德維特 (DVA) 2005 Q1 法說會逐字稿

Good afternoon. My name is Miranda and I will be your conference facilitator today. At this time I would like to welcome everyone to the DaVita First Quarter Earnings Conference Call. [OPERATOR INSTRUCTIONS] Ms. Zumwalt, you may begin your conference call.

Good morning, thank you everyone for joining our first quarter conference call. We appreciate your continued interest in DaVita. I'm LeAnne Zumwalt, Vice President of Investor Relations and with me today are Kent Thiry, our CEO; Gary Beil, VP and Controller; and joining us from Baltimore our acting CFO, Tom Kelly.

I'd like to start with the 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 includes statements that do not concerned 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 the risks and uncertainties please refer to our SEC filings included in the most recent annual report and form 10-K. 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 fact -- factors, new information, future events or other developments. Additionally our press related -- press release and related disclosures includes certain nonGAAP financial measures. These measures should be considered in addition to the results prepared in accordance with GAAP and should not be considered a substitute for GAAP results. Also included in the press release is a reconciliation of the nonGAAP measures and -- excuse me measures to the most comparable GAAP financial measure.

I will now turn the call over to Kent.

Thank you LeAnne. And thank you for your interest in DaVita. I'll address five subjects to start the call. Number one are clinical results, number two are Q1 economic performance, number three the Gambro transaction, number four public policy, and number five our 2005 outlook.

Number one, clinical results which we always report first because they come first. We will provide the same two scores that we provided in the past plus one new one. First with respect to adequacy which is essentially how well we are doing in removing toxins from our patients blood, 94% of our patients had a Kt/V greater than 1.2 in the fourth quarter. The second measure, anemia management . The percentage of our patients with [hematocrits] greater or equal to 33 was 86%. Both measures remain consistent with the last quarter and are very strong as compared to the industry.

The third measure, the new one, is a percent of our patients who have had fistula displaced for the access to their blood steam and dialysis. First, just why is this important? Fistulas have a lower rate of infection and require less frequent revision than any other type of vascular access. It's very important, this importance is reflected by the fact that CMS itself made it one of it's primary areas of focus and in fact launched a program called "Fistula First". DaVita had launched it's own fistula initiative, a couple years before this however and our early emphasis has paid off. As of March we have 43% of our patients receiving their dialysis treatments through through a fistula. And several CMS officials have recognized DaVita for the fact that we are the outcomes leader in this important area. As a footnote the clinical stats I presented and that we have always presented related to patients that have been with DaVita for at least 90 days.

On to the second subject. Q1 economic performance. The first quarter was rock solid. Key metrics as follows. Volume, treatments per day up 13.5% over last year's quarter. Operating income, up 9.5% over last year's quarter. Operating margins holding at 17.4%. And perhaps most importantly rolling free cash flow an outstanding 307 million excluding, I repeat excluding the tax benefits from stock option exercises. Including that benefit it would be 357 million.

Subject number three, the Gambro acquisition. Let me try to preemptively address a few of the questions that are probably first and foremost on your mines. When do we expect to reach agreement with the FTC regarding divestitures? And when does the second request expire? We continue to be involved in active discussions with the FTC although no agreement has been reached, I repeat although no agreement has been reached. Based on our discussions with expect to be required to divest approximately 5% of the combined number of centers and these are spread cross several states. The 5% of centers represents approximate the the same percentage of combined revenues. However, of course, any final resolution with the FTC could be materially different but we have made good progress. I would also note that we received many inquiries from serious buyers hoping to have the opportunity to buy the centers we are divesting. The second request does not expire but continues until we reach agreement with the FTC or until we substantially comply with their document and information requests.

Next question. Well what is the likely timing for completion of the deal given everything else you just said? Well, there is no other answer than to say it's difficult to predict that when we are working with the Federal Government and everything else that they have on their plates. So it just is what it is. We continue to strive for closing in the late second quarter but that's not something that we can guarantee.

Next question, what multiple do you expect for the divestitures? And that of course is too soon to tell. All we can do to be useful is say that we received indications of interest at multiples would suggest we may have little to no negative arbitrage versus the multiple we paid. But it's just not fruitful to go any further than that because those conversations are too preliminary.

Next question, well how much work have you had done with respect to integration planning? Short answer is a lot. The short answer is a lot. We've had over 100 senior managers from the two Company's working together on integration teams since January. We've made a lot of discussions including preferred operating systems, establishment of timetables for system migration as well as enhancement, development of the new field structure with communications surrounding that. The implementation of a retention bonus program and list could go on and on. Across the ten to twelve most important functional areas of the new company that have been significant planning and in fact in many cases going beyond planning to substantive progress. In addition there is a wide range of communications program that includes a lot of people from both Companies talking to each other.

Next question. Please go over again why the EPS impact of this transaction is dilutive in year one and some approximation of the numbers there in? The primary drivers are straight forward, incremental debt cost and integration cost net of synergies. In other words, the net integration economics once you take the expenses of integration and compare them to the year one benefits of integration. And the fact that the incremental debt cost and those net integration economics will exceed the year one incremental EBITDA from Gambro itself.

Let me give you a sense of what the numbers are, and there is in fact one change from before. On our call, our first call post announcement we thought the net integration economics year one would be about 30 to 35 million. At this point to be safer we think we ought to assume 45 to 50 and we'll explain the decisions we have made that led to that change in estimate. And, of course, the exact ongoing operating income will be impacted by what divestitures are, in the end, required.

