德維特 (DVA) 2004 Q3 法說會逐字稿

Good morning. My name is Princess, and I will be your conference facilitator today. At this time, I would like to welcome everyone to the DaVita third quarter 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. Gary Beil, you may begin.

Thank you, Princess, and welcome everyone to our third quarter conference call. We appreciate your continued interest in our Company. I am Gary Beil, interim CFO. And with me today is Kent Thiry, our CEO; LeAnne Zumwalt, our Vice President, Investor Relations; and Denise Fletcher, Senior Vice President, Special Advisor to Kent.

I would like to start with our forward-looking disclosure statements. During this call, we will make forward-looking statements which can generally be identified by the content of such statements or the use of forward-looking terminology and include statements that do not concern historical facts. All such forward-looking statements are subject to known and unknown risks and uncertainties that could cause the actual results to differ materially from those described in the forward-looking statements. For further details concerning these risks and uncertainties, please refer to our SEC filings, including our most recent annual report on Form 10-K and our most recent quarterly reports on Form 10-Q. Our forward-looking statements are based on information currently available to us. And we undertake no obligation to update these statements, whether as a result of changes in underlying factors, new information, events or other developments. 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 the GAAP and should not be considered a substitute for GAAP results. Also included in the press release are reconciliation of these non-GAAP measures to the most comparable GAAP financial measures.

I will now turn the call over to Kent Thiry.

Thank you, Gary. And thank the rest of you for your interest in DaVita. I will address 6 subjects, 3 of them right now. Number 1, clinical results. Number 2, the recent subpoena. Number 3, a third quarter key number overview. Then after Gary elaborates on the quarter and year to date, I will cover public policy, capital structure, and our '05 outlook. This is the same sequence we have used before.

I'll talk about clinical results first because that is what comes first. We are a care-giving Company. With respect to our clinical results, we'll provide the same two scores that we provided historically. A. Adequacy, which is essentially how well we're doing at removing toxins from people's blood. In the third quarter 94% of our patients had a KTRB greater than 1.2. Second measure is anemia management. The percentage of our patients with hematocrits greater than or equal to 33 was 87%, up 1% from last quarter. These two statistics, which I just presented, are for all DaVita patients who have been with us 90 days or more. And, once again, as we have observed before, although it is difficult to be sure that you're doing apples to apples comparisons because of potential differences in methodology, et cetera, it is clear that our numbers compare very favorably to the industry, as a whole, as well as to other companies like ourselves.

Second subject, the recent subpoena. As we reported, the Company received a subpoena from the United States Department of Justice, the Eastern District of New York. As did others. The subpoena requires the production of a wide range of documents relating to the operations of the Company and its subsidiaries including, in particular, DaVita laboratories services. The subpoena also includes specific requests for documents relating to testing for parathyroid hormone levels and to products relating to vitamin D therapies. I will respond proactively to a few questions. However, in general, it is not prudent for us to revisit this ground in a speculative manner, given we just received the subpoena and have not had any significant conversations with the government. And we will refer people back to the tape of the call -- the focus call we had a week ago on this subject. Having said all that, we will nevertheless answer a few questions proactively right now.

What percentage of our revenue is from vitamin D and PTH testing? About 6% of our total revenue is from vitamin D therapies, and about 60% of that relates to Medicare. Less than 1% of our total revenue is from PTH testing.

Next question. What percentage of your patients are on vitamin D therapy? Answer -- approximately 71%, although that's not the same 71% each month. Over the last two years this has been relatively stable, moving up perhaps 2 to 3 points from where it was a couple years ago, from approximately 68, 69 to 70, 71.

Next question. What percent of our patients are in the recommended K/DOQI range? There still different clinicians use different ranges. We'll provide an answer with respect to 2 of them. 52% of our patients in the range of 50 to 150 and 39% in the 75 to 150 range.

Next question. Why did you indicate that this might be a joint civil and criminal investigation? Answer -- because we were told this by the attorneys in the U.S. Attorneys Office.

I repeat, pretty much any other question on this subpoena will be referred back to our taped call from last week. It is not prudent to speculate on exactly what the government is curious about.

