德維特 (DVA) 2006 Q3 法說會逐字稿

Good afternoon, my name is Katherine, and I will be your conference operator today. At this time I would like to welcome everyone to the DaVita Quarter 3 earnings conference call. [OPERATOR INSTRUCTIONS] Thank you. Ms. Zumwalt you may begin your conference.

Thank you, Katherine and welcome everyone to our third quarter call. I'm LeAnne Zumwalt, Vice President of Investor Relations and with me today are Kent Thiry and joining us for the first time, our new CFO, Mark Harrison. I'll start with the forward-looking statement disclosures.

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

Additionally our press release and related disclosures include certain non-GAAP financial measures. These measures should be considered in addition to the results prepared in accordance with GAAP and should not be considered a substitute for GAAP results. Also included in the press release is a reconciliation of these non-GAAP measures to the most comparable GAAP measure. I'll now turn over the call to Kent Thiry, our CEO.

Okay. Thank you, LeAnne and greetings to everyone, both new and old shareholders. Q3 was rock solid. I'll provide a review of the normal agenda items which are number one, clinical results, two, the third quarter in '06 outlook, three, the Gambro integration status, four, public policy and five a brief commentary on the longer term outlook. So our standard agenda.

First, clinical results. We continue to present our clinical outcomes first because that is what comes first. We are first and foremost a caregiver company at this point serving over 100,000 patients. With respect to adequacy which is essentially how well we're doing at removing toxins from our patients' blood, once again, this quarter, 93% of our patients had Kt/V greater than 1.2. We'll also report on a new clinical measure this quarter, albumin. Albumin is a key indicator for assessing mortality, risk and [officinal] status and 84% of our patients meet or exceed a standard of greater than or equal to 3.5. For both of these measures, our patient outcomes compare very favorably to national averages. And these clinical stats relate to patients who have been with Da Vita for 90 days or more.

Subject number two, the third quarter and our '06 outlook. We have increased the bottom end of our operating income guidance for the year from 670 to 690, and therefore, the new OI guidance for '06 overall is 690 to 700. The operating cash flow guidance remains 450 to 500, which just to remind you, exclude the $85 million divestiture tax payment. We are very happy with this year's cash flow results. We basically achieved all of our plans in this realm in this year. We wish every year could be like that.

Subject number three, the Gambro integration. The short answer is we are absolutely on track, if anything, exceeding our hopes as of a year ago. As you may recall from the last call we have completed three of the five major system integration projects, namely HR and payroll, inventory and purchasing, and patient registration. However, billing and collecting and critical documentation systems are still very much in the mid to early stages of implementation. And these rollouts are difficult, are expensive, and are distracting. That said, we are on plan with just over 500 of our 1300 centers on the new clinical management software, for example. We continue to predict that the entire project will take two more years to complete. Although from an operating risk point of view, most of that should be dealt with in the next 15 months. Successfully or unsuccessfully, time will tell. But the next 15 months more critical than the tail thereafter.

Subject number four, public policy. The big industry bill called the Kidney Care Quality Improvement Act has unprecedented bipartisan representation in both the House and the Senate. The visibility that ESRD currently enjoys is unique in the history of the community and the breadth and depth of the realization that Medicare does not pay its way, that in fact those 800% of our patients cost us more than we are reimbursed. That realization continues to grow and anyone in Washington DC will tell you that DaVita is the community leader in this sphere, all-important sphere, from a shareholder point of view.

Subject number five, the longer term outlook. What about '07? Our operating income guidance range remains where it was, 680 to 750. The most important swing factors in '07 and beyond are not necessarily in order of importance, number one, private rates, number two, Medicare reimbursement, number three, the potential for Medicare secondary payer extension, number four, pharmaceutical trends and number five, the billing and collection integration risks.

Let's just reflect a moment beyond those five subjects. What about private rates? In 2006, one again, we have done fine in our negotiations, taking some hits, winning some victories. We expect that during '07 and '08, some of our commercial rates will be reduced just as we have incurred sometimes in the past. It is difficult, of course, to predict the timing of future wins and losses. It's difficult to predict the mix of wins and losses, but if we get hit with a batch of losses within a defined time period, it will materially impact our P&L.

You might ask, well what assets do we carry into these negotiations? Why did '05 and '06 go okay? First part of the answer is our superior clinical outcomes carry a lot of freight for us. In part just because they are what they are and in part because better dialysis leads to lower total healthcare cost because it leads to lower hospitalizations and surgical procedures which saves the payers a lot of money. And remember it's often the case that the hospitalization and surgical costs are twice the annual cost of dialysis. So there's a lot of total cost leverage when you do dialysis well, which we do.

And then secondary set of assets just has to do with our broad geographic coverage, which provides great simplicity and convenience of aggregation for payers and all-important access for patients and doctors. I'll also preemptively answer the common question, the frequent question, which is what -- given your size, what about exclusive contracts? And as we have stated before, it makes no sense for us to enter into that type of contract. Our business is low-fixed cost and very high variable cost with sticky referral patterns. So it is very difficult to come up with a model where increased volume justifies price discounts on the small percentage of our patients which subsidize all the rest and generate whatever profit there is. And this is particularly true given the longer term implications for what contract renewal battles and competitive responses -- what that picture looks like.

Next subject, more effective, what about government reimbursement now and going forward? If our industry doesn't get Medicare inflation updates, more dialysis centers will close. In fact this quarter we closed four centers. The basic fact is that when there is not enough private revenue to offset the Medicare losses, it becomes eventually impossible to keep that center open. It doesn't mean that there won't be lots of dialysis centers in more economically healthy parts of the country. But it means that those in some parts would close.

Finally, an important qualifier to our guidance, and the normal qualifier, and that is that our guidance for '07 captures a majority of the probabilities associated with all the key swing factors. Although, collectively if almost all of them go well, or almost all of them go poorly that would cause us to be either above or below the stated range. It is now my pleasure to introduce to you our new CFO, Mark Harrison. He's only been with us two months, so please be gentle.

Thank you, Kent. Let me address a few key questions about our quarter results. First, regarding the major drivers in the quarter. Q3 results were primarily driven by continued improved revenue per treatment, continued strong treatment volumes and solid cost performance. Q3 revenue per treatment increased by approximately $2. This was driven primarily by an increase in our standard fee schedule, partially offset by a decrease in physician-prescribed pharmaceuticals.

Non-acquired growth in the quarter was 4.2%. We expect non-acquired growth to return to the 3 to 4% range in 2007. Year-to-date, through October, we have opened 34 de novo facilities and we now expect to open approximately 45 centers in 2006. This year, we have experienced significantly greater Medicare certification delays, and as a result, we have a higher number of completed projects awaiting certification than ever before. We currently anticipate that in 2007, we will be able to open about the same number of new centers as 2006, which, of course, could be more or less depending on available opportunities.

With respect to acquired growth, we have acquired centers with approximately 1300 patients so far this year and we hope to acquire additional centers with approximately 200 patients in the fourth quarter. In 2007, our acquisition expectations are in line with 2006. Our investment, of course, will be dependent on the number of available properties at reasonable returns.

On the cost side our solid Q3 results also reflect favorable performance in operations, with lower self insurance costs and lower than anticipated integration costs, which were both offset by higher incentive accruals. What should you expect for G&A going forward? G&A was 9.2% within our guidance of 9 to 9.5% of revenue. Our expectation for 2007 is that G&A will remain in this range. If we continue to grant options at historical levels, our 2007 option-related expense should be 35 to 40 million pre-tax. You should also expect that the fully diluted share count will go up next year by approximately $1.5 million shares and at year end, the 2007 share count could be approximately 107 to 108 million.

What about taxes? This quarter we adjusted our annualized tax rate down to 39.25% for the year. You should expect the tax rate to stay at this level in 2006. For 2007, our previous guidance of approximately 40% remains a good estimate because we expect upward pressure from state's tax increases. Regarding the one-time valuation gain, on August 25th, 2006, we amended the supply agreement with Gambro renal products. Among other things the new agreement reduces our purchase obligations for certain products, supplies and equipment and as a result we recorded a net valuation gain of 38 million. This valuation gain represents the difference in the fair value between the original agreement and the amended agreement.

Accounts receivable and DSO, DSO increased three days this quarter to 70 days. The increase is due primarily to the government's temporary suspension of claims processing for the last 10 days of their September fiscal year. We expected to collect these delayed payments in the fourth quarter. Regarding cash flow in the quarter, our free cash flow was 67 million in the quarter, key cash flow drivers in the quarter included the semi-annual bond interest payment of 47 million, the timing of certain payables and the previously mentioned delayed Medicare claims processing of approximately 28 million.

Year-to-date operating cash flow was 329 million and free cash flow was 252 million, including the 85 million divestiture tax payment or 337 million excluding the tax payment. What about the cash flow for 2006 and 2007? Operating cash flow is expected to be in the 400 to 500 million range in 2007, which reflects our assumptions that certain working capital items may be a use of cash in 2007.

So comparing 2006 excluding the $85 million tax divestiture payment with 2007, first let me talk about operating income. Operating income, 2006, 690 to 700 million. Operating income 2007, 680 to 750 million. Operating cash flow, 2006, 450 to 500 million. Operating cash flow, 2007, 400 to 500 million. Free cash flow defined as after maintenance capital, 2006, 340 to 390 million. 2007 free cash flow 300 to 400 million. Growth capital, 2006, 220 million. Growth capital 2007, 200 to 220 million. The 2006 end of year cash balance after debt repayment and gross spending should be approximately 150 million. And that's after a planned incremental 75 million term B optional repayment in Q4.

The primary drivers of the operating cash flow range for 2007 reflect, first, the $70 million operating income range, next, the inherent investment and working capital as the company grows, and then other factors including an expectation that DSO could fluctuate approximately two to three days along with other working capital fluctuations. We would expect stock option exercises to generate approximately 75 million to 100 million, leaving approximately 150 to 300 million available for debt repayment or additional growth activities in 2007.

Our guidance ranges for 2006 and 2007 incorporate key swing factors on a probabilistic basis and collectively they could cause us to be above or below the stated ranges that I've just reviewed. What about our capital structure? Outstanding debt at quarter end was 3.8 billion, which includes first our subordinated notes totaling 1.35 billion with average weighted rates of 7%, our term A loan borrowing of 279 million at LIBOR plus 175. The term B loan borrowing of 2.2 billion at LIBOR plus 2% and our debt expense for the quarter was 68 million, the weighted average interest rate was approximately 6.8% and that excludes amortization of deferred financing costs.

Repayments for the year have totaled 325 million, and as I said earlier, we have decided to repay an additional 75 million in term B loans within the next week or so. Our current leverage ratio is 3.96. Mandatory payments on the term A loan are covered through Q3 of '07 and for the term B, we're covered through the final term payment which is due in 2011. And now, I'll turn the call back over to Kent for closing remarks and then we'll move on to Q&A.

Okay. I'll just make four points in closing, number one, was a rock solid quarter, number two, '07 and '08 could be tough from an earnings trajectory point of view. Too soon to know for sure. Number three, strategically the company is well positioned and number four, it remains true that this is a business which unusually attractive in terms of its fundamental stability of cash flows and demand.

Katherine, could you please open it up for Q&A?

At this time I would like to remind everyone if you would like to ask a question during this time, simply press "*" then the number "1" on your telephone keypad. We will pause for a moment to compile the Q&A roster. You do have a question from the line of Darren Lehrich.

Thanks. Good morning, everyone, couple of things. First, just a question with regard to the GAO report coming up here. Our understanding is a big area of focus might be on whether a bundle would promote more efficiency and clinical flexibility for the government. Do you view the GAO report as a potentially important step with regard to moving more rapidly to bundling in terms of the public policy discussion in Washington?

Short answer is no. I guess, slightly longer answer would be, we're fine with bundling, and we're fine not being bundled. The key, if there is a move towards bundling, is that the number be thoughtfully calculated, and the complexity is that it's not a single number, and it's incredibly difficult to try to figure out ahead of time what is the right bundled number for different patients in a world where there's still over 1,000 independent centers with an average census of 68 patients and wildly different consumers of different pharmaceuticals and supplies, but most particularly pharmaceuticals. So short answer is no, but bundling is very much on the radar screen for a lot of public policy makers for very good reasons, and we are -- we have a very secular point of view on bundling. We're happy either way.

Great. And just another question that you don't talk a lot about the vascular access business that you operate but a little bit more interest here with an acquisition or a transaction last week and just monitoring your own website for lifeline. It looks like there has been quite a bit of development activity there. Can you just update us a little bit on -- in terms of your development activity there and how many units you currently operate, and the opportunities you are seeing, given the rapid growth in units there?

It's just not economically material, and while we are experiencing some growth, there's also just a lot of issues about the long-term reimbursement picture, which procedures will be able to be done, at what price. Whether or not ultimately physicians will do all this stuff themselves. So it's just not -- it's just not economically material, so I don't think it's a good idea to go into too much analytical detail.

Okay. Last thing here, just a question on cash balances. I think last quarter you mentioned to us that you thought 100 million or so plus or minus was a good kind of continuing cash balance. You ended with 260 million. I understand you've got 75 million on the term B in the fourth quarter, but what is -- where do you think you're going to manage your cash levels on a go-forward basis?

Yeah, I think we would just stick to what we said historically, that we don't really -- we're not comfortable going under 100 million. Although perhaps there'll be some situations where for a short period of time that would be prudent. But in general we're not comfortable being south of that and we're not uncomfortable at all with being north of that for some periods of time. And the obvious advantage of that is just picking up flexibility on the acquisition or growth side. But the right range of the numbers that we have talked about historically with 100 being sort of the low end of the cash balance world.

Okay. Thanks.

All right. Thank you.

Your next question is from the line of Bill Bonello.

Good morning. A couple of questions here. First of all, you mentioned that the rate increases were offset by some changes in prescription or prescribing behavior. Can you tell us how much changes in drug utilization reduced revenue per treatment in the quarter?

No.

No. Okay. Can you tell us whether you expect the trend of declining drug utilization to continue going forward and why or why not?

Yeah, I think it's going to operate within a very right range, Bill. That there's been more dynamism in these numbers than usual because CMS and what they -- the imposition of the EMP, the EPO management policy. And so that has made things more difficult to forecast because in some cases the government is forcing doctors to change prescription patterns that they would otherwise use. So that's why there's more dynamism and that's why we don't want to call too much attention to any quarter-by-quarter movement because it's still settling out. Having said all that, I do think it's going to operate within a relatively narrow range. Does that give you enough to go on?

Sure. And then the second question had to do with the Washington outlook you were -- you mentioned positive Congressional sentiment. I guess, I'm just curious. It does seem like there's a lot of concern that's expressed, at least in written format, about EPO utilization and I'm just curious if you can elaborate on that at all. If you are concerned that Congress may attempt to do something on that and any other thoughts you have.

Well as to the specific question, would Congress do something on EPO utilization, that's hard to envision. And frightening to contemplate. And the reason that EPO is getting all this publicity is that anemia management -- or just focusing for a moment, just calling that EPO expenditures are very, very high. It's one of the most expensive drugs in all of healthcare and so it's getting an awful lot of visibility. And what everyone who studies it with an open mind and any respect for actual data sees that all the providers use EPO according to evidence-based clinical protocols that have been scrubbed 17 different ways because we all know we're going to be subject to CMS audits, to OIG investigations, to subpoenas, et cetera.

So the reason that anemia management is expensive in America is the price of the drug, not the utilization of the drug, and whether or not the government is going to do something about that or the market is going to do something about that is sort of above our pay grade. But at this point, anybody who -- and many people have done it over the years -- anybody who does an intellectually honest and data-intensive review of EPO utilization, sees that it is all done according to strict evidence-based protocols reflecting years of scrutiny. Am I getting to the question you were asking or not?

I think you did and you also got to the issue of would they do anything on the pricing side, which is, you don't know. So that's great. Thank you.

All right. Thanks, Bill.

Your next question is from the line of Justin Lake.

Thank you. A couple of questions. First, just given that right now it appears you're at a run rate of operating income for the third quarter that was about 720 million for the year, looks like you're projecting even at the low end of guidance to stay there for the fourth quarter, what are you incorporating -- what are the negative scenarios that you are incorporating into an '07 guidance that would run, 40 or $50 million light of that run rate especially given the overall growth in dialysis business and any kind of acquisitions you might be making going forward.

Very fair question and the simple answer is the scenario where we experience a bunch of cost increases, most particularly on the labor side, but also with respect to some of our supplies, and in a world where we have a batch of private rate contract defeats, that is the scenario that gets you to the low end of the OI range, despite the fact that our treatment volume would increase.

Got it. And I guess just focusing on that commercial -- the commercial rate issue, can you give us an order of magnitude as to what you would have to see from a loss standpoint on the contracting side to get there? Is it your two biggest payers? Is it your three biggest payers? It just seems like that would be pretty substantial given how spread out your business is from a geographic standpoint and from a payer standpoint.

Yeah, that's a fair question too, and it is true that our payer base is quite -- fragmented. There's no payer that's -- I think this will be very close to accurate. There's no payer that's more than 4% of our revenue, and most, most, most are such smaller, and they are all by definition when we count those numbers, that means it's a nationwide payer, which means that the number of patients is distributed across 42 states or something close to that.

So it's kind of a portfolio issue. It's not a one payer thing. It's not a two payer thing. It's that we fight 50 or 60 -- fight our way through 50 to 60 intense negotiations every year as well as some others that aren't as intense, some years you have a hire batting average, and some years, lower and some years, more of the big guys are up and some years, more of the small guys. And this is what it makes it so difficult for us to provide you with more specific guidance, because we don't know exactly what is going to get hot when and how exactly it's going to unfold and how quickly it's going to unfold. So it's kind of a portfolio answer, but our gut is that '07 and '08 are going to be tougher than '05 and '06.

Okay. That's helpful. And just from an '07 standpoint given that we're in November I would assume that you are in the middle of or probably through a significant amount of your one-one contracting. Is there anything that you have seen for '07, since you updated us last that leads you to believe that you might have been too conservative or you might be ending up in one way or another in that range from a commercial pricing standpoint?

Well I don't know that we have ever been too conservative. And this is not the first, so this would not be the first time for that. And at this point, no -- we don't have any, sort of victories or defeats or ties locked up for the first quarter. Let me take a stab at answering the question this way and then you tell me if it's useful. That we have got some significant balls in play, and we don't know how they are going to end up, and we don't know if they are going to be resolved for January 1 or February 1 or March 1 or April 1 there isn't anything locked and loaded, positive or negative that we're holding back and telling you, but there are some -- there are a bunch of balls in play. Is that responsive?

Sure. And just one other quickie on non-acquired treatment growth. You have seen numbers this year that have been substantially above the rest of the industry and certainly above your longer-term expectations. Is there anything that you have seen in particular that's allowed for better growth than what you expected and from a growth perspective is there anything in your mix in regards to payer mix from commercial versus government that you are seeing with that growth?

Okay. Let me answer the first one and then I might need you to re-ask the second one so I get right. The non-acquired growth for us this year has been a very pleasant surprise. We thought the acquisition was going to bring that number down much further than it did, so we're very happy with that. At the same time, the fact that we're getting hit with so many certification delays now, that is going to bring the number down. That's our expectation. It is a different world today than nine months ago in terms of the number of months it takes around getting a set of issues built just to get them to come by and say that you're approved for treating patients. And we've got a number of centers just sitting there waiting for the government to come out and approve them, and of course we're a company where we haven't had one turned down, so to speak, for a long, long time.

They are all built to very exacting standards and we have done so much of it. So it's been a really good year, and unfortunately for that structural reason as well as the normal pitter-patter around integration distraction as we rollout the systems, it doesn't look like we're going to necessarily be able to sustain it.

On the second one, were you asking for a correlation between non-acquired growth and private payer mix? Or was it a different question?

No, that was exactly. I'm just wondering if within that growth you are seeing any changes in mix.

Yeah, the short answer is no, but I don't think our analysis for that issue is particularly impressive at this point given all the noise and the data with the acquisition. So it's no, but we could be wrong, because our analysis is currently unimpressive in that regard.

Okay. Thank you very much.

Thank you, and I am -- and Katherine before you do the next person, I would like to go back and make one other comment about EPO. Just from a clinical point of view, this is an awesome drug, and if any of us were on dialysis, we would want a high [Imatycris] close because we would feel better and we'd be in the hospital less. So separate from all the other stuff, if you go out and talk to patients, you'll find that they want Imatycris close to what you or I have, and it's a big deal, not a little deal. Okay. Katherine.

Your next question is from the line of [Mark Apersyadi].

Yes, hi this is Mark Apersyadi. Just wondering if you could give us your thoughts on your most recent thinking about how much more de-leveraging you will do and also what kind of capital structure targets or metrics you like to think of as your comfort level?

Yeah, well we have said for seven years now -- maybe six -- maybe the first year we didn't talk much about it because we were just turning the company around -- is that given the structure of this business, given the unusual level of fundamental stability of cash flows and unit demand, given those attributes that we're comfortable with a leveraged ratio of 3.0 to 3.5. But we, at any point in time, may be significantly above or below that, depending on what we think our relative opportunities are.

So, for example, when we were thinking we might have a shot at buying Gambro, we ended up bringing our leverage ratio down significantly below that range to the point where some shareholders were very antsy, talking about the fact that we should be buying back more shares. Didn't want to do that because we had to keep enough powder dry in order to be able to do the deal. At the same time then, in doing the deal we flipped to a leveraged ratio significantly above that range. The good news is we did that with a two to three year outlook on the business, where it was virtually inconceivable to come up with a scenario where we would not be able to comfortably bring that ratio down dramatically as we have.

At the moment we announced the deal the pro forma leveraged ratio was north of 5.2. And as you heard earlier, we're already beneath 4.0 and it's only 12 months after the deal. So 3.0, 3.5 is the simplistic answer but the pitter-patter around it is equally significant. And the reason there can be that wide range is because our outlook in the two to three to four year time frame on low-risk free cash flow is one that has more clarity and certainty than you have in most businesses. Does that take care of the question?

Yeah, that's great. Thank you. If I could just put one follow-up there. If you could just tell us about any possible -- what kind of acquisitions in terms of size -- after having -- with Gambro now being -- what kind of acquisition would you guys be comfortable doing in terms of sort of dollar size in the next 12 months?

We're comfortable doing lots of different things as is reflected in the fact that we bought Gambro itself. So we don't have a number in mind because it's pretty difficult. Your tolerance for doing a larger deal needs to be proportional to your confidence that it's a good one, and therefore to pick a number in isolation of a specific context and a specific transaction, how related is it to our core business, how confident are we that we've got the right people for it. How confident are we of the near term cash flows after it. I don't think I can give a quantitative answer, but we would not be afraid to spend some money on acquisition if we were sufficiently confident.

Thank you.

Thank you.

Your next question is from the line of [Ben Naeb].

Hi. I was wondering where you are in terms of converting from a re-use to single use for dialyzes in your clinics? Hello?

Yeah, I just had to check and make sure that I had an up-to-date number. About -- between 30 and 35% of our treatments are done with single use and the balance are re-use, and that number is relatively stable.

Okay. And then is there a date when you expect to complete conversion?

We're not in the process of conversion. Which way did you think we were converting?

From re-use to single use.

No, we're not doing that.

Okay.

In fact, Gambro at the time we bought them in the prior two years had moved from, roughly speaking, 65% single use, down to about 40% single use because after moving towards single use over a couple of years, they concluded that there was no clinical benefit, and it was incremental cost, and so they had reversed course, reversing from a conversion towards single use instead to a movement towards re-use.

We are non-denominational on this subject, the physicians make the ultimate decision, but all of our data also shows that there is no clinical difference and there is -- for most patients, there is no clinical difference, and there is in most cases an economic difference, hence, re-use which then liberates dollars which can be spent in other ways to the benefit of patients.

Okay. Thanks for clearing that up.

Thank you.

Your next question is from the line of Matthew Ripperger.

Hi, thanks very much. Just two questions. First, I don't know if you quantified, but can you quantify what the effect was on cash flows from the nine-day Medicare delayed payment late in the quarter?

It cost us $28 million -- a negative $28 million impact to our normal cash flows.

Okay. Great. And then second question I had is just -- I think you mentioned that you expected to end the year with cash balances of 150 million, which is down 110 million from what you finished this quarter at 260. And I guess I'm just trying to understand if you're going to have a receivable pickup of 26 million and CapEx post-development maintenance are pretty constant, where is the use of cash coming from in the fourth quarter?

It's just associated with normal working capital fluctuations. And the 75 million -- that we referenced earlier, the $75 million debt repayment.

And specifically, besides receivables which seem to be going in your favor in the fourth quarter because of the Medicare delayed payment, is there anything else specifically from a working capital standpoint that would fluctuate?

Just normal -- just normal -- normal movement.

Okay. Great. And then the last question I had is I saw the minority interest increase this quarter, have you changed your partnership strategy at all with physicians to potentially impact that?

No.

Great. Thanks very much.

Thank you, Matthew.

Your next question is from the line of [Paul Lie].

Hello?

Hello.

Yes, I have a question on one of the new investors you mentioned about. I have a question with regard to the Gambro's acquisition. I recall you mentioned that Gambro has some commercial rates that's below your average rate. I'm wondering, what progress you have made -- or in what stage now you are bringing that rate in line -- in line with the rest of the corporation?

Yeah. We're making steady progress. What we said when we announced the deal is that the Gambro rates were not going to move up to the DaVita rates, and that in many cases we would be meeting in the middle, or hopefully someplace a bit north of the middle, and as we combine the two portfolios of contracts, that's turning out to be true, that we're coming out north of the middle overall so far, and that is good.

You have already converted all the contracts Gambro had, right?

No, but a lot of them.

Well what is roughly the percentage of conversion right now?

I don't know offhand and it is a little bit tough because you have the number of contracts but then secondarily you have a different number of patients attached to each contract. Separate from that, what really matters is sort of a dollar-weighted average as opposed to the number of patients or the number of contracts. And since its at this point totally embedded into our forecast, our normal operating forecast, we no longer separate out the portion of Gambro business.

Okay. You -- in your guidance for next year, you sort of painted a pessimistic picture about commercial rates going forward in the next two years, what usually -- what -- when you negotiate with insurance companies, how long the contracts last? How many -- how frequent do you have to review that? Is that on a yearly basis?

Well, I'll answer the question, Paul, and then we do want to make sure other people -- you can come back into the queue but we try to limit everybody to two or three questions before they have to cede the floor to another shareholder. But contracts come up every one or two years is the most typical thing. Having said that, most of them -- each party has the right to cancel with 90 days notice. And so they could come up more often, but they just don't. If you reach an agreement, usually everybody breathes a big sigh of relief and then you wait another year or two before you go at it again. So one year is the most common answer but that's not actually written into the contract a lot of the time.

Okay. Thank you very much.

Thank you.

Your next question is from the line of Art Henderson.

Kent, what is your latest thinking on [Sarah] as far as the timing of that drug and what the pricing may look like and how that might impact your business?

Yeah, unfortunately, Art it's a big we don't know. And everyone who follows it knows all the variables, the lawsuits, the -- and then separate from that [Rosch] has to make -- if they do introduce the drug they have to make a whole bunch of strategy decisions none of which we're privy to. So we just don't know.

Generally speaking, though, when a drug is -- when a new drug comes on to the market, is that based on -- how is the pricing generally based? Not necessarily specific to Rosch but just -- or this particular drug but just in general is it based upon like an AWP framework or something along those lines?

Well in terms of mechanics, in the private side some things are still tied to AWP, on the government side, they are tied to ASP. In terms of the actual number as opposed to the mechanics, that's totally subject to the strategy of the manufacturer. Although they have got certain issues to deal with, with respect to getting stuff approved by payers and so I can't really shed any more light than that.

Okay. That's fair. Last question I had was, is just talking about AWP. Obviously that's received a lot of attention lately with the first data bank tentative settlement. And was wondering are you guys exposed in any way to that with any of the drugs that you guys sell?

Yeah, on the AWP -- well I don't think you mean sell ...

Well, distribute.

Yeah. This is going to affect likely Medicaid reimbursement because Medicaid reimbursement, I understand, in many states is tied to an AWP vehicle, and many states do use first data bank. That said, most of our large states [inaudible] is at a fixed-pricing level either statutorily on an annual basis or it's been a permanent basis. So the non-EPO drug from Medicaid programs, you'll likely see a 5% reimbursement cut, something like that. There are a few of our commercial contracts that are tied to an AWP type vehicle. Our contracts stipulate Red Book, not -- can't be 100% certain but our understanding is Red Book is not impacted by this litigation, but I think we have to watch going forward to make sure that that is true. So there would be expectation of some small decreases, yes.

Okay. All right. Thank you.

Your next question is from the line of Gary Taylor.

Hi. Had a couple of questions. Minority interest has been picking up both percent of revenue, percent of EBITDA, really since you closed the deal. Just wanted to see if you'd comment on fundamentally what is driving that, and what your outlook is. And then also a bit of a pickup in the depreciation run rate this quarter. Anything unusual there?

With respect to minority interest it's just that we're both A, doing more joint ventures with physicians, and B, some of those that we did before are growing. And we think that's -- those are both good things. What was the second question?

Depreciation. Seemed like it's moved up a little more than $2 million, almost 3 million sequentially, but just a few acquired centers in the quarter, if I'm not mistaken, so --

That reflects not only acquired centers but our de novos as well.

Right.

And you can take that as a pretty predictable run rate for the future.

Okay. And then lastly, Kent, could you just remind us on the dialysis bill, what the status is in terms of which house or houses it has been introduced, and what your expectation is around any activity over the next three to six months?

It's been introduced in both the Senate and the House. It has unusually broad and deep bipartisan co-sponsorship, and if the Republicans retain control of both houses there's a good chance there will be a Medicare Bill of some sort, and a good chance that we would be in it. If the Democrats take control of either House, it becomes impossible to predict, because things will be relatively chaotic, and so therefore the probability would decrease.

Would you view that as a timing issue or does it just become too unpredictable at this point?

Realistically, if it doesn't happen in the November, December, lame duck session, it won't happen until the fall of '07.

Right.

When the next batch of Medicare Bills might be on the table.

Right. Great. Thanks.

Thank you.

Your next question is from the line of John Ransom.

Good afternoon. I was curious about our thoughts of your large national competitor cut a deal with Amgen and I just wondered about your thoughts about the pros and cons of thinking through something like that particularly given there's a chance there may be a competitive offering out there either next year or never, and how you think about that. Thanks.

Yeah, John, it's a fair question, but we don't think it's prudent to comment on what FMC decided to do with Amgen. Just not -- just not prudent.

Is it -- can you -- are you contemplating a similar type of structure, or should we not expect that?

I have been here seven years. We have been negotiating with Amgen virtually continuously for seven years and -- about all sorts of things and all sorts of ideas. So to say no we don't think about different ways of doing business with Amgen would just not be true, but to say that we're doing it in some differential way right now would also be misleading. We're talking with them all the time because they are a big part of our clinical care, and they are a big part of our economics. And they are the only game in town right now.

So we talk to them all the time about all sorts of things, but who knows what will happen. And I'm sorry I can't be more useful, but it's just impossible.

No, that's helpful. I mean I just didn't -- I didn’t think we should be on the lookout for anything coming out of you in a similar vein but I thought I'd at least get you on record saying that. So that's helpful. Thank you.

Your next question is from the line of Andreas Dirnagl.

Good morning, this is Dawn [Broch] for Andreas. I was hoping you could give us, Kent, an update on Gambro integration spending, both the level of spending to date as well as the focus right now. I think we were expecting a shift from a development-based focus to be more labor intensive in nature in the second half of the year. And I was wondering where those plans are progressing, and then what the spending expectation is for next year as well.

Well first of all if Andreas isn't on the call, tell him that he and I need to talk because--

He is on the call, just a bit hoarse with bronchitis.

Okay. Well Andreas I hope you get better soon. Otherwise I was going to be deeply hurt. And we can't answer that question. What we decided the last quarter or two quarters ago, I don't recall, is that it just no longer useful to split out integration expenses, because it's -- it became an arbitrary cost accounting decision because of so many things that we're doing now or to somehow ask the operators in each center or the operators in each department to please tell us what things are integration versus what things are normal operations wasn't productive anymore. Because so much of the expenditures are tough to categorize. And if we just took the numbers that were strictly obviously integration-oriented, that would be misleading as to the magnitude of the expense. So it's just -- it's a fair question, but we can't give a reasonable answer, and it wouldn't be a good use of time for us to try.

Is it -- is it fair to ask what the direction is right now, whether or not you are indeed moving into that more labor intensive area of the integration?

I cannot say. So what I would say is call LeAnne back in a day or two and she can answer that question. I simply don't know the answer. It wouldn't surprise me if the answer was yes, because as we do the big clinical software rollout and as you heard we had 500 centers already, that typically does lead to the most intense labor portions. On the other hand, the front part of the integration is where often we end up using more of the expensive IT consultants in the whole design of the new applications. And so as they go away even though it's a much smaller number of bodies there's a big dollar sign attached to it. So I literally don't know what the trajectory is currently if I parse it the way that you asked the question.

Okay. That's fair. Thank you.

You have a follow-up question from the line of Bill Bonello.

Patient care costs, can you remind us why patient care costs for treatment has increased so much on a year-over-year basis? Is that just a function of Gambro or was it something else? And then kind of what you would expect in terms of cost per treatment going forward?

Okay. Let me put you on hold one second to make sure the answer I give is accurate.

Okay. This is Mark. The year-over-year increase in patient care cost per treatment is attributable to three factors, higher labor and benefits costs, higher supply costs, and increase intensity of physician-prescribed pharmaceuticals.

Okay. And on that -- on that last piece, that seems to run a little contradictory with your comment on revenue per treatment where you mentioned decreased intensity of physician supply --

One is quarter-over-quarter and one is year-over-year.

Okay. Okay. So it really doesn't have anything to do with Gambro.

I don't -- I don't know, Bill, just based on what we answered and the numbers we're staring at right now, I think that's probably true, but it -- figuring out whether or not in fact it is, is usually a little more complicated than this high level pitter-patter we're engaged in right now.

Okay. How about just in terms of cost trend?

The -- well, say the question again, so I make sure I give you a useful answer.

Going forward, would you expect a similar level of cost inflation going forward?

I would say cost inflation going forward will be similar to what it has been in the past, and that's not comparing any particular quarter or year, but look at the last two to three years, and the next two to three could look very similar.

Okay. And then just the final question, and I apologize if you touched on this, just I'll call you back, then, but in the last couple of quarters you have divested a handful of centers in each of those quarters. I'm just curious what is going on there? And sort of your expectations?

Nothing major. There just are times both in the acquisition front and the divestiture front where it makes a lot more sense for someone else to own a facility than it does for us to own it and vice versa. And so I would imagine there would continue to be a smattering of those. And as I said a subset of our acquisitions are actually other people's divestures too, although in some cases they don't talk about it.

Okay. So just kind of a portfolio management?

Exactly.

Okay. Thank you very much.

All right. Thank you, Bill.

Your next question is from the line of [Jeff Matthews].

Hi, I apologize, I'm sure you've already explained this, but I wanted to understand the reason for the delays in certification at the state level now versus nine months ago. Thank you.

Yeah, just the state governments who are the agents of the federal government in this regard are either cutting their staff or not able to increase it proportionate to the demand, and therefore, they take longer to get to us.

Is this something you have seen in past cycles or is this something new?

It has happened before, particularly in some states, but I would have to think back a fair amount of time to remember when it was happening as pervasively, and also, a time when the length of the delays was as long. So it's kind of new -- I think it's new territory, but I would have to kind of go back and reflect more on -- on times in the 90s before I said that.

Okay. Well thank you very much.

There are no further questions at this time.

All right. Thank you all for your time, interest, and attention and we will do our best over the next three months to do everything that we said we would do. Thanks.

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