德維特 (DVA) 2004 Q2 法說會逐字稿

Good afternoon. My name is La Tasha, and I will be your conference facilitator today. At this time, I would like to welcome everyone to the DaVita second quarter 2004 conference 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. If you would like to ask a question during this time, simply press star, then the number 1 on your telephone keypad. If you would like to withdraw your question, press the pound key.

Thank you. Mr. Beil, you may begin your conference.

Thank you, La Tasha, and welcome, everyone, to our second quarter conference call. We appreciate your continued interest in our company. I have with me today Kent Thiry, our 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 our press release dated August 2, 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 the forward-looking statements, forecast, 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. These measures should be considered in addition to the results prepared in accordance with GAAP and should not be considered as a substitute for GAAP results. Also included in the press release is a reconciliation of these non-GAAP measures to the most comparable GAAP financial measures.

We will now turn the call over to Kent Thiry, our CEO.

Thank you, Gary. I'm going to address 6 subjects, 3 of them up front. Number 1, our clinical results. Number 2, our '04 economic performance year-to-date. Number 3, the PDI transaction. And then later on, after Gary discusses some of the quarter details, I'll cover subject 4, public policy, subject 5, capital allocation, and subject 6, our '05 outlook.

Subject 1, clinical results. We will provide the same 2 scores that we have provided in the past. First, adequacy, which is essentially how well we're doing at removing toxins from people's blood. 94% of our patients had a Kt/V greater than 1.2 in the second quarter. The second measure, anemia management, the percentage of our patients with hematocrits greater than or equal to 33, and incidentally higher hematocrit scores correlate with a higher quality of life for the patient and lower costs for Medicare overall, was up to 86%, up 1% from last quarter's outstanding result and from all data we see, the best in the nation. Although once again it's difficult to be sure that you're applying apples to apples comparisons across the industry, these numbers suggest that we compare very favorably to the industry as a whole, as well as other companies like ourselves.

Second subject, 2004 economic performance. Our Q2 operating performance was again rock solid, making our year-to-date operating performance again rock solid. For the quarter, treatment per day growth was 7.9%, operating income up 16.5%, and 12-month rolling free cash flow of $254 million. That excludes all the after-tax lab recoveries and the tax benefit on the exercise of options. For the 6-month period, treatment per day growth was 8.3% and operating income up 19.2. Based upon this current performance and our assessment of all the other near-term factors, we're increasing our '04 operating income target to 385 to 400 million.

Third subject, the PDI acquisition. As announced, we've entered into a definitive agreement to acquire Physicians Dialysis, Inc. in a cash-for-stock merger transaction valued at approximately 150 million. The acquisition will immediately add approximately 1,700 patients at closing, which should take place in the September/October if all goes smoothly. So the $20 million question, or so, is why did we pay a "premium" for PDI? It is a two-part answer.

Number 1, over the first 24 months of operation, we expect the treatment growth from this asset to significantly exceed that of our base business overall. At the end of 2005, we would expect to have approximately 1900 patients from these centers, for example, and that should drive corresponding growth in operating income. Second point is that these centers are in attractive locations for us and have positive operating implications for our other centers in those areas. In specific, our footprint in Michigan, Pennsylvania, and Texas will be enhanced. As to the question of what are we seeing with respect to acquisition pricing generally, unfortunately several of the recent industry deals have been at higher multiples than a year ago, and we hope this is not a trend. 4 to 6 times EBITDA or 5 to 7 times operating income is still the target range, although some of these recent deals by us and others appeared to have not achieved that.

I will now turn the call back to Gary.

Thanks, Kent. As Kent mentioned, we had another strong quarter financially. I'll cover a few key points about Q2 performance.

Our Q2 revenue was up 3% sequentially, with nearly all the increase due to treatment growth. Total treatments for Q2 were up 2.9% over Q1, and average treatments per day were up 2.2% compared to Q1. Of the Q2, 7.9%, year-over-year increase in treatments per day that Kent mentioned, 4.5% was nonacquired growth, and 3.4% came from acquisitions. Average dialysis revenue per treatment was up 52 cents over the prior quarter, and we continue to expect that the private pricing environment is likely to be tougher going forward than it has been in the past few years.

On the expense side, patient care costs for Q2 were 68% of revenue, compared to 69.9% for Q1. We continue to have good productivity performance in our centers. Comparing Q2 to the year-ago quarter, patient care costs were up about $7 per treatment, or 3.4%, principally driven by labor rates and pharma costs. Normal labor rate pressures will continue to be a principal driver to our cost structure going forward.

G&A was up 8. -- was 8.3% of revenue in Q2, compared to 8.0% in Q1. As usual, you should expect G&A to fluctuate from quarter to quarter due to the timing of expenses. For the foreseeable future, we expect G&A will grow, more or less, in line with revenue, due to our continued investment spending for improving clinical quality and compliance programs, as well as selected new initiatives. Our operating margin of 17.5% for the quarter was down 60 basis points from last quarter, primarily due to the higher G&A and minority interests. Our income tax rate for the quarter remained at 39%, which reflects our estimate for the entire year.

