 diluted EPS was 67 cents, up 29 percent versus the prior year quarter, and year-to-date diluted EPS was $1.74, up 30 percent on 17 percent lower average shares. As for our cash flow, our rolling 12 month operating cash flow was 300 million and rolling 12 month free cash flow was 254 million. For the quarter, operating cash flow was 100 million and maintenance CAP expenditures were 10 million, resulting in free cash flow of 90 million. One note on expected Q4 cash flow. As has been the case in prior years, operating cash flow is expected to be down sequentially in Q4 due to the timing of inventory purchases, tax payments, and other working capital items.

Here are some other highlights for the quarter. Again, please note that all of the year-over-year comparisons exclude the income from prior period lab recoveries. Starting with volume, total treatment growth was 7.1 percent in the quarter. Our not acquired treatment growth rate was 3.8 percent, up slightly from the last few quarters and in line with our 3 to 4 percent guidance. Acquisitions contributed to a 3.3 percent balance.

Next, revenue. Dialysis revenue was up about 12.5 percent versus the prior year quarter with approximately 7 percent of that being driven by volume and the balance by about a 5 percent increase in revenue per treatment. Revenue per treatment growth was driven by a number of items including improved pricing and contracting on the private side, pharmaceutical intensities, payer mix, and billing and collection improvements. Generally the private pricing environment has remained solid, but it is our continued expectation that pricing is likely to be much tougher in the next few years than it has been in the past few. Near-term we have a handful of contract negotiations that we expect to result in rate reductions, and one large contract where an increase becomes effective January 1st.

On to expenses. As far as operating expenses per treatment, they were up 5.3 percent or about $11 versus the prior year quarter. A few details on those expenses. First, labor. Overall labor cost per treatment was down 1.5 percent sequentially and up about 2 percent year-over-year. Productivity in the third quarter was by far our best performance in recent years, and going forward we expect normal labor rate pressures as well as some deterioration in our productivity number, primarily related to de novo openings and importantly the fact that Q3 productivity is typically seasonally strong.

Pharmaceutical expense was up 8 percent per treatment year-over-year, primarily related to the increased intensities and pharmaceutical pricing. Higher insurance costs and de novo center openings also contributed to the expense growth year-over-year. As far as general and administrative expenses, they were down $2.00 per treatment sequentially, reflecting the timing of certain expenses. Depreciation and amortization increased by 11 percent per treatment versus the prior year quarter, reflecting our investments in new centers and the depreciation of our previous IT spending initiatives. We've discussed that IT spending over the previous several quarters.

DSO was 65 days for the quarter, down one day sequentially and down five days year-to-date. As of October 31st, we've converted approximately 400 facilities onto our new billing system. It is generally going as planned but, until it is fully implemented, we will remain a bit nervous about the potential for profit leakage and DSO increases. Regarding our capital structure, during the quarter we called the 5 5/8 convertible notes that converted into approximately 4.9 million shares of common stock on July 15th. Also on July 15th we refinanced our senior credit facilities, resulting in lower interest rates and an increase in borrowings of 200 million. We used those proceeds to redeem a portion of the 7 percent convertible notes and, on October 14th, we completed the redemption of the remaining $145 million 7 percent notes with cash on hand and the issuance of 16,000 shares of stock.

Net debt at the end of the quarter was just under 1.1 billion and our quarter end net leverage ratio, calculated on a lightest quarter annualized basis was about 2.3 times. As for fixed versus floating interest rates, our percentage of fixed-rate debt has historically been in the 40 to 60 percent range. Recent transactions have eliminated all of our fixed-rate debt. As a result, subsequent to quarter end we entered into swap arrangements that have the effect of fixing rates on approximately 13 percent of our outstanding debt for various periods of time. Pro forma for these swaps, our current weighted average interest rate is 3.87 percent, up 26 basis points from the end of Q3 levels. As we stated last quarter, it is likely that we will continue to migrate back towards a 40 to 60 percent fixed-rate percentage over time.