Third topic -- Q3 key number overview. The quarter, and at this point the year-to-date operating performance, remains rock solid versus guidance previously provided. Key numbers, excluding the 8.3 million of lab recoveries are -- volume operating income, operating margins, and rolling free cash flow. On the volume front, quarterly treatments per day up 11% over the prior year's quarter, 9.2% for the 9 months. Operating income, up 8.6% for the quarter, 15% for the 9 months. Actually 15.3. Operating margins are 17.6% for the quarter and rolling 12-month free cash flow -- very important number -- $268 million, excluding the lab recoveries and excluding the tax benefits from stock option exercises.

Those are the four key numbers on an overview basis. Again, reflecting rock solid Q3 performance, rock solid year-to-date operating performance versus guidance. Based upon our current performance and our assessment of everything going on out there, we expect our fourth quarter operating income to be comparable to the third quarter that we just completed.

I will now turn the call back to Gary.

Thanks, Kent. As Kent mentioned, we had another strong quarter financially. Our key financial data is summarized in our press release. I'll address a few key questions regarding financial performance, factors, and trends.

First, what are the current and likely near-term drivers of revenue per treatment? Our $2 increase in average revenue per treatment in Q3 over Q2 was due to commercial reimbursement rates, partially offset by lower intensities in physician-prescribed pharmaceuticals, principally EPO. The year-over-year $7 increase in revenue per treatment was also principally due to commercial rates, while pharma intensities have fluctuated.

With respect to the commercial reimbursement environment, it is reasonable to expect that it will be tougher going forward. Of course, 2005 will be an adjustment year with the one-time hits from the 2003 Medicare Modernization Act that Kent will discuss shortly.

Second, what about treatment volume trends this quarter and going forward? As Kent mentioned, Q3 treatments per day were up 11% year-over-year, with 4.8% from non-acquired growth and the balance of 6.2% from acquisitions. We expect that over the long term, non-acquired growth will average 3 to 5%, with acquisitions adding, on average, 2 to 4%.

Next, what are the key trends in patient care cost? Salaries and benefits represent about 40% of total patient care cost and we will always experience higher labor rates and benefit costs, which this year have been partially offset by productivity improvements. Normal labor pressures will continue to be a principal driver of our cost structure and there may be limited opportunity for further improvements in productivity going forward. Pharmaceuticals and supplies also represent about 40% of total patient care costs. Pharma unit costs have been relatively stable since 2003.

Next, why was G&A higher than last quarter and what is the outlook for G&A spending? For 2004, we stated that it was our expectation that G&A would be between 8 to 8.5% of revenue, and that remains our current thinking. G&A was 8.3% of revenue for the 9 months. You should expect G&A to fluctuate from quarter to quarter due to timing of certain expenses. Given our comments with respect to revenue and expenses, you can expect continued pressure on our operating margins going forward.

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

As to government policy, the subjects we discussed last quarter are still very relevant. Specifically, EPO utilization policy and the MMA, the Medicare Modernization Act. On EPO, the comment period ended October 7th. Current reality is -- the new guideline has not been finalized, our operating income downside risk remains in the 5 to $10 million range. We continue to absolutely stand by the appropriateness of our clinical protocols and our physician practice patterns and prescription decisions and we'll continue to vigorously defend them. Lastly, there is a reasonable probability that the policy will be delayed -- the implementation, that is, will be delayed until sometime in 2005, in which case we will then have to deal with our respective fiscal intermediaries with respect to end utilization standards they contemplate, given that the old national government guideline -- federal guideline, has expired. That's it on EPO.

Second, with respect to the MMA, last night CMS released final rules for ESRD, which will be effective January 1 for the most part. We are, of course, in the very early stages of reviewing the rule and cannot provide you with a comprehensive financial assessment at this time. However, in order to be useful to you, we are at this moment cautiously optimistic that the final rule will result in an impact slightly less negative than we had previously feared. Before we get to the number, let's just highlight a couple of provisions of the revised rule.

Number 1-- CMS did choose to go with a single add-on factor. And by their own estimate, this will cost freestanding facilities an average of $1.41 per treatment. This shift in revenue from freestanding centers to hospitals was not Congress's intent.