Moving on to the balance sheet, DSO was at 68 days for the quarter, down 2 days, sequentially, but was still 2 days higher than it was a year ago. The timing of Medicare certifications for new centers will contribute to contribute to the DSO fluctuations. Debt net of cash at the end of the quarter was 943 million, and our net leverage ratio calculated on the annualized quarter was about 2 times EBITDA. Last Friday, July 30, our revised credit facility terms became effective, and our new term loan "C" for 250 million was funded. The amendments included modifying covenants for acquisitions and share repurchases. We're also in the process of extending the maturity of the existing term "B" loan by 1 year. That would go out until June, 2010. The new term "C" loan of 250 million is priced at LIBOR plus 175, with maturity schedules similar to the extended term "B" maturity.

We'll now turn the call back to Kent to discuss government policy, capital allocation, and our 2005 outlook.

As to government policy, subject number 4, there are three issues we should discuss. 1 is EPO, and the new nationwide utilization policy -- or proposed policy, I should say. 2 is the 2003 MMA implementation, and 3 is the ESRD modernization bill. Before covering those 3 topics, I just want to remind people that we did achieve a 1.6% composite rate increase that will be effective January 1, 2005. That is unchanged by anything else I'm about to discuss.

First, EPO. The draft policy was released on July 8, as many of you already know. Jumping right to the net financial take-away, a range which covers the majority of likely outcomes is that our operating income could be reduced [ INAUDIBLE ] annually. Very difficult to estimate, because there is so much uncertainty in where they are going to end up. But we are trying to provide you with some sort of estimate to help you do your job.

The proposed policy in general had some positive and negative attributes. CMS has done the right thing and acknowledged that a broader hematocrit target range is appropriate, in fact, up to 39, without review in any normal situation. This is an unambiguous positive for patient quality and for overall healthcare expenditures, because people with better anemia results end up going into the hospital less.

However, for higher hematocrit patients, CMS is proposing specific review thresholds that in our mind are not properly conceived and not -- in fact, not analytically conceived and will place a greater administrative burden on the docs, on the sensors, and on the fiscal intermediaries if implemented as contemplated. The audit criteria appear arbitrary to us and are below average doses across the population today and could subject as many as half of ESRD patients to an audit at some point in the given year. So, we think there's a lot of work to be done, impossible to determine ahead of time where they come out.

Perhaps most problematic is the risk that the policy could have a chilling effect on physicians who, out of fear, will change their ordinary practices so patients may no longer receive the medically correct dose. I repeat that the net financial take-away is that there is downside risk, impossible to estimate with any kind of precision right now, but we think the 5 to $10 million estimate captures the majority of the likely outcomes. We will, obviously, keep you posted as we protest what we think are the illogical or nonpragmatic portions of their proposal, and, hopefully, they will be as willing to listen as they have been up to this point.

Second government policy issue is last week CMS did issue the draft report on the add-back in the case mix adjustment system. Financially, the estimated downside is 10 to $20 million to our 2005 operating income, if the rule is implemented as currently drafted. Just to remind people, our '05 composite and drug payments are to be adjusted so that the drugs will be reimbursed at cost, and the current margin on these drugs is supposed to be added back to our composite rate in a manner that is literally revenue neutral to our industry; we're to be paid what we would have been paid under the old system.

Additionally, a new case mix adjustment system is to be developed and applied to the composite rate. It is our assessment that, so far, CMS has not accomplished the literal mandate of the law as to revenue neutrality. There are several areas that are inconsistent. I will highlight one or two. The first one is the most material one financially.

CMS calculated the drug addback with a preference toward shifting drug margin dollars from freestanding facilities to hospital-based units. We believe this is totally inappropriate, not contemplated by the legislature, and should not be implemented as they are currently contemplating it. This provision alone would shift $2.00 per treatment from freestanding units to hospital-based units. A second example is that CMS has set pharmaceutical reimbursement at ASP minus 3%, rather than using the acquisition costs that were determined by the OIG pursuant to the legislation. In some cases, this has resulted in reimbursement being set unreasonably low for particular drugs.

So, I repeat, the net take-away is if they implemented the new payment rule as it is currently drafted, our operating income would be reduced by somewhere in the 10 to $20 million range versus our previous estimate of 4 to $8 million in our capital markets presentation last year. Both estimates exclude any impacts in the case mix adjustment, because that will be analyzed in the weeks to come. Hereto we will be vigorously participating in the process of refining the draft policy and hope that CMS is open to working at the next level of detail.

Third subject, and a refreshingly positive one, is that in connection with The Kidney Care Partners, we've introduced bipartisan legislation in both the Senate and the House. This ESR demodernization bill, as it is called, highlights the need for an annual update for the composite rate, patient education services, reforms that will improve the cost and quality of vascular access, et cetera, et cetera. It is our goal to gain momentum going into 2005 with the hope that some of these provisions would be included -- with the hope that these provisions would be included in a bill that would be effective in 2006.