But let's step through the numbers. Gambro borrow, 2004, U.S. GAAP EBITDA, 314 million. Q4 was 80 million, Q1 U.S. GAAP EBITDA for them looks like it's going to be about the same as Q4. So if you look at what they did in '04 U.S. GAAP EBITDA and what they are running recently you put them in between the 314, and the 320 level. Somewhere in between that range. If you assume divestitures it will be about 5% of combined revenue, you have to subtract EBITDA from those centers as well as related D&A of about 68 to 75 million, a minority interest of six to eight million that net number for year one integration economics, 45 to 50. Offset, of course, by the reduction in interest expense from lower debt load tied to the same divestitures, that net debt will go down by the after tax sale proceeds of course. So that is why, in year one, we are dilutive and it gives you some sense of the extent thereof.

Next with respect to those higher net integration economics, can you give us a little more color as to why the number is higher and what benefits shareholders can expect from that additional investment? The -- the lions share of the increase is tied to IT. Our original number assumed that we would be migrating the core DaVita technology and clinical management system onto the Gambro installed base of centers. And that is in fact what we are going to do. However, once we learn more about their system and as a couple features that are going to be incrementally valuable for us. And so now not only are we migrating the core DaVita clinical management platform on to their 500 centers or so but we are also going to want to migrate a couple important features from their system on to our 600 centers, something that wasn't contemplated in such a material way. So it is actually good news that there is that much value there to be procured for 10 to $15 million but it was not something that we were counting on before.

Okay. Fourth topic, public policy update. On our last call we discussed three primary areas. But we will focus our efforts this year, or that you need to be focused on in order to asset your models, these have not changed. Number one, case mix. Number two, EPO. Number three, the annual update holy grail.

First, case mix. It went effective April 1st as we had previously indicated. It was likely to do. At this time it does not look like it will have a negative impact on our payments. However, we don't think you should lock and load that because the implementation is not done.

Second, EPO. There are rumors afoot that there will be a new national coverage policy. Of course this has been rumored now for over a year but I think there's a good chance that it will in fact happen. And that they will be published in the next few months, a new national coverage policy. The industry as we talked about before has worked well together to present the right scientific data in contemporary clinical judgment and we will see what they decide. They have told us multiple times straightforwardly that the new policy will be very close to current industry practice and the collective recommendation of the Kidney Care Partners Industry Coalition. We will retain our prior guidance which is that when you think about this EPO National coverage policy it is probably good to think about a to our operating income of five to $10 million hopefully that is safe.

So lastly right now operating without a national, formal CMS policy we are continuing to work with individual F I.s. Regarding EPO administration of practice patterns one of our larger F I.s is currently demanding additional documentation. And we are having to spend additional administrative time defending our practices which, we believe very strongly, are clinically appropriate. The practices of our physicians, that is. And at this point these are views that have not had a material impact on either our cash collections nor our revenue but we thought we should give you the heads up. That continues to reflect the fact that there is a lot of interest. And that is for the very straight forward reason that you are all aware of is that a lot of money is spent on EPO and people what about the to make sure that these are clinically based decisions with real clinical value.

Final subject for me, number five, the 2005 outlook. Our '05 operating income guidance remains unchanged. Although we do have the incremental pressure from the new subpoena. And we expect, therefore, operating income to be in that 2% to 6% range, the same as we said before. So a 2% to 6% increase versus '04 exclusive of the effects of the proposed Gambro acquisition and related [debt] financing. As noted last quarter we are assessing financing alternatives and that could include completing the financing in advance of the close of the acquisition. Operating cash flow is expected to be in the 330 to $360 million range. And free cash flow which is after maintenance spending of approximately 50 million, again, appro -- maintenance spending of approximately 50 million. After that free cash flow is expected to be in the 280 to $310 million range.

Final note, the SEC as you have all heard has delayed the requirement to expense stock options in accordance with FASB 123 so we plan to implement that in Q1 of '06 assuming they stick with their current time line. I will now turn the call over to Tom Kelly. Tom?

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

First, what about operating margins in the quarter and going forward? Operating margins improved 30 basis points from the fourth quarter to 17.4%, which is within normal ranges. Going forward and as we have stated for several years we expect some long-term decline in operating margins.

What are the current and likely near term drivers of dialysis revenue per treatment? Dialysis revenue per treatment was essentially flat with Q4. There were no unusual fluctuations within revenue and you should not expect any major shifts up or down for the balance of the year.

What about treatment volume trends this quarter and going forward? Q1 treatments per day were up 13.5% year-over-year, with 5.6% from non acquired growth and the balance of 7.9% from acquisitions. We continue to expect non acquired growth to average 4% to 5% with acquisitions adding an average of 2% to 4%. This guidance of course excludes the Gambro transaction.

What are the key trends in-patient care cost? This quarter there were no material changes in historical trends. Operating costs overall were relatively stable and were consistent with trends experienced over the last several quarters.

Next, why was absolute G&A higher than last quarter and what is the outlook for G&A spending? G&A in the first quarter was 8.9% of revenue compared to 8.6% in Q4. Normalizing for the first quarters lower number of treatment days, G&A would have been 8.3 percent of revenue. For 2005 we previously stated that it was our expectations that G&A would be approximately 8.5% of revenue. This guidance was before any incremental costs associated with the Gambro acquisition and before the announcement of the St. Louis subpoena. Taking these added costs into account our expectation is that G&A will be in the 8.5% to 9% range for the year. You should expect G&A to fluctuate from quarter to quarter due to timing of certain expenses.