Turning to growth, we acquired three centers in the quarter, bringing our total for the nine months to 14 centers acquired, with approximately 1150 patients served. Our current full year expectation is for acquisitions totaling approximately 1500 patients served. We continue to target treatment growth from acquisitions of 2 to 4 percent per year on average during the 2003 to 2005 period with 2003 likely coming in at the higher end of that range. During the quarter we closed two underperforming centers. One closure was because we no longer had enough private pay patients in the center to subsidize the government patients and the reimbursement shortfall on those patients.

As for de novos, we opened seven new centers in Q3 bringing the year-to-date total to 22 new centers. We expect to open an additional three to six centers during the balance of the year for a total of 25 to 28. For comparative purposes, we opened 19 centers in all of 2002.

Now, turning to outlook. One might ask the question why is Q3 annualized OI at the high-end of your 2004 target? Well, there's four factors. Factor number one is volume. Q3 has a higher than average number of treatment days, just the way the calendar falls, and that equates to about $1 million of OI in Q3. Factor number two, we do not expect to maintain our record Q3 labor productivity which, as I mentioned, is at least partly driven by seasonality. That equals about 1 to 2 million per quarter. Factor number three, Q3 G&A spending was lower this quarter due to the timing of certain expenses, that equals about 2 to 3 million. And factor number four, our 2004 target includes known Medicaid cuts including the California Medicaid cut that begins on January 1. That equals about 2 million per quarter. So the total of these four items is about $6 to $8 million per quarter.

So going forward, as Kent mentioned, our outlook for the next several quarters is for OI to be similarly strong compared to Q3 levels, and as a result we are currently targeting our 2004 OI to be between 360 and 385 million, which is approximately 3 to 9 percent higher than expected 2003 levels. Our operating cash flow target is approximately 275 to 315 million, and while we have not finalized our capital budgets for 2004 at this time, we expect maintenance spending to be in the $40 to $50 million range and new center development and expansion spending to be similar to 2003's spend levels in the range of $40 to $50 million. This latter number, of course, depends upon the number of new centers opened during the year. I would now like to turn it back to Kent for a few closing remarks before Q&A.

Okay. I'll try to provide a reasonable summary of the current situation and the big issues that you need to weigh in evaluating our valuation now and over the longer term. Number one, it was a great quarter. Number two, the next few quarters look similarly strong plus or minus a bit. Number three, as to next year specifically, 'A', some margin compression is likely. 'B', nevertheless we're targeting some growth in operating income over 2003, as you heard. Number four, in the longer term, I would make two simple points. 'A', you simply have to discount future profit expectations because of government policy, pharmacy, and private payer risk. There is more downside than upside in these externalities. 'B', on the other end, we have to value very highly the strength and stability of our free cash flows, the steady unit growth inherent in the industry, and even more significantly in our portfolio, and lastly the good chances of some government reimbursement increases.

For more on these and other issues, we invite all of you to join us at our capital markets day, our annual capital markets day, on December 10th in New York City. Thank you very much, and, operator, if you could help us by leading us into Q&A, I'd appreciate it.

(CALLER INSTRUCTIONS) Bill Bonello of Wachovia Securities.

Just a couple of questions. Were the Q3 topline results at all impacted by physician attrition, or has the impact of that attrition completely annualized?

In Q3 there's very little related to physician attrition. It would've annualized mostly in the previous quarter.

Okay. Any thoughts on why your same market growth or non acquisition growth might be what appears to be a little bit below what the industry is growing from a volume standpoint and what the outlook for that would be going forward?

Bill, could you say the question again, please?

It seems like the industry is growing volume at about 5 percent or so from a treatment standpoint, and has for awhile. And I'm just curious, 'A', if you agree with that? And if you do, why your volume growth is a little bit lower than that and what the potential for getting to industry levels would be?