Subject number 5, capital allocation. We chose to borrow an additional $250 million at this time to fund the PDI acquisition, other recent transactions, and to be able to maintain flexibility in the event of additional acquisitions and/or share repurchases. We maintain our philosophy that we will first allocate our cash to growth at reasonable returns, in the form of acquisitions and de novos, primarily.

To the extent that we generate more cash than we can invest in growth, we will either reduce debt or return capital to shareholders. In addition, we may, from time to time, accumulate cash to maintain operating and strategic flexibility. The most likely opportunity would be in the area of increased acquisitions. This overall cash allocation philosophy is executed with a long-term view, so it is impossible to comment quarter to quarter regarding why we did or did not buy stock back or did or did not pay down debt.

The sixth and final subject, before the Q&A, is our outlook. As I mentioned already, we're increasing our '04 operating income target to 385 million to 400 million. Regarding '05, because of the recently released CMS proposed policy changes on EPO and the MMA implementation, and the fact that they have the potential to have a material negative impact on our go-forward operating income, and that that income impact, the range which could capture a majority of the likely outcomes, is 15 to $30 million annually.

Still very difficult to put a box around because of where they are in the policy discussions, but given we were going to be having an earnings call we felt it our responsibility to take our best guess at what current language would lead to. Taking all this into account, we currently expect '05 operating income to be flat to 6% higher than the '04 level, and our wonderfully recurring cash flow to continue in any event. We will update our 3-year outlook at the capital market's day, which will be late this fall or early winter. And I should add that this outlook excludes any impact, or potential impact from the implementation of FAS 123 in 2005.

So, with that, Operator, could we please move to Q&A?

At this time, I'd like to remind everyone, in order to ask a question, please press star, then the number 1 on your telephone keypad. We will pause for just a moment to compile the Q&A roster.

Your first question comes from Darren Lehrich with Piper Jaffray.

Thanks. Good morning, everyone. Thanks for your commentary on the Washington stuff. I'm just wondering if you can give us a little bit more sense on how much of your change in outlook versus, you know, what we heard from you earlier in the year, relates to the rule itself as opposed to, you know, changes in your utilization pattern of drugs over the last several months, if that's had anything to do with this? And then if you could, I mean you -- you did comment that you were disappointed in the ASP minus 3% aspect of this. If you could just maybe provide us some sensitivity in your analysis, if you were to get acquisition costs like we saw in the IG study? And then I have a follow-up, thanks.

Yeah, okay. Fair question, let me restate the first part just to make sure I've got it right, which was how much of our change in outlook is driven by the current language of the bills themselves, as opposed to other changes in our business, for example, changes in pharmaceutical use patterns.

Right.

Is that the first question?

Right. Yeah.

Yeah. I would say it is 90% driven by language in the policy drafts. So it's somewhere between 80 and 100. The -- so that answer is straight forward. The second question is if they moved from ASP minus 3 to the OIG acquisition cost, how much of a difference would that make?

Right.

It would be a little tough, because, sort of, the devil's in the detail on some of this stuff, but I'd say a couple million, and maybe it's a few.

Okay. And then, you know, I suspect your comments will be focused primarily on -- on the things you've already identified. Is there anything that you'd also want to highlight in terms of where your comments will -- will be focused, you know, in the comment period?

Well, yeah. Pretty much I'd be redundant to everything I've already said. There are another 4, 5, 6 issues, but they're all sort of subpoints to the headlines that we have provided. There are just a lot of things stirred up by the language, some of which is absolutely contradictory to specific legislative intent. Now, that doesn't mean, however, that they're going to make changes. That's the battle we have to fight. In general, the quantity and quality of interaction on this stuff has been good over the last 6 months, and the EPO policy just proposed is far more thoughtful than what they were inclined to propose 5 months ago, because there was sufficient, high quality, evidence-based, thoughtful dialogue.

And, similarly, on the other stuff, where they have faced a hellacious challenge of trying to sort through all the numbers and do what's right, they have listened a bunch and made a number of improvements, refinements, corrections, et cetera. They, of course, live in a world where they always wonder, out of all the things we say, what can they believe? And so, at this point, if you were to ask me if I'm optimistic or pessimistic about getting some changes, I'd probably be frozen in indecision about giving an answer. Because while, in general, they have been interactive, also at some point they just have so many things on their plate that they just stop revisiting.

Okay. And if I could, just one more thing, housekeeping-oriented. Just in terms of your patient care costs, is there any way for you to segregate wage rate increases versus pharmaceutical costs? Just the major components there? Thanks.

I cannot do it spontaneously, and if we can do it without violating any FD regs, go ahead and give Le Anne a call after the call.

Okay, and maybe you can find those numbers while the call progresses. Thanks.

Okay.

Or I'll call Le Anne. Thanks.

Your next question comes from Justin Lake with UBS.

Hi. I guess my first question would be regarding the PDI acquisition. Can you give us any further detail on what kind of EBITDA multiple that was completed at, given the -- maybe even if you use the 2005 effective date, you know, versus that 4 to 6 number that you've been looking for?

Yeah. The short answer is no, we're not providing EBITDA guidance on the transaction, instead deciding it would be most useful to provide the EPS guidance that we did.

Right. Okay, fair enough. And I guess following up on that -- on acquisitions, has there become kind of a bifurcation between the -- what you're paying for the smaller, 300 to 500 patient acquisitions, to what you're paying for the bigger stuff? I mean, are you still able to get those smaller ones funded 4 to 6 times?

Correct. There is a very substantial difference in the multiples being paid for the larger deals versus the smaller.

Great. And then one more question on this line, and then I just have one follow-up. As far as what's still left out there on the acquisition market, you know, reading some of the trade journals, it only -- it seems like there's only 2 or 3 more providers out there that are not -- that are for profit, I should say, that have more than 1,000 patients available. So, do you think this kind of high multiple acquisition growth has kind of petered itself out as far as between yourselves and RCI? Or are there more targets out there that you might be looking for?

Only time will tell.

Okay, thanks. I will just get back in the queue. Appreciate it.

Thank you.

Your next question comes from Bill Bonello with Wachovia Securities.

Clarification. Your estimate of the Medicare impact, is that including the positive impact of the 1.6% increase in the composite rate or excluding that?

Excluding.

Okay. That makes sense. 2, any idea why CMS decided to reallocate dollars from freestanding centers or why they decided to use ASP less 3% as a proxy for average acquisition costs?

It's speculation, Bill, but on the shift to hospitals, the only kind of rational hypothesis is sort of imperically-based is that there are some folks in CMS that despite the fact that the for-profit -- the for profit segment of dialysis has by far the best clinical outcomes and is the best use of taxpayer dollars, nevertheless, don't like us, and since the mix of not-for-profit presence on the hospital-based units is far, far higher than on the freestanding, that they see it as a way of shifting from one for-profit sector to a not-for-profit sector. In addition there, may be some who think that hospitals have a higher cost structure, while we see in the acquisition world that it, in general, is true, that hardly seems like a good reason to give them more money, just because the freestanding centers, in general, are lower cost and have better clinical outcomes. So that's all speculation and, again, was not intended by Congress.

On the ASP, I think you had on the first part of your question, the ASP minus 3, and that one, literally no idea. Literally no idea. They had a tough task, and I'm sure both approaches have their weaknesses from their point of view, but I don't know.

But I am correct that the ASP less 3% prices were significantly lower than what the OIG had as prices at average acquisition costs, is that right? For a number of the drugs?

On a net basis it's our assessment that the ASP minus 3, in aggregate, comes out with lower reimbursement than the other.

Okay. And then on the EPO, just kind of what's -- and I know you're saying it's a wild guess, but -- but what's driving, sort of, your impact assumption? In other words, are you assuming that you would have an increased number of claims, if not denied, you know, limited at the upper level, or is this simply reflecting an expectation of greater billing costs?

Primarily less use at the top, that if they start denying claims -- and we have the best anemia management outcomes in the nation, and anyone will tell you that that correlates with higher quality care. However, it does move you into the range of being subjected to discretionary FI decisions, which is dangerous. So, if they start denying them, or if they just make it such a huge pain that it creates a chilling effect on the doctors even attempting to prescribe, then it's reduced use.

Okay. But you already document, sort of, the need for EPO levels as used, is that correct?

Correct -- say the question again, I want to make sure I give you a --

I'm trying to make sure, in other words, for your patients that are using a lot of EPO, you wouldn't be doing something new to have to provide documentation on why they're using that much EPO, you already provide that documentation, don't you?

No, it depends what they -- that's one of the ambiguities in the current language, is what's going to constitute sufficient documentation of medical necessity? Right now we don't know, and so without knowing that I can't tell you if we're already doing that which they will want.

Okay, so you may -- so that could change. Okay. And then just, besides the negative Medicare impact, can you give us a sense of what the other assumptions underlying your '05 guidance are, just in terms of expectations on volume growth and commercial pricing?

No, not at this time. Because, as you will recall, Bill, we usually don't even do it right now, but we just felt it would be unfair to lay out these Medicare scenarios without putting it in some sort of '05 context. Because what I would point out is that, absent PDI, we would still be on track for our 3-year outlook, given all this other -- despite all this other noise in the system. We sufficiently accommodated all of this stuff in our three-year outlook that we would be tracking along within it. PDI, of course, is sort of a -- sort of a snake going through the rabbit that disrupts some of these 3-year averages, we think, ultimately, in a positive way, but nevertheless makes the old 3-year averages kind of irrelevant. But we felt that since it was incumbent on us to give you some sort of analytical response on the Medicare drafts as they exist, that it would be irresponsible to not do that within the context of some early '05 assessment.

Okay. And then just one last question. Can you give any more detail on how the loan covenants regarding acquisitions and share repurchase were modified?

