德維特 (DVA) 2006 Q1 法說會逐字稿

Good morning, my name is Kristin, and I will be your conference operator today. At this time, I would like to welcome everyone to the DaVita first quarter 2006 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 session. [OPERATOR INSTRUCTIONS] Thank you, Ms. Zumwalt, you may begin your conference.

Thank you, Kristin. And thank you, everyone, for joining us today on our first quarter call. I am LeAnne Zumwalt, Vice President of Investor Relations, and with me today are Kent Thiry, our CEO, and Gary Beil, who will be our acting CFO, shortly. I would like to start with our forward-looking statements. During this call, we will make forward-looking statements which can generally be identified by the content of such statements, or the use of forward-looking terminology, include statements that do not concern historical facts. All such forward-looking statements are subject to known and unknown risks and uncertainties that would cause the actual results to differ materially from those described in the forward-looking statements. For further details concerning these risks and uncertainties, please refer to our SEC filings, including our most recent annual report on Form 10-K and our most recent quarterly reports on Form 10-Q. Our forward-looking statements are based on information currently available to us, and we undertake no obligation to update these statements, whether as a result of changes in underlying factors, new information, future events, or other developments.

Additionally, our press release and related disclosures include certain nonfinancial GAAP 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 these non-GAAP measures to the most comparable GAAP financial measures. I'll now turn the call over to Kent Thiry.

Thank you, and thanks to all of you for your interest. As you can tell from our release, our Q1 operating performance was solid, comprehensively solid. I will provide a review of the usual agenda items, which are number 1, our clinical results, number 2, the Gambro integration, number 3, public policy, and number 4, I'll talk a little bit about the '06 outlook. First, clinical results. We've always presented them first, because we are first and foremost, a care giver Company. With respect to these results, we'll provide the same 2 scores we did last time. And for the first time, these scores relate to the full patient population of the combined Company, approximately 98,000 patients. First adequacy, which is essentially how well we're doing at removing toxins from our patients' blood. 93% of our patients had a Kt/V greater than 1.2 in Q1. The second clinical measure is the percent of our patients who have had fistulas placed for the access to their blood stream and dialysis. And as of March, we have approximately 49% of our patients receiving their dialysis treatment through a fistula. And these clinical stats relate to patients who have been with DaVita for 90 days or more. Our clinical performance remains strong.

On to the integration. Overall, our 2006 net integration economics look like they will probably be better than what we had anticipated originally. But let's go into some detail. For the past 2 quarters, we've talked about 6 big challenges. Last quarter, 3 of those were reported to be on track, in terms of being overcome. The CIA, the Corporate Integrity Agreement that is, the general operating policies and procedures, and clinical protocols. These areas continue to be on track, and I will not comment any further, unless you have questions.

The 3 that continue to be significant challenges are private contracting, revenue operations, and then the package of big IT transformation projects. Let me comment on each, in turn. First, private contracting, how are we doing? There's really 2 aspects to this. And 1 is the integration, and the second is broader trends. With respect to the integration, here too, we are on track. This year's numbers look very solid so far. So year 1 of the integration looks to be right on track. The broader trend, however, impaired contracting is negative, in ways that we've commented on before. But it's worth commenting on again with more intensity. First, plans and employers are moving to create more incentives for their members and/or employees to stay in network. And in general, in network rates are lower, and have lower rates of annual increase, than out of network rates. So that's a broad observable macro-fact with negative impact on us. The second aspect of the broader trend, which is negative, is payer consolidation, and the resulting increase in their very straightforward leverage. The result is that we expect our year-over-year private rate economics over the next 3 years to be significantly worse than it has been the last 3.

Second specific area is revenue operations. Question, are they stable, and when will the Gambro centers move to the DaVita billing and collection platform? Last quarter I informed you that the DaVita billing and collecting system was not ready to absorb the Gambro transaction volume, and so we were going to keep running them in parallel for awhile. We still hope to begin the conversion in the fall. It will take about a year. In the meantime, collection performance is stable. In fact, it even improved a little bit in this quarter. So it is not efficient, but it is stable.

