德維特 (DVA) 2004 Q4 法說會逐字稿

Good morning. My name is Cory, and I will be your conference facilitator today. At this time, I would like to welcome everyone to the Fourth Quarter 2004 Earnings 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 "one" on your telephone keypad. If you would like to withdraw your question, press the "pound" key. Thank you.

Ms. Zumwalt, you may begin your conference.

Thank you, Cory. And welcome everyone to our fourth quarter conference call. We appreciate your continued interest in our company. I'm LeAnne Zumwalt, Vice President of Investor Relations; and with me, today, are Kent Thiry, our CEO, and Denise Fletcher, our Chief Financial Officer.

I'd like to start with our forward-looking statement disclosure. During this call, we may 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 changes in underlying factors, new information, future 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 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.

I'll now turn the call over to Kent Thiry.

Thank you, LeAnne. Welcome to all. I'll start off by addressing five items. Number One, clinical results; number two, Gambro; number three, public policy; number four, '04 economics; number five, '05 outlook.

I'll start with number one, clinical results, because we are the first and foremost a care-giving company. And with respect to our results, we'll provide the same two scores that we've provided in the past. First, adequacy, again essentially, how well we're doing it, removing toxins from our patients' blood. 94% of our patients had a Kt/V greater than 1.2 in the fourth quarter. Second measure, anemia measurement, and more specifically the percentage of our patients with hematocrits greater than or equal to 33 was 86%, actually down 1% from last quarter's outstanding results but nevertheless very strong.

On to the Gambro acquisition. Let me address, preemptively, a few questions, which hopefully will facilitate an efficient treatment of this subject. When do we submit our antitrust filings, and can we give you any guidance with respect to clearance timing, probability of divestitures, etcetera, etcetera? We filed January 19th, and I really wish it were different but it's just not a good idea to speculate about what they're going to decide and when. We're having very intense conversations with them, but it is simply too soon to predict exactly what they're going to do.

What steps are we taking right now to prepare for a smooth integration? The answer is a bunch. We're working very collaboratively with the Gambro people both in Sweden and here in the States. The goal of the integration is to ensure that we have a good cultural transition and also that we pick up the best practices from each entity. We've got a steering committee set up with folks from each of the two companies, a lot of the working committees reporting to them, and we're trying to do a whole lot of communication to alleviate people's anxiety.

Next question regarding Gambro. Why again will the EPS impact be dilutive in year one? Answer, it's the combination of the additional debt costs iand an estimated 30 million to 35 million of net year-one economics. Please also remember that Gambro does have to incur operating costs associated with implementing the corporate integrity agreements and, of course, preparing for the integration itself.

What about those key integration costs? What more specifically are they? I think the single biggest one will be the IT systems and related implementation costs. The good news for those of you who have been shareholders of ours for a while know that, between 2000 and 2004, we changed every major transaction system in DaVita -- patient registration, clinical management, and billing and collecting.

And so the good news is that we've got a lot of recent experience, and we're able to do that without missing a beat. The bad news is that, nevertheless, it's a lot of work and expensive and takes some time. Additional integration costs will come from some inevitable productivity declines because of some of the communication bumps in the road. There'll be some retention pay, and there will be some additional legal and compliance spending. So, those are the big ones.

The next question, what does the CIA imply for your operations? And the short answer is, it will be a pain, and it will cost some money, but because DaVita has on its own implemented very strong proactive compliance, there is not going to be a stunning difference. The fact is that the difficulty lies in the different procedures to achieve this end and the CIA reflects particular procedures that the government wanted done in a particular way and so the awkwardness under additional expense comes in, when we try to decide whether or not to do those different and in some cases higher costs procedures in the DaVita centers as well, or incur the cost of running two different sets of procedures for the five-years that the CIA runs. For any other questions regarding Gambro, you might want to check back on the December 7 conference call transcripts or ask them again here today.

Third subject for me is, Public Policy update. There are three big areas active right now:. Number 1, fixing the MMA. Number two, working on the EPO policy, and number three, get in annual update, the Holy Grail for us for so long. Regarding -- excuse me -- regarding fixing the MMA, they made some mistakes in implementing it, most particularly, transferring about $1.40 per treatment from the freestanding facilities to the hospital outpatient facilities which was not intended by Congress and we will be working to address that in justice.