Yeah, the -- the baskets for acquisitions was increased, and the individual transaction amount that requires bank approval was also increased. Under the old terms -- any acquisition greater than 50 million required bank approval, the new level is -- for an individual transaction is $165 million. And the aggregate basket with the leverage ratio less than 2.75 is moved up to 500 million.

And on the share repurchase?

Share repurchase, that was increased to kind of a base amount of 225 million, with an additional $150 million annually whenever the leverage ratio beginning is less than 2.75, as well. So, right now, that would give us 375 million basket for the -- and under the new amended agreement.

Okay, thank you.

Thanks, Bill.

Your next question comes from Matthew Ripperger with Smith Barney.

Hi, thanks very much. Just a couple of questions here. First, I just wanted to clarify that in your revised guidance for the impact from the Medicare reimbursement changes, you are not including any assumption related to the case mix adjustment or the budget neutrality adjustment?

Say the question again, please?

Sure. One component of the reimbursement proposal last week was to implement a case mix adjustment of roughly 1.16 times and also having an offsetting budget neutrality a factor. I just -- I wanted to clarify that in your prepared remarks you stated that the -- the guidance you provided today related to the projected Medicare impact, did not include any assumption related to the case mix adjustment or the budget neutrality factor.

Correct. There is no -- at this point, we have no analytical assessment of the case mix adjuster. I do want to clarify one part of your original question, however, is we've -- we've not adjusted any guidance other than moving our '04 guidance up, that, absent PDI, our 3-year outlook would still have been in place, and we have not provided any '05 guidance, and the current '05 guidance would still fall within the original 3-year outlook. So I just want to be clear that we haven't changed anything, other than increasing our '04 guidance.

Right. But you did also change the projected negative impact from the reimbursement -- Medicare reimbursement rebalancing from 4 to 8 million before to 15 to 30 million now?

Oh, excellent point. I stand corrected. While we have not changed any of our aggregate numbers, like operating income, et cetera, that particular subpoint, that particular subassumption, that $10 million on the 2.5 billion of revenue, we did change.

Okay. And when do you believe that you will be in a position to comment on the case mix adjustment? And do you believe that your patient mix is representative of the industry-wide case mix numbers that were included in the proposal last week?

As to when --

Most likely we'll be needing to do that over the next few weeks. There is a couple of issues with that. Clearly, not all of our parents have been classified by our physicians into the categories, the AIDS and the peripheral vascular disease categories, and CMS has not provided a definition of peripheral vascular disease. So, one issue that we have is a classification issue of these patients, and so we'll need to seek some input from them, and we'll need to work through our physicians to get these patients appropriately classified.

And as for the question, will our Medicare mix be different or the same, the short answer is, we don't know. What little we do know would suggest that it will be the same, because we take care of about 1 out of every 6 in America. But it so much has to wait to see how they end up exactly defining the categories.

Okay. Great. And the second question I had is just clarifying the forward guidance. A year ago when we were on this call, sort of August 1 of '03, you provided operating income guidance for this year of relatively flat, and now as we stand here today, you're providing operating guidance for next year of flat to up 6%. Given that the commercial pricing environment has gotten tougher and the potential Medicare reimbursement changes due to this proposal seem to be a little more negative than you were initially expecting, what specifically accounts for the marginal, incrementally more favorable outlook for next year versus the guidance you provided for this year a year ago?

Boy, there's clearly 30 different things that affect every year's guidance, and so, I don't know that the question is answerable. In each year we have to try to figure out what's going to happen on the acquisition front that changes a lot in terms of quantity and price. We have to look at the maturing of our de novo class, which is much larger today than it was a year ago. We have some very large contracts that can skew any one year's number on the payers side, positively or negatively, and then there's always our friends in the government who, at the point of a year ago, as well as today, can be contemplating some negative stuff or some positive stuff. So, I can't spontaneously isolate what things are different that led to, sort of substantially the same, but slightly different guidance now versus a year ago. I don't think I can do that, because every year is -- is the net result of 30 to 40 different things. Do you have a hypothesis or something that you want to try to where maybe I can add more value in the response?

I -- just looking at it, it would appear that, from your prepared comments, commercial pricing would be an incremental negative. Medicare pricing would be an incremental negative. Based on your same store volume growth this quarter, it would appear that that would be an incremental positive. And then the PDI acquisition would appear to be an incremental positive. So I was thinking that those two latter points were more than able to offset the two first negative pricing points and then therefore contribute to an incremental more positive operating income growth outlook for next year versus what you've observed this year, at least what you expected this time last year.

Yeah. And then there's sort of generic factors that I listed in responding, the quantity and pricing of acquisitions in our de novo class were 2 of the things I listed. At the same time, it's just so difficult to pick 2 things out out of the 30 since they're all moving around every year.

I understand. I understand. Last question I just had is related to the debt, the term "C" that you took out, part for the PDI acquisition. Can you give the rate of that term "C" debt? And then just review again why you decided at this point to use additional bank financing rather than cash?