I can't comment directly on analytically how they calculate their numbers and what they throw into that category. And then, the answer to the question, if there's is higher than ours, it's a reflection of one of two things. I guess one of three. There's either a difference in the inherent growth rate in the markets we're in, our portfolio of markets versus theirs. 'B', there's a difference in the growth characteristics of the portfolio of physician practices that they're affiliated with versus ours. Or three, that they're just better at it than we are and we haven't caught up yet. And I can't opine with any analytical justification about what the mix is between those three answers.

Let me ask it a different way. Does 3 to 4 percent seem like a reasonable expectation for volume growth going forward, or would it be higher or lower than that?

I think it's best to keep it in that range.

Another thing to note, Bill, is that all the other companies weighted average same center growth reported for the first six months was about 3.9 percent. That's us, RCG, Gambro, Fresenius. So I think you have seen a slowdown of all the companies over the course of the last 12 to 18 months.

Great. And then, just your '04 guidance, does that assume some insignificant attrition of patients from the contracts that you renegotiated positively, where you've given up some exclusivity?

I'll make two points. First, our issue with our physician contract portfolio, as we've said consistently, is a recurring issue, which is to say every year we have some renewals come up where we're at a structural disadvantage with respect to the contract terms. So that issue doesn't go away. It just pops up in little bunches every now and then. And then second, we did assume some patient losses tied to some of the renegotiated contracts.

Okay, great. Thank you.

John Ransom of Raymond James.

Good morning. A big picture question and a little nit. What will your big share count be for the fourth quarter?

Did you say base share count?

Beginning fully diluted share count. Just trying to get a sense of the timing of the repos during the quarter.

It looks like about 65 million.

Okay, and --.

That would be the basic accounts, you want the fully diluted accounts? (multiple speakers) for the quarter it was 76.5.

Okay, so is that 65 million basic or is that 65 (indiscernible)?

John, we can't hear you.

Is it 65 basic or fully diluted?

65 is basic.

Okay. And what's a good rate -- interest expense and fully diluted share count for the fourth quarter, do you have a sense for what that will be?

I'm sorry, you have to repeat the question.

I'll call back in, thanks.

Chuck Roth (ph) of Insight Investment.

Can you talk at all about some of the revenue assumptions you've got -- when you give us the '04 operating profit growth range, can you tell us what private pay rates assumption you have in there, Medicaid, Medicare? Are you expecting growth there and if so how much?

There's literally tens of components, as you can imagine, underlining our revenue forecast for next year. I'll give you some color. We certainly are counting the known Medicaid cuts, which I mentioned earlier. We do have some contracts that we expect to take some price decreases on. We're counting that. We do have a major contract that has a price increase on January 1. We are counting that. And as Ken mentioned, we assumed some reduction in patients in that contract. But that's a big wild-card in estimating it with the contribution of that contract is how many of those patients we actually keep. And then you have private pricing. We are assuming that we will get some private pricing increases next year; although, as we mentioned, we anticipate the overall environment to get more difficult. And I'd say those are probably the major drivers.

And what are you assuming for Medicare?

We're assuming no increase in Medicare at this point in time. Although I think, based upon an assessment of the probabilities of all these things, it's really hard to pick out one particular item and say no Medicare rate increase, so if it increases you've got to add it on, but it is a mix of really tens of things.

Can you talk at all about the acquisition environment out there, whether it's more fertile, less fertile, and just generally how you view that?

Well, we've picked up some traction near-term compared to what we did last year. The pricing environment continues to appear to be rational. And I think we're still comfortable with our 2 to 4 percent ranges being a realistic range. We're getting better at it and more competitive at it and the same time there is a limited number of acquisitions remaining in the marketplace, it is highly consolidated.

Okay. Lastly, this year you've carried quite a bit of cash. Obviously you're earning less on it than your debt. Even now, after redeeming the last of the sevens, you've got over 100 million in cash. Is that something we should expect to continue to see, and also can you comment on why you've done that so far this year?