We'll also working with Congress and CMS on the case mix, which they are supposed to implement soon, but may have to delay. Our current '05 MMA financial exposure, taking all that into account, is about $2 to $7 million on the negative side and this number takes into account the reimbursement loss from the implementation of the average acquisition pricing for Pharmaceuticals, an estimate of our exposure to the case mix move, and the 1.6 statutory increase in our composite rate which was effective January 1, '05. So the number netting all that together is in the $2 to $7 million negative range. The bad news is that it's negative; the good news is that it is much smaller than we feared a few months ago.

Next, on EPO, the government has still not finalized what their policy will be here and in fact, if they will have one and when they will come out with it. And therefore, our estimate of our operating income downside remains at $5 to $10 million, pretty impossible to speculate as to what exactly they're going to do. It does seem clear they're not going to do anything dramatic, but nevertheless we think having this downside in mind remains proved. Last government topic is ESRD Modernization Bill, it will shortly be reintroduced with a bunch of bipartisan support and we will push it as best we can.

Fourth of my five topics is the '04 economic performance. Both the fourth quarter and the entire year were rock-solid once again. A couple of the metric worth focusing on, volume, up 14.5% quarter-over-quarter and 10.6% for the year, so our best growth in five years. Operating income, 8.2% for the quarter and 13.3 for the year, was very satisfactory and operating margins, 17.1 for the quarter.

The rolling free cash flow, that's the rolling 12 month free cash flow more specifically, we think perhaps the most important single number certainly among the top few, was a strong $314 million, excluding the lab recoveries and excluding the tax benefits from stock option exercises. If you include those items, it jumps up to 373 million, but we think the 314 is a better reflection of the recurring fundamental economics of the business.

My last topic is the '05 outlook. Our previous '05 operating income guidance was for operating income to either be flat or go up 6%, somewhere in that range, 0 to 6% over '04. Our new '05 operating income guidance is for operating income to be up 2 to 6% over '04. Importantly, this excludes, of course, the effects of the proposed Gambro acquisition and the related debt financing as well as the anticipated expensing of stock options going forward.

By the way, with the Gambro acquisition, we are, of course, assessing all sorts of financing alternatives and that could include closing some or all the financing in advance of the closing of the deal itself. Operating cash flow for '05 is expected to be in the 330 to 380 range and free cash flow is expected to be -- which is after maintenance spending of about 50 million, is expected to be in the 292 to 310 million range. I will now turn the call over to Denise.

Thank you, Kent. Hi everyone. As Kent mentioned, we had another strong quarter. Our key financial data is summarized in our press release. I will address the two questions regarding financial performance factors interest.

First, what about operating margins in the quarter and going forward? Operating margins declined 50 basis points from the third quarter to 17.1%. The majority of the fourth quarter margins compression was from one, adding PDI operations with lower revenue per treatment, two, the opening of 19 de novo units in the quarter and 39 units in the last nine months, and three, the integration costs associated with PDI and the six other acquisitions.

Going forward, as we stated previously, we expect continued pressure on operating margins. As operating cost pressures continue, while increases in revenue per treatment are constrained. So, what are the key -- I am sorry -- what are the current and likely near-term drivers of revenue per treatment? Our $2 decrease in average revenue per treatment in Q4 over Q3 was due to the acquisition -- the addition of PDI with lower overall reimbursement rate and to lower intensities in a physician prescribed pharmaceuticals, principally EPO. The year-over-year $5 increase in revenue per treatment was principally due to commercial reimbursement rate and to increases in pharma intensity.

As noted last quarter, with respect to commercial reimbursement environment, it is reasonable to expect that it will be tougher, going forward. What about treatment volume trends in this quarter and going forward? Q4 treatments per day were up 14.5 year-over-year with 6% from non-acquired growth and the balance of 8.5% from acquisitions. We expect non-acquired growth to average 4% to 5%, with acquisitions adding on average 2% to 4%. The guidance, of course excludes the Gambro transaction.

Next question. What are the key trends in patient care costs? Salaries and benefits represent about 40% of patient care costs. We will always experience increasing labor rates and benefit costs, which this year, have been partially offset by improved productivity and there may be limited opportunities for further improvements in productivity going forward. Pharmaceuticals and supplies also represent approximately 40% of patient care costs. Pharma unit costs have been relatively stable since 2003.