Number 2 -- They've raised drug reimbursement levels which correspondingly lowered the composite add-on.

Number 3 -- They have reworked the case mix to include more age categories, low body mass index, and body surface area, and they've eliminated some of the other potential case mix adjusters, which were very problematic. So some very thoughtful work on their part with respect to this issue. And lastly, the composite increase of 1.6% remains intact, as it has throughout the process.

So, as to our financial assessment of the impact of government policy on our '05 economics -- number 1 -- EPO exposure remains at that 5 to $10 million figure, although, obviously, every month it's not implemented, would result in a pro rata reduction of the '05 impact, but nevertheless not change the annualized impact.

Number 2 -- The prior MMA exposure that we estimated was in the range of 10 to $20 million negative operating income impact. At this point we would amend it to be 10 to $15 million instead of 10 to 20.

Number 3 -- The 1.6 sticks, as previously mentioned.

Number 4 -- All of the numbers that I have mentioned above exclude the likely negative impact of any case mix adjustment that they ultimately choose.

Onto the capital structure. I'll just make a few simple points, most of them very redundant to what we have said for the past 3 years. We think about our capital structure with a very long-term view. We don't discuss it in any detail on a quarterly basis with respect to stock repurchases, debt payments, accumulating cash, et cetera, et cetera.

Specifically regarding leverage, we remain comfortable with leverage at 3 to 3.5 times EBITDA. However, we'd also be comfortable going outside this range on an opportunistic basis.

Third, our philosophy remains exactly the same. We first allocate cash to growth at reasonable returns. That would primarily be capital deployed for acquisitions in denovo centers. Then, to the extent that we generate more cash and we can invest in growth at reasonable returns, we will either reduce debt or return capital to shareholders. And lastly, we may from time to time, accumulate cash to maintain operating and/or strategic flexibility. The most likely opportunities would probably be in the area of increased acquisition activity.

On to the '05 outlook. We expect, as we mentioned already, that our fourth quarter operating income will be comparable to the third quarter operating income. Unfortunately the magnitude of the CMS cuts mean that our '05 operating income expectation is for operating income to be flat to 6% higher than the full year '04 level. I repeat, it remains, as it was, which is flat to 6% higher than the full year '04 level. And I should add that this outlook excludes any potential impact from the implementation of FAS 123. We will, of course, update our 3-year outlook on this year's Capital Markets Day, which is planned for December 14th in New York City, and hope to see many of you there. Details on that will follow shortly.

Operator, would you please open it up for Q and A? Princess?

Yes, sir.

Would you please open it up for Q and A?

Yes. At this time, I would like to remind everyone, if you would like to ask a question, press star, then the number 1 on your telephone keypad. We'll pause for just a moment to compile the Q and A roster. Our first question comes from Justin Lake.

Good afternoon. Or good morning. Just have a couple of quick questions. One, on the new physician fee schedule rules, obviously they're in place for '05. I was wondering if you have any expectation on what drug reimbursement is going to look like in 2006.

I'd say the short answer, Justin, is no. A lot of speculation, a lot of discussion, but it wouldn't be worth much to you.

Okay. I guess on the share repurchases -- I know you said you were buying in the third quarter. Have you been buying in the fourth quarter as well?

We never comment on interim quarter activities or, if that's technically incorrect and we have once or twice over time -- I should be a little more careful. But as a general practice, we don't comment on interim or partial quarter activities. We'll just always report fully at the end of each quarter.

Okay. Fair enough. Has there been any thoughts as far as looking at a dividend, considering the amount of free cash flow you're generating there?

Short answer is yes. We've given it a lot of discussion, and it's still a live subject for us when we are looking at a period where we think we might be consistently returning cash to shareholders. Then we have a lot of good discussions about whether or not there's more shareholder value created through dividends versus share repurchases, and those are excellent discussions. Up to this point, we've always thought we did the right things by shareholders to do what we have done, but we have not precluded ourselves from doing dividends in the future.

Okay. And finally on FAS 123, I know you mentioned that quick. I just wanted to have a -- to ask a quick question regarding -- if that does go into place next year, do you think -- do you -- do you think about possibly changing your thoughts surrounding options and, you know, executive compensation? Do you think about going to restricted stock or cash instead of stock options?