We have not decided yet how much cash we're going to hold through the course of 2004. And when we to hold cash, it's either because we want to have the strategic flexibility with respect to the business in case a good use of it comes up; or secondarily, we're just not sure situationally what the best alternative is between the generic high-level choices or paying down debt, giving the money back to shareholders, or investing it in the business. So we haven't yet decided on the level, but it could continue to be substantial for some time.

Why would you do that rather than having a credit line so if you do have a need for cash you can you've got the flexibility? You do have a credit line.

(multiple speakers) what kind of credit lines and/or revolvers to have simultaneous to a cash balance either instead of or in addition to. So that's always a part of the mix of what we think of. There's clearly differences in flexibility, but that is always part of the mix.

Okay, I'll let someone else go.

Andrea Bici of Schroder Investments.

Just a quick question. When you're saying that you think managed care pricing may be mitigated -- may be becoming more difficult, have you evaluated or begun to evaluate the impact on the industry consolidation that has been announced with some major managed care providers? And can you speak to perhaps your exposure to the WellPoint/Anthem transaction or the United/MAMSI transaction?

We've got this in L.A. and the first part of your question just didn't come through, so (indiscernible) please.

Sure, just the impact that you've seen on pricing just in your history in the dialysis industry, when there's a lot of managed care consolidation like we saw announced last week and maybe give us some color on your exposure to --?

The short answer is consolidation is bad for providers and the market share of folks like Anthem and WellPoint is already pretty big. In many cases some of these consolidations, when they involve payers who do not have much market overlap, it doesn't necessarily dramatically change anything right away, because most contracts are done on a more localized or state-level. But consolidation is bad for providers. When the payers are more consolidated than the providers, that is a bad thing. And of course for us since all of our profit comes from the private sector, we don't like to see that happening. Did I answer every part of the question?

You did, but how do you feel your exposure is to any of the specific transactions? Do you --?

There's no way to -- there's not a good way to sort of put a number on it, and especially with something like Anthem/WellPoint where it cuts across so many different markets, and United/MAMSI, what that does in the market where MAMSI was strong, it does create more pricing pressure on us. Offhand I don't know what percent of our revenue comes from the MAMSI marketplace, what percent of our private revenue. It's not very large, I know that. As part of our annual forecast every year, there is it bottoms up forecast by all our major payers as to what we think we're going to get paid, and then to the extent that's changed by a transaction, it's immediately changed in the bottoms up forecast.

Are you at liberty to say if you had already renegotiated your '04 rates for any of the four companies that are involved in these mergers, or not?

What I would say generically is we probably have agreements in place for the most part with most parts of all four, but a lot of our contracts have 90 day mutual outs. And so it's not like there's two-year contract or anything like that. So the bulk of that business would be up for renegotiation through the course of 2004 if either party wanted to do so.

Thanks very much.

Andrew May of Jeffries & Co.

A couple things. By the end of next year clearly your leverage ratios will be substantially less leveraged than the kind of three times EBITDA sort of target that you've discussed. There are obviously several levers you can pull to bring those back toward three times or perhaps you want to change them. Do you have any commentary on your capital structure plans for the next four or five quarters?

Andy, not specifically. I think we would say the same things that, you're probably getting sick of hearing, we've been saying for four years now, which is we have a target range for capital structure but there could be significant periods of time when we'll be below that range or above that range and it really depends upon the situation. As it relates to the next four quarters, I think Kent's answer is really the way to think about it which is we haven't made decisions about how much cash we'll hold or how we might allocate that cash. But we certainly will report on those as we make those decisions or as it becomes more clear.

A couple more things. Could you give us an update on previously announced investigation and give us the level of spending that is causing you to undertake as a run rate right now? And secondly, I wonder if you'd talk about your disease management acquisition that you announced over the summer, give us a hint about the strategy for that small acquisition and your attitude toward the upcoming Medicare demonstration projects.