The -- this is Gary. Yeah, the term "C" loan for 250 million that was funded on Friday, the rate is LIBOR plus 175. Our term "B," as you recall, is LIBOR plus 200. And the reason we took the debt down was to, as Kent mentioned earlier, just to maintain our flexibility after doing, with the PDI acquisition in the closed process and the other acquisitions, maintain our -- our flexibility to -- to do additional acquisitions or repurchases as opportunities arise.

Great, thanks very much.

I guess, what I would add to that is just, in today's world, if you think you may want to have money, you don't want to necessarily assume that the capital markets are going to be the same 2 months from now or 6 months from now as they are today, you're just one terrorist event away from dislocations. And so, while it would be nice to say -- to adopt a 'just in time' attitude toward having capital, that did not seem prudent for us in today's world.

Great, thanks very much.

Your next question comes from Andreas Dirnagl with JP Morgan.

Yeah, good afternoon. I had a question, let me start off with the PDI acquisition. In terms of your comments that you expect that to be EPS neutral for 2005. Is that taken in isolation, or is that in combination with the in fact you're drawing the $250 million, in order to fund that and to have that flexibility?

What we assumed is our -- our normal full capital structure, and then within the portion of that which is debt, the capital structure that we're moving to. So, in other words, 40% fixed and 60% variable rate, and so that's the -- that's the way we calculated the interest expense to put against the purchase.

But in other words you did calculate an interest expense against the purchase, whereas if you would have done the transaction for cash, then theoretically it would have been accretive in 2005, is that correct?

Correct. But what is in our mind conceptually illegitimate is, in a company with debt, to somehow assume that when you make an incremental acquisition it's all equity, just because you use cash, is not conceptually legitimate. It's nice to incrementally fool yourself, but it's not correct. Similarly, it would be inappropriate to say that gee, the last $10 that you borrowed was used to make a $10 acquisition that you just consummated. So the fact is that one should assume your existing debt and the existing mix of fixed and variable rates on a weighted average basis and apply that charge to a transaction.

All right, yeah, I think that's a valid point. Although it -- I think is a little less valid in the circumstance where you don't actually need the debt in order to fund the acquisition, but that's neither here nor there. Another question, then, just to clarify. The negative impact that you're anticipating, the 15 to $30 million from the changes, again, does not include any positive impact from a 1.6 Medicare composite rate increase, correct?

Correct. That is separate. We had previously discussed it. It was already put into people's numbers, including our own. So trying to take credit for it again did not seem appropriate.

Great. And then when it comes to specifically the EPO utilization new proposed rule. It seems to me, I mean as you said, raising it from roughly 37.5 to 39 is an unambiguous positive, both for quality as well as for providers, and so the problem seems to be once you get above 39, the sort of arbitrary 40,000 unit cap -- is that also correct?

You're correct. The cap, and what they might do for the many patients that will exceed it.

Right, but also it -- it seems like the government has generally a much more constructive stance, vis-a-vis the industry, than it has for a number of years, so that is something. Is there any update you can give in terms of, at least, preliminary arguments that Kidney Partners has had, or you that have had directly with CMS concerning that issue?

The issue of the EPO and the higher use levels?

Yes.

Well I would say 2 things. First of all, your -- your statement was correct and important in that 2 years ago if you took CMS's view of EPO, they were highly suspicious. And because of the spotlight and the investment they made in developing this policy, they have probably increased by 1,000% their knowledge. Which, of course, they couldn't do until they spent the time on the science and with physicians, and the good news is that all sorts of stuff that we did the last 2 or 3 years, where they were suspicious, is now clearly, unambiguously, incontrovertibly viewed as having been the right thing to do for patients, independent of any economic impact.

Separately, as to your question about what the nature of the conversations is on the higher level patients, my hope is that it will be as science-based, evidence-based, and clinically-based as a lot of the other conversations have been over the last few months, but it's a little too soon to tell. They're just taking place right now. Our point of view is very straight forward. That, give us a policy that's right clinically, and if you have to change some numbers in order to make the federal government budget work, that's a separate issue, but don't -- don't force us into a situation where we can't do what's right clinically.

Great. That was surprisedly optimistic from you, Kent! One quick housekeeping question, then, for Gary. Just on the share repurchases and the increase in the basket under the new facility, Gary, can you just outline what, if anything, you have remaining available under your currently Board-authorized share repurchase program? And then also, does that -- is that $375 million what is currently available, or has that already been taken down by some of the activity you've done prior to the first quarter of this year?

The 375 is currently available. The remaining Board authorization is 145 million.

Great, thank you very much.

Your next question comes from Gary Lieberman with Morgan Stanley.

Thanks. I wanted to follow up the comment that was made in your remarks about private pricing being somewhat more difficult going forward. Can you talk about some of the dynamics there and what, in your opinion, will cause that to happen?

