德維特 (DVA) 2003 Q4 法說會逐字稿

Good afternoon, my name is Renee and I will be your conference facilitator. At this time I would like to welcome everyone to the DaVita fourth-quarter 2003 conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks there will be a question-and-answer period. [Operator Instructions] Thank you, Mr. Whitney, you may begin.

Thank you, Renee, and welcome everyone to our fourth-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 statement.

Certain statements included in today's presentation as well as in our press release and related supplemental information dated February 11th, 2004, are forward-looking statements. These forward-looking statements are based upon information available to us at this time and we do not have any current intentions to update these forward looking statements, forecast, or guidance whether as a result of changes, underlying factors, new information, future events or otherwise.

Additionally, our press release and related disclosures includes 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 Thiry, our CEO.

Good morning or Good afternoon. As we've already seen, we had another strong quarter which wrapped up a strong year -- clinically, economically, and in terms of treatment growth. Our 2003 clinical outcome was the best ever in the history of this enterprise -- exceeding our 2002 performance which had also been up to that point the best care ever.

In addition to 2003 being the best year ever, the fourth-quarter was the best quarter within that year. Again, we feel it's important for shareholders to know that we are first and foremost a caregiving enterprise. Our operating income was $97 million -- up a couple of million or so from Q3. And our treatment growth has continued to accelerate and reached a total of 8.5 percent in the quarter.

Before I turn the call over to Rich for some detail I will comment on three areas.

Elaborate on the clinical side, reiterate our outlook for '04, and talk about recent lab developments.

First on the clinical side we will provide the same scores we have in the past. First -- adequacy which is essentially how well we're doing in the (indiscernible) constant from people's blood. 93 percent of our patients had a [indiscernible] greater than 1.2 in the quarter which demonstrates a very strong relative performance to our own past as well as to other industry participants.

The second measure -- anemia management. The percentage of our patients with (indiscernible) greater than or equal to 33 was 85 percent. Once again although one always has to worry about whether or not you're doing apples to apples comparisons in a very specific way, these numbers suggest that we compare very favorably to the rest of the American dialysis industry.

As to our target for '04, our operating income target, it remains $360-$385 million. While at this time we're not changing our 2004 target we are entering the year with very solid momentum. As a result, the likelihood that our performance will end up at the higher end of this range or perhaps even exceed it is greater than the probability that we would be at the lower end or fall short of that range.

Third -- what about these Medicare lab recoveries? Well, more good news. We recently heard from the carrier both in writing and verbally and this good news from an accounting perspective translated into $24 million in Q4 revenue recoveries from prior periods. From a cash perspective we've already received 5 million of the 24 and eagerly anticipate the remaining 19.

Finally, as you know, Rich Whitney's planned departure was announced in September and Rich has just transitioned into a consulting role with Gary Beil -- our Vice President and Controller -- who started here at the same time I did, was one of our -- my first new hires, has been an interim CFO as the search continues. Most importantly, however, Rich will continue to consult on a full-time basis. On to Rich.

Thanks, Kent. As Kent mentioned we had another strong quarter financially. I'd like to start with a few key points about the fourth-quarter performance. Please note that these numbers exclude refinancing costs as well as the income from lab recoveries.

Q4 operating income or OI was 97 million up 27 percent versus the prior year quarter. For the year OI was 355 million up 10 percent.

Q4 net earnings were 53.9 million and diluted EPS was 79 cents. However after the normalizing for the quarter's tax rate of 39 percent, diluted EPS was 77 cents. I will comment more on our tax rate in a few minutes.

Fully diluted EPS -- again, adjusted for the tax rate -- was up 57 percent over the prior your quarter. For the year net earnings were 177.3 million up 17 percent versus the prior year and diluted EPS was up $2.51 up 33 percent on 16 percent lower average shares.

As for cash flow, our rolling twelve-month operating cash flow was 294 million and our rolling twelve-month free cash flow was 249 million. For the quarter, operating cash flow was 35 million and maintenance CapEx was 15 million, resulting in free cash flow of about 20 million.

Operating cash flow was down sequentially as expected due to delays in certain cash collections, year-end inventory purchases, tax payments and other working capital items. These items are all timing related. The prior year's Q4 cash flow for comparison was 41 million, excluding lab recoveries, and was similarly impacted by the timing of working capital items.