Let me dive into that portfolio of questions and see if we can cover each. Number one, with respect to the demos, we have decided not to submit anything on the bundling proposal. And with respect to the global cap, we have decided to discuss whether or not we would do a demo with the government. So in one case we actually are in discussions. We'll see what happens, and in the other, we are not. With respect to the disease management acquisition, it is on track and we remain very happy owners of that enterprise. We repeat that we don't expect it to have any material impact on our profitability one way or another over the next year or two, but we think over the next four, five, seven, eight years it will become a very important part of our strategic positioning. On -- what was the --?

Give us the spend on legal.

First with respect to investigation, and then Rich can handle the spend which is large. The investigations, there's been nothing significant that happened. Very few conversations of any type with respect to the Department of Justice and the process they launched a long time ago at this point. And then finally, on the spending, Rich, do you have a number here?

Yes, I think the best way to think about -- we don't have a specific number. The best way to think about it is millions of dollars, and the spending and management time and attention is also variable quarter by quarter, as you can imagine. But it is still costing us a bunch and taking a bunch of time and share of mind.

Good, thank you very much.

John Ransom of Raymond James.

For the fourth quarter, what should we be thinking about in terms of fully diluted share count and interest expense, just trying to work through all of your capital structure adjustments?

Okay, on the fully diluted share count, in the area of 68 million.

Okay, and interest expense?

I'll get back to you on that. I don't have it at my fingertips.

Does 13.5 million sound outrageous there?

No, but what I'll do is in answering the next question, I'll give it to you.

And secondly, as we look to '04, kind of the bigger picture question was 90 days ago operating income was going to be flat in '04. Now it's up some $40 million at the midpoint, $45 million. What changed?

We had a really good quarter. In the two cost areas, the two revenue areas and volume, everything went right. It doesn't happen very often, but it is happening right now.

Okay. And looking at your cost area, do you expect any material change for '04 relative to EPO price increases; any comment there?

As usual, we do not think it is in anybody's interest for us to discuss EPO negotiations, specifically. We are in discussions right now for renewal of our contract, which expires at the end of this year, and that is all we really want to say about it. Also, on the question of interest expense, it will actually be a fair bit higher in Q4 because, remember, we still have the 7 percent notes outstanding, and so a better number for Q4 would be in the $18 million dollar range. Of course, it depends upon the movement of rates. And then down after that to more of the range that you were talking about.

Okay, so just a timing thing.

Yes.

Okay, thank you.

Matt Ripperger of J.P. Morgan.

Just a couple questions. First of all, can you give us some color in terms of how the vascular active clinics are hitting the P&L and how those 12 clinics are performing year-to-date?

Yes, I think what we would say since we don't typically discuss individual business unit performance, I think what we would say that it is on plan, what was assumed when we bought the businesses. And then in terms of how it is hitting the P&L, right now it is just recorded as one line item, other income.

Okay, so it's not hitting the patient volume or treatment amount for patients?

No.

And do you still have just 12 clinics in vascular access?

I believe it is either 12 or 13, yes.

Second question, can you just give a little more color about the acquisition you announced in late October of the five facilities and 250 patients? Specifically, can you give a sense of multiple range or anything like that at this point?

I think they are kind of your standard transaction that you should anticipate seeing us do, which each transaction tends to be small. We tend to focus on markets where we're building on an existing market position or centers that have a good market position already, and the multiple range that we had talked about in the past of four to six times, I think is still very much the relevant range to be thinking about pricing in this market.

Okay, great. And then the last question I had, realizing you don't want to give any firm specific guidance about EPO pricing, but in terms of the guidance range that you've provided for next year, have you assumed any change in EPO pricing in that?

Once again, I think discussing the line item aspects of our forecasts on that will is probably not a good idea.

Okay.

We've incorporated into our forecast our best thinking on where that outcome will likely be.

Okay, thanks very much.

Michael Sansky (ph) of Tudor Investments (ph).