Well, it's just the same stuff we've said for about a year and the same stuff you read about in the newspapers, and you read about when you follow the analyst reports on the whole health insurance business. Consolidation on the health insurance side is, in general, bad for us. In addition, as employers start to kick back and push back more, that gets translated directly to us, and employers and health insurers are doing a lot more stuff around plan design to offload costs to the consumer, which can affect which plan they choose. That can hurt us and/or how they behave, which can hurt us. So, those are the 3 ways, and they don't ever mean that something dramatically changes in 1 month, but cumulatively it adds up.

And so, are there any changes on the competitive front that can lead you to that conclusion, as well?

No, none that I can think of.

Okay. Thanks a lot.

And let me elaborate, I don't think any -- I would not think any major provider would be foolish enough to misunderstand the nature of payer contracting to hurt the long-term health of the industry. Enough said.

Thanks a lot.

Your next question comes from James Lane with Argus Partners.

Hi. Excuse me. Good afternoon. My question was just related to Darren Lehrich's question earlier today, in the call. I think you mentioned that 90% of the 0 to 6% growth in operating income expected for 2005, 90% of that outlook was related to the draft proposals that came out last week. I just wanted to make sure there's nothing in your core business relative to the 3-year plan that has changed also. What makes up the other -- I think you kind of said, you know, 80 to 100% and picked 90 in the middle, but what makes up the balance?

All right, well let's -- let's sort of recast what the other question was, so we make sure that the answer gets applied to the right question. I think it was, as we talked about the completion of '04, and as we began to talk about '05, were the comments we were making more a function of the swing factors in these policies or a reflection of changes in our actual current pharmaceutical use patterns? And my answer to that question was it's 80 to 100, and I picked the number 90% driven by the stuff going on with government policy as opposed to any change in intensity patterns or usage patterns independent of government policy. Although at some point, depending how things unfold, it becomes impossible to separate the two. But right now, one pretty much can. As to what the other 10% is, you know, I -- I mean that's just where you get into that -- it's kind of all other factors, which is a long laundry list. So am I being responsive or not?

Yes, yes you are. And then just one follow-on question. With using your projections of the impact of the draft proposals, the 15 to $30 million in operating income, would those changes make your Medicare business overall unprofitable? In other words, have they put through changes that no longer allow a dialysis provider with your patient profile to actually make any money off of serving the Medicare program?

We are already unprofitable on Medicare, on average, which is to say there is a small number of locations around the country where -- where it works. But we are already, on average, underwater in Medicare, period, and these changes would put us further underwater. This is why you're seeing for the first time in the history of the industry the larger companies setting down some centers. That never used to happen. Basically, when you no longer have enough private patients to subsidize the government, you kind of go to having more shifts and having 65-year-old patients dialized at 7:00 at night, which is not clinically or socially sound. Why you have people driving 40 miles, each 1 way, 3 times a week to get it. And why, in some cases, they have to go even further, because we shut down the centers. So, we're already losing money, and this will make it worse. We've even got MedPac to the point where they -- I think their last characterization of us was that we were absolutely 0 in '03 or something, and we were about to go into the red, which I was very reluctant to acknowledge, by the real numbers, because they exclude a number of legitimate cost categories. We've been in the red for a few years.

Thank you.

Your next question comes from Andrew May with Jeffries.

A couple things. First, the shift in money from freestanding centers to hospitals. As I read the -- the language in the draft -- in the proposed rule, they basically acknowledge that -- that that makes no sense on the statute, and they kind of say in general because -- because the whole business of budget neutrality is intended to help dialysis facilities, we want to help all of them, and so we want to give some to the hospitals. Is there -- do I read that right? Is there -- I mean, they acknowledge right there in the proposal that it's not what the law requires.

Yeah, I don't know if they would concede that or not. That is certainly our perspective, and, so far, no one's delivered a compelling response to our objections, and we hope they get back on track with what Congress intended and what makes sense, but who knows.

And you guys will do about what, about 5 million Medicare treatments in '05, is that -- am I in the right ballpark?

You are.

So, the delta, the $2 delta there between the single add-on scenario, as they described it, and the separate add-on scenario, as they described it, is -- would be ballpark $10 million --

Correct.

-- on its own?

You are correct.

Okay. Next question -- totally different topic. I know one of PDI's strategies had been to work with medical directors whose contracts were expiring to basically do new de novo developments that were joint ventured with the medical directors, and I was wondering, was there any possibility that you were going to lose any medical directors to PDI in the near term?

No.

Okay. All right. Fair enough. And have you compiled a list of centers that are likely to be closed in the event that the proposed rule is implemented as written?

That would be a slight exaggeration if we were to say that. Do we have some centers that are in the yellow zone because there aren't enough private patients? Yes. Have we decided that we will definitely close them if they implement the stuff in a foolish way? No. The closing a center is serious business, and so we move to that conclusion awfully slowly.

Alright. One final thing, and I -- a naive question. Would you give us just a little -- the difference between ASP minus 3 -- I mean, if I go to Wal-Mart and buy a box of detergent, their selling price and my acquisition cost are the same number. I mean, there's -- I mean -- so how can the drug company selling price and the industry's acquisition price be different -- I'm just -- I don't quite understand it.