Now let's turn to G&A. Why was absolute G&A higher than last quarter? And what is the outlook for G&A spending? G&A in the fourth quarter compared to Q3 was flat as a percent of revenue and flat on the per treatment basis at $28. You will recall that for 2004 we stated that it was our expectation that G&A would be between 8% and 8.5% of revenue. G&A for the year was 8.4% of revenue.

You should expect G&A to fluctuate quarter-to-quarter due to the timing of certain expenses. In 2005, we expect G&A to be approximately 8.5% of revenue, due to, one, our continued investments in clinical quality, two, strategic initiatives, and three, compliance. But excluding integration costs related to Gambro that we may incur before the close of the acquisition.

Okay. On to financing updates. In December 2004, we entered into an $800 million fixed floating swap with an effective date of July 1, 2005. DaVita will pay a fixed rate of 3.875% quarterly and receive LIBOR. The swap has a four and a half year duration, which terminates on January 1, 2010 and amortizes over the life of the contract.

And now Operator, we are ready for questions.

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&A roster.

And your first question comes from Justin Lake from UBS.

Good morning. Good afternoon. What were the accelerated -- what were the drivers behind the accelerated non-acquired treatment growth in the quarter that you saw, going up to 6%?

Primarily, the growth of the de novos that had been opened up in the prior 12 months and maybe a little bit on the pure organic side as well, but primarily the de novo.

Okay. Specifically, I believe that there might have been some facilities that were either just opened or were looking to be opened in the fourth quarter that were acquired from PDI. Can you tell me what kind of effect they might have had on growth? I'm talking, I guess, to be little more specific, I believe there might have been a hospital based facility that had a contract with PDI that had a couple hundred patients.

Yes, I cannot comment on the growth of a specific PDI Center, although I think the situation you're describing -- you are describing accurately, I don't know the exact numbers pertaining to that.

Okay. So you're saying that the 6% might look like more like 4% or 5% next year?

Correct. That is correct. That was what we said that looking forward look for non acquired growth in the 4% to 5% range.

Got you. Do you have -- as far as the growth that you've seen there obviously, at the high end of the industry range do you have -- can you talk a little bit about the payor mix among those patients, for instance what percentage of the patients are covered by insurance that you saw in '05 versus the last three to five years?

Just among de novos or you mean across our overall population?

Across the population.

We experienced no material change in our payer mix in the fourth quarter.

Great. I just have one other question, looking at the Gambro acquisition, its my understanding that you've stated that the new Medicare reimbursement changes would have minimal effect on their '05 results. I was just wondering what you might have built into your assumptions in regard to (inaudible) and how their assumptions might have matched up versus yours?

I can't be sure about what calculations they have made, as to our estimates they are exactly what I mentioned in my prepared remarks, which is on MMA alone. We're looking at a negative impact to somewhere between 2 million and 7 million and separately, on EPO -- potential EPO exposure if they come up with some dumb rules we would have exposure of negative 5 to 10. How that compares to them exactly I just can't opine. And I should clarify one thing I said that the number I just gave for MMA is net of the 1.6% rate increase, just to remind people.

Right. I guess, what I'm trying to ascertain here is that the -- there is some, I guess lack of kind of, kind of consensus in what the run rate EBITDA number for Gambro is, and I'm wondering if what you've kind of, talked about for the possibilities for '05 that we might be able to back into, might have included some deterioration in profitability because of the MMA that maybe Gambro had said they didn't expect to receive, then you and your calculations using your assumptions is that now maybe it's going to be a hit of $10 million or $50 million such as the one you're looking at.

Yes, I hear you very much, and I'm afraid we're not -- we're just not well positioned to pierce whatever confusion exist there, because we do not have perfect insight into all of their numbers and all their accounting policies. And on top of that, of course, exactly, how someone forecast the impact of MMA is highly dependent on the specific assumptions that you make. So, I hear what you're saying, but I don't think we can clear up any discrepancy because we are, of course, still -- even though we're working very collaboratively on integration, there are certain things which are still just separate.

Okay. Well, thank you very much. I'll get back in the queue.

Thanks Justin.

Your next question comes from Bill Bonello from Wachovia.

Right. Just a handful of questions. If de novos have been driving the non-acquisition growth, which makes perfect sense, and you just opened 19 de novos in the quarter, it seems like, logically, we wouldn't expect to see a near term drop off in that non-acquired growth rate, am I not thinking about that right?