The third and final big area of the integration, is the portfolio of IT conversions, big transformational projects. 4 areas worthy to mention. First, human resources payroll; second, patient registration; third, center level purchasing/inventory; and fourth, clinical management. Let's give you a quick status report on each. With respect to HR/payroll, that work has begun, and we intend to finish it by early '07. Next, patient registration. We are up and running in 112 of the 540 Gambro centers. We expect to complete that rollout by Q1 of '07. With respect to purchasing/inventory, we're actually going to be changing the system at all of the centers, since we incorporated some wonderful features from the Gambro system. And the new system is up and running in 649 of the 1,241 centers. And we expect to substantially complete this transformation by the end of 2006. Lastly, the clinical management system, we still intend to start that conversion in the fall. It will most likely take 2.5 years to complete, maybe 3. Of course, the bulk of that work is done in the first couple, as we proceed center by center across the nation. In addition, let me just repeat what was already done as of the last quarterly call, that we've fully integrated the current clinical building and financial systems in the common data warehouses and systems, which allows us to produce all of the reports that we use to manage revenue -- revenue operations out of 1 data warehouse.

Third big subject, public policy. The industry bill, the Kidney Care Quality Improvement Act, now has 139 sponsors in the House and 23 in the Senate, significant bipartisan representation. The kidney care community has never had anything close to those numbers before. Unfortunately, this year looks to be a more difficult one for getting Medicare rate increases than most. But we are very much in the running. And of course, this is essential since we still lose money on Medicare, despite the fact that it's 87% or so of our volume business. As of April 1st, the new EPO payment guidelines went effective. Although the general directional intent of this CMS policy is reasonable, it does have some very specific flaws. And even more specifically, with respect to some dose reductions that the government is mandating for patients with hematocrits greater than 39, there is significant confusion and inconsistency on the part of the fiscal intermediaries, and some of the applications of the policy being discussed would lead to patients being harmed; would lead to inappropriate clinical care. We are in constant dialogue with the government to try to get them to appreciate this; cannot say what will happen.

In any event, our guidance regarding the negative earnings impact of the HMA in aggregate, remains what we have been saying for a long time, $10 million to $15 million annually, negative again, that is. Although I will repeat, there's still uncertainty about exactly what they're going to do in some areas. So we have both the clinical issue, and an economic issue.

The Deficit Reduction Act which was passed earlier this year, and in which we received our 1.6% update in an environment where very few segments of American healthcare received any funding increase, also unfortunately contained some provisions that could be negative for our industry longer term. The 2 most notable are the new Medicaid requirement for redetermination of eligibility -- of eligibility, excuse me, where people will be required to provide proof of legal residence or citizenship, or lose their benefits. And it's difficult for us to know how much uncompensated care we might provide while all that is in flux. And then secondly, Medicaid plans may also change reimbursement for some drugs. And at -- well, at this time we haven't seen that happen, it could happen, and it could be a negative. And so it's impossible for us, right now, to put an analytical box around this. We'll do our best as soon as we can to do that.

My fourth subject, the '06 outlook. Our operating income guidance remains unchanged at $630 million to $700 million before the implementation of FASB 123R. From this point forward, however, we'll express our guidance after FASB 123R, since it's now implemented. Which means on an apples to apples basis, the OI guidance range is 600 to 680. 600 to 680. Our free cash flow target remains the same at 305 to 385. 4 of the most important swing factors, with respect this OI guidance are private rates, revenue operations, integration, and treatment growth. As always, we've incorporated these and other risk factors on a probabilistic basis in our guidance. And collectively, if things go well or poorly, they could cause us to be above or below our stated range. Again, quarter, comprehensively solid. And I'll turn it over to Gary.

Thanks, Kent. As Kent mentioned, we had another solid quarter. A summary of our key financial data is included in our press release. I'll address a few key questions regarding financial performance, factors, and trends. First, what about operating margins in the quarter and going forward? The operating margin for Q1 of 13.9% was at the higher end of our OI margin expectation for the full year, which is 12.5% to 14%, consistent with our OI guidance. This is after the impact of FAS 123R. As Kent mentioned, this quarter we implemented FAS 123R relating to expensing of stock options. And the incremental pretax expense was $4.6 million. The quarterly amount will increase as new equity grants are made. Q1 had integration costs of approximately $5 million, and we continue to expect the highest integration costs in Q2 through Q4. And our current estimate for 2006 integration costs is $40 million to $50 million.

What were the drivers of dialysis revenue for treatment in Q1? Our Q1 combined average dialysis revenue per treatment was approximately $3 -- or $317, up $6 per treatment from Q4. The increase is primarily a result of the Medicare 1.6% rate increase, and the 14.5% drug add on, both of which went into effect on January 1. What about treatment volume trends this quarter? Q1, nonacquired growth was 4.6%. It is our current projection that nonacquired growth will be approximately 3.5% for the full year. And we expect to open approximately 40 de novo centers in 2006. With respect to acquired growth, we expect to acquire additional centers with approximately 1,000 patients during the balance of the year, including an acquisition completed in April with approximately 500 patients.

Next, what about collection performance and DSO? Our Q1 bad debt provision remains at 2.6%, and reflects our new combined policies. We expect bad debt provision to be in the 2.6 range for the full year. DSO at the end of March was 69, down from 71 at year end. What should you expect for G&A going forward? G&A expense includes the $4.6 million incremental impact of expensing stock options. Integration costs are also included in G&A. And so, you should expect G&A to increase over the course of the year. 9% to 9.5% of revenue remains a reasonable target for the year. It may be slightly higher or lower in any 1 quarter due to the timing of certain expenses and charges.

What about the tax rate going forward? We currently project that the 2006 effective income tax rate will be 39.5%, higher than for 2005 due to favorable tax valuation adjustments in 2005. And in 2006, higher effective state income tax rates and lower levels of tax exempt interest income. Regarding cash flow in the quarter, with the implementation of FAS 123R, the tax benefits of the exercise of stock options have been mostly reclassified from operating cash flow activities to financing activities. The tax benefits in the quarter were approximately $19 million. On this basis, our free cash flow was $61 million, and this excludes the $85 million income tax payment associated with our divested centers. Cash interest payments in the quarter totalled $116 million, and included the semiannual payments on the bonds of $46 million, and $20 million related to the term loans which were paid in advance for Q2.

What about cash flow for the year? Operating cash flow for the full year from continuing operations continues to be in the range of $350 million to $420 million, again, excluding the tax benefits from stock option exercises, as well as the exercise proceeds. We continue to expect the tax benefits and proceeds from stock options to be in the neighborhood of $100 million, plus or minus. Maintenance capital expenditures continue to be $125 million to $135 million, including IT integration capital spending. For development and acquisition capital, plus or minus $150 million remains a good estimate. This leaves free cash flow of approximately $150 million to $250 million available for additional acquisitions and/or debt repayment.

What about your capital structure? There were 2 noteworthy events in the quarter. First on March 17th, we repaid $105 million of the term loans A and B. And second, effective March 1st, the term loan margins were reduced by 25 basis points as a result of the Q4 reported leverage ratio being below 4.5 times EBITDA threshold. Our outstanding debt now includes subordinated notes totaling $1 billion 350, with average weighted rates of 6.91%. Term A loan borrowing of $279 million, which currently bears interest at LIBOR plus a margin of 1.75%. Term B loan borrowing of $2.01 billion, which currently bears interest at LIBOR plus a margin of 2%. Debt expense for the quarter was $70 million and the overall weighted average interest rate for the quarter was approximately 6.8%. The March term loan payment of $105 million effectively covered the next 7 quarters of mandatory payments and therefore, our next mandatory payments are $19 million due at the end of 2007. Call protection on our term loan expires in June, at which time repricing becomes an option.

Finally, as you think about your 2006 quarterly models, you should consider the following: First, Q2 as in past years, will include significant costs associated with our national leadership training meeting. Second, salary and wage increases for former Gambro teammates will occur as of April 1st. This is consistent with our past salary and wage review cycle, and is in contrast to the DaVita policy which is staggered throughout the year. We do plan to transition to our cycle in future years. Third, as we indicated, integration costs will be weighted more heavily in Q2 and 3 through the balance of the year. Before we go to Q&A, we'll turn it over to Kent for further comments on the longer term outlook.

Thanks, Gary. I'll just make 3 wrap-up comments. 1 negative, 1 neutral, 1 positive. The negative is what I referred to before. Over the long march of time, there will be private rate compression. And while a lot of good things going on with the integration now, with improvements in our billing and collecting operations will go a long way towards offsetting all of that in the short-term. In the long-term, we continue to believe there will be significant private rate compression. The second comment is a neutral one because it could go either way. Government policy. We are doing a better job by far, than ever before, an increasing number of people in the government know that we are underfunded on the Medicare side. Having said that, it would be naive to be optimistic. It would also be inappropriate to be pessimistic. It simply could go either way. And third, and positively, there continue to be more dialysis patients every year. We continue to grow at a differential rate. And we continue to invest our incremental capital with a view towards long-term cash on cash returns. And ironically, to the extent the business gets any tougher, independents and some of the new entrants will have a far harder time than we, to continue to grow. Let's go on to Q&A, please.

[OPERATOR INSTRUCTIONS] Bill Bonello.

I wanted to follow-up, Kent, on your comments on the payer trends. Specifically, are you not in network for a lot of commercial payers? And if so, can you give us a sense of how much of your commercial revenue actually comes from out of network cases?

No, we've never gone to that level of detail. It wouldn't be in our shareholders' best interest to start spreading around a lot of numbers. But we do have a number of centers with a number of payers that are out of network. That's correct.

Okay. And so, as payers push to keep cases in network, is the strategy then that you will be trying to become a preferred provider with those payers? Or will you actually see an impact on volume?

Well, I could go -- well, I guess the answer to the question is, it's unlikely that this would ever lead to a material volume impact. It more likely is, as the incentives for members to stay in network grow, that we will go in the network in those cases where we're not already there.

Okay. That's helpful. And then, just on your comments on increased payer consolidation. Obviously we've seen that at the national level. But has there been a tremendous amount of consolidation actually within the local markets within -- where you operate? And enough so that it offsets say, the level of consolidation that's happened in the dialysis industry?

That's a great question, Bill. What you've seen is -- the short answer is no, it's not that there's an unusual amount of local consolidation. But here's what's happening over the years. It used to be that Memphis or Kansas City or whatever, pick your city. It used to be we used to contract by city. And sometimes it would cover a lot of area around the city. And then it got to the point where you're contracting for multiple cities. And then you started having more of the business done at a state level. And now there's more of it done at a multistate level. So it might be in a WellPoint region or a United region, or whatever. And so, on a strategic basis, the market is evolving. And so that the -- even if the payer is in a particular area you haven't consolidated, they have consolidated more of their contracting for specialty services. And then the percent of the business that is going that way is larger than ever, because of the national consolidation. Because of what has gone on among the Blues and the among the top non-Blues plans over the last 5, 10 years.

Okay. That's helpful. And just 1 additional question on a different topic. There's been a fair amount of turnover in the CFO spot over the last several years. I was just curious if you could comment a little bit on why that might be, and sort of what the thoughts are going forward for filling the CFO position?

Yes, it's a very fair question. But just to clarify, there's only been 2 CFOs, and then we've had some acting CFOs. So in 7 years, there's only been 2 CFOs. And clearly, we're looking forward to finding the right third CFO for the long term future. I think 1 reason why people might have more nervousness around this than one would wish they would is, I came in late '99, and Gary Beil came 1 month later, LeAnne Zumwalt came 1 month after that. And so Gary and I -- Gary's been Controller and now is acting CFO. We've been working together the full 7 years. LeAnne has been here the full 7 years. The other 2 senior finance executives, Guy [See] and Rob Mahan, have both been here the entire time. They, in fact, arrived before I did. And Rich Whitney, the original CFO, continues to work with us on a nearly continuous basis over the last year and a half. So I think what the market probably can't get comfortable with - and I understand - but which makes us very comfortable with how we prioritize different things over the last year and a half, is that 5 of the 6 finance team members, who have done all of this stuff for the last 6.5 years to be more precise, have been exactly the same people, in exactly the same rooms, doing exactly the same stuff.

Okay. Great. Thank you.

Matthew Ripperger.

Just a couple of questions, if I could. I just wanted to go back and clarify 1 comment you made earlier. Which I think you said that the net integration economics were going a little bit better than expected. And then you went off and broke out sort of 3 that were off track and 3 that were better.

And the question is? Was it Matthew?

Okay. That question has been withdrawn, I'm sorry. Justin Lake.

Justin, just before you go, if the other gentleman would like to return, please do. I just wasn't clear on the question. Justin, go ahead.

The sequential revenue for treatment was up about $6. I know you talked broadly about some of those trends there. Can you kind of break down some of those components a little bit more finely, and give us some idea of how you expect that to run throughout the year, or through the rest of the year?

Well, first of all, most of the revenue per treatment increase was because the Medicare change, where that revenue rate went up. And so that by definition, means in the private side things were stable. And for the balance of the year, we provided our overall operating income guidance. And on the revenue side, I think stable is probably the right word to use. There's some up side, there's some downside, but nothing -- nothing dramatic.