Here are some other highlights for the quarter. Again all of the year-over-year comparisons exclude refinancing costs and income from prior periods' lab recoveries. Starting with volume total treatment growth per day was 8.5 percent versus the prior year quarter -- our best performance in four years. Our non acquired treatment growth rate was 4.3 percent up from the last few quarters. And acquisitions contributed to the 4Q (ph) percent balance.

Next is revenue. Dialysis revenue was up about 14 percent versus the prior year quarter driven by the volume growth and a 5 percent increase in revenue for treatment. This year's growth in revenue for treatment was principally driven by improved pricing and contracting on private side and intensities of physician prescribed pharmaceuticals.

It's our continued expectation that private pricing is likely to be tougher in the next few years than it has been in the past few.

On to expenses. Operating margins were 18.4 percent for the quarter, down 10 basis points from last quarter. Dialysis facility cost per treatment were up about 1 percent sequentially and 4.8 percent or about $10 per treatment versus the prior year quarter.

As for some specific operating expenses. First, labor. Overall labor cost per treatment was up .6 percent sequentially and up 1.8 percent year-over-year. Productivity remains strong in the quarter and has helped offset labor rate pressures this year.

Going forward, we expect some normal labor rate pressures as well as deterioration a bit in productivity. Pharmaceutical expense per treatment was up .6 percent, sequentially, and 9.7 percent year-over-year -- primarily related to the increased intensities and also higher pricing for certain pharmaceuticals. Higher insurance costs and de novo (ph) center openings also contributed to our expense growth year-over-year.

As far as general and administrative expenses they were down slightly for treatment sequentially and down 10 percent over the prior year quarter. You should continue to expect G&A expenses to fluctuate from quarter to quarter, reflecting the timing of certain expenses.

Depreciation and amortization increased by nine percent for treatment versus the prior year quarter reflecting our investments in new centers and the depreciation of our previous IT spending initiatives.

Tax rate. Tax rate for the full year is 39 percent. Reduction of (indiscernible) .9 percent from the September year-to-date rate, reflecting equalization of previously unrecognized tax losses and the achievement of lower state taxes. The lower full year tax break resulted in a 37.5 percent effective tax rate for the fourth-quarter. Now our near-term forward expectation is an effective tax rate of approximately 39 percent. And, therefore, from a run rate perspective Q4 EPS is 79 cents should be normalized to 77 cents to adjust 4th the lower tax rate in the quarter.

DSOs was 69 days for the quarter, up four days sequentially and up 1 day from the end of 2002. Two factors contributed about equally to the four-day increase this quarter. First the implementation of our billing system. We brought on about half of our centers in the fourth-quarter and as expected there were some delays in billing, related to the conversion.

Second. Growth. We opened and acquired a total of 19 new centers in the quarter and 57 for the year and we are experiencing the normal billing delays, related to establishing these new centers. Specifically related to the transfer of the ownership of provider numbers and licensure delays.

While we have now implemented the new billing systems in all of own centers the work is not done and we continue to expect some difficulties and delays in billing. As a result, as we have said since the beginning of the system implementation six quarters ago, we continue to expect DSO to fluctuate several days at least for the next several quarters as we work to finetune the new system and the related operating processes.

Regarding our capital structure, during the quarter, we completed the redemption of the remaining 145 million of 7 percent notes with cash on hand and the issuance of 16,000 shares of stock. We also once again refinanced the senior credit facility, resulting in an immediate rate improvement of 25 basis points with a further reduction of 25 basis points which we affected towards the end of Q1 '04 as a result of our achieving certain financial performance targets in this quarter.

Net debt at the end of the quarter was 1.1 billion and at quarter end net leverage ratio calculated on our latest quarter annualized basis was about 2.3 times. At this time our senior credit facility represents virtually all of our outstanding debt. The pro forma for the further reduction in LIBOR margin and for interest rate hedging transactions that we have already executed our weighted average all in weight for the credit facility 3.74 percent.

Of course this rate is subject to fluctuations and LIBOR rates and changes in our debt levels and the impact of any further hedging transactions that we may enter into.

At this time, we have entered into some swap arrangements that have the effect of fixing LIBOR rates on approximately 25 percent of our outstanding debt for various periods of time. For these swaps our current weighted average LIBOR rate is fixed at 3.24 percent for an all in rate of about 5 1/4 percent. As we stated previously we have historically targeted 40 to 60 percent fixed-rate debt as a percentage of total debt. Therefore it is likely that we will continue to migrate back towards a 40 to 60 percent fixed-rate percentage over time. Of course depending on market conditions and other factors.

Turning to growth, in the quarter we acquired 11 centers bringing our total for the year to 27 centers with approximately 2,000 patients served. We continue to target treatment growth from acquisitions of 2-4 percent per year on average for the next few years. As for de novos we opened eight new centers in Q4, bringing the total for the year to 30 new centers.

Now turning to outlook. As Kent mentioned, we are currently targeting our 2004 OI to be between 360 and 385 million. Please note that performance is not typically uniform throughout the year, due to the timing of certain expenses and the lower number of treatment days in Q1. Our operating cash flow target is approximately 290-325 million. We expect maintenance spending to be in $40-$50 million range, yielding free cash flow of 240-275 million. We expect new center development and expansion spending to be similar to 2003 spending levels in the range of 40 to 50 million.

As a reminder the major components of our three-year outlook are volume growth of 5-9 1/2 percent, revenue for treatment increases of .5 percent to 2 percent, expense for treatment increases of 1.5 percent to 3.5 percent and overall OI growth of 3-8 percent. These ranges represent our targeted three-year averages.

I would now like to turn it back to Kent for a few closing remarks before Q&A.

As usual, we will attempt a reasonable summary of our situation to facilitate your reflecting on our evaluations with your partners or clients or family. First the long-term, then the near-term.

As to the longer-term, you simply have to apply some sort of discount to future profit expectations because of the risks and uncertainties surrounding government policy, pharmacy dynamics and private payor risks. Netting it all out I think there is typically more downside than upside in these externalities as you look out into the long-term.

On the other hand, we have five very tangible and significant positives to reflect on as you look a few years out. Number one is our differentiated clinical outcomes becoming ever more so. Two. The strength and stability of our free cash flows. Three. A steady unit growth, inherent in the industry. Four. Our particular additional growth from acquisitions and [indiscernible] in de novos -- and de novos, excuse me, and five, a good chance government reimbursement increases from time to time and maybe an annual update.

That's longer-term. And as for the short-term 2004 looks very solid. Operator, Q&A, please.

[Operator Instructions].

Darren LaReche (ph) Piper Jaffray.

Just a couple of things here. Wonder if you can just comment a little bit further on the cost side -- I guess your cost per treatment was up about 5 percent pretty consistent with the last few quarters, below the trendline you're guiding to over the next several years. Guess the question is, what's going to moderate on the cost side for you? And if you can also comment specifically on the practice pattern changes that you saw with regard to the intensity on the pharma side just so we can understand what that might look like throughout '04 and I have one other thing after that? Thanks.

I think the primary difference between recent expense trends and what we've got in the three-year outlook is the increased pharmaceutical intensities. So the bad news is that drugs cost money and it drives up expense. The good news is that they also drive incremental revenue and so you're not going to get one without the other. If we're wrong on our pharmaceutical utilization assumptions from an expense point of view looking forward then we're also wrong on the revenue side. And so we will need to be concerned at least under the current reimbursement format.

The second part of your question about pharmaceutical practice [indiscernible] could you reiterate that please?

Your Pharma per treatment was up about you said 9.7 percent and maybe just remind us what it was in the last couple of quarters and seems like bigger than usual number so maybe if you could just explain that a little further?

Yes the increased for the spread across anemia management which is (indiscernible), vitamin D and iron. So in those three areas which are the most pharmaceutically intensive aspects of our practice in all three cases there was more utilization and (indiscernible) not coincidentally, you also heard some clinical outcomes.

And just two other quick things. First just the spot number, the fully diluted shares outstanding today and then, if you could just characterize briefly for us, the acquisition environment we've seen you be a little bit more active on that front? Thanks.

Okay, the fully diluted share count for the quarter was 68.4 million and at the end of the quarter shares outstanding -- the shares outstanding -- were 64.5 million. And as you look forward, our expectation would be fully diluted shares would go up a few million in '04 related to option exercises and the dilutive impact on exercised options as well.

