德維特 (DVA) 2006 Q2 法說會逐字稿

At this time, I would like to welcome everyone to the DaVita second quarter earnings conference call. [OPERATOR INSTRUCTIONS] Now at this time, I would like to turn the conference over to Ms. LeAnne Zumwalt. Ms. Zumwalt, you may begin your conference.

Thank you, and welcome to our second quarter conference call. We appreciate your interest in our company. I'm LeAnne Zumwalt, Vice President of Investor Relations and with me today is Ken Thiry, our CEO and Gary Beil our acting CFO. I'd like to start with our forward-looking disclosure statement.

During this call we will make forward-looking statements which can generally be identified by the content of such statements or the use of forward-looking terminology and includes statements that do not concern historical facts. All such forward-looking statements are subject to known and unknown risks and uncertainties that could cause the actual results to differ materially from those described in the forward-looking statement. 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 Report 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 the underlying factors, new information, future events, or other developments.

Additionally our press release and related disclosures include certain non-GAAP financial measures. These measures should be considered in addition to the results prepared in accordance with GAAP and should not be considered 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, our CEO.

Thank you, LeAnne. Our Q2 performance was strong and we are in a period where an unusually high percentage of things are going well. I will provide a review of the normal agenda items which are number one, clinical results, number two, the second quarter and our '06 outlook, number three, the Gambro integration status, number four, public policy, and Number five, our longer term outlook.

With respect to number one, clinical results, we present it first because that is what comes first. We are first and foremost a caregiver company and for the first time, we are providing you clinical results for over 100,000 of America's dialysis patients. With respect to adequacy which is essentially how well we are doing at removing toxins from our patient's blood, 93% of our patients had a KT of RV greater than 1.2. With respect to access we have 50% of our patients dialyzing through a fistula, both of these measures compare favorably to national averages. And these clinical stats that I just related pertain to patients who have been with DaVita for 90 days or more.

Category number two, the second quarter and our 06 outlook. The strong Q2 results were primarily driven by A) improvements in billing collecting; B) higher than expected treatment volume; and C) favorable cost performance. As a result of the strength of our current momentum, we are updating our '06 guidance which was 600 to 680 million of OI to 670 to 700 of OI. We're also updating our operating cash flow guidance which was 350 to 420 and now is 450 to 500 excluding the $85 million divestiture tax payment. As always, these guidance ranges capture a majority of the probabilities in our estimation, but not all and in aggregate , key swing factors could emerge such that we ended up above or below the range. With respect to the balance of '06, our guidance range anticipates a strong third quarter followed by some pull back in Q4, a result of one less treatment day in Q4 versus Q3, and normal seasonal labor productivity patterns.

Category number three, the Gambro integration. First of all with respect to the five big IT projects/transformations that we have discussed since the integration began, with respect to billing and collecting, we've been able to make some actual improvements over the last quarter. With that said this remains one of the most significant integration challenges and we will be working hard on this through 2007 and beyond. Good progress, long way to go.

With respect to some of the other IT major projects that we have discussed in the past, HR and payroll, I'm happy to report that we are now processing on a common platform and it works. With respect to inventory purchasing, once again, good news. We've implemented the new systems in both the new and old DaVita centers almost 1,300 of them and while we're still working out the bugs, it fundamentally works, and then patient registration, we are very close to completing the installation of the patient registration software and all the new DaVita centers, literally expecting to complete it in the next couple of months. So good news down the line there. Finally, the implementation of the new clinical documentation system, a massive project that will take the next 2 to 3 years to complete is solidly underway but way too soon to call in terms of effectiveness, quality, et cetera. This rollout will be difficult, expensive, and distracting.

Category number four, public policy. Our industry consensus bill, the Kidney Care Quality and Improvement Act now has 164 sponsors in the House, 34 in the Senate, significant bipartisan inclusion. This is by far the most support this community has ever garnered for a bill by a significant multiple. We have therefore, a reasonable chance, no better than that, but a reasonable chance of receiving a rate increase this fall, and we badly need it given we lose money on the 87% of our patients who are government pay. The drug add-on, second component of public policy that we've consistently updated you on, we expect to actually see the proposed rule from CMS relatively soon. If they follow the 2003 MMA major legislation, we would expect to see the drug add-on adjusted for utilization to price inflation trends as the legislation indicates which clearly should result in increase in the drug add-on in '07. Having said that, we don't know what they will do and for purposes of your modeling, you must contemplate the risk of no change or even a negative change.