Okay. That's helpful. And as far as the same store or the nonacquired treatment growth of 4.6%, can you -- you kind of stuck with that 3.5 number for the year? Is there any reason why you expect that to trend down?

Here's the answer, I would give, Justin. We are very pleased with the first quarter number. It is -- we did better than we thought we would. And we haven't yet figured out if we just got lucky, or if in fact, we're good at it. And so, some stuff might go wrong. We might have some physician defections, we might have some centers go south. So that's why we think we -- we don't think people should assume that every quarter is going to be like the first quarter, I guess is what it boils down to. Although, there is nothing sort of 1-time oriented in the first quarter. It was one of those magical times where lots of stuff goes right, and none of the bad stuff happens. And just because it happens for 3 months, we don't want to assume it'll continue. And in fact, you kind of wonder if the bad stuff is queueing up just outside the room.

Right. Okay. And just 1 last question on patient mix. Was that 4.5% number, I've just been curious, we've always kind of thought about, from a payer perspective, 80% coming from the government and 20% coming from commercial. First of all, is that kind of in line with what you're seeing right now? And then just over the last 12 months, that 4.5%, those new patients that have been coming on, what does that mix look like, versus the total?

The mix has been -- has remained stable. So the mix of our patients, as we have laid out in the 10-K, for example, have not materially changed.

Okay. Great. Thank you very much.

Matthew Ripperger.

Thanks very much, sorry about that. I just wanted to -- my question was related to integration economics. Has the number changed versus what you had before? And then secondly, I wanted to see if you could provide a little clarity, why the integration economic costs get worse later in the year, versus early in the year?

Okay. On the first question, yes. What we said was that our net integration economics in '06 look like they're going to be better than what we had thought before. And if we had to throw out a guesstimate on that, we'd say right now we're going to come out $10 million better on net integration economics in '06 than we thought a few months ago. And then the reason that integration expenses go up as the year goes on, is that we're getting into the more labor-intensive system conversions. So we need a lot more extra hours of work when we're rolling out some of these systems across centers, than we do when it's just a bunch of design people and programmers working out the new system and creating it. So, the labor-intensive expensive part, both with respect to doing that work and the concomitant impact on productivity in the centers, as you're mucking around with their computer screens while they are trying to take care of patients, those are the 2 reasons why operating expenses go up more as the integration rolls on.

Okay. And then my next question is just related to the private pay outlook. You said for the next 3 years, it would get worse than the previous 3. Does that imply that it would be negative, or that it would just be less of an increase going forward versus the prior 3 years?

Well, we'll have to wait and see. We certainly have a very substantial book of business that's already in contract, with annual increases of one number or another. And whether or not that would ever be offset by stuff that happens on the noncontracted side, we'll have to wait and see.

Walter Branson.

You sort of partially answered what I was about to ask. But let me just ask for a little bit more color on the private rates. Since you're making the comparison to the last 3 years, can you tell us what sort of increase you did achieve in private rates over the last 3 years? And it sounds like this isn't something you expect to show up this year, is that correct?

With respect to the first question, we'll provide more analytical visibility on Capital Markets Day in June 1, and some of this stuff, it gets pretty difficult to do too much parsing verbally on a telephone conference call. But we do absolutely get the question, and so I think we can be incrementally more helpful on June 1. And then with respect to impact this year, we've already commented on this year's numbers. We're running so far, right on track for our guidance. And is that responsive? Or do you want to take another cut at that question?

I don't know that you've given guidance -- have you given guidance for private rate increases for this year?

No, but everything that's happening is falling within our aggregate guidance. So take -- maybe ask the question again, and see if I can be more helpful?

Are you expecting private rate compression this year?

Some of our private payers will reduce rates this year. Of course, some of them did last year, and in '04 and '03, as well. But what we are saying, is we think the incidence of that historical fact will increase as we go forward. Right now, how this year compares to last year, probably pretty close. Probably pretty close, in fact, is what it looks like so far. So what you have in any given year, you have some payers where rates go down, and that's typically tied to an out of network, in network thing. It may not be anything the payer does. It may be something that we do because we go in network. So you have some payers with whom aggregate rates go down, and some where it's a wash. And then we have a bunch where it's an increase, either because we negotiate it or because it's part of a longer term contract. And what we're saying, is that the next 3 years, the mix of activity in those 3 buckets is going to be different than the last 3. But there's been activity in all 3 buckets throughout the entire 6-year period. Does that help?