And on the acquisition front, I don't know exactly what to say. At this point the 2003 numbers are in for everybody. In addition there's been some early 2004 activity. Always difficult to know how many people are going to put stuff up or sell through the course of the year. We certainly demonstrated a significantly higher level of activity in '03 versus '02 -- about a tripling in fact if you look at the math and we become a pretty significant participant in that stuff. And I would imagine that 2004 could look a lot like 2003 but one always predicts these things with a huge amount of trepidation.

Bill Bonello. Wachovia Securities.

I have a couple of questions if that's okay? First of all, can you just tell us the other revenue per treatment was up quite a bit. What was -- why that was up and kind of the expectation going forward?

Sure, Bill, the primary reason that that is up is related to the acquisitions of the nondialysis businesses we had earlier in the year from Baxter.

That's a pretty good run rate, then?

Yes that's a reasonable run rate in fourth-quarter level.

Okay and then can you just remind us also the large managed care contract that you've talked about renegotiating? That has not been -- the new rates have not yet taken effect or as of the fourth-quarter the new rates have not yet taken effect is that correct but they will be effective in Q1?

Matter-of-fact, January 1, 2004, the long awaited moment took place.

Okay and then on your analyst day, you mentioned a handful of contracts that you were in the process of negotiating but you thought things weren't going to maybe go so favorably. I am just wondering if you finish negotiating and if you could give us any sense how things shook out there?

Yes, the tussles that we were having in that period and then coming out a little bit better than we feared at the time. And of course the -- what happened -- what we thought would happen and what did happen is already baked into our '04 estimate and our three-year outlook. So there's nothing material to report but the answer to your specific question is they end up coming out a little bit better than we had feared.

Okay and then just a -- in Q1 of '04, should we expect the facility cost per treatment to go up a little bit more than it has been... ? Is that some kind of normal EPO price increase?

Well Bill, you expect the cost for treatment in Q1 would go up more than that sequentially just because of the lower number of treatment days?

Good point.

That would be the primary driver in Q1 and what we have in EPO contract has been placed and as usual we don't comment about the specifics of the EPO agreement.

Jeff Gates, Gates Capital Management.

Regarding the new bank deal, could you tell us what the structure is between revolver and term? And what the restrictive payments basket is?

Yes. Nothing changed on the revolver and the [indiscernible] $115 million revolver with nothing is drawn on the revolver but about 100 million is available. Balance is since taken up by letters of credit. And, then, we still have our [indiscernible] term loan A which is right now a little less than $120 million outstanding. And then the term loan B is the piece that was refinanced again in November and that's about a billion 35 outstanding and essentially there's a 25 basis point further reduction immediately and another 25 (indiscernible) we'll get look at toward the end of first-quarter. The restricted payments basket is -- give me one moment. Under the credit facility we have $275 million of restricted payments availability for dividends or share repurchases. 150 million of that expires at the end of 2004. And in addition to that we are eligible to earn another $75 million annually up to a maximum of 300 million, as long as our senior (indiscernible) ratios are below 2 1/4. Just to be complete I remind you that our [indiscernible] board authorization is somewhat lower than that at 145 million.

Balaji Gandhi, Deutsche Bank.

I had a question regarding DSOs. How low can they get beyond this fluctuation as you start to integrate the new billing system looking out to 2005 or 2006?

If we look out over a long-term we think -- compared to where we are today -- we can pick up a few days and then beyond that so much depends on how payor systems evolve as opposed to what we can do. But once we get past all the finetuning of our system we'd be real disappointed if we didn't pick up a few days.

Few is 3, 4?

Few we typically define as three and you could make us feel bad if we didn't achieve four.

At this time there are no further questions.

Hold on here for 15 seconds in case anyone is wrestling with the exact wording they want to use.

Andrew May. Jeffries & Company.

The big managed care contract that was asked about earlier you thought that there was some risk of losing some volume on that contract as you got improvement on the price. I wonder if you have a sense of what your continuing yield in that arrangement is?

So far so good. It appears that volume is holding okay. I can't say for sure that we have not lost some. I can say for sure that we have not lost a lot.

Eric Percher, Thomas Weisel Partners.

Quick question on the lab side. I know that there's been discussion about the payment screen that's in place there and I am curious if we should expect any change in that structure over the next couple of quarters?

Structure -- excuse me, the structure of what.

The payment screen on current lab revenue.