EPO monitoring policy, the third and final aspect of public policy which we will discuss as of April 1, the new EPO payment guidelines became effective, the guideline as implemented has had an unambiguous negative impact on certain patient's health and outcomes and we continue to work with CMS in hopes that they will make appropriate amendments to the rule and it appears to us they are seriously considering that. Our guidance regarding the negative earnings impact of this policy remains as it has for some time at 10 to 15 million annually. We won't know for sure until the dust settles.

Number five and finally, what about the longer term outlook? Let's first define longer term outlook as '07. What about '07? Our prior operating income guidance was 650 to 750 million. We are moving the bottom end of that range up by 30 million and the new operating income guidance range is therefor 680 to 750. Once again, this captures a majority of the probabilities.

What about pure contracting in general, second aspect of a longer term outlook? Given our more significant geographic foot print, we have been asked about exclusive contracts. It makes no sense for us to enter into this type of contract. We are in a low fixed cost, almost purely variable cost business where more volume does not justify significant discounts. It is unlikely that you could ever make up for the decrease in rates with more volume. In addition, all contracts come to an end and one potentially creates an even more problematic renewal situation in terms of competitive response. As indicated in our Capital Market stay, we believe that over time the parent climate will be tougher.

What about the government? Third aspect of longer term outlook. With respect to the government there are two swing factors which tend to dwarf all others. One is the timing and extent of our rate increases over time, and the second is the likelihood of an MSP extension. In the case of rates, it is just impossible to predict the outcome in the intermediate term with any significant confidence. It could go either way; however if our industry does not receive rate updates, the housing centers will close and patients will be negatively impacted and that will get a lot of attention.

With respect to an MSP extension, I would be surprised if it doesn't get extended in the next few years, although if you have a change in control in Congress, that's an open bet again; but, even if one thinks that it will be extended over the next few years is impossible and not constructive to try to guess when and by how much. Suffice it to say it would be a material positive for us.

The fourth and final component of a longer term outlook would be to talk about '08 and beyond. We have historically provided a three year outlook that included explicit numerical operating income guidance. We have done that because we believed it added to your ability to calibrate the risk and reward of an equity investment in DaVita. While we will continue to provide a three year outlook, we're going to withdraw our recent '08 operating income guidance. The reason is there are simply too many swing factors and our range would be too wide to be useful.

The major swing factors for '08 and beyond in addition to of course normal operating performance trends are number one, the negative of a trend of a tougher payer contracting environment. We believe some of our rates will be materially lower in the years to come. Number two, the uncertainty of Medicare reimbursement. Number three, the positive of an MSP extension. Number four, the uncertainty of future pharmaceutical economics. I think there's more downside than upside there for our shareholders, and number five, finally, the reality of our ability of collecting integration.

Let me just quickly repeat. The five major swing factors for '08 and beyond in addition to normal operating performance trends, the negative of private rate compression, the uncertainty of Medicare reimbursement, the positive of an NSP extension, the uncertainty of future pharmaceutical economics, and the reality of an intense billing and collecting integration. While all five of these statements about swing factors are true and important, it is also equally important to remind everyone of the following, although many of you have been with us for awhile and already know these to be true. We provide an essential service, demand is stable. We have a very strong market position growing stronger every day, and we, both DaVita and our industry, have unusually attractive operating and free cash flow. Thank you. I'll now turn the call over to Gary for some more detailed discussion of the quarter.

Thanks, Kent. I'll address a few key questions. First, regarding the major drivers for the strong performance in the quarter, and the improved guidance for the year. As Kent mentioned the strong Q2 results were primarily driven by improved cash collection and revenue capture. Stronger than expected treatment volumes, and favorable cost performance.

Let me give you a few examples of contributors to improved revenue capture. One, billing of all billable ancillary services; two, reducing untimely billing losses through better denial management; and three, optimizing recoveries from secondary payers. At this time, it appears these collection performance levels should be sustainable for the near term. Of course before considering the impact of changes and rates, pharma intensities and other factors. With respect to treatment volume our non acquired growth of 4.1% for the quarter was on the high side of our previous projection of 3.5 to 4%.

It should be noted that Q3 and Q4 will compare favorably to last year's quarters which were negatively impacted by Hurricane Katrina. This favorable short-term same center growth factor will not continue into 2007 and we would expect non-acquired growth to return to the 3 to 4% range. We currently expect to open approximately -- we continue to expect to open approximately 40 de novo centers in 2006.