First, this is a board issue primarily. Second, the board has had a bunch of discussions on that very subject. Third, the board has altered the mix in recent years, with some of the equity awards being in the form of restricted stock, and that percentage has increased slightly over time. And so, the answer is, yes, it's very much a live issue, but at this point there's no explicit decision about what next year's mix or the year after that's mix will be between restricted stock and options. However, I repeat, the use of restricted stock relative to options has increased over the last couple of years.

Great. Thank you very much.

Thank you, Justin.

Your next question comes from Darren Lehrich.

With regard to clinical adequacy measures, the amenia measures clearly, you know, continue to improve here. I'm just wondering where you think that could go and, maybe, if you could just talk about best practices from your best facilities on that particular measure -- what those facilities are doing, so we can get a sense for where that might go. And then, if you could just speak similarly to vitamin D, as well, on some of the metrics that you provided earlier -- best practices in your system -- where some of those measures are in relation to the -- I guess the 52% number that you gave us.

Okay. Excellent question. But I'm going to have to caution you that one can't, in this area, sort of extrapolate out that the whole distribution is going to shift to the right towards the -- whatever the upper end is. We do have centers that have 94, 95, 96% of their patients with hematocrits greater than or equal than 33, for example, versus the Company-wide average of 87. In my lifetime, it is highly unlikely that we'll ever get the fat part of the curve up at that 94, 95. There are some patients whose physiological condition just precludes that from being possible.

At the same time, 10 years ago no one would have said you could have gotten to 87% with hematocrits of 33 or greater. So, the answer to your question of what are the best demonstrated practices, if you just looked in terms of results, you would see centers with 94, 95% above 33. You call those best demonstrated practices, not necessarily, because best demonstrated practice is really using the right clinical protocol and clinical judgment on the population which you're dealing with.

What about, then, our forecast for future anemia management outcomes? We don't know how much better we can get. We're down to a very small percentage that are less than 30. We've done a good job of promoting a very intense evidence-based clinical protocol and so we don't know how much better our numbers can get.

On vitamin D, it's even more difficult, because of the interplay between vitamin D therapies, which are typically designed to handle and bring down PTH, but the often byproduct, side effect, of increasing calcium phosphorus levels, which can be bad for a patient, so here trying to say, what are best practices, gets a lot more difficult. There is simply not the same protocol clarity that there is with anemia management, although there's some good science and a lot of good discussions. So we do have, again, a wide range of clinical outcomes with respect to PTH and calcium phosphorus product across our units, but for me to cite the best numbers and the best units would be pretty misleading for me to interpolate into any sort forecast of the use of vitamin D therapies.

Have I answered your questions?

That's helpful. I guess just one follow-up there, then I do have one other. Is there any trend, you know, that you're seeing at all with regard to increased amount of parathyroidectomies? Maybe just give us some comments and thought about how that may impact vitamin D therapy.

Yeah. I don't have anything useful to say on that. If you want to call back, and we could reflect a little bit and see if we can sort of get at -- help you as to what you're trying to get at, feel free to. But at a high level, I don't have anything useful to say.

Fair enough. That's sort of left field there. One thing, just on the G&A side, my understanding was there was some one-time legal expenses, maybe in some severance costs inside that number during the quarter. Can you just quantify that for us a little bit better and maybe help me understand what the severance costs were related to, if there were any in there.

G&A moves up and down a bunch. I mean, just look over the last 8 quarters and you see it moves up and down, depending upon when our nationwide meeting is, depending on what happens with our legal bills, depending upon what happens with some of our expenseable CapEx type of investments, et cetera. So, with respect to this quarter, we did have higher levels of legal costs. We did have some severance for some higher paid people, which we expensed, and so, if you want to pick out those items, it could very well be that they explain some of the quarter-to-quarter increase. We think probably, more economically relevant for you and your model, is just to look at our G&A being within 8 to 8.5% of revenue over the near term, and not spend too much time looking at any one quarter blip in any one category.

Fair enough. Then if I could, you know, I heard you pretty clearly, you're not going to say much more on the D.O.J. issue, but any movement at all or any discussions related to the OIG in Philadelphia, which seems to be a separate issue and any more commentary there, please?