There aren't any significant payment screens in place right now. They were suspended a while back, and at the time that they were suspended, the only information that we got from the carrier was that they were going to study what payment screens would be -- what new payment screens would be appropriate going forward. We don't have any further information since that time and that was over a year ago.

Right so now can they apply a payment screen to the revenue that's already run through and do you reserve for that?

They certainly can and we try to take that uncertainty into account in our estimates as best we can but it is -- still had some level of uncertainty.

Okay and at some point when they come up with a new payment screen you could in theory be less conservative at that point?

Could you say that again?

At some point when they come up with new payment screen you could have -- hopefully you're being conservative when that comes into effect you could then be less conservative in that area.

Hypothetically, yes.

Andrew J. Dirnagl -- Harris Nesbitt.

Question for you on the capital structure on a last quarter annualized basis you're now down around 2.3 times EBITDA. You stated in the past that your sort of EBIT goal or comfort level for debt would be 3-3 1/2 times. Any update on that?

I think we won't say anything we haven't said before that we continue to feel that the 3-3.5 is a prudent long-term average and that it can be created while we're above or below and right now we're below. Right now we also have not that much cash because of a lot of the things that happened in the fourth quarter in the business just in terms of the timing and tax statements, etc., and some of the balance sheet decisions we made particularly the retirement of the notes. And so it's a little bit of a theoretical question right now but as we proceed in the coming months -- right now we're anticipating accumulating some cash to maximize our business flexibility and then as that number gets bigger we will revisit it with your help.

Okay, is there sort of a general -- can you bracket that cash amount that you're sort of comfortable with that gives you maximum flexibility?

No.

Well, I had to try.

But you counsel will be appreciated.

Thanks a lot -- great quarter.

Charles Weston, Morgan Stanley.

I just wonder if you could take a minute to talk us through your thoughts on the ESO demonstration project due to start in the summer?

Yes. We did not submit a proposal for the bundled demo project. We did submit a first-run proposal for the global cap demo. We are in conversations with its wit the government now and so we and they will find out in the coming months whether or not we can agree on the specifics which will be just to actually do it or not.

And if you were successful, then, how many patients do you think you would want to put into this demo?

It's not clear yet. That's part of the discussion. It would not be a huge number and in general the way I look at it is if we did it it would probably cost us a couple of million bucks a year of a net decrement to our profitability in order to do a good job. And to eyeball the learning, that is the intent of the thing. So to help you put a bracket around it to use Andreas's word, in terms of economic implications I think that's a reasonable guess and we just don't know if they're going to be reasonable enough to come up with something where it actually makes sense to do.

Bill Bonello, Wachovia Securities.

Just to add one to follow up on this whole cash business as well and maybe you've said everything you're possibly going to say. But I'm wondering if you could possibly give us some more thinking around why it is you want to build your cash balance up significantly? I know, at one time, you were considering a fairly large scale acquisition. I think that's gone. Your outlook for the business seems to be as positive as it's ever been. I guess what I'm asking is why don't you maybe be a little more aggressive on using cash to repurchase shares?

I don't quite know what to say, Bill. Right now, we have about $60 million in cash. And next month, we will have a little bit more than that and we'll keep revisiting what to do with it as we proceed through the year. So at some point it just gets -- I think it's not that productive to be hypothetical about it. We got 4 1/2 years now of history behind us as to what we've done with cash flows and it's been a mix of acquisitions and share repurchases and having different levels of debt at different times. And for me to right now start to hypothesize about the relative probabilities of what we will do in August or something I think is just not a good use of your time.

I guess maybe what I meant was, is there anything that could be out there on the use of cash fronts that we're not contemplating strategically? In other words, would you consider acquisitions that might be strategic but are not necessarily dialysis providers?

Oh, okay, I'm sorry. I didn't pick up on that one in respect to the question. I apologize. There is no intention to go outside of dialysis/nephrology/ESRD. So that is not contemplated or every time it's been contemplated, it's been rejected.

Perfect. Thank you.

Thank you, Bill. Sorry I didn't pick up on it the first time.

I didn't state it clearly.

At this time there are no further questions.

Once again we will give it 10 seconds for people to -- have that last shot. And, having heard none, we say thank you very much for your interest in our Company and we will do our best between now and next time we get on the phone. Thanks.

Thank you for your participation in today's DaVita fourth-quarter 2003 conference call. You may disconnect.