I would echo that. We do not understand for the drugs that fall into that category how that happened, and we have doubled back and are having conversations with the manufacturers as to what price they have indicated to CMS, and was it a CMS error, was it a manufacturer error, and I cannot answer the question as to the answer.

All right. Fair enough. I just wondered if there was a subtlety I was missing.

No.

Thank you.

Your next question comes from Chuck Rust with Insight Investment.

Hi. The operating profit guidance you gave us for '04 and '05, does that include PDI?

Yes.

Okay, so that's in there. Can you talk at all about what you expect for operating profit or -- or revenue from PDI?

No, we're not disclosing anything beyond that which we have.

Okay. You talked about, a number of times, raising cash and capital allocation. I'm just not sure -- do you measure acquisitions versus share repurchase? Do you kind of look at those things, you know, one versus the other?

We do compare the two, yes.

Okay. In prior years, your second half operating profit was -- was much stronger than the first half. Based on your '04 guidance, that does not, you know, you appear not to expect that. Why, you know, has there been a change in the seasonality? Or what -- why is this?

Our business, in general, except for a small number of centers, is not seasonal. And so any differences in prior years could have been driven by the timing of acquisitions, de novos, big contract changes, up or down, changes in pharmaceutical purchase pricing, introduction of new drugs. It's changes to pharmaceutical practice patterns, so in any given year, if 2 or 3 of those -- if there is, sort of, a perfect storm, positive or negative, it ends up leading to a quarter or a 6-month period being significantly higher or lower than the other quarters of the year, which is one reason why we focus on annual --

Sure.

-- things, because in every year there is some up and down that's not driven by the normal flow of the business.

Right. Well, certainly, it makes sense that it wouldn't be seasonal, but historically it was. So, thank you. Lastly, can you telling us, you know, not -- not acquisitions, but just what total CapEx is supposed to be this year, or what you expect it to be this year?

Yes. We stated that before that we would expect non-de novo spending to be 50 million. So, maintenance spending on the core business, 40 to 50 million.

Okay. Thank you.

Thank you.

Your next question comes from Balaji Gandhi with Pacific Growth Equities.

Yes, I just had two questions. First one, I hate to go back to this again, but just the Medicare guidance. If I were to think about the old Medicare drug impact guidance of 4 to $8 million, and the new being 15 to 30 million, is it correct to say that the lion's share of that comes from this shifting from freestanding to hospitals, let's say 10 million, or so, and then the balance being from OIG versus ASP minus 3?

Correct. Let me make one other refinement. The 4 to 8 estimate was just for the MMA bill, and so that's moved from 4 to 8 to 15 to 20, and it's dominantly explained by the hospital shift. The 4 to 8 did not take into account a new nationwide EPO policy. The 4 to 8 was an estimate on MMA.

Got it. Okay. That's helpful. And then secondly, to PDI, you mentioned that you could see the patient population go from 1700 to 1900, and if that's -- should we view that as organic? And if so, sounds like pretty robust treatment growth of 12%, or so. 1, is that correct? And 2, what's the rational there for that happening?

I -- number 1, it is correct. And number 2, it's because some of the recently-opened or acquired centers are in the early high growth phase of their life.

And are they in any specific markets that you're seeing that growth?

Yes, but we won't disclose them.

Okay. Thanks.

Your next question comes from Jeff Gates with Gates Capital Management.

Yeah, this is actually [Dax Velasis]. I was wondering, your nonacquired growth has been jumping up from last year, increasing quite a bit, and it's kind of at the high end or higher than the guidance you had previously given, I think of 3 1/4 to 4 1/4. Do you expect this to continue? And who are you taking share from? Because it seems like some of the other companies aren't growing quite as fast.

Number 1, no, we are not changing any of our previous guidance with respect to our nonacquired growth rate at this time. Number 2, we are very happy with our relative performance in this area. Number 3, as to who we're taking the share from, I think the answer is pretty distributed, so there's nothing interesting to say.

Okay, thanks.

Your next question comes from [Rob Crystal] with [Brent Point Capital].

My question was answered. Thank you.

Your next question comes from Justin Lake with UBS.

Thanks. Quick question on minority interest. It looks like your minority interest line has been up about 100% year-over-year, and about up 30% sequentially in the quarter. Just wondering what's driving that? And what would you look for going forward?

This is Gary. And yeah, that has gone up. The number of partnerships that we've got has risen quite a bit since -- from a year ago, as well as the revenues, the -- the operating levels of those partnerships. And so, the minority interest is simply a reflection of the growth in the number and -- and the revenue and operating income of those partnerships. The -- going forward, what happens with MI depends on additional future partnerships and percent ownerships.

Are you doing partnerships in existing facilities, or is it really more just on the de novo?

Dominantly de novo.

Okay, great. Thank you very much.

At this time, there are no further questions.

Okay, well thank you all for your perseverance in sifting through all the issues, and thanks for your interest in DaVita.

This concludes today's conference call, you may now disconnect.