No new news on Philadelphia.

Okay. Thanks very much.

Thank you.

Your next question comes from Gary Lieberman.

Thanks. Good morning. Was hoping maybe could you talk a little bit about your decisions in terms of use of capital on acquisitions versus stock buy-backs. And, I guess, specifically comment on what you've seen in the acquisition environment. It would that appear that based on last number of transactions that have happened, that you all thought, and some of your competitors, that prices have increased. You still have in your guidance that growth will come from acquisitions, but could you talk about, at what point do you believe that maybe the acquisition prices rise to a point where, you know, there's a better use of capital?

It's a great question, Gary. We used to say that we paid 4 to 6 times. We can't claim a lot of deals closing at 4 times first-year EBITDA this year, and so I think, for shareholders of our Company and/or the industry, they should be adjusting their models to assume 5 to 7 times, or something like that, is more the true mathematical average of what's going on out there. The good news is that still provides very sustainable return on capital for us and/or the industry.

As to, sort of, at what point do you stop doing them, first of all, that's still very much asset-specific. There are some centers where if you're anticipating 13% treatment growth a year and a nice healthy payer mix, then you would pay a higher multiple than 7, and be smiling for years. There are other centers that you would pay a 5 times multiple for and end up having poorly deployed your shareholders' capital because it might be a center that's declining and be a market which has a lousy payer mix.

So it's always so situation-specific but, on average, the multiples are up. That is bad. They still reflect a sustainable return on capital. That is good. And as for us, we do stare a lot as what is sustainable and what makes long-term sense for our shareholders. Is that sufficiently responsive?

That's very helpful. I guess on the margin, does it -- are there fewer deals that you're able to do, or is it more difficult to find, you know, deals that interest you, given your ability to buy back stock, the price of your stock versus the rising price of the private assets?

No, it is not more difficult right now, nor less difficult to find deals. The higher prices has brought more sellers out of the woodwork. And all the confusion and trauma and tension around these government policy changes have also brought more sellers out into the market. So I would say, there hasn't been a change in, sort of, supply out there. There's just been an increase in the price expectations and the willingness of what some companies are willing to pay.

And then as to our stock, we just stare at it over the long term. We don't pay a lot of attention to it going up or down in any one day or week or month with respect to share repurchases.

Great. Thanks a lot.

Thank you.

Your next question comes from Bill Bonello.

Hey. Couple of questions. First of all, in regards to your guidance about operating income in Q4, why wouldn't operating income increase in Q4, given the large number of centers acquired over the course of Q3?

Because of the integration costs associated with integrating the large number of acquisitions in that period.

Okay. Got it. And then I wanted to revisit your comments on acquisition multiples. Are multiples up for acquisitions of all sizes, or are they only up because you did some larger size deals? Then I have a follow-up to that.

Yeah, I think the honest answer, Bill, is that they're up for all, but they're up more for the bigger.

Okay. And then, shouldn't we -- I mean, just looking forward, wouldn't it make sense that multiples might actually decline for a couple of reasons? One, because of the impact of the Medicare rate changes on some of these independent facilities, and then just also because some of the other consolidators in the marketplace have been taken out over the course of the last year.

We would hope so. And we, ourselves, would like to, and are striving to, pay less and still win, so we can both keep our fingers crossed.

But you haven't seen any evidence of that yet in your latest acquisitions?

I'd say there have been some glimmers of hope, but nothing that should effect your outlook on our valuation yet.

Okay. And then just a final question. I understand why you needed to beef up infrastructure in '04, again, probably given the pace of acquisitions. But at some point shouldn't we expect to see some G&A leverage?

Bill, you are most tactful. I think what we would prefer to have you think is no, that we will continue to invest for the long term in 3 areas -- clinical improvements; state-of-the-art, preemptive, proactive compliance, which we think has huge long-term return characteristics for shareholders; and third, strategic investments, so that the kind of structural changes that inevitably happen in industries over 5 and 10 and 15-year periods, that we're very well prepared for those. So might it happen? Yes. But we think you ought to assume it will not, because we'll continue to find what we think are very sound long-term investments, some of which will fail, but some of which will succeed, and you will be very happy about the fact that we invested in them 5 years from now, if you still own the stock.