With respect to acquired growth, we have acquired centers with approximately 1,000 patients in the first half of the year and we hope to acquire additional centers in the second half with approximately 500 patients. On the cost side, our strong Q2 results also reflect favorable performance in operations, lowered health insurance accruals, and lower than anticipated integration costs.

Regarding cash flow in the quarter, our free cash flow of 227 million in the quarter was unusually strong and benefited from normal timing fluctuations in liabilities, primarily interest accounts payable, accrued payroll and taxes. As you may recall, the Q1 free cash flow was unusually low and this was due to the $85 million divestiture tax payments, the 46 million semi-annual bond interest payment in the first quarter, and $20 million of early payment on the term loan interest. Year-to-date, free cash flow is 184 million after the special tax payment or 269 million excluding this tax payment.

A final note regarding Q3 cash flow. As a consequence of the Deficit Reduction Act, new Medicare claims will be processed by our fiscal intermediaries from September 22, through the end of the Federal government's fiscal year end which is September 30. This temporary suspension of Medicare payments may have a major impact on our September 30 cash and AR balances. Unless we are able to successfully submit August claims earlier than normal, and the FI's are able to process claims by September 22. LYs from this could impact our Q3 cash flow by up to 150 million or more.

What should you expect for G&A going forward? G&A for the quarter was 9.2% within our guidance of 9 to 9.5% and that remains our guidance. G&A expense includes the impact of expensing stock options which was approximately 10 million year-to-date. We still project stock option expense to be in the 25 to 30 million range for the year.

What about cash flow for the year? Operating cash flow for the full year from continuing operations is expected to be in the range of 450 to 500 million, again excluding the 85 million divestiture tax payment, tax benefits from stock option exercises as well as stock option exercised proceeds. We continue to expect tax benefits and proceeds from stock options to be approximately 100 million for the year plus or minus. Maintenance capital expenditures are expected to be 125 to 135 million. As a reminder, our guidance includes 25 million related to IT integration. We are increasing our development in acquisition capital spending estimate from about 150 million to about 180 million plus or minus. This increase relates to investments we are making in relocating a number of the Gambro clinics and creating additional capacity in a number of centers. This will leave approximately 250 million plus or minus available for additional acquisitions or debt repayment.

What about capital structure? On May 26, we repaid an additional 100 million in debt and through June 30, total repayments were 205 million. Outstanding debt at the end of the quarter included our subordinated notes totaling 1.35 billion with a combined average weighted rate of 7%. Term A loan borrowing of 279 at LIBOR plus margin of 1.75%. Term B loan borrowing of 2.3 billion at LIBOR plus a margin of 2%. Debt expense for the quarter was 68 million and the weighted average interest rate was approximately 6.6%. That excludes the amortization of the deferred financing cost.

Additionally, yesterday, we repaid 120 million of term loan B debt bringing our total repayments for the year to 325 million. The outstanding B loan borrowing is now 2.18 billion and our current leverage ratio is 4.07. Mandatory payments on term A loan are covered through Q3 2007 and for term B through Q3 2011. We will now turn the call over to Kent for closing remarks before we move to Q&A.

Let's go ahead and move right into Q &A.

[OPERATOR INSTRUCTIONS] And your first question comes from the line of Elan Southwicz from Red Dawn Partners.

Hi, this is Elan Southwicz from Red Dawn Partners in London. Thank you very much for taking my call. I've just got one question relating to your outlook on the private payer rates, and I was just hoping, Kent, if you could please just go into a bit more detail to exactly where that pressure is coming from, why you see it arising and maybe if you could try and split that out, if there is a difference between that and the potential negative you see from pharmaceutical billings, and it just seems to at the last quarter you were quite negative on the pricing but certainly we don't seem to be seeing any sign of that coming through in your numbers this quarter.

Correct. I don't think there's anything that we can add. We are predicting that across-the-board getting pay rate increases will be tougher the next few years than the last few and in some instances, we expect our rates to actually be reduced, and exactly when that will happen and how pervasive it will be is of course devilishly difficult and we wish it wouldn't happen at all, but we do think it will and therefore, it's our obligation to say so and this does apply both to private rates on the treatments and then just all the dynamism that exists within the pharmaceutical sector now with some new drugs coming out and oral drugs coming out and SARA coming out as a potential replacement to EPO in some situations or all situations, so there's just so much going on there and at such a significant chunk of our revenues that we feel people have to have a very healthy respect for the risk inherent in all that movement.

Thank you very much.

Thank you.

And your next question will come from the line of We Dial from Stahl Harbor.

Yes. I just need a little more clarification on the cash flow. Obviously the cash flow was very strong from reduction in working capital, and it looks like to me when I compare the cash flow statement from the first quarter Q, you have accrued compensation liability generating a lot of cash this quarter as well as other current liabilities generating a lot of cash beyond the income tax item that you mentioned. Can you just elaborate on that?

Yes. I think what you'll find is that the levels -- those balances will fluctuate through the year fairly significantly and as of June 30, we had the balances tended to be on the high side and it's just the timing, normal timing and fluctuations of payments and liquidation of the liabilities.

Okay. So these are just timings, so they could reverse in the next couple quarters?

Yes, exactly. And there's a fair amount of interest accrued as of June 30, about $50 million with about -- on the notes, the payment was made on July 3, and the bonds payment is in September.

Okay.

There's a reason why we've always provided every quarter rolling 12 month operating and free cash flows, and why we also provide some element of go forward guidance on both OCF and FCF, it's in order to help you smooth out some of the inherent vagaries of our cash flows.

Okay. And can you just repeat how much you say you expect to receive from cash flow, the stock option exercises? I didn't catch the number.

Yes, both from the exercise of the options and the tax benefit, we're looking and projecting somewhere in the range of of $100 million plus or minus for the year.

Okay. Thanks.

But let me make one addition to that comment which is to say we are beginning to issue some SARS as opposed to classic stock options which on the one hand do not create the same earnings dilution, share dilution, on the other hand do not result in the same generation of cash so while Gary's answer accurately answered the question with respect to this year on a go forward basis, the model should be adjusted to reflect a disproportionate use of SARS.

Okay, thanks.

Thank you.

And your next question will come from the line of Justin Lake.

Thank you. Just one quick question on the quarter. You mentioned your costs were a little bit lower than expected. Can you kind of go through some of those cost issues such as the Gambro salary increases and the -- what actually the changes cost you, the integration cost in the second quarter versus the first quarter? Can you kind of walk through the moving parts there and get us to where we need to be as far as the run rate?

Yes, Justin, it's Kent. I think my answer will disappoint you a little bit although it's accurate. The fact is the cost performance, the good cost performance was spread across a lot of categories. Not only productivity but also integration, even things like healthcare accruals and so we had five, six, seven of the cost categories, each of which delivered unusually strong results either in this exact period or as results of tweaks to accruals because of longer running performance and things like healthcare. So there's no one or two items that you're going to be able to fundamentally adjust because it was much more broadly distributed.

Okay. Maybe you can just focus on the integration cost then. I think you said there were 5 million in the first quarter if I'm not mistaking. What were they in the second quarter and what are you expecting for the back half of the year?

As we move forward with the integration, it becomes tougher to break out the integration costs discretely. That being said, we are performing favorably to what we had projected on the integration costs.

Is that just a timing issue from a spending perspective or is it just maybe you were a little conservative as far as what the kind of hourly impact was going to be from a patient treatment standpoint?

Yes. It's a little of both. We are doing -- I don't think we were inappropriately conservative or anything, but we are doing better than we thought, but also in some cases, some elements of the IT integration are running a little behind and therefore, there is -- there are some expenses which we wish we would have had this past quarter and we did not.

Okay. And just one quick question on the commercial side. Maybe a little bit of what -- it appears from the Investor Day that the place that you feel the most pessimistic I guess I'd say about the commercial environment would be on the percentage of revenues you're getting from out of network patients. Would that be correct?

That's one issue. We're really not trying to calibrate different categories of private payer, upside or downside relative to one another, but that is certainly one relevant piece of the forecast, yes.

Okay, well I guess I'm just looking at your 2005 10-K and you reported that that represents about 10% of your total patient revenues? And I'm just wondering if you can give us an idea directionally as to what percentage of your actual patient it represents.

None of us are familiar with that reported number, Justin so you'll have to give us a ring and point out exactly what number you're talking about because we don't think that number has been disclosed and in fact is not a black and white categorization so it's a little difficult to put an exact number on it.

Okay, it's actually in the sources of revenue concentrations and risks on page 6, just reading it, it says approximately 10% of our revenue is associated with non-contracted commercial payers. So that's where I was getting that number from. We could talk about it off line if we need to.

Yes. Why don't we check and make sure we've got the right definition there, Justin. But why don't you go ahead with your question now? Again, let me take another stab at it.

Well, maybe you can just tell us or maybe you can give us an idea directionally of what percentage of your revenues and what percentage of your patients are non-contracted where you might be at risk from going out of network, in network as commercial plans work to tighten up their networks and try to get national contracts out of you.

And the answer to that would be no. We don't think it's in our shareholder's best interest to disclose that. Suffice it to say for us like every other American healthcare provider, out of network rates are higher than in network rates so that's the definition. It's like retail versus wholesale and so while we acknowledge that reality just like every other healthcare provider we don't go into more granular public discussion.

That's fair E enough. All right thank you very much.

Thank you.

And your next question will come from the line of Darren Lehrich from Deutsche Bank.

Thanks. A few questions here. First, I know you mentioned you repaid 120 million of the term loan and I know that your commentary around the DRA impact on cash flow may hurt you in the third quarter. I guess my question is really what is the level of cash that you need to have in the business on a routine basis? It still seems like you're running with cash balances that might be a touch higher than what we would expect, and can you just help us think about that? And then will you have an opportunity -- when will you have an opportunity to step down your interest rates in your pricing grid on the term loans? Did this 120 million payment allow you to do that?

Yes. We obviously obviously are very focused on the September 30, issue with the Medicare claim processing issue. Our target, our cash target we've always said is in the range of 100 million and looking ahead to the third quarter, that is very much, like I said our focus and we will continue to assess additional debt repayments as we go through the year.

And to your question about the step down of interest rates, there's no specific opportunity now.

Okay, that's fine. My other question really relates to Gambro and organic growth inside of Gambro. I guess our calculation here would point to high single digit treatment growth for Gambro. I'm not sure if that's accurate, but can you just give us a sense for what the treatment growth and the revenue for treatment growth was in Gambro so we can understand how the top line is tracking in this business?

Short answer is no. First of all, the same-store Gambro center growth which we will let you know is not in the high single digits. Second, we will let you know that it's better than it was before the acquisition and it's better than we expected which is one of the things that drove the second quarter performance. And third, in general, our revenue for treatment forecasts for the Gambro base of business, we continue to do well relative to those forecasts, again, and that's reflected in the performance of the quarter, but we're not going to start breaking out new DaVita versus old DaVita, same-store growth and/or revenue for treatment trends because it's not really analytically achievable. In all sorts of markets the operations are basically blended and so actions we take in one center or in building a new center can affect a new DaVita centers an old DaVita center proportionately and action we take with respect to a contract can affect one type of center more than another, but the action was not driven by what outcome was best for that individual center but what outcome was best for the market overall.

So breaking out those numbers could literally be very very misleading and just doesn't make sense because that's not how we run the business; however, the embedded question within your remarks, how are we doing on same-store growth in the Gambro centers and how are we doing on revenue per treatment increases in the acquired centers? The answer to those two questions is we are doing fine, a little better than we expected.

Okay and if I could just clarify was there any sequential improvement in organic growth in the Gambro business and can you just comment on that at least and I guess one clarification I'd like is when Gambro comes into the same-store calculation given the experience so far being better than expected, do you anticipate that that will skew the same-store metrics when that comes into the same-store group?

Okay, you got to -- ask the question again, please, so we--.

Sequentially, did Gambro improve?

And that we won't disclose.

Okay and will Gambro based on the experience so far which you mentioned was better than expected, improve your non-acquired treatment growth statistic when it comes into the non-acquired group?

Well, Gambro is already in because we did not treat -- normally, if we open a new center, we don't count it in the numerator nor the denominator for same-store growth and non acquired growth . until the 13th month which is what you're picking up on. In the case of Gambro, we just used all the historical data from the Gambro centers themselves and so they were put in the numerator and denominator day one with the data that preceded the close of the deal. So they have been in the non-acquired growth number since we closed the deal.

Fair enough. Okay. And then just one last thing here with regard to the integration. Can you update us on single use to reuse and how that is a tracking and when you expect that to be substantially completed? Thanks.

Right now single use is running in the neighborhood of 33 to 35% and of the -- I'll provide the standard historical context DaVita was at about 25 and Gambro was at about 45. Gambro had moved up as high as 60 because they were on their way to moving to 100, they then discovered as they hit the 60 threshold which of course took awhile to get there that they weren't getting any clinical benefit and they were paying a lot of extra costs so they started moving in the other direction. So those are the numbers. That's the historical context, and as to what will happen going forward, it's just hard to say. In the end this is an area where physicians get to make significant choices and we'll see what choices they make over time. Is that responsive?

Yes. Thank you very much.

Thank you.

And your next question will come from the line of Jeff Grove from Segal and Bryant.

Hi, guys thanks for taking the question. I was just curious, you guys have launched somewhat of a test pilot program called village pharmacy in some centers and I'm curious what you're learning from that. Does it look like you'll be rolling that out more broadly sooner or later? What's the nature of that program?

It's very tiny and it's very young, so it's too soon to say much other than patients like it and we're losing money.

Okay. And your next question will come from the line of Patrick Freely from Banc of America Securities.

Hi, thanks. Just a quick question on the balance sheet again. Can you give us some of the detail behind that other current liabilities line or at least some of the detail of what's driving the increase? I know you guys said it's going to be lumpy, but if you could just give us some of the detail compared to the first quarter?

Yes. The major -- largest item fluctuating in there is the accrued interest. There's 28 million accrued for the bonds.

Yes.

And that payment, that's a September payment and additional 22 million related to the credit facility, the term loans, and that interest was paid on July 3.

How much was accrued interest at the end of the first quarter? That's 50 million or so this quarter.

It was only 7 million at the end of the first quarter. We had heavy payments in the first quarter.

So that's driving a big chunk of that increase?

Exactly.

Okay, thank you.

Thank you.

And your next question will come from the line of Bill Bonello from Wachovia.

Good morning. A couple of questions. I'm sorry, but I'm hoping I can get you to repeat first of all a couple of numbers. Would you mind repeating the amount of debt you've repaid year-to-date and then the amount of cash that you said you would expect to have available for acquisitions and debt repayments and then I have a couple others.

Yes, including the debt repayment that we made yesterday, year-to-date net totals 325 million of debt repayments. The operating cash flow for the full year -- the range that we've got is 450 million to 500 million and again that excludes the $85 million divestiture tax payment. The stock option proceeds and tax benefits, somewhere in the range of 100 million. Maintenance CapEx, 125 to 135. Development and acquisition capital including the additional relocations about 180 plus or minus, and that leaves about 250 plus or minus for additional payments and those numbers are as of June 30, and then we had the additional payment yesterday.

Okay so you would -- in terms of sort of what you would think of as available you'd maybe take 120 out of that? Yesterday's payment?

Yes.

Okay. And then on the cash flow, I understand that your comments -- I'm not trying to extrapolate too much from any given quarter's cash flow given the timing, but I'm not sure I understand why you would expect '06 operating cash flow to be lower than operating cash flow for the trailing 12 months. Was there something unusual in the trailing 12 months or in the next six months other than the Medicare situation which it seems like what you miss in Q3, you pick back up in Q4 that we need to be aware of?

Yes. The Medicare issue would be gone by the end of the year, and so what's really driving that difference is working capital fluctuations and higher interest.

Okay. And then on capital expenditures, can you give us a sense of whether your expenditures, your integration related CapEx has been consistent with your expectations thus far this year and is there any change to your outlook for either this year or next year on that, aside from what you already mentioned about the relocation of centers?

Yes. As it relates to the integration CapEx, year-to-date, the IT integration CapEx has been about $14 million, pretty evenly split between Q1 and Q2, and that's on line with what we had projected.

Okay and no change going forward? Your outlook?

No.

Okay. And then a question for Kent. Can you just elaborate on why you would think the pharma economics are more likely to be negative in the future than they are to be positive? Specifically what kinds of things could change negatively?

Yes, I think it's sort of a macro view, Bill, I don't know if it will be satisfactory to you that there's an awful lot of focus in Medicare on pharma reimbursement as you know and they made a number of changes to reduce it the last couple years. I think they will be continuing to look at ways to reduce Medicare's pharma bill. I think you're going to see increased focus on that stuff on the private side and then separately, there's just lots of new drugs coming out including new drugs that are going to affect our space and while historically in many instances the introduction of new drugs meant increased revenues, I think the world has changed, particularly as some drugs that are currently injected or infused might be available orally and so it's sort of a high level world view, but I think it's going to play out that way and pharma revenues are a big chunk of our business. In addition, there's an overlap between the private rate issue and pharma stuff because obviously, some of our pharma revenue is from the private side and so you get sort of an overlap between those two trends and we think there's going to be some negative stuff there including, again also some of the out of network stuff.

Okay and then just as a final question and follow-up to that, have you given any consideration at all to providing an expanded pharmacy service, if not benefit, to your dialysis patients?

Short answer is yes, but the math does not look attractive right now.

Okay. Could that change if there was a significant shift towards oral medication?

Maybe, but inherently working on oral drugs is a low, it's always been a low margin business and I don't really see that changing, and so the answer is maybe it could but I wouldn't bet a lot of money on it.

Okay. Thank you very much.

Thank you, Bill.

And your next question will come from the line of Balaji Gandhi.

Thank you. I just had a question about next year's guidance, the new guidance that you set out today. Is there an assumption in there you're making for acquired growth versus non-acquired growth?

Well, yes. Our '07 forecast incorporates a mix of acquired and non-acquired growth.

In terms of revenues, contribution from acquired versus non-acquired?

Yes, we've never broken that out.

Okay wasn't sure if you brought that up at the Capital Markets day or not. That's it. Thanks.

Thank you.

And your next question will come from the line of Art Henderson from Jefferies & Company.

Kent could you give us an update on what's going on with the Gambro product and supply agreement dispute I guess is the best way to characterize it.

Sure. We're engaged in pretty constructive negotiations with them. We're hoping that we reach a settlement and don't have to go to court. I think they hope the same thing.

And so basically, it's -- in effect this is coming to an end so we can pretty much assume that's going to happen.

No. I think that would be going a bit too far. If I had to bet $1 either way, I would bet that we will reach a negotiated settlement, but we haven't yet and therefore, we could end up going to court where one can never predict with certainty what the outcome will be. It could be one that makes us very happy and them very sad or the opposite or anywhere in the middle. So I don't think you can quite be that confident that we're going to settle, but it is more likely we will than we won't as of today.

When you indicated that there had been a violation of a contract which triggered I guess was a 90 day period?

Yes.

And that 90 day period ends when?

I believe in late August, so plus or minus a bit in that range.

Okay. Great. And then one last question. How many de novos have you opened year-to-date?

The answer to that question is between 15 and 20, in that range, and let me go back to the GRP thing. I'd like to make one thing clear which I've tried to make consistently clear throughout the process. We think very highly of Gambro as a company. We think very highly of Gambro products. Just because of some of their current challenges, they have been unable to reliably deliver us product and we had to take action to secure stable supply for our patients and physicians and caregivers and so we fully anticipate buying lots of stuff from Gambro very happily for a long time. Nevertheless, we simply have to get amendments to the contract or seek court mandated changes if we can't get them to agree, but I want to put that in the right context. We have every expectation of very happily buying lots of product with them for a long time.

Okay fair enough and then real quick back on the de novas. Are you focusing your de novo development in markets where you already exist or new markets or rural or urban or is it kind of all of the above?

Most new de novos are in geographies where we are already present. Most, but not all.

Okay. Great. Thank you, Kent.

Thank you.

And your next question will come from the line of Andreas Dirnagl, JP Morgan.

Kent, I was wondering if you could provide just some clarity on the changes that you're making the guidance. If I look at it you raised your guidance for operating for 2006 by a not inconsequential amount, your 2007 guidance you've now tightened up to the higher end of your range and that '07 guidance now in effect blankets the lower end of what used to be your 2008 guidance, yet you're withdrawing your 2008 guidance given as you claim sort of uncertainty in being able to project it. I guess the question is what's changed in the two months since you first gave that 2008 guidance besides the fact that you've raised it for every other year?

Well, very fair question, Andreas. I think what's changed is pretty much nothing. Our near term operating performance is stronger, so that's a change and that's why we adjusted '06 and '07 and as we reflected on '08 and as we reflected on the questions we've been getting on '08 since we provided that guidance, we just came up -- came to the conclusion that we were not adding value by providing the guidance, that in fact there's just some major swing factors and in particularly, you know we have a negative view on private rates going forward but trying to quantify that and then apply it to a particular 12 month period just didn't seem constructive anymore, so that's why we're withdrawing it. It just -- the range of outcomes for '08 and '09 is too large when we analytically calculate it and it doesn't seem to be constructive or productive for us to provide it.

Having said that I repeat, we will continue on an annual basis to provide a three year outlook of key trends and we'll continue to do that in a highly analytic way and by the time we do our next Capital Market, we may be right back with numerical operating income guidance spanning three years, but right now, it just didn't seem to be leading to constructive conversations. Is that responsive?

Yes, I think that's responsive. Let me try and turn it around and look in the other direction then. You have talked a lot about your negative outlook for private pricing or private pay pricing. Given the fact that you call sort of your '06 and your '07 operating income guidance, guidance that includes most of the probable outcomes is it sort of safe to say therefore -- I guess it must be that you are comfortable enough to be able to say look, private pricing may be getting tougher, we're comfortable with these ranges through 2007 so if there is a problem with private pay pricing it's sort of with 2007 and beyond.

That's a reasonable statement. Now, I just want to point out you said 2007 and beyond. There's not--.

2008 and beyond.

Oh, see now you're changing it. No. We said explicitly our '07 range captures a majority of the probabilities. We could, if things go well, beat the '07 number on the high side and we could if things go poorly and most particularly that would mean no Medicare rate increase and a bunch of private rate compression, miss the number on the low side. So your statement is one bridge or one year too far.

Okay and then sort of final question for either you or LeAnne. Just in terms of the Washington outlook, I guess traditionally, there have been various dialysis bills that have been introduced and again traditionally, they have not passed on their own, rather they've usually been sort of tacked on to larger healthcare legislation. Is there anything that would change that outlook for this year? If not, do you see a larger piece of healthcare legislation that a dialysis bill could be tacked on to or is the outlook looking a little tough this year?

The answer to the first question is the world has not changed, there will not be a discrete separate stand alone Kidney Care Bill. We need to have a vehicle to attach our little package to. The second question is what would that vehicle be or what might it be? There are two potential answers. One is a Medicare Bill and most people think the most likely provocateur that would lead to there being a Medicare Bill is the need to fix the physician rate schedule where unless Congress does something, the docs experience a significant rate cut. So if that happens, which is slightly more than 50% probable, then that would be an attractive vehicle for us.

Now the problem with that is most people in Congress would say well, if we're going to fix the physician thing let's do nothing else because once you say yes to anyone, it's much harder to defend saying no to everyone else. But, that is part A, to the answer to the question about what might a vehicle be. The second type of vehicle that might exist for our little package is just some of these omnibus reconciliation-type bills that they have to pass at the end of the year in order to keep the government running and keep authorization for some standard expenditures flowing.

Okay, great. Very helpful. Great quarter. Thanks.

Thanks Andreas.

And your next question will come from the line of Bill Bonello from Wachovia.

I just had a follow-up on the pricing too, but it's from a little different angle. Kent, do you think that pricing pressure is something that is specific to the dialysis industry or do you think this is part of a sort of broader macro level trend where you think just providers in general are probably coming under pricing pressure due to managed care consolidation et cetera over the next several years?

I would probably say sort of 60% everyone that this is a -- we're a cyclical industry and year-over-year premium rate increases are going down for a bunch of reasons and history tells us when that happens, providers get squeezed, so there's going to be a bunch of that, but I'd say a full 40% is it will affect some segments more than others and part of that is just smaller segments, like ours, that are going to get more attention the last three or four years than we got the last three or four because the payers were consolidating and focusing on obviously the biggest segments. So obviously you can't quantify this sort of thing, but I'd say something like that.

Okay. And just on the first point because you've said that before that when premiums come down, provider payments tend to come down and just thinking sort of chicken and egg. Is that usually the cause and effects, so it's not that premiums come down when provider payments have already come down?

Yes. I hear you, and it is both. When you're a payer, you're trying to assess what premium you think the employers can absorb and you bake that into your pricing expectations and then you give instructions to all your operating managers to negotiate deals that will fold under that budgeted amount. So it is both the chicken sometimes and it is the egg sometimes if there are just some fundamental trends which are favorable in your medical loss ratio. So I couldn't describe a percentage to it, but it's a healthy dose of both the chicken and the egg.

Okay, that's helpful. Thank you.

Thank you.

And you do have a last question from the line of Matthew Ripperger From Citigroup.

Hi. Thank you. Has there been any change in how DaVita looks to contract with commercial payers such to look for longer term contracts at lower near term rates, but with annual escalators versus what you did before?

Yes. Well, is there more of it? I'd say yes, there is incrementally more of that than before. Again, not an attempt to think that we're going to achieve market share gains through price discounts because there's no history to support that working sustainably in the healthcare service period much less dialysis, but in order to stabilize a relationship and start to focus on creating value together instead of a more distant transactional just claims based relationship, for those two reasons, yes, we're doing incrementally more of that. Does that answer your question?

Yes, it does and if there was a change in the MSP level then ultimately the longer term contracts would apply to that change in MSP?

Correct. If we had a longer term contract and MSP was extended, all the patients that are on private pay would fall under that contract.

Thank you.

And I just want to provide a little bit more color on a question that Darren posed which was on the step down in interest rates. The term A-loan would move from LIBOR plus 175 to LIBOR plus 150 when leverage reaches 3.75.

[OPERATOR INSTRUCTIONS] And there are no further questions at this time.

Okay. Thanks, everyone, for your interest in DaVita. We will do our best until we talk to you again in three months.

Thank you for participating in today's DaVita second quarter earnings conference call. You may all now disconnect.