You're thinking about that as rational as always, Bill.

Okay. And just to be crystal clear, PDI had no impact on that number, right? I mean that's part of your acquisition growth I assume.

Correct. Our PDI stuff would have been in the acquired.

Okay.

I don't think -- had we literally opened up a new center a month after the close that was built from the ground up, would anyone have categorized as a de novo. I don't think so. We can go back and check. I'm not sure it's worth, quite frankly, checking one way or another. The fact is the PDI results are on or ahead of plan, and our overall non-acquired growth, as you know, is ahead of plan. And so, parsing out anything between the two with respect to some individual center in the fourth quarter, I'm not sure it's worth people's time, and if I'm missing something, we'll spend the time.

Got it. Better you than me. Why do you think you're seeing a lower intensity of EPO utilization and did that continue to trend down during the quarter?

First, let me just go back for a second. On the non-acquired growth, I just want to return to your statement that it is true we've opened up a bunch of de novos, and it is true they are driving some of that growth. And if things go well, it could be that we would burst outside the top of that 4 to 5% range. But a lot of the new de novos are so young right now though that we just don't want to be necessarily assuming that they're going to do as well as the batch that we have planted a year ago and eight months ago.

Sure.

That's why -- that's how to reconcile your statements to our forecast. And maybe a year from now we'll be able to say that we did just as well with the second batch as the first batch.

On EPO, the usage was down, as you heard in our clinical remarks, our hematocrit were also slightly down, and as to what exactly the trend was through the course of the quarter, I'm not sure, and I don't think we want someone getting to discussing month-to-month movements in EPO, but quarter versus prior quarter usage was down and the clips were down a little bit too. Am I answering your question, or do you want to come at me again?

No, I get that. I'm trying to understand why you think that's happening?

Don't know is the short answer, it's a pretty small adjustment across 50,000 patients and 650 centers. So, sometimes it moved up a little bit, this time it moved down a little bit. Having said that, there is some indication that it could be, given we've had some patients at a very healthy hematocrit level for a while, that the amount of EPO it takes to keep them there is might be less than the amount of EPO to get them there and keep them there for the first year or two. So, that may be part of the explanation as well. I cannot say for sure.

Okay. That's helpful. And then, just one last question on the revenue, and I'll hop back in the queue, but last quarter, you indicated that you expected to open 25 to 30 de novos in '04, and if I'm doing my math right, you did 44. Should we just assume that some stuff open sooner than you expected and that we'll sort of see a drop-off, a pretty significant drop-off in the pace of openings in '05, or how should we think about '05 activity?

A fair point. We did, in fact, do better on our timing on a number of them. And, so, some of the '05 did go into '04, and so, there is an element of that. We can't really quantify that for you, we are just thrilled to be ahead of plans in the fourth quarter. So, the short answer to your question is, yes, the '04 Q4 surge has to be taken into account when you think about '05, and should probably think of maybe about six or seven centers that were stolen from '05 by '04.

Okay. That is perfect. I'll hop back in the queue. Thanks.

Thanks Bill.

Your next question comes from Gary Lieberman from Morgan Stanley.

Thanks a lot. You said that the effective filing date with the FTC was January 19th on the Gambro merger. Have you received any second request from them for additional documents?

No.

Okay. So then, am I correct in assuming that if you don't receive any second request that you would get HSR approval as early as February 19th -- 30 days after you filed the documents?

No, you can't conclude that because in some cases the time period might be, by mutual agreement, extended. I think it would be inappropriate for anyone to start to expect that we would not get a second request, while we would be thrilled by that outcome. It would be inappropriate for anyone to anticipate it.

Would you need to file an - K if you receive a second request or put press release out?

I don't know offhand. But I think what I want you to just do for now is expect it, and then, there's always a chance that we'll be pleasantly surprised.

Okay. Is there any way you can elaborate sort of what you mean by mutually agreed upon timeframe, because, I guess, my understanding was that if you didn't -- if you hadn't received a second request within 30 days that you, typically, a merger would be granted HSR approval.

That's unless the two sides agreed that they wanted to -- if they wanted to consider a couple more things. And we agreed to waive the deadline; otherwise they are required to respond within 30 days. But if they're not a quite ready to respond, however, they don't feel like necessary launching entire second request, then we agreed to waive the 30 day deadline then both can work together for another week or two on any outstanding issues.