Great. And then I lied. I'm going to ask one last question. It looks like operating cash flow and free cash flow are growing considerably faster than operating income, even when we exclude the lab recoveries and the tax benefits from stock option exercises. Is that something that we would expect that differential to continue going forward?

This is Gary. The answer is no. It's just timing of the flows relative to the income.

Just timing? Okay. Thank you.

Thanks, Bill.

Your next question comes from Matthew Ripperger.

Hi. Thanks very much. Just a couple of questions here. Number 1 -- I wanted to see if you could help bring us up to speed on the denovo schedule, and how the ramp-up of the denovos that you added in 2003 are maturing.

The guidance that we had provided for this year was, we hoped to have 25 to 30 new centers opened and certified, and we are on track for that number. Was there a second part to your question, Matthew?

Yes, there was. I believe you opened 30 in fiscal '03? Then the question related to that was, where do those stand in the maturation cycle? Are they mature, or are they fully occupied?

I can tell you that they are on plan, the portfolio and aggregate, in fact, are slightly ahead of plan. We just reviewed the numbers yesterday. That's -- they're on track as to the economics.

I did not ask what the percent average utilization was. That's not such an important metric. The most important one is -- what are the actual earnings or losses relative to plan, because that is much more patient mix and pair mix centric than it is patient volume centric. So the '03 portfolio is on plan.

Is it easy to carve out what the contribution was to your same-store volume growth in the quarter from denovos?

I believe we have that. Hold on 10 seconds, please.

Out of our 4.8% non-acquired growth, somewhere between 2 and 2.2% of that would be from the denovos. As always, there's an element of subjectivity, and that's why I have to say approximately, because when you build a new denovo that's in the northwest suburbs, some of the patients that go into it were patients that were previously in your downtown center. Our analysis of denovo growth seeks to carve out those patients, the canniballized patients, and only give the denovo credit for the incremental patients. Nevertheless it's an imperfect science, although we do it on a bottoms-up basis, by patient, by center. Nevertheless, the answer to your question is -- at about 2 points out of the 4.8 are denovo driven.

Okay, great. The second question I had is -- it related to the MMA proposal that came out, or the final version that came out last night. It looked like there was a pretty material reversal in the Epogen reimbursement level from about 904 per thousand units to about 976. I just want to get your color on why the government, sort of, retraced your steps so dramatically within such a short period and whether you felt that, given now that the reimbursement level is going to be in excess of what the smaller operators are buying EPO at, will it have any kind of derivative effect on the acquisition market going forward?

As to why the government changed its mind -- they started out, as you probably know, at ASP minus 3. They found themselves subjected to a barrage of reasonably rational observations that, if you reimburse people at less than the average of what they're paying for something, when, in fact, there are some paying an above-average amount, that you're subjecting those that pay an above-average amount to one heck of a financial trauma, and those centers disproportionally are the smaller and independent centers. And so that, combined with, one might guess some very effective pharmaceutical lobbying, led them to change their mind and switch to the price and the reimbursement, excuse me, that you just referred to. And then the second part of your question had to do with acquisitions? Could you repeat it, please?

Sure. It was -- I mean to a certain degree, the acquisition has picked up here in the last few months. I think you alluded to, partly because of the uncertainty related to this reimbursement issue and, in part, related to the reduced reimbursement for drugs. So my question was, given now that they have reversed themselves to a certain degree and restored Epogen pricing to a level was more comparable to where it was beginning, will that potentially impact the acquisition opportunities going forward?

I think there will be some people who will be less inclined to sell, you're absolutely right.

The last question I had is related to the Medicare lab recoveries. Is this quarter's lab recovery the extent of it, or are there still potential recoveries in the future?

We have less than $4 million of disputed billings that remain unresolved.

Okay. Thanks very much.

Thank you. And I would like to just remind people that, over the course of this five-year saga, we have been paid now slightly over $100 million and 94% of the resolved items were resolved in our favor. And a couple of percent of those that were not resolved in our favor were ones that we just conceded because it would have had to issue a secondary appeal on issues where we had already won 99% and the administrative and legal costs would have exceeded the benefit of winning the final claims. But that is the 5-year cumulative result of the lab issue that we inherited.