That does help, thank you.

John Ransom.

Yes, I'm going to probably engage in a futile quest here. A fool's errand to try to parse this whole pressure on the profit rate side. But my question is, if you exclude the move to in network, is the rate environment on the commercial side in '06 similar to what you saw in '05?

The short answer would be yes.

Okay.

[inaudible] answer would be yes. Although, again, I wouldn't want people to take too much comfort from that. Because I think even outside, I cited 2 things. 1 was this movement to in network. And the second was just the increased leverage that comes from the payers being more and more consolidated, and them aggregating their contracting. And so, that second fact I think, will become more intense for us in the years to come.

Right. And then secondly, looking longer term, when do you think realistically an alternative to EPO, is that in anybody's investable horizon in your opinion? And secondly, do you see a day within the next 5 years where say, the majority of nongovernment patients will do normal dialysis at home? And are we making any headway longer term on getting reimbursement for more frequent dialysis with less EPO? Thanks.

Wow. All right. 3 parts to that. First on EPO, the notion of an EPO substitute is more real now than ever before. Certainly, with Roche's new entry, and the fact that that -- it might not be too long before that's out there. Although, there's going to be a lot of attorneys fees between now and then. So things may change for EPO, and we're not experts in that sphere. But it certainly looks like there are more potential alternatives, more imminent than ever before. And we're just not really qualified to do any handicapping beyond that.

Okay.

You probably know everything we know.

Well, I guess my question would be, even if you had something tomorrow, is the physician behavior going to be the gating issue, you think? Just they're so comfortable with EPO that something -- it's going to take them a long time to feel comfortable with something else, in terms of the dosing patterns and that sort of thing?

No. No. Clinically equivalent and less expensive, things will happen very quickly. Because we're -- you have to understand, we work so closely, and FMC works so closely with our respective physician groups, so the amount of protocol and formulary-driven behavior in the kidney care community vastly exceeds what you see in 90% of American healthcare. For example - and this is a worthwhile tangent because it's an important reason why we're picking up so much public policy credibility. One of the hot issues, Congressionally, and in CMS these days, is healthcare disparity. Which is to say, some states have a clear empirically different standards of care than others, both from an economic point of view sometimes, more or less expensive, and from a clinical point of view, more or less effective. There's a lot of disparities in America. There are fewer disparities in kidney care, particularly in dialysis, than perhaps any other segment of American healthcare, because no other segment has such a well-defined, evidence-driven set of clinical standards and practice patterns that gets followed-up on, with shared information, shared education et cetera, et cetera. So, no. And when there is -- if and when there's a substitute that's either better clinically, or better economically, change will happen relatively quickly, compared to the rest of American healthcare for very good reasons.

Second, on the issue of home, it's very good that you linked it to MFD, because there is a lot of sort of superficial pitter patter around this, where some people are saying home dialysis is better. Better in terms of convenience, may very well be the case for some people. But better clinically, is not supported by the facts. That at this point, from what we look at, it is far more compelling to say that more frequent dialysis is better clinically. So if you get dialysis 5 or 6 times a week, whether you're at home, in a center, in your car, or at the shopping mall, is better. And the folks in Washington, D.C. are just beginning to appreciate the distinction between home and more frequent. And so we have high hopes for more frequent dialysis, because it makes intuitive sense, and there is a lot of evidence to support the fact that it may be better for patients. And that would be exciting for us from a business point of view, and perhaps for Medicare, because it could reduce hospitalizations, thereby allowing all those extra treatments to be paid for without taxing the system any more. So home care will continue to grow, because it is more convenient for some of the patients. And home care technologies continue to improve. But never confuse what is driven by more frequent dialysis, with what is driven by location, which is basically nothing other than patient convenience.

Thanks very much.

Is that responsive?

Very much so, thanks very much.

Balaji Gandhi.

I just had a couple of questions on the acquisitions. So you mentioned you bought 500 -- acquired 500 patients in April. Was that the total acquired for the quarter, or just 1 acquisition?

First of all, we never acquire patients, we acquire centers that have a patient census. Second, with respect to the answer to your question -- .

That acquisition was in April, so it's not part of the first quarter results.

Oh. Right. Right. Okay. So then what was the -- I guess my real question was, what was the total for the first quarter?

We had 6 centers acquired in the quarter, and a census of a few -- a little over 300 patients.