Okay. That's very helpful. And then if I can just ask one quick follow up on pricing. Sequentially revenue per treatment came down just a little bit. I'm assuming that's from some of the acquisitions that you did in the second quarter. Is that correct or is there something else driving it?

As we mentioned, a bunch of it is from PI alone, the big acquisition from the third quarter. Some of is from the other smaller acquisitions, and some of it is from the drop in EPO usage.

Okay. Thanks a lot.

You're welcome.

Your next question comes from Andreas Dirnagl from JP Morgan.

Yes. Good morning. A couple of questions probably for Denise in terms of the financing. First of all can you just provide some color as to what was going on in the interest expense line during this quarter? What caused it to go up from third quarter sequentially despite the fact that...

It was mostly all in the rates line.

Okay. And then concerning those, what's in the press release and Ken's comments about your assessing financing alternatives, which could include closing some or all of the financing in advance of the Gambro transaction, can you maybe provide more color or details on that? I mean specifically, what would cause you to want to take down a great deal of money that you don't need at that time until the Gambro transaction is completed?

The most I'm going to tell you is that if we do something like that it's going to be part of a hedging strategy. Hedging define broadly.

Okay. Great. Thank you.

Your next question comes from Eric Percher from Thomas Weisel Partners.

I had around for the integration costs for next year was 20, 30, 40 million and cost looks like. And I wonder you've lot of experience with systems integration and rollouts, what does it cost to go through the three systems is gone through and most of your centers and maybe at a single center level what's the cost were you want to related PDI and what you cost you've seen? Just trying to get some level -- to compare it to.

Okay. Let me try rephrasing the question and answer it in the way that I can and let's see if it gets to where you want to be.

Sure.

If you ask us how much did we spend to develop and implement the patient registration system, clinical management system, and building collecting system and will close out through the DaVita network that total cost over about four years was enable, had about $36 million.

Okay. Great. That gives me some level to compare. Totally unrelated question you didn't mention in policy the conditions for Medicare certification it doesn't look like anything that would change the way operate. I wonder if there is a material compliance costs for those regs?

The regs as you know, number one are not final, there is a 90 day comment period. They are extremely detailed and they are asking actually for comment in number of areas and the number of areas what I call exploratory. Pass that, there are going to be some changes in documentation and a few other things. We have not quantified yet because again it's not final, what that operating impact could be.

Okay. Thank you both.

Thank you.

Your next question comes from Matthew Ripperger from Smith Barney.

Hi. Thanks very much. Just a couple of questions. You mention that potential for insert the modernization build and brought by the partisan support for that. I just wanted to see if you could give a little more color to that and whether there is a chance that anything could included in that related to extended period for commercial payers around that market? I think, I recall that was on the table back in 2003.

Okay. Matthew, the answer to the second question, might they extend the private pay coverage period, is yes. They might do that. And the answer to the first question, give me the first question about the bill itself. You wanted elaboration on the nature of partisan support?

Yes. Please.

It's pretty good, although young in that we are early in the legislative year. On the Senate side, we had Senator Sanctorum, on the republican side, and these are of very influential Senator part of leadership. And we have Senator Conrad on the democratic side and both these folks on the Senate Finance committee. In the house, we've got Dave Camp on the House Ways and Means Committee, which has been our sponsor several years in a row and represented Jefferson from the democratic side Champion (ph) Republication. There is a list, which I'm all go through of co-sponsors from each parties that's being added to each week in both the House and Senate. But those of the Champions, those four people.

Okay. Great. Second question I had is just assuming that the deal goes through, after the deal will you continue to allocate capital to growth would be de novo or acquisitions or will you priority be towards leveraging?

We will continue to allocate capital to growth and, in fact, we have designed our financing strategy such that we will have the flexibility to do that, well at the same time the good news is being able to bring down our leverage ratio quickly just because there's so much cash flow to deal with. So remove the leverage ratio down at a very good pace and we simultaneously do de novo and acquisitions, such as the beauty of our dialysis business cash flow.

Great. And last question I had is when you look at the G&A costs and aggregate for the company right now, how much of that would you characterize as being corporate and more centrally based rather than in the field based? And how leverageable do you think that cost would be assuming the deal goes through?

I do not -- we don't ever look at, sort of corporate versus field the lines are too blurred. So we really don't have an answer to that one, although, obviously, we look at every single component of its all the time. As far as how leverageable it is, the fact is there will be some leverage and we can't put a number on it yet. And it will be a nice number of dollars, but not a stunning number of dollars. Historically, as DaVita has grown, the amount of leverage that we picked up on the normal overhead side, the normal G&A De side, we have taken those dollars and invested them in strategic initiatives leading to flat G&A as a percent of treatment revenue.

In the new company, how much of the freed up dollars we put into the profit verses we put into the push for these strategic initiatives is not yet been determined.

Okay. Great. Thanks very much.

Thank you.

Your next question comes from Herman Hammer (ph) from -- he is a private investor.

Good afternoon. I want to ask this question, please, I had an occasion to go to a nephrologist a number of years ago, and he had a dialysis operation -- by the way, Ken, I remember you from Viva. That was a long time ago.

It was.

Yes, I was with Merrill Lynch at that time and we did very well with the stock. But at any rate, I had occasion to go to a nephrologists a couple of years ago, he had a dialysis operation of about 10 machines. And he has since sold it, I am sure, to someone. But one of the things that I noticed there was that on Saturday and Sunday, the assets stood there unused. Are the dialysis machines at DaVita used seven days a week?

Short answer is no. There is very little in our centers on Sundays. A lot of our centers are very busy on Saturdays, so a lot of our centers are used six days a week, and a small number are just used three days a week because while it was a good idea to put the center there, so there's enough patients and the patients really appreciate the geographic convenience, there are not yet enough to run two shifts a week.

Well, unfortunately, Ken, we're dealing with something where the patient in a crowded area, as far as supply is concerned, really doesn't have much that they can say about it. And I just throw out the idea that, especially down here in South Florida, I noticed going up Hillsborough Boulevard one day last week, that you have an operation opposite a very large complex called century village that has 15,000 people in it. I just wonder, have you ever thought about the idea of extending it to Sunday's in the areas where the demand was there.

It's a great point. We probably haven't given it much thought as we should, and we will take it into consideration.

Well thank you so much, Ken, for even listening to me and I wish you continued good luck. It took me five years to find out where you were.

Thank you, sir.

I kept looking and looking and looking. I just could never find -- who was Viva sold to any way?

It was sold to Gambro, ironically.

So this is a homecoming.

Yes. Anyways, but Herman, I'm getting coached by my people here that we are hogging the airtime. We have to answer other people. But it's good to hear from you again and we will do the best we can.

Thank you so much, and I'll take the liberty of calling you at the home office sometime.

Have a nice day.

Thank you so much.

Okay. Bye.

Your next question comes from Balaji Gandhi from Pacific Growth.

Ken, I didn't know you were such a hard man to track down. But, my question was for commercial pricing. You've mentioned in the past and today in the prepared remarks that it's getting tougher. Can you provide any more color on anything you're seeing out there to make you feel like it's going to get tougher anytime soon?

Two things, and they are both also the high level, but I think directionally relevant. One is that the year-over-year premium increases that the insurance companies are getting are lower and that always portends lower rate increases for the providers.

Now, in this case, since there -- part of why their rate increases are lower is that their medical loss ratios have been lower than expected, and particularly a lot of the blues plans are under pressure not to do anything with their rates because there surpluses are building up so significantly, and once they stop raising rates as much before profits have to as well. And therefore, that would not necessarily portend any tightening for providers because they've got essentially the same margins with a lower increase. So with that qualification, nevertheless, I always want shareholders to pay close attention to what's going on with the year-over-year premium increases.

The second thing is just that the payers continue to consolidate and those that have consolidated continue to become more coherent and the first phase of that can be additional rate pressure on folks because once they get to the second phase of consolidation and become more thoughtful, we have a lot of upside because we bring a huge amount of value to the table. For in the first wave of their consolidation, when they are just trying to justify the deals they did, they tend to look at short-term rate cuts or smaller increases wherever they can. So it's for those two macro reasons that we kind of want to have the yellow light blinking in our shareholder spreadsheets. Is that responsive?

Yeah, that's fine.

Your next question comes from Darren Lehrich from Piper Jaffray.

Thanks for taking my call. Just a couple of questions here. As it relates to your not acquired treatment growth, just to get a slightly better understanding of what's driving that, and if you are able to mainly break down the impact that's driven by the De Novos versus organic, and, I guess, similarly if you could just maybe comment on some other clinical metrics that may have played into the strength of that number, such as mortality or hospitalization rates, just so I can understand if there is some clinical things that might be impacting that as well.

Number one, there was no difference in hospitalization rates that we know that would have explained any of it.

Number two, we did accomplish a slight increase -- a slight improvement, which is to say a decrease, in our gross mortality rate, about 2/10ths '04 versus '03, and that would add to it. I will also point out that we continue to have the lowest gross mortality in the industry.

Number 3, as to the breakout between the non-acquired growth due to De Novos verses the non-acquired growth due to organic, I will probably be able to get back to you within two or three minutes with it. My guess is it's going to be organic growth, it's going to be in the 2 to 2.7% range and the balance is going to be De Novos, but I might be understating the organic via TAD (ph).

Okay, fair enough. And then if I could just follow on the -- on Balaji's question regarding the contracting, is there any way that you can maybe help us understand how contracting itself may have changed for you or if you foresee any changes as it relates to either national contracting or more regional base contracting versus more localized contacting, which I propose you would prefer and probably still have quite a fair bit of. So just help me understand that part of the commercial environment.

Yes, if you look over a period of years, you would say that yes, there has been some shift from local to regional. Now before going any further with that, please note that the Big Blues plans have always been, dominantly a leading state wide contracting, not local, and they are very large part of the market. And so when I say local to regional, in some cases that's moving from state to multi-state, in other cases it might be city to multi-city.

Independent of the specific starting point and ending point, the clear strategic trend is for a higher level of aggregation. Nothing dramatic year-over-year, but cumulatively a difference. This is one of the reasons why the acquisition of Gambro makes so much sense. Because the larger footprint will allow us to sell in the higher value added products to the more aggregated purchasers, meaning case management, disease management, vascular access, more stuff with the home, et cetera.

Few more things if I could, I'm still not really understanding why the interest expense jumps sequentially by more than $2 million. Was there a one-time payment to put that swap into place? I don't really think rates for all that volatile, and I'm just trying to understand why there was a sequential jump in your debt balances were down?

There were no costs associated with putting in any kind of swap. And the interest rate did go from 4.09 on a wanted basis to 4.47 on the whole, so it did jump up pretty substantially.

Okay. That's what I was looking for. And then finally, de novo costs in the quarter, startup losses, if you would fourth quarter relative to third quarter so I can kind of normalize what that might look like going forward. And then one final housekeeping item just patients managed and patients in your operated units, please.

And the second question is, and I'll answer that question for you. We have now a total of 32 managed centers with 3,100 patients in those. Does that answer your question? We have 51,000 owned patients.

That's fine. And as far as cost of de novos?

Say that question again, please about the cost of de novos?

Well, you're clearly funding startup losses and given the amount of openings you had in '04, there was I guess a big bonus of facilities that came on in the fourth quarter, so I think it would be fairer to ask the question what would your startup losses have look like in the fourth quarter relative to the third quarter, which I would assume look like one of a normalized period of de novo opening. So I'm just trying to get a sense for how much extra startup losses you observed in the quarter because of the some -- the surging in openings. Thanks.

I don't know that number. We don't take -- in total in that quarter I think we had about $700,000 in de novo operating losses, but how that would compare incrementally to the third quarter, I don't know.

Okay.

What I can do, and it may be might be helpful, I mean is a very fair question. And if you want a follow up with Li (ph) and you can get the answer. Our de novo portfolio is on plan overall, so at least you don't have to worry that we were running at a level of operating loss that was different from what had been intended.

Okay. Got the response. And thank you.

Thank you.

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

I am looking at the 6% and non-acquired growth and I understand lot of de novos but would you say that the market growth accelerated overall or that you gained share?

We gained share.

And where do you see the market kind of growing today?

I would pay I guess somewhere in the 4.5% to 5% although I haven't seen any fresh analysis for a while.

Okay. And what would you expect your number of de novos and your CapEx budget to be for 05?

We will probably target about opening 35 centers. And because of the timing of bringing those on, I think the capital you could say would be in the $60 million to $70 million range.

For the whole company?

No, related to growth expenditures because we will be spending money for those who not come on line. So I - and you are going to estimate, that would be total spending for that. In addition, probably about 45,000 for maintenance CapEx.

So it's something about 110 or so?

Yes. That's a reasonable number.

Thank you.

Let me go back for a moment to give the earlier person, a specific answer regarding the breakout of the total of 6% non-acquired growth. The base organic growth was right around 3% and the '02 and '03 to know vintages added 1.5% and the '04 vintage was already adding 1.5% because it was so large. Next question please?

Your next question comes from Chuck Ruff (ph) from Insight Investment.

One of the things I worry about with Gambro is that the FTC forces you to divest a material portion of their centers in you're then have to run and sell them for a smaller multiple than you've just bought Gambro for. That is something that I'm sure you've thought of and looked at before you struck that deal. Can you tell me a little bit about how you looked at that risk and how you think about it?

I guess I can only say the obvious, we looked that at a lot and took it into account and everything we did. And the good news is that we have received many, many calls from many, many people hoping to have a seat at the table and make offers on any centers that we have to divest. And I don't know, how to respond beyond that.

Okay. Secondly, on a totally related thing, can you talk at all about before the Gambro what you expect this new stock option expense to be this year and whether that will have any effect on the stock option plan going forward?

The expense will be, we are going to implement 123(R) and it's going to be about $20 million to $30 million annually.

After-tax or pre-tax?

Pre-tax.

20 million to 30 million, okay. And the second part of that, do you expect any change in the stock option plan going forward or no?

The Board is discussing that and they have not made a decision yet.

Okay. Thank you very much.

Thank you.

Your next question comes from Blake Goodner from Bridger Capital.

Hey guys. Just a couple of questions. Ken, there was a lot of talk on the call to stop the commercial price outlook, and I know historically when you've given long-term goals, you've talked about 0% to 3%. Is it fair to say that that's still an intact estimate?

Well, we haven't refreshed our three-year outlook. That was our three-year outlook, and we're about halfway through. I think we're about a year and a half into it and we feel no pressure to change the second half of the three-year outlook. And as to what we would say about going out further, I think that rather than giving a spontaneous answer I'll just wait to our next capital markets day when we do another three-year outlook.

Okay. Great. And then, second question, just back to the G&A, I just wanted to dig into this a little further because when I look back at the history of the company, you've typically shown some seasonality to the G&A and this year it just kind of increased as we went through the year.

And I know you talked about some strategic investments, but if we are reinvesting that money which otherwise would have basically flown through to the bottom line as part of your leverage, could you at least give us a little more color on when you say you've made these strategic investments in '04 and you're going to continue to make them and that's why G&A is going to be at the same half percent margin. Can you give us a little more color on what exactly those strategic investments are?

Yes, that's a fair question, although its spread across so many categories, but it includes things like our vascular access product line, our disease management product line, our home dialysis product line, our nocturnal product line, DaVita clinical research, some work we're doing with some physician practices on an operating basis, our - what we call our wisdom operation, which is our professional development for our broader team. We decided to ramp up that investment some more because we feel our patients and our shareholders have gotten a nice return off our big investments in the first five years of the company. So, those are seven of the items where we've, in each case, incrementally bumped it up that's prevented us from getting profit leverage on the overhead line.

Okay. Great. Thanks very much.

Thank you.

You have a follow-up question from Justin Lake from UBS.

Justin?

Sorry about that. The tax rate in the quarter was a little bit lower than normal?

We reversed -- we were able to close the year and we reversed the reserve.

Okay, so 39% should be a good number to use?

I think that's probably a good number at this time.

Okay. And then just a follow up on the, I thought that the numbers you gave on the break out between de novo and kind of, organic growth were very enlightening. Do you have those numbers going back through 2004 on how that growth broke out?

Perhaps, but you're probably pushing us into a zone of discomfort by getting into too many micro analyses, then you'll ask for quarterly updates on.

Fair enough. Okay. Thank you very much.

Thank you Justin.

You also have a follow-up question for Bill Bonello from Wachovia.

Yeah, just a couple of balance sheet questions. There was a pretty big hike in the other liabilities, like 40% year-over-year. Can you just tell me what that is?

I think part of the numbers that were in there had to do with compensation numbers and also the advent of PDI.

Okay. And similarly, there was a big hike in the accrued benefits and expenses on a year-over-year basis. What's driving that?

Same type of items.

Same items. Okay. That's helpful. Thank you.

Thanks Bill.

And at this time, there are no further questions.

Okie-dokie. Thank you all for your interest in DaVita, and we will continue to do our best. Have a good week.

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