Your next question comes from (indiscernible).

Kent, I was just wondering if could you reconcile the fact that the denovo -- the number of denovos expected to be done in this year has not changed. And your CapEx seems to be trending higher than your original guidance. Can you reconcile that and can you give us a new estimate for capital expenditures for 2004 and 2005?

As to CapEx versus the number of denovos, I cited a few minutes ago. We may beat the 25 to 30, and so some of that CapEx numbers that you are seeing are monies that we have spent, but we're not sure when the centers will, in fact, be opened and counted in the total, because there can be a delay. After we've spent the money and the center is sitting there, there can be quite a delay before the state licenses it and certifies it, and it is, in fact, open, and we report it to you as done. So part of a gap in the dollars versus the number can be explained in that way.

Second, the average center being built today is slightly larger than the average center a year ago. So that also would lead to a different ratio. If you hold 15 seconds, I'll see if there's any other piece of information I can provide that would be useful. Did I cover everything or not?

No. What do you expect capital expenditures to be for the full year this year, and what are you budgeting for for 2005?

Wait one second, please, so we make sure we give you a good number. Why don't we come back to that in the next 5 to 10 minutes and make sure we give you a number that is clearly defined.

Okay. And then I have two more questions. On the denovos, has your ability to accelerate, given the processes and improvements you've made in the overall business -- has your ability to accelerate the denovos increased? My last question is, what percent of your debt is currently fixed with swaps? Thank you.

The percent of our debt that is currently fixed with swaps is about 25%.

And on the other question, yes, we can do denovos faster and cheaper than we could 3 years ago. Having said that, it's not a dramatic difference. It's relevant, but it isn't so dramatic that it's going to change your model.

Thanks.

Your next question comes from Justin Lake.

Hi. Just a quick housekeeping question. The share count going into the fourth quarter, what should we be using there?

I'm sorry, the question was what?

The share count. I know you were repurchasing stock during the third quarter.

Yes.

So at the end of the quarter, I would assume the share count is probably lower than the diluted reported for the full third quarter. So what should we be using going into Q4?

We'll get that for you in a moment.

Thank you. That's it.

Your next question comes from John Ransom.

John?

He has withdrawn his question. At this time, there are no further questions.

Okay. If those that are interested in answers to their previous questions want to hold for 30 seconds, hopefully we'll be able to provide those. If not, you will be able to call us right back on a direct line and get the answers.

We have a question coming in.

Okay.

Okay. From Darren Lehrich.

Just one other follow-up here. Related to PDI. I'm just wondering if you could give us a feel for how many patients are in that book of business. I remember when you announced it, I believe it was about 1500 patients, if memory serves me right. If you could just give a sense for what that number is now, just given that, I think that there are a number of fairly immature centers, just so we have a good sense for what that is, now that you own it.

Yeah, we estimate approximately 1700 patients.

1700. I'm sorry.

That we would have at this point, and that's about the number we have.

Okay. And they were running at about $286 per treatment? Is that correct?

That is correct.

Okay. And what do you think you'll be able to do with the revenue per treatment? And, just maybe comment on lab integration -- how quickly that will occur. And then I'm done. Thanks.

Yeah, the revenue per treatment is something that we hope to improve over time, and it's not possible for to us attach a schedule to that. Suffice it to say our expectations are embodied in our '05 outlook. And did I miss the second part of your question?

Just lab integration. That's a piece of it that maybe I can think through a little bit -- how quickly you'll integrate that.

They will start using our lab very quick quickly, and there will be some -- ultimately some incremental margin created by that, and that also is incorporated into our '05 outlook.

Okay. So they will be fully on the lab, I should interpret that as, by the end of the fourth quarter or sooner?

Yes.

Okay. Thank you.

Thank you.

Your next question comes from John Ransom.

Sorry for the phone crash. I was wondering, Kent, if could you elaborate on the negative color that you hinted at relative to the case mix and how I might think about that. Thank you.

Sure. First let's just answer the end of quarter share count question, then I'll come to that.