Matt just asked my question which I guess you're not going to discuss. Actually, can I ask another question? Kent, you talked about four or five factors that created the productivity in the out performance this quarter. Which ones of those do you feel are not sustainable or sustainable? It looks to me like the labor productivity, the G&A and the private pricing look sustainable.

Rich went down the list of four specific areas where Q3 was a little unusual. One was treatment volume, just because the number of treatment days. Two was productivity, which is in part driven by seasonality. In the third quarter you have a lot of voluntary vacations which tends to, whether you like it or not, force higher productivity. Number three, the G&A spending, which was unusually low just because of the timing of certain expenditures that we make, and it used to be 10 years ago that you would, for certain annual (indiscernible) expenses, even if they happened in one quarter, you would spread them out across the four quarters because they happened once a year every year.

It's no longer how the accounting profession prefers to deal with them, so it necessarily creates more volatility in the quarter-by-quarter earnings, and Q3 was low because we had less of those and, again, in part that's because of everybody being vacation so much, you do a lot fewer of the travel expense intensive, overtime expense intensive type of activities. So -- and then the fourth area he mentioned which you didn't refer was the specific Medicaid cuts.

The other item you brought up, so those are four specific ways in which Q3 was either unusual or we know that some future quarters will be different. On the private side, that's always a tough one to call. We have 1000 relationships out there and we engage in battle on a reasonable percentage of them, 20 percent or so every year. And we win some and we lose some. And it's always tough to know, and they don't exactly know today exactly what posture they're going to take because it depends on what kind of premium increases they're getting, what they're getting from Medicare, what they expect to happen in their business mix, what they think of the Anthem/WellPoint merger, etc.

So the private stuff is hard to know quarter-to-quarter what's going to happen. It's impossible to know and then what you do is you make sort of a weighted average prediction on the portfolio.

Okay, thank you.

Blake Goodner of Bridger Capital.

Two quick questions. Kent, I was wondering if you could perhaps address the EPO utilization review that CMS is undertaking. I know a couple years ago this was a big question with the FITs and how they would react, and I think there's a plan to put out some new guidance early next year. Could you maybe just talk a little bit about that situation as it's unfolding?

Yes. It's a big deal. It's pretty impossible at this point to make any predictions about how it will come out. The -- CMS spends a lot of money on EPO and wants to see if the guidelines for its use should be amended because of a lot of new clinical evidence that's accumulated, most of which points towards -- from many doctors' perspectives -- points towards the fact that there should be more EPO used, not less. So, that gets pretty expensive to contemplate. In addition, just the mechanics of how the government has handled this has turned out to be very problematic for the fiscal intermediaries they use for paying us. And so they have a strong desire, separate from anything that's done with utilization guidelines, to try to change the mechanics to something that's easier for them to administer.

This could be a pretty healthy process because the industry is working more collectively and coherently in trying to be a good dancing partner in this process than it perhaps has at anytime in the past. And so I think everybody is entering into it with reasonably good intentions about coming up with a sensible answer mechanically and clinically, while at the same acknowledging the fact that it's a lot of money involved. To go further than that and actually predict whether there'll be -- we'll be able to use more EPO without fear of being unreimbursed as long as we can demonstrate continued improved outcomes and the value to the taxpayer and the patient for that would be inappropriate to predict that.

Similarly, I think it would be inappropriate to predict that they're going to come and try to restrict and reduce current EPO use because even if there are not Class A clinical research studies proving incontrovertibly that every ounce that's used, every unit that's used is directly beneficial, there's a tremendous amount of circumstantial and community evidence to support it in patient support.

So this is a big, tough issue clinically, economically, and mechanically. And right now all they've said is hey guys, we want to sit back and think about whether or not we're doing this right and whether you're doing it right. And so, as the months go by we'll see how the process begins to unfold. Is that responsive? It's a big monster with a lot of pieces to it. And so far it feels like everybody is submitting their data and listening and talking and no one is prejudging.