300 patients, and can you share the geography for those centers?

We typically don't do that.

Okay. Were they new markets or existing markets?

Existing.

Existing, okay.

Either most or all were existing. At this point we're in 41 states and lots of cities, so there are fewer and fewer new out there.

Okay. And then Kent, you mentioned, you talked about Medicaid a little bit in terms of some of the provisions in the DRA that could potentially hurt you. With Medicaid, with drug reimbursement, how different is the way you get paid on average from all the states, versus Medicare or commercial right now?

This is LeAnne. It is different. Each state has a slightly different way of reimbursing. Some states still reimburse EPOGEN on a statutory rate, or a flat rate. But I would say in general, it's a discounted AWP system. And they could move to an average sales price system.

Okay. And then would that include some of the Medicaid managed care plans, as well, that they'd pay off of AWP?

I don't have that level of specificity with me.

Okay. Great, thanks.

Gary Taylor.

Is it fair to conclude that the merger costs or integration expenses increased sequentially from the 4Q?

Increase sequentially from -- meaning Q4 '05 to Q1 '06?

Yes.

No.

It actually went down from Q4, integration costs in Q1 net integration economics were about 5, down from Q4 of about double that. But again, the projection for the year is in the $40 million to $50 million range.

Increase, okay. And maybe I'm confused, but I guess, given your comment that perhaps the negative net integration economics could be $10 million better than you had guided, yet that isn't reflected in the guidance, there's essentially no change in guidance, ex the FAS 123? Any reason that wasn't moved into the guidance yet?

We just think it doesn't make sense to be bumping guidance up and down for every $10 million adjustment. It's early in the year. It's just too small a percentage of the total. There's too much give and take. And increasingly, with every passing month, trying to figure out what's an integration expense versus what's a normal business expense gets very difficult. If a center's productivity goes in the dump for 2 months while we're putting in the new purchasing and inventory system, how much of that do we attribute to normal operations, and how much do we attribute as an integration expense, gets pretty difficult. So we're trying to be useful and provide hard data on how the integration is going, while at the same time not developing foolishly precise numbers and jerking guidance around.

Fair enough. And just 1 more question on cash flow, certainly understand that you've reiterated your free cash flow guidance, and understand the implications of the tax payment. Still would have been a little light of what we were modeling, which doesn't necessarily mean anything. But the 2 things I wondered if you could provide any color on, was the sequential decline in payables, and the sequential increase in inventories? Was there anything that was just seasonal about that? Would you expect both of those trends to continue or to stabilize? Any color would be helpful.

First on accounts payable, that will fluctuate at any end of month, end of quarter point. And so, at year end, the accounts payable balance was unusually high. And so you're seeing that flow through on the first quarter cash flow statement. With respect to inventories, that involves timing of purchases, and that will fluctuate, as well.

Do you -- from either an inventory day or percent of revenue perspective, have inventory levels, I guess, peaked from that standpoint? Understanding that they'll grow as the number of patients and treatment grows. But from a metric perspective, should we still be expecting growth? Or is that relatively stable?

It will fluctuate, so it's hard to predict. One thing to keep in mind is that the inventory balance represents only a -- from several days to a few weeks worth of inventory usage. So there's very high turnover in that inventory number.

Okay. Thank you.

Gary Lieberman.

Patient care costs per treatment looked like they were up about $5 sequentially. Was just hoping you could give a little more color in terms of what was going on there.

Patient care costs are up with labor rates, and benefits were the principal drivers to that increase in cost per treatment.

So was that primarily a seasonal event that just happened to occur January 1, or something else going on?

The increases in salaries and wages is a year-long process. And that, plus increases in the benefits, reflect in the first quarter.

Okay. Was there anything to do specifically with Gambro in terms of changes in their operations which might not have occurred in the fourth quarter, but that you guys felt you needed to put into place come the first quarter?

Nothing significant. We have the integration costs, which would cover, perhaps, some of that, but nothing significant.

Okay. Thanks a lot.

Herman Timmer.

I've been with you since [inaudible]. Has any study been made of the age brackets that you take care of? I hope I'm phrasing that question properly.

Yes, we've got a fair amount of data, and thanks for sticking with us, by the way. We've got a fair amount of data on the percentage of our patients at each different age level, and sex, and race, and all of that kind of stuff.

I'm mainly interested in age.

Yes, we do have that information.

You do have it?

Yes.