The actual share count at the end of the quarter was 99,168,930, and the average for the fully diluted calculation was 102,889,781. Of course, that average for the fully diluted calculation will change for fourth quarter based on the activity in the fourth quarter.

On to the case mix question and why I had a negative outlook on it. When the government implements a case mix system, they say, gee, out of every 100 patients, 20 are harder than others, more expensive, 20 are easier than others, and 60 are normal. Of course, this is a gross oversimplification. And this is how much different we're going to pay for the ones that are more difficult and the ones that are less. Very important to the government to not end up paying more than they would have before under the non case-mix adjusted system. So they will tend to be conservative and assume that there are more of the higher cost people and, therefore, they'll cut the reimbursement more for the other categories in order to have enough money to pay for those higher cost patients. And so, you could very well end up at the end of the year, where the government has paid out less because it turns out there were fewer of the more expensive than they assumed when they set the 3 pricing levels prospectively, and that leaves us with exactly the same patients we had the previous year and less money.

This is a follow-up to that. Is it possible that you would be paid in such a way for your trouble that it would be positive? Or is it going to be an averaging system where the providers that provide more intense levels of care automatically are going to be penalized?

Well, I guess I'd just -- just look at the most recent MMA experience. The Bill was supposed to be absolutely revenue neutral for what we would have been paid otherwise in '05. That's literally the words that Congress wrote. You just heard our estimate several minutes ago about how much of a revenue reimbursement cut we are going to take. And so I think, while the answer to your question is yes, that could happen, theoretically, it is simply unlikely because the government wants to play it safe and make sure they don't end up spending more and, therefore, the numbers they use will create a very high probability that they, in fact, spend less.

And finally, do you think you would be in a position to bracket the impact of this by the time of your capital market stay, or is it going to take longer?

I don't think we'll have any more information from the government which will help us, because they're still working this issue, and they won't have anything to share with us between now and then. Not for any bad reason, because they'll still be working their formulas, looking at the data, et cetera, et cetera. So perhaps, we could do what we did a year ago on some of the pharma issues and add-back issues, where we just come up with our own little construct of what might happen just so you guys have some sense of how to put it in your model, even though we can't at all represent it as being the most likely alternative, it's just that it's better than a number of 0 and not providing any help to you whatsoever. So we'll take a stab at that, and if we think it's a better number than 0 and this negative watch-out comment, we'll provide it.

So I would presume the 0 to 6% operating income guidance is before any adjustment you might make on this particular topic.

Correct. Our outlook -- our '05 outlook excludes the case mix adjustment just because we could come up with something, as you pointed out, positive, or more likely could come out with something significantly negative, and, therefore, it's impossible to incorporate into our outlook at this point.

Okay. Thanks a lot.

Thank you.

Your next question comes from Matthew Ripperger.

Hi, thanks. Just one follow-up question, if I could. You mentioned in your remarks that your -- that historically you're comfortable going up to a debt EBITDA ratio of 3 to 3.5 times, but then this time you said you're comfortable going outside of that range to be opportunistic. I just wanted to see if you could help us explain -- how high above the 3.5 times leverage ratio you would be willing to go? Number 2 is -- when you consider opportunistic, would you consider share repurchases opportunistic or would it be something other than that?

Excellent question. Before answering, let's go back and cover the CapEx question, so if you can hold one second, Matthew.

Sure.

This is Gary. With respect to denovo expenditures, first, the projects take, on average, 18 months to complete. We have completed and certified 25 centers so far this year, year-to-date through September, and likely we'll get a few to several more certified by year end.

We expect 2005 to be a similar number in terms of projects and expenditures, and our quarterly spending rate is typically in the 15 to $20 million range. Hopefully that answers your question.

This is not --. Matt, let me address your question. Number 1 -- We have always said that we're comfortable at 3 to 3.5, but there may be significant periods of time we're above or below. So there's no news there. That's a restatement of what's been said many, many times before over the last 4 years. The answer to your second question is, yes, that we could decide that opportunistically, it makes sense to go above that leverage ratio for either an acquisition or a share repurchase program.

Thanks very much.

At this time, there are no further questions.

Okay. Well, thank you, Princess, and thanks everyone for your interest in DaVita. We will do our best in the months to come.

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