That's helpful. We'll just have to monitor that. And I guess my second question, I was wondering if maybe you could comment on the progress you guys are making with the medical directors? Again, if I look back over the last couple quarters, about a year ago that sort of tripped you up a little bit. And it seems like we're annualizing some of those issues, some of those losses. Just wondering, a year ago at the analyst meeting you talked a little bit about -- I think you said there were something like 25 medical director contracts that were coming up in '03, and you sort of said some were high-risk, some were middle risk, and then there was low-risk. How has that played out relative to your expectations and what does that situation look like going into '04?

With respect to how we've done compared what we said a year ago, we're right on plan. And with respect to how we did in the prior year compared to what we said, we're pretty much right on plan or a bit ahead in that year. At this year's capital markets day, we'll provide another update, a more analytical update reemphasizing what I just said in laying out a little bit more data for helping people think about the next one or two years to come.

It's impossible to predict of course with total certainty because every year we've some tougher negotiations, and if we win them all that means we'll do a little better than we planned, and if we lose the planned amount then it happens and it shows up in our numbers, but the good news is it was a blip that was expected. And if we ever lose more than we thought, then you'll be very unhappy with us. So we are on plan versus what we said a year ago and we'll give a more analytical update on December 10th.

Sounds great, thanks.

Andrew May of Jefferies & Co.

If you'd rather do this off-line I'll do it. But you said interest expense net Q4 18 million plus. That's 2 million up sequentially from the third quarter. It was different from the way our arithmetic was coming out and I was just curious how interest expense moves up from Q3?

It's funny, Andy. Somebody just handed me a note right before you came on that said that I wasn't sufficiently clear in my answer. The 18 million is unusually high because of the sevens. There's two components. One is the 7 percent notes are still out as we still have (ph) the interest on them, but also included in that 18 million is the debt redemption premium that we incurred through taking them out, so that would be why it would be striking you as unusually high.

The premium is in that number as interest expense as an expense in the quarter?

Yes, and if you wanted to walk through it, (multiple speakers).

Fine, I won't try to take anybody else's time. Thanks.

Andreas Dirnagl of Harris Nesbitt.

Three different questions. First of all, Rich, can you just sort of refresh my memory as to what the component of, for lack of a better term, other revenue is? In other words, the difference between total revenue and what you would get just multiplying your number of treatments by average revenue per treatment?

Sure, it's a number of categories including income from our laboratory, management fees from obviously management arrangements, and then a bunch of miscellaneous other stuff, although the miscellaneous is a small piece of it. It's primarily lab and management fees. You'd also see the impact of the new disease management organization in that area as well.

That's what I was thinking. Then without handicapping or -- Kent has already said that he was unwilling to handicap the possibility of the composite rate increase and the Medicare secondary payer extension going through. Can you provide some idea as if they were to go through what a 1.6 percent composite rate increase and a six-month extension could potentially do to your numbers next year?

The 1.6 percent on Medicare would be between $8 to $10 million annually, in that ballpark. And on the MFP extension, we don't think it's a good idea to speculate. It depends on how exactly they kick it in, how they would start it, and then of course how my patients make it beyond 30 months. So it would be a positive, but we're not going to start throwing around speculative numbers.

And the 8 to 10 million, is that pre or after-tax?

Pre.

Pretax. And finally, Kent, is there any update just sort of on how the search for Rich's replacement is going and whether there's sort of timing as to, Rich, how long you're going to be around still?

As to how the search is going, we've retained a search firms and they are generating candidates, so it's basically on schedule. But we're in no hurry because Rich is still here helping us. Rich, do you want to add anything to alleviate any fear of his part?

No, just that I've committed to stick around until we find a suitable replacement.

Great, thanks a lot.

At this time there are no further questions.

Okay. Well, thank you all very much for your interest and for your questions. I appreciate it. I hope to see many of you on December 10th in New York.

This concludes today's conference call. You may now disconnect.