Does it tend to rise as people get older?

It does.

Have you been in south Florida recently in the last 5 years, Kent?

Personally, yes.

You have been. So you know that 1 of your centers is located probably about 10 miles from where I live, and it is 100 yards from a community that has 15,000 people living in it, and the average age in that center is between 70 and 74. My question is, your center across the street, which by the way, needs a new sign, when it becomes overloaded, or what have you, because of its location, are the machines used on Saturday and Sunday to take care of that need?

Yes, many of our centers, in fact most of our centers do run 6 days a week, multiple shifts. But rarely on Sunday, because it's awful hard to get quality care givers on the Sundays, and so we shy away from that.

Do you run into that problem mainly in Arizona and Florida?

No, pockets across America. And we do have to be fair here, because we try to limit folks to 1 or 2 questions, even folks that have been loyal for a long time, just so everybody gets a turn.

Thank you.

Well, no, could you go -- you could always go back into queue, and come back in at the back end or something. But we just want to be fair to everyone.

Thanks a lot.

Thank you.

Darren Lehrich.

Sounds like economic costs for the integration may go up another $1,000 next quarter if you have to buy a new sign down there in Florida. I have 2 questions. First, and I'm sorry if I missed this earlier in the call, Gambro same store revenue growth in the first quarter, can you share that with us, or just give us a sense for where you are there? And then secondly, with regard to the -- I guess your plan to migrate more of your supply and equipment purchases into the Gambro organization, can you just share with us some thoughts as to how those discussions are going with medical directors and whether you expect to feel any resistance as you move more into Gambro versus some of the other suppliers that perhaps some of your medical directors may prefer? Thanks.

With respect to the first question, we're not going to split out the nonacquired growth old DaVita versus old Gambro, because it becomes impossible since we're, and have been for the last 6 months, making sort of joint decisions about where to build things, and which groups we're involved with, and where we're putting in PD programs, and where we're doing this and that. And so it very quickly becomes a number that's incalculable. And so the combined number is the combined number. And fortunately the predeal numbers for the 2 companies were very public, and so one can do an arithmetic weighting, and then compare how we're doing to that, as we go forward.

And then on the next question, I got a little confused about the medical director aspect versus -- well, let me answer what I thought I heard. Which is as we introduce Gambro equipment to some of the doctors with whom we worked, and we introduced it in centers where there previously was non-Gambro equipment, that process is going fine. Which is to say, most doctors are very comfortable, very quickly, because it's good equipment. Now, in some cases, we haven't made any changes, in particular because Gambro, the manufacturing company is having problems now and can't deliver some of their equipment into the United States. But where it has happened, it has in general gone well, because the evidence is objective and clear that it's quality equipment.

Okay. That's responsive. Thank you.

Bill Bonello.

Yes. Just a couple of follow-up questions. And I apologize if you gave this number, but can you tell us what the stock option tax benefit impact on operating cash flow in Q1 of '05 was?

We're checking on that, Bill. Why don't you go on to your next one while we scurry.

Okay. And the next one is just how far out do you have visibility on your EPO cost?

Roughly -- well, a 2-part answer to that. Part 1 is that about 21 months. But part 2 is that the -- what we pay is affected by what we buy, and what some of our clinical outcomes are. And so to that extent, we don't have visibility at all. It depend on what happens out there in the real world.

Sure, okay. But in terms of sort of a base rate, about 21 months? And then the final question is -- ?

No, no, Bill. It's 21 months today, which is to say it was 24 months 3 months ago, and will continue to go down until [inaudible] expires.

Right.

So it's not a rolling 21 months. I just wanted to make sure I didn't mislead you.

No I got that. And then the final question is, just as we look to the June investor day, I assume we shouldn't be looking for any big new news there. I mean there's no analysis or anything you're trying to work through right now. It will just be going deeper on the things that you talked about today?

Correct.

Okay. Thanks. And I'll wait for number 3.

Bill, on the tax benefits, compared to the $19 million we had in the first quarter this year, last year's first quarter number was about $15 million.

Okay, and last year it was in operating cash flow?

That was pre-123R.

Okay. Thank you.

Okay, there are no further questions at this time.

Okay. Thank you all for your interest, and we will work hard for you until we re-meet 3 months from now, or in this case, I guess 1 month from now at Capital Markets Day. Thanks.

Ladies and gentlemen, this concludes today's conference call. You may now disconnect.