On to a financing update. On March 22, 2005, we issued 500 million of 6 5/8% Senior Notes due 2013. And 850 million of 7 1/4% senior subordinated notes due 2050. We used the net proceeds along with available cash to repay all outstanding amounts under the term loan portions of our existing credit facilities including accrued interest. In Q1 the issuance of these higher rate notes resulted in approximately $1 million of incremental interest expense.

Going forward quarterly interest expense before deferred financing cost and amortization on the notes is $24 million. Also related to this financing we wrote off a majority of the deferred financing costs related to the term loans which we paid off. The new deferred financing costs were about $29 million will be written off over the life of the notes. You should expect the amortization to run $750,000 in Q2. With respect to fixed versus variable rate date -- debt and as we have stated over the last few quarters we are inclined to fix a significant portion of debt and have taken steps to move in that direction. We have now entered into a total of approximately 1.6 billion of swaps which amortize over the next five years. The overall blended swap rate is 3.87%.

Back to you, Kent.

Okay. Thanks, Tom. Let's go ahead and launch right into Q&A, please, operator.

[OPERATOR INSTRUCTIONS]. Justin Lake, UBS.

Thanks, good morning. Just two quick questions. One, can you talk about -- your revenue per treatment in the quarter was relatively flat sequentially. Given that historically it's normally your strongest quarter, Q4 versus Q1 sequential growth, look -- if you look back over last four years, I think the average has been about a little over 2% sequential growth. Can you talk about what led to that -- that flat sequential growth Q4 versus Q1? Was there anything in particular there?

Tom, you want to go ahead?

Sure, I can tell you that some reduction in intensity of physician prescribed pharmaceuticals was offset by changes in payer mix and commercial rate increases.

Are you saying that your payer mix is your commercial mix as far as your patient mix is getting, is going heavier towards commercial?

Just a very slight bit.

Okay. Can you give us a number regarding that pharma intensity as far as dollars per treatment?

We typically, Justin as you know, don't go into that sort of micro ana -- micro disclosures on a dollar per treatment here or there. It's just not constructive.

Got you. Is there any -- is there anything driving that pharma -- pharma-utilization that you might want to talk about or is it something that you think might fluctuate back upward later in the year?

There is one thing going on which is that the dialogue around PTH has changed in the clinical community. And whereas it used to be that they were more, the doctors that is, more focused on PTH as a primary clinical indicator, they are now placing equivalent and in some cases more emphasis on phosphorus or calcium phosphorus product. And without going into all of the reasons for that in some cases that means they are willing to tolerate higher levels of PTH in exchange for giving lower levels of phosphorus. And if you are willing to tolerate higher levels of PTH you use fewer pharmaceuticals to get it down. And so yes, there is some change in the underlying clinical judgment in American nephrology.

Got you, that -- that -- that's great. (Inaudible) from a color standpoint. If you could just -- I guess that's something that wouldn't be -- wouldn't be -- wouldn't be (inaudible) rebounding in the second quarter or third quarter, then, that's -- that's something more longer term so this is a good base rate like you said during your -- during your comments.

Correct. This PTH phosphorus thing that the dialogue that's launch will go on for the next one, two, three years and it's provoking a number of new studies and things like that so it's going to be in play for awhile.

Okay just one more question along those lines. Can you give me an -- can you give us an idea of what you've seen -- you know the -- the number of doctors that you've seen kind of move away from that and if it could cause any further declines in revenue per treatment in the next year or two?

It's much too diffuse a conversation. It's not a monolithic trend and there's no clear, tight clinical consensus. So the -- the short answer is, no. We can't provide any more sort of analytical precision around it because it's a live, clinical conversation.

Well that's great. I will jump back into the queue. Thanks for the color there.

Eric Percher, Thomas Weisel.

Another question on pricing. Can we talk about any change that you've seen with the Medicare modernization act changes on January 1? Does that have any effect?

LeAnne go ahead.

Sure. Well of course as you know the drug pricing has gone down. Correspondingly not dollar-for-dollar, the composite rate went up. Overall we are about at the same place we were last year, maybe a very, very slight -- pennies up. Does that answer your question?

Yes. How does that compare to the guidance that we had talked about when everything was said and done on the changes?

It falls right in line. Now obviously the outlier is yet the case mix which will come into play on April 1. And then we have -- we are just going to submit those claims next week.

Okay and then a question on pricing. The fee schedule that you have for commercial payers that patients that may come out of contract, I think that was last changed in 2004. How often does that change and is there any significant impact from that?

Can you repeat the question?

Sure. The fee schedule for payers where we are out of contract, the general fee schedule I think that was last changed back in 2004. Is that a big impact when that is changed and would there be -- what's the timing for another change or increase?

We never discuss the timing of any price changes.

Okay.

Ahead of time. And it's not always a single monolithic change. Instead it can be broken into a lot of different parts and a bunch of it is negotiated even though it's ostensibly a non-contracted fee schedule. So it's really, -- we're not able to comment. In a three-year outlook which we are a year and a half into we forecasted the typical annual rate of increase on the private side and I think we just stick to that as a better, longer term barometer of what's going on.

Fair enough. Thank you.

And I just want to clarify one thing which is to say that the -- the fact that we are sort of break even on Medicare, is the glass half full or half empty. The fact is we had a rate increase and it was totally offset by our getting hurt by this transfer, allegedly revenue neutral transfer from pharmacy to the composite rate. So the -- the net, while being basically neutral, were a couple of pennies positive, was unfortunate in that it means our rate increase was offset by the other analytical shenanigans.

Thank you.

Gary Lieberman, Morgan Stanley.

Good morning. If I could sort of follow up on the -- some of the pricing questions. If, I guess revenue per treatment on a Medicare basis was essentially flat from a year ago. Would that imply that incrementally you've seen a little bit more pressure on the managed care pricing or am I -- am I mistaken?

Tom, you want to cover it?

Yes, I would say I don't believe there's been any change in the level of pressure on managed care pricing. It remains and is -- is a constant source of attention as we renew contracts.

I mean could you quantify that a little bit, is the rate over -- year-over-year rate growth consistent with where it had been or has it -- has it moderated at all? Because I guess at least in my model it - it would look like it -- the pricing growth may have moderated on the managed care side or does it go back to what you were talking about before , Kent, with -- with maybe a change in dimini -- diminished prescription trends?

Yes, I would say right now it would be premature to say there's been an actual mathematical change and what's going on in managed care pricing. And what you are seeing now is much more of the change in the pharmaceutical intensities and sort of the normal ebb and flow of other stuff.

There -- there is no timing difference in terms of when the increases are going through this year versus last on the managed care contracts, does that continues to be on a rolling basis or is it waited more in one quarter this year than maybe it had been?

In general there's no change in the timing of what's going on in the aggregate portfolio. Last year we had one large contract that kicked in with the increases at one point that materially affected the numbers and that won't happen again one way or another until there's a renewal a couple years downstream. So separate from that single large outlier the normal portfolio timing is unchanged.

Okay, and then if I could follow up on -- on patient care costs, your patient care costs per treatment were essentially flat year-over-year. So it's you've seen a little bit of a -- of a benefit in terms of the rate of growth in patient care cost. Is there anything specifically that has slowed down that's enabled you to -- to get some benefit there?

No. You should look at the trend as being the same as they've always been and within any short time period of a few quarters we can look a little bit better, a little bit worse, just based on profit sharing decisions or something going on with a particular manufacturer or a change in De Novo and acquisition mix. First -- so it's just -- it's not -- it is not -- there's nothing -- one should not look at the good number and derive from that some sort of positive conclusion about a change in long-term cost trends.

Okay so when I look out through the rest of the year I should expect that cost per treatment would -- would sort of pick up back up to maybe the 2%, 3% year-over-year growth rate that you've seen?

I would say that -- to expect -- should expect to see on labor stuff is the same trend that we've experienced historically.

Okay. Thanks a lot.

Alright. Thank you.

Matt Ripperger, Smith Barney.

Thanks very much. Just a couple of questions here. I just wanted to review in terms of the financing options for the deal are you still considering financing the 2.9 billion to acquire Gambro with all term loans. Is that correct?

Yes.

And can you just review, you've commented on the amount that you've hedged historically but can you just add up the forward hedges you've entered into so we know exactly how much of that term loan you've sort of fixed already?

In total we have about 1.6 hedged. We -- I will go back through history here. In December we hedged about 800 million and then earlier this week we hedged another 450 million. That was in addition to the 345 we had already. Does that answer your question?

Yes, it does. And then in terms of the -- the blended cost of debt or borrowing rate for the whole 2.9 billion can you give a range of what you expect that to be?

Not at this time.

Okay. The second question I had is just post the deal, maybe sort of in year two, can you give some comment in terms of how aggressively you expect to de-lever?

Well I guess the best answer is to look at our history. And to look at the aggregate math. With respect to our history, we inherited a leverage situation in 1999 and de-levered quite quickly. We then levered up again when we were very confident of this stability of the cash flows for the foreseeable future and then de-levered quickly after we did the stock repurchase. Now we are levering up again, once again in a time -- at a time when we are confident of the stability of the foreseeable cash flows and at the same time we would expect to use that stability to pay down a bunch of debt quickly.

In addition if you just look at the math and this was the -- the second -- the second way of looking at it that I refer to, it is not possible for us to spend all of our cash flow on growth. We will have too much of it. And at that point one only has three choices; get into a new business, or buy back stock or pay down debt. We do not intend to get into new business. And when you are at these leverage ratios it is, in general, more prudent to pay down debt unless you feel that the equity markets are very, very out to lunch in how they are valuing your company and we don't think that's the case.

Okay, great. And the -- the third quarter I had was related to your net negative synergy number of 45 to 50 million in year one. I want to see if you could try to decouple that for us. So for instance, give us what your baked in synergy number is versus what your negative cost integration number is.

Yeah, we decided not to do that.

Okay. Does that -- do -- how about just specifically related to maybe the lab business given that you both have lab businesses, is that built into the immediate synergy number?

All decisions are baked into the synergy numbers but we decided just it's not constructive for anyone to go into any level of detail. The last stuff in particular is relatively a small percentage of the overall relative economics. So it's -- it's not -- it's not high up on the list.

Okay. Great. Thanks very much.

Thank you.

Kevin Ellich, [Apollo] Advisors.

Question. Just a quick -- could you guys update us on any changes or potential changes to Medicaid reimbursement?

We anticipate that there will be cuts in Medicaid reimbursement either through the front door of reducing rates or through the back door of changing eligibility and stuff like that. And our estimates of Medicaid cuts are baked into our overall guidance. Half of our Medicaid revenue is from California and California is in a tough budget situation as most of you know. So we anticipate some cuts in the years to come.

So outside of California any other states that you can point us to.

Well we have an evaluation of every single state and there's quite a distribution of risk and exposure. So I don't -- I don't think it's productive to go through our assessment of each state. Suffice it to say that California is half of the total and there's another four or five that have a lot of budget pressure and where Medicaid's on the agenda. And you can pretty much just tell by asking around and finding out which states -- of those we have a bunch of centers in , which of those states have Medicaid cuts on the state legislature agenda and there you have it.

Then when you were going through the public policy update, did you touch on the annual update or did I miss that?

You know what? I neglected to. After I said I would so I appreciate your pointing that out. We -- the bill has been introduced. It's been introduced as bipartisan support in the house. It's been introduced as bipartisan support in the Senate. Nevertheless, there's big deficits this year and so we are going to work hard and whether or not -- whether I guess the question are we optimistic or pessimistic? Probably neither. We just have our head down and we are working it and we will see what happens.

Okay and then lastly, the sequential decline in number of treatments, is that due to calendar effects or leap year by any chance?

Yes, there were two less treatment days in the quarter and that is the reason.

Okay. Thank you.

Justin Lake, UBS.

Thanks. Just have one other question following up on commercial contracting. Can you tell us what percentage of your patients are covered by commercial payers that are not under contract with DaVita? Or in other terms what percentage of your patient mix is covered by out of network commercial insurers?

No, it's not a good idea because in fact the boundaries are not nearly as clear in reality as they sound in theory. And so it's just not a good way to go.

Okay. Thank you very much.

Gary Taylor, Banc of America.

Hi. Good morning. I had a couple of questions. First on your guidance that -- that Gambros dilutive in year one, do you -- does that mean dilutive for the [forward] 12 months from the closing of the transaction or does that mean you are generally saying dilutive for calendar '06?

Year one of the transaction.

Okay. And on the commercial side we've kind of beat this to death. But I just wondered you've -- you've guided historically that you thought -- I think you've guided that the year-over-year reimbursement growth wouldn't be quite as robust as you had seen historically. And I just wondered if you had noted [Fresenius] recently had said they felt like they had an opportunity to increase their commercial pricing. And given how consolidated the industry is, just wondered if you think that does anything to firm pricing in the industry, does it, consolidation continue to keep pricing firmly in some sort of year-over-year increase?

Tom, you want to go ahead and take that one?

I don't expect a consolidation is going to have -- have a big impact on kind of on pricing consistency. So I think it's always good to have payers who understand the economics of it all. But it's -- it continues to be a very competitive business, a lot of new entrants, still a lot of local contracting decisions. All of which mitigate against any likelihood that the large players can influence it.

And then the last question I guess I'll -- I'll be the brave one and I will dive into this. I -- I -- I think there was a confidentiality agreement when Denise left. So I just wondered, Kent, if you can just address a couple things. One, how quickly do you think you have a replacement? And then the other is, what's the -- what's the possibility that someone internally may have that roll? I mean I know you have a number of people with financial experience inside the firm already. Is this a necessity that -- that you are going outside the Company?

Yes, well, first of all, no bravery required to ask legitimate business questions like that. Let me just go back to your prior one though too, Gary because we have consistently said it is correct. That we've said that we do think the commercial pricing environment over the next few years will be tougher than the next -- then the -- the last few. And the way we try to convey to shareholders is to say that -- that the larger the premium rate increase that insurers are getting, the better environment it is for providers to give rate increases. And secondly, during times of margin expansion for payers those are times when providers do better. And so you can get a pretty good leading indicator I think from looking at them and you are right in assessing our general long-term outlook. Now hopefully we are going to be increasing the -- the strength of our value-added story where we can offset that. But -- but at the same time you need to understand we do think things will get more intense.

On the CFO issue, I will answer the last part first. We will not be filling the spot internally. We do want to add an additional executive to the team. The good news is exactly what you point out, however. That we could fill it internally. And we have gotten by just fine in the other periods where we've been without a CFO because our bench strength in this area is unusually strong. Nevertheless the answer to your question is we will be going outside to continue to add to our executive capability in the context of the larger and every more aggressive entity that we'll soon be becoming. And as to how long it will take, who knows? There's a -- there's a bunch of folks that are interested and hopefully we will button it up soon but these things tends to take a few months and we are not in any particular rush. We want to get it right. Did I hit all aspects of that?

Sure. I just -- in parting I just wonder, is -- is there anything you are willing to or can just about the latest departure? Obviously we -- you get a lot of questions about that, so kind of your -- your angle on it for whatever you can say will be helpful. Thank you,

I think all I will do is repeat exactly what we said before. It was mutual and we thank Denise for her contributions and she's continued to offer us good counsel. And we are both moving on with our lives.

Mr. Bill Bonello, Wachovia Securities.

Good morning. Did -- did you guys give any color or can you give any color on whether the expected divestitures would be concentrated in a limited number of geographics markets?

All we said, Bill, is that the divestitures are spread across several states and we let it go at that.

Okay. That's all you are going to say?

I don't know. Would there be any value in getting any more specific? I don't -- I don't know that there would so help me out if I could be more useful to you. I mean kind of the obvious think California is getting more scrutiny than elsewhere just as everybody anticipated.

I would just think that -- yes the reason I thought it was interesting is I thought you might have varying margins depending which markets you are and some markets may be more costly from an EBITDA standpoint to divest than others.

I hear you but I think we will stick with where we are and, of course, the multiple we get paid is the -- is perhaps the most dramatic variable in assessing the net economic impacts of the divestitures and that aspects of this process looks good right now.

Okay. And then I apologize if you commented on this. I missed it if you did. I -- in -- in -- I know you haven't quantified magnitude of dilution, accretion, et cetera. But would this level of divestiture have been within the, sort of realm of what you would have anticipated as you thought about timing of dilution and accretion and magnitude of dilution and accretion?

Yes.

Great. Thank you.

Andreas Dirnagl, J.P. Morgan.

Yes. Good morning. Kent, I'm actually going to try to follow up on Bill in one with respect when it comes to the FTC. You stated previously that with your experience historically the FTC has looked at these sort of mergers or acquisitions on a state by state basis rather than an MSA basis. Are you finding that to be the case this time around?

What they actual do is -- is look at both levels, Andreas. They look at certain local markets. They look at MSAs and they look at state. Because, while theoretically, one could argue for any of the above, pragmatically just depending on what the new entity would own in some geographic areas ends up trumping any sort of broader decision around what's the quote, unquote right way to look at it. So we are not going to just look at it on a state basis. If the new entity would own 100% of the centers in the southwest corner of the state it just wouldn't be pragmatic. So it's a comb -- it's a combination which is what we said in the past and it is the way it's working out. And both MSA and state level analysis ends up being relevant.

Okay. Great. On the -- the synergy costs or expenses going up to 45 or 50 million, would you still characterize sort of the timing of those expenses the same, i.e., that it is going to be probably the highest, i.e., that 45 to 50 million level in year one of the transaction and then you would -- you would expect that to diminish? Or does the extra spending of migrating some of the existing software from Gambro to you sort of extend the time frame?

Yes, it's a great question, Andreas. What -- what we commented on with the change in the IT plan is just the impact on year one. And -- and your question is appropriate. Will some of those increased expenses bleed into year two and year three, and the answer is yes. And we just decided that we thought the number was small enough that we wouldn't change any of our higher level statements about year two and year three. But there will be some incremental bleed in -- in those two -- in years two and three.

Great. Okay. Then final question just on the various public policy issues that you covered. You sort of stuck with your -- your characterization of EPO as -- as maybe having a potential five to $10 million negative impact that hasn't seemed to change. But when it comes to sort of the other areas of -- of MMA and case mix and things like that when you net it all out. We have been sort of originally talking about potentially a 10 to $20 million negative impact, that kind of got moved down. And I think I'm correct in that the last characterization you gave was about a negative two to $7 million impact. Are you now, I know it's going to -- you are going to tell me it's still a bit early, but are you now sort of more comfortable that it's -- it's probably looking like it's just going to be neutral?

The characterization over time starting with 10 to 20 including the EBITDA and that still, as you know, is -- is out there, five to 10 million. We do believe that this years results will be impacted as we did before by cuts in Medicaid and potentially some of the secondaries going away. That has been taken into our forecast. I would not say that we've necessarily moved completely, that we have not moved from our characterization with the exception of the first cut were we now know that with the 1.6% increase we came out neutral. So that did have a positive impact but the other component we have characterized consistently, the unknown is case mix.

Andreas, are we answering the question you wanted to us to answer?

Yes, I think so. But just maybe just one last follow up, then. LeAnne, if you said in the past the unknown was case mix, although it is still early the initial indications are that it is sort of as you said kind of neutral?

Correct. So the -- that [correction] will update you if you are interested in how that comes out once we have a quarter or two of claims.

Great. Okay. That answered it. Thanks a lot.

On case mix it's sort of two things. What is the -- what are the actual formulas they announce and roll-out? And then second, how exactly that gets implemented. And the fact is we've passed through the first gate and it looks like -- that they have achieved what they said they would which is revenue neutrality and so that's good news. It's just that we have one more gate.

John Ransom, Raymond James.

Hi. Good Morning. Just a couple of longer term questions. As you look out five years what sort of odds would you put on, two scenarios? One would be Medicare moving toward a bundling type of reimbursement scenario? And secondly, a higher -- a substantially higher ratio of your commercial lives being treated in a different venue perhaps at home than they are currently? Thanks.

I will handle the bundling and Tom Kelly will handle the home. Let me first go backwards. Let me first go backwards and just address something that Bill Bonello raised, which is the portfolio of things that are contemplated for divestiture on the DaVita side have margins that are quite close to the average company margin. So there's no -- from a modeling point of view one shouldn't assume anything dramatically different from average.

All right. Now on to bundling and then Tom Kelly will take home. Do we think bundling will happen? First let's define bundling as pharmacy and lab as being bundled into the composite. If you ask me to bet a dollar either way on whether or not bundling of pharma and labs into composite would happen in the next five years I would bet a dollar that the answer is yes. Many people will tell you it's inevitable and many of those would be the same people that have been saying it's inevitable for the last eight years. And there are reasons why I don't ascribe to that characterization. Number one is statistically it's very difficult to take 30% of the cost in revenue structure for facilities that have an end of 65 patients. And a variable like pharmaceuticals which -- which move around a lot both by patients and across patients where it's very difficult to predict what as a person will get and then come up with a bundle that's not going to put a lot of centers in significant trouble. Or a bundle that's going to have so many outliers that you defeat the whole purpose of having a bundle in the first part -- the first place.

So just in the single DRG business with a lot of small facilities and pharma being such a large part of the cost structure it's just statistically daunting. So they are going to have to be very careful. And then second by reducing, basically eliminating pharma-margins across much of what we do, if not all, it's sort of like, what's the point. And there is still conceivably a logic for it but it's certainly not nearly as powerful as what was motivating folks to do it in the past. So those are the two reasons that I don't use -- I don't characterize it as inevitable. At our -- at our sites a revenue neutral -- a revenue neutral bundle is -- it doesn't matter to us one way or another whether it goes in or not. But there's always risk that in fact it wouldn't be revenue neutral. So that's the answer on bundling.

I will repeat the first part. If you just ask me to bet a dollar when that whether that would happen in the next five years or not I would bet that that was yes. But not with nearly the certainty that some other people predict and have been predicting for the last almost decade. With respect to home, Tom?

Home EPO and Home PD have always been options for our patients and are primarily a physician-patient driven choice. We are doing some small trials today with both nocturnal and daily dialysis both in home and in centers. And are looking at some interesting new technologies to see how they might impact the feasibility of -- of really future expansion of home hemo. So I tell you the technologies today are, to some extent, untested and not so competitive from a pricing standpoint with in center options. We also have challenges in terms on whether both Medicare and private payers will figure out how to pay for home hemo which will be more frequent than in-center hemo.

And just secondly, is there a thought in the back of anybody's mind, down the road, as to ways to reduce the pharma-intensity? If that indeed becomes the motivation without compromising patient outcome semi similar to maybe more frequent dialysis with less EPO and that sort of thing? Is there away out there that's -- that's kind of a win-win-win for everybody and reduces the pharma-cost inputs which I guess increasingly become a cost to you and less of a --a profit center? Thanks.

Tom, you want to do that? Or do you want me to?

I can do that. More frequent dialysis does tend to reduce pharma-intensity and I think the interesting question will be, can we -- one, can we ask patients to have dialysis more frequently than today. It's a -- it's a major impediment in their lives. And secondarily will the technologies themselves to be used at home become cost competitive enough to permit that to happen.

Okay. And lastly, do you see anything? Let's focus on year three, I think most of your shareholder are longer term oriented. As you look at year three, forgetting all the kind of short term timing stuff is there anything that diminishing your enthusiasm around year three accretion by any order of magnitude? Thanks.

I think the short answer is no. All the reasons we decided to do this six-months ago, when we started the process with Gambro, are still very much -- very much true. So we -- we think this is a wonderful time given the overlap between our business reality and the state of the Capital Markets that the odds that this is a good thing for our shareholders long-term are dramatically higher than the odds that this ends up being a bad thing. We actually don't even think it's close. That pretty much you can certainly, like in any -- any industry, create a negative scenario for the industry in which shareholders would be hurt. But those scenarios would apply to us whether we did this or not. And in every one of them as we stared at them we were still better off having done it than not having done it.

In other words, our shareholders would be harmed less and in fact we would be better positioned to capitalized on the industry situation from that point forward. And then one would say, okay, maybe that is true. But in the short term, when you are so levered, could there be things that go wrong that means this deal would hurt shareholders even though the rest of the industry was not harmed. And we simply don't think that that is at all likely because there is nothing out there that is likely to the change externally so dramatically. And we think we are being sufficiently thorough and conscientious and unhurried in our integration approach. So that the risk our shareholders have for that scenario which is a Company specific problem or a dramatic immediate industry problem when we are levered we think the odds of either of those two things happening are really low. Is that responsive?

Perfectly. Thank you.

[Jeff Moore, Arie Management.]

Good morning, all, congratulations on another great quarter. Most of my questions have been answered, Kent. I think the only thing I might ask you to comment on briefly is your non-acquired treatment growth this quarter was quite good and I think even a bit ahead of what the guidance had been and I was wondering if you could give us any insights into what might have driven that and to what degree you might expected to stay sort of in this context versus the prior guidance?

Yes, Jeff. We are excited by it. We are excited by the trajectory of the last five quarters of our non-acquired growth and it -- nothing special, it's just our De Novo's that we've opened are doing well. Some of our contracting of payers is leading to some incremental patients here and there in places where we didn't have a contract before. And our general work with physicians is leading to some incremental referrals. So as we talked about four, five years ago as you'll recall that building non-acquired growth is sort of a ten pronged program. There is no one silver bullet. And for us we've been working on all ten and a bunch of you will remember that for the first couple of years we thought, you thought we weren't making enough progress. But things did kick in and we always said it would take two to three years. So nothing's, special, nothing singular but it's all those different components of the dock piece, the payer piece and the De Novo piece coming together. Now will it stay as high and as differentially which will high as it is right now? I think we are not going to change our guidance. It's just, integrations are tough and any one who starts to get too optimistic about not missing an operating beat when they are integrating two companies is someone to really watch out for. Even though we are ahead of guidance now I would just assume that the integration is going to screw us up enough that we'll end up within it.

Got it. But the good news is the -- the things that are driving it are largely sustainable in your view.

Absolutely. Absolutely. If -- if -- if it goes down it'll be primarily because we just can't do the integration without screwing some of that up.

Got it. Thanks, Ken.

[Elan Shandlewith, Kenneth Mills]

Hi this is [Elan] (inaudible) in London. Just an apology I'm not too familiar with DaVita but I have a couple of questions on the cost side. First, you mentioned labor costs have been -- have risen in line with historical trends. I'm not too familiar with -- with what those trends are and I know that they fluctuated a bit over the last year so if you can explicitly state what the growth was Q1 year-on-year that would be great. Second question relates to EPO costs, how much your purchasing your EPO for and as one of your biggest cost line items can you give us some color on -- on how that's, that line item has progressed again year-on-year?

With respect to labor, the historical trend is that rates go up, starting from the low 3% to the low to mid 4% and that's offset by -- that's partially offset by productivity increases in the half a percent to a percent and a half range. So that's historical trend reality that you should pretty much lock and load in thinking about as on a go forward basis. Although we never ask anyone to blatantly assume the productivity increases because it's not like we have some guarantee that they are going to happen. It's just that that's our operating goal.

On EPO. I don't -- I don't know exactly what to say. Our contract goes through December of '05. And we've never disclosed specifics about the rate because in fact we are contractually precluded from from doing so. So help me out, maybe to see if there is a way that I can be more useful to you on that one.

I appreciate that. I was trying to find out whether the rate that you are paying is -- is -- stayed the same gone up or down really from -- from the last time you negotiated your contract.

Yes, there hasn't -- let me -- let me take a cut at this and see if this gets you what you need. There hasn't been a lot of change in what we pay for our pharmaceuticals. In the time frame that you're asking about.

Great. Thank you very much.

Thank you.

[Jack Shalasas], Gates Capital Management.

It's actually Jeff Gates. Can you just refresh our memory, Kent, on the -- the amount of one time cash outlays as well as the corresponding cost savings in year one, two and three from the acquisition in the guidance you've given?

Yes. What we've done here is a little frustrating for some, which is we've just discussed the net integration economics so without going into each year the integration benefits and also disclosed integration costs we disclosed the most important number which is the net. And so that net in year one is the 45 to 50 million, the net negative. Then in year two, we've said the transaction is EPS neutral compared to if we hadn't done it. And then year three will be accretive and increasingly so thereafter.

So the 45 - 50 in year one is basically the one-time cost less the -- the annual savings that's realized in that year?

Exactly. What it -- and what it really means is we had spent a monster amount of money getting the I.T. stuff migrated in both directions. That's -- that's where there's a lot of management time, extra hiring, consultants. It's something that we are going to sort of do in a belt and suspenders kind of way. Because whether or not we do it in -- in 28 months or 34 months is not the issue from a shareholder point of view. It's getting it done without any big mistakes. That's where all the shareholder value is. So we'll be spending most of the money right there.

And does that -- does -- I mean the 45 to 50 is all expensed? Is there anything additional in your CapEx budget?

The -- most of the integration expenses are cash. In addition we will be spending some capital as we standardize technologies across the two installed bases. I don't have that number offhand in my head. In the grand scheme of things, meaning the annual cash flow of the business or the historical CapEx expenditures of either business, it's simply not that large. And that's why I don't know it by heart. The fact is they have a lot of technology in their centers. We have a lot. We need to add a little bit for them. And when you think about it's not that we have to go out and build new factories. We don't have to go out and build any new centers that we would not have built otherwise. And so from a capital point of view you have some capitalization of some software development and you have some servers you are going to buy and in the grand scheme of things it's a tiny number. Is that -- is that answering your question?

Well if you could give us indication of the relative magnitude of the one time cost versus the -- the benefits in year one, that would -- I mean is it -- is it 150, or is it -- you know or is it 80 and 30? Is it? I'm trying to get an order of magnitude.

I think we will just stay away from it. There's an awful lot of movement in year one when you are putting two companies together and it's very tempting for management to provide false precision to their shareholders. And so, yes, we can answer but I just -- I think it would be mis -- misleading and it would be false precision.

Okay. Thank you.

Balaji Gandhi, Pacific Growth Equity.

Good morning. I just had a question about the payer mix for the quarter. Medicare, Medicaid and other.

Yes. Just what was the mix?

Just what was it?

Okay. LeAnne or Tom?

Sure. Total government mix was still about 79% of the patients, something like that.

So did you have Medicare versus Medicaid?

I don't for you.

Okay. Thanks.

If you call LeAnne back she can get you that in ten minutes.

Okay I'll -- I'll do that.

I don't think there was a significant shift there but you can call me back.

Okay. Great. Thanks.

Bill Bonello, Wachovia Securities.

Just one regulation or government question, I guess. The recent Medpack recommendations, anything in there that, if adopted, would have a material impact on you?

You are talking about conditions of coverage?

I will take that, Bill. As you know many of their recommendations, I think are -- are positive towards dialysis. But, for example, the specific recommendation of leveling the playing field on the composite rate although it's $4 for the hospital centers it's only 15% -- excuse me 15% of the treatments in the United States, it resulted in about $0.50 to our composite rate. Now that's just the recommendation. It's a long ways from getting CMS or Congress to act on it. So all of the recommendations are very minor as it relates to our economics. And we -- and you know, simply the recommendation does not mean that that's something we will get. We're -- we're hopeful it would be a positive influencing factor but we have a lot more worked to do.

Okay. But at the end of the day it sounds like not a big deal either way. Thank you.

Thanks, Bill.

And at this time there are no further questions. Ms. Zumwalt are there any closing remarks?

I don't think so , operator. Thank you very much for your help. Thanks everyone else for your questions and interest in DaVita. We will of course get back to work and try to make this deal one that you are very, very happy with over the long-term.

This concludes today's DaVita First Quarter Earnings Conference Call. You may now disconnect.