德維特 (DVA) 2007 Q2 法說會逐字稿

Good afternoon. My name is Lamont, and I will be your conference operator today. At this time I'd like to welcome everyone to the DaVita second quarter 2007 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers remarks, there will be a question and answer session. (OPERATOR INSTRUCTIONS). If you'd like to withdraw your question press the pound key. Thank you. Ms. Zumwalt, you may begin your conference.

Thank you, Lamont, and welcome everyone to our second quarter conference call. We appreciate your continued interest in our Company. I'm LeAnne Zumwalt, Vice President of Investor Relations, and with me today are are Kent Thiry, our CEO, and Mark Harrison, our CFO.

I'll start with the forward-looking statement disclosure. During this call, we may make forward-looking statements which can generally be identified by the content of such statements, or the use of forward-looking terminology and include statements that the 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 quarterly report on form 10-Q and annual report on form 10-K. Our forward-looking statements are based on information currently available to us, and we undertake no obligation to update these statements. Whether it is a result of changes in underlying factors, new information, future events, or other development. 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, welcome to all of you. Q2 was very strong, as I assume most of you have already noted. I'll cover four subjects up front, number one, clinical; number two, government; number three, anemia; and number four, the forecast for the balance of '07 and longer term outlook.

Subject one, clinical results, we continue to present them first as we always have, because it is what comes first, we are first and foremost a caregiver company and now serving approximately 106,000 patients every week and we're proud to report our clinical outcomes continue to be among the best in the industry. Two specific measures, first adequacy which many of you know, is essentially how well they are doing at removing toxins from our patients' blood this quarter, 93% of our patients had a [KGRB] greater than 1.2. Second, in the area highly visible area these days of anemia management, 84% of our patients had hematocrits greater than or equal to 33 and in both of these cases, our outcomes compare very favorably to the national averages. In addition, our vascular access, our nutritional, and our mortality outcomes also continue to compare very favorable to the national averages. As always, these stats relate to patients who have been with DaVita for 90 days or more, we would welcome any additional questions about our clinical results in any area.

But on to the second subject, the government. The House has their Bill. This is the starting point, and a multi-month process as we head towards the Senate, to the conference, excuse me, between the Senate and the House assumingly in September. After that, the President makes his decision about signing or vetoing the legislation. So, it's early in the process.

There's good and bad stuff for our community in the existing legislation. One bad thing is apparently targeted at FMC and DaVita, which is puzzling to us, given we take care of two-thirds of the rural and inner city patients and in those locations, there are few private patients to subsidize the big Medicare population, and it's not obvious why you'd want to pay one urban or inner city center less than another one just a couple of blocks away, so it's a bit puzzling from a policy point of view, and we look forward to working within the process of the next couple months to understand better what the objective is there. Virtually the entire Kidney Care community is opposed to any differential reimbursement and so that of course makes us feel a lot better as we enter into the next phase. I'll leave it at that until Q & A with respect to the legislation.

Now, let's move to subject number three, anemia. Certainly, a lively subject in America these days. CMS did announce the new EMP, the new EPO Monitoring Policy, and it's a reasonable set of policy proposals without some fine tuning, however, it will lead to a slight increase in the percentage of patients with hemoglobin levels below 11, and we will of course continue to report to CMS and Congress and you and our patients exactly what does happen, and with respect to one of those measures, the issue of patients getting 400,000 units or more, that policy will differentially affect those with lower hemoglobin levels, also disproportionately affect African Americans and those getting dialysis or with catheter but I repeat, reasonable policies, without fine tuning, some patients may get hurt and we'll have to sort that out with them.

Next question about anemia, what were the actual trends in Q2. As we had forecasted, utilization was down between 2 and 5%. There's quite a bit of volatility these days relative to historical norms and this has had an impact on our patient outcomes. Those of you who have been with us for a while will know that we have, we're now literally more than 2% higher in terms of the percent of our patients who are less than 11 so that's about, roughly speaking, 2,200 human beings that would have been above 11 awhile ago and are now below 11 and that concerns us somewhat. Of course, although we're watching it carefully.

Last subject on anemia is the FDA panel meeting coming up in September. The FDA has itself suggested that they are open to the idea of distinguishing ESRD from other conditions covered in the label, and that's consistent with our historical conversations with them and lots of other people's conversations with them. They had a lot of time pressure to get the work done that they had to get done so we are not critical on the quality of their work. We are grateful for the open mindedness that they appear to be displaying, because virtually the entire nephrology community feels very strongly that portions of the label are not appropriate for the treatment of anemia in the ESRD patient population.

The fourth and final topic for me is our guidance. The new guidance for '07 in total will be for operating income in the range of $790 million to $820 million. This new guidance obviously reflects the fact that 2007 is forecasted to finish strongly and in particular the third quarter looks like it's going to be very strong. Some of this operating income growth in '07 beyond what we thought we might enjoy comes at the expense of operating income growth that would otherwise have happened in '08, primarily because of some deferred private rate compression, but nonetheless, it's excellent news when looked at in aggregate across the two years of '07 and 08.

And what about additional thoughts on 08? Absent assuming any Medicare legislation because that's simply too big a wild card to do any productive speculating about at this point, our best estimate is that '08 operating income will be somewhere in a wide range and right now we're using 790 to 850. We are entering into a period of unusual earnings uncertainty, and therefore the guidance range for '08 does not capture as high a percentage of the potential outcomes as our guidance historically had. In other words, there's a higher probability than the past that we could be outside the range. We're trying to provide one to be useful, but at the same time, have to provide it with less confidence than in the past.

The key swing factors are the obvious ones. What's going on with labor costs? What's going on with pharma utilization reimbursement and what's going on with private and public rates in general. Independent of whatever the specific '08 number ends up to be , we are very excited about the fact that the immense task of the integration of Gambro is nearly over and are eager and in fact are returning to the field with our historical level of aggressiveness as opposed to the reduced level of aggressiveness that's been inherent to the challenge of dealing with the integration for the last 19, 20 months or so. We also expect to be even better positioned strategically as we move through the balance '07 and '08, and as we always hasten to point out, the fundamental stability of our cash flows and unit demand in this segment remain distinctively strong.

I'll now turn it over to our CFO, Mark

Thanks, Kent.

I'll address a few key questions about our quarter results. First, regarding the major drivers in the quarter. Operating income from continuing operations was $206 million for the quarter, excluding the valuation gain on the Gambro supply agreement. Operating income results were primarily driven by treatment growth, improved labor productivity, and a decline in payroll taxes and workers compensation expense. These improvements were partially offset by an increase in G & A expense. The flat revenue for treatment versus Q1 relates primarily to the Medicare composite rate increase of 1.6%, beginning April 1, being offset by lower revenue from a decline in utilization of position prescribed Pharmaceuticals. The increase in G & A as a percent of revenue relates primarily to the timing of professional fees and an increase in stock option expense. We continue to expect 2007 G & A to be in the 9 to 9.5% range.

What about cash flow in Q2 and for 2007? DSO increased three days due to a temporary $40 million increase in Accounts Receivable from industry-wide changes in government forms and documentation requirements that were implemented during the quarter. These delays are expected to resolve in the next two quarters. Our updated forecast is for cash flow to be $480 million to $530 million in 2007 reflecting our assumption that certain working capital items will be a use of cash in 2007. There is a risk that cash flow could be impacted by the ongoing billing integration. Our CapEx forecast for 2007 continues to be $110 million to $120 million in maintenance capital and $200 million to $220 million in growth capital for acquisitions and de novo. We continue to expect stock option exercises to generate approximately $60 million, leaving approximately $200 million to $280 million available for additional growth investment, share repurchase, or debt repayment.

What are we planning to do with our cash flow? Our top priority is attractive growth investment followed by share repurchase and debt repayment. At times, we may be holding cash opportunistically for growth. Holding everything constant, we are are likely to do some share repurchases in the coming months.

What about the Gambro supply agreement? As a result of terminating our obligation to purchase dialysis machines from Gambro, we realized a $55 million non-cash gain. In subsequent quarters, we will see amortization expense increase by $1.7 million per quarter through Q3 of 2015, with the elimination of this liability.

I will now turn the call over to Kent for closing remarks before we move to Q & A.

Thanks. I'll just be redundant. First, it was a very strong quarter. Second, the quarters are going to be a bit dynamic on the earnings front with a wider range of possible outcomes than is normal. Third, it feels great to be going back on offense more so than we've been able to for a couple of years. Fourth, we think we have a great strategic position and it's going to be even better 18 months from now, and fifth, we love the fundamental stability of our cash flows in unit demand.

Now, Lamont, would you please open it up for Q & A? Lamont?

(OPERATOR INSTRUCTIONS). Your first question comes from the line of Art Henderson with Jefferies & Company.

Hi, very nice quarter. A couple of questions here. Kent could you kind of talk a little bit about what you're seeing out on the managed care pricing front right now?

Well, it's kind of everything along the spectrum in some cases we're fighting to keep rates the same and we'll probably take some cuts and other situations we're getting nice increases and of course sometimes the difference in those two experiences is explained by what the rates are to start with, so we end up, as has always been the case, talking to lots and lots of payors every single year with a wide mix of experience and there's no clear trend other than as you can see from our forecast for '08, we think that over the next 18 months, we're going to take some net hits.

Okay, that's helpful, and then, could you describe sort of what the firm's relationship is now contractually with Amgen? Is there an ongoing contract that you have out there, and if there are any sort of material changes to dosing guidelines or anything, is there any ability to go back to them on rebates or dosing patterns or anything like that? Could you describe that?

We do have a contract in place with Amgen and it is hard to think of a single quarter in the last seven years where we haven't been negotiating with Amgen about something, so that doesn't change. They make some absolutely wonderful drugs and biotech products and as to what's going to happen going forward, who knows. We know we'll be buying a lot of what they make, but exactly what the terms are going to be as we go into '08 and '09, we don't know anymore than you do.

Okay, one last question and I'll jump back into queue. You talked about being more aggressive now that you've gotten the integration largely complete with Gambro. Can you be a little bit more specific about what you're thinking? Are you talking acquisitions or are you talking more sort of financial engineering with paying down debt, buying back stock? Can you detail a little bit more what you're thinking?

Yes, when I referred to the aggressiveness, I was referring explicitly to the field, which is to say that when you've got your best General Managers and leaders and other folks on the team having to spend a significant amount of their time each week figuring out new information systems, meeting new people, dealing with new reports, meeting new doctors, all that kind of stuff that happens in an integration of one Company with 15,000 people and another with 12 and overlapping and all the Markets, et cetera, et cetera, et cetera, It necessarily means that there are days when instead of spending six hours out there spending time with existing physicians we have relationships or meeting new ones, instead you're spending that internally, working out all that kind of stuff I was just was just talking about, so it's much more a field thing and it's much more nimble in terms of playing both defense and offense versus our competition out in the field, competing to do great work with patients and physicians and payors so that we get chosen by more and more of them both from a retention point of view and a new business point of view. Is that responsive?

Yes, no, that's very helpful. Thank you very much.

Thank you.

Your next question comes from the line of Darren Lehrich with Deutsche Bank.

Thanks. Good afternoon, everyone. A couple items here. I guess Kent, with regard to the outlook for 2008, just would love to get your commentary on what were the key changes to management's thinking there and in terms of what you're seeing in the environment, you obviously were a little more bearish last conference call and it would be helpful for us to understand what you're seeing differently.

I don't know that there is a difference, so could you come back at me again perhaps slightly more precise?

Well, sure. I guess the commentary from the last conference call is that you saw operating income as being flat, and I think you put a particular emphasis on private rate compression and I think your words that you said in your commentary today was that you're seeing deferred private rate compression, so maybe you can expand on what you mean by that, and why it's not a flat view like it was last quarter I guess just 90 days ago.

Well, let's play with it for a minute and see if I can be helpful. If you look at how well we might do this year and you look at the current guidance range for next year, what we're saying is we still could be flat. The good news is, it's flat from a higher level than what we talked about before, but we still have that sort of balance, ironic balance that to some extent the better we do in '07 and have a higher growth rate in earnings '07 versus 06, to some extent that comes at the expense of how '08 will look versus '07, and then hopefully '09 and beyond things become more steady state, but there isn't actually a dramatic substantive difference other than the fact that Q2 went well. Q3 looks very good, but some of the year-over-year observations are directionally similar at least. Am I getting to what you want or not?

Yes, no, that's helpful. I guess your commentary about Q3, do you care to expand at all about what you're seeing? It's August, so what you're seeing at this point in the third quarter?

No. It's consistent with our historical norm. Some quarters are good. Some quarters are bad and we try not to pay attention to them other than when there's a takeaway that has implications beyond that particular quarter, so I want to let people know that it looks good in part so when that happens, people don't necessarily extrapolate it out into the future because that would be inappropriate and unfair to you, but beyond that, it's just sort of the normal mix of puts and takes that happen in the quarter.

Fair enough. I think one of your larger competitors, Fresenius reported hemoglobin in a couple of different ways today in their earnings report and with regard to your clinical measures. Is there anything that you can provide to us with regard to your mean hemoglobin in the second quarter and would the average hemoglobin above 11 was at the end of the period, because it seemed to have dipped down significantly for Fresenius .

I don't have those numbers here. Obviously we have them all. Historically, we've for years we've reported what number which is a percent above 11 and we're not happy about the fact that that's down.

Okay. I guess my last question and I'll jump off here, just do you care to say anything more about Village Health and your plans in the snip business?

We believe that the best thing that can happen for dialysis patients and the American taxpayer is for there to be more integrated and holistic care for dialysis patients, and so in our Village Health subsidiary, we do disease management stuff and prevention stuff and care management stuff that is essentially service R & D, and hopefully, we're going to be a significant part of the solution for coming up with a better way, again, for both patients and the tax payer with respect to managing care in a more holistic and thoughtful way. Beyond that it is just essentially R & D, it doesn't make a lot of sense to go further. We're making good progress, and we're coming up with good insights but it's not something that you can bake into a model yet, or have effect our valuation and by the way, we did go ahead and go grab some of the mean hemoglobin numbers. We're at 12.1 now. We were at 12.2 a while back.

Great. Thanks very much.

Thank you.

Your next question comes from the line of Gary Taylor with Banc of America.

I dropped off so I missed one question, so hopefully I'm not repeating. I just wondered, obviously, your guidance is incorporating for the second half of '07, what happened a few weeks ago, with respect to the bundling of the Epogen and the cancer and the dialysis setting in that 4 or 5% sequential drop in the reimbursement, so the question is, is there any hope or optimism that bundling, which treats dialysis somewhat unfairly, perhaps with respect to how the discounts are being implemented in cancer, is there any hope at this point that administratively there might be redress for that?

This is LeAnne. No, the policy was put into play in legislation in 2003. CMS is implementing it according to law, and so no, you shouldn't expect any relief from that.

The implementation takes place in the third quarter and that's obviously reflected in the guidance that you've given today.

Correct.

Okay, thank you.

Your next question comes from the line of [Mark Ofrayzbee with Zemco].

Hi, there, just quick question on the capital structure and deleveraging. I think I heard you earlier mention you would be deploying cash for share repurchases as well as further debt repayment. Could you maybe just expand on that in terms of the tradeoff at the margin here? Obviously you've de leveraged significantly after the Gambro acquisition here and beforehand you had been talking about just debt repayment, and this just sounded like a little bit of a change, so just wanted to get an update on your sort of optimal capital structure leverage ratio and so on and how you're thinking about that?

Yes, that's a good question to ask and the way that we think about capital structure and the way we've talked about it before is that our sweet spot is roughly in the range of 3 to 3.5 times leverage, and of course we have been both above and below that range. We are now about at the mid point of that range and the other factors that are worthwhile considering is that our debt is now actually very attractive relative to the kind of debt terms that we could get under current market conditions , so that has made share repurchase relatively more attractive at this point as compared to debt repayment. That is not to say that we won't consider debt repayment in the future as well. Did that

Yes, that's great. I just wanted to check to make sure you hadn't changed your 3 to 3.5 kind of range and given the debt markets have changed a lot in the last month, I was wondering if that also made you revamp your analysis in any way but it sounds like it's the same range.

Yes, I think that's the right way to think about it.

Okay, thanks a lot.

The next question comes from the line of Andreas Dirnagl with JPMorgan.

Good afternoon, guys. Kent or Mark, LeAnne, a quick question, the guidance that you're giving for both '07 and 08 sort of along the lines of what was previously asked does that also include the potential impact of the CMS reimbursement change for patients above 13 to more than 90 days?

Yes.

Okay, great. Kent, sort of just a general question, just trying to clarify and maybe get a better understanding of the relationship between physicians and sort of the medical Board and the clinical guidelines that you guys put on a corporate level. Obviously you have placed a lot of importance on the clinical guideline of getting the maximum number of patients above 11 and that did drop this quarter. Can we basically take that as an implicit sign that shows that doctors are doing things according to their own clinical patterns and they see the guidelines as exactly those guidelines but not laws written in stone?

Absolutely. It has always been the case that some doctors ignore the guidelines totally. Most doctors use them in a significant way, but not fully, and very few entirely. The guidelines were developed over a year or two with hundreds of docs being involved in different ways and having it circulated and in this area like other areas, there is no perfect consensus on what to do and then in addition, different doctors have very different patient populations, which also leads to practice pattern differences, which in fact aren't philosophical differences about the guideline but it's one thing to have a patient with the same lab values that weighs 300 pounds and has diabetes and has had one below the knee amputation and another one who is 32, fully employed, and healthy in every other regard. They might have very different needs with respect to anemia management even though in the statistics they would show up as the same or in the guideline they might, and as for the guidelines, our anemia guidelines have three goals: one is to maximize the number of people who are above 11. Two, maximize the number of people who are between 11 and 12 , and three, to minimize the variability of patient hemoglobin/ hematocrit condition. That is sort of the holy trilogy of the goals, which manifest themselves in the rest of a very complicated

Okay, great. That's great detail. Maybe one last question. I'm trying to just get a feeling, sort of given your commentary about the upcoming cardio renal panel and that your discussions with the FDA seem to be pointing to that there's a high likelihood there is in effect a bifurcation of the label between the oncology and the nephrology patient populations. Given the clinical differences between these populations, I know you're not going to sort of comment per se on the outcome because it is unpredictable, but isn't it clinically sort of a relative assumption to make that if you're going to bifurcate the label, it's not to make it more restrictive for dialysis patients, probably to ease some of the restrictions for that?

Short answer is yes, to the second question, but what direction the changes are most likely to be in, if there are changes. I wouldn't want to be characterized as being optimistic. I think it's more a 50/50 thing. The nephrology community and DaVita are absolutely fervent about the need for change and the fact that it should change.

Nevertheless, the FDA has got a lot of stuff on their plate and don't have the same sort of knowledge and experiential base that we do, so we respect the world in which they are working in and we hope they get to spend enough time on this issue. If they do, then we're confident that there will be changes, but with everything else going on and their scarce resources , I fear there's a non-trivial probability that they could leave it the same and that would be overly restrictive and inappropriate for our patients in many ways, and puts doctors in a very uncomfortable position.

I've talked to doctors personally who say they don't agree with this stuff in the label but they are very nervous about not following it in some cases, even though it doesn't have the force of law and off label use is common throughout all of American healthcare. Nevertheless with all of the media attention and government commentary, you have some doctors who started prescribing out of fear and that's really

That's certainly quite true, and Kent, I don't think you need to worry. I don't know if many people are ever going to characterize you as overly optimistic.

Are you done now?

Yes, thank you.

All right, see you later.

Your next question comes from the line of Matthew Ripperger with Citigroup.

Thanks very much. Your patient care cost per treatment declined by, it looks like about $4 sequentially from $238 to $234 and I think that's the lowest level in about a year. Could you just give a little more detail about what really contributed to that sequential decline and whether this is a good baseline for us to model going forward?

Well, the decline in patient care costs quarter-over-quarter were largely related to the decrease in the utilization of physician prescribed pharmaceuticals, obviously, and in our case, the decrease in payroll tax, so that's kind of an explanation of quarter-over-quarter. As to how to model this going forward, obviously, we have, we face the same labor pressures and increasing labor costs that the rest of the healthcare industry faces, so that will be a significant factor going forward, and I think that would be the primary thing that I would think about. And then the other thing is that we will have fluctuations in these costs, related to some of the utilization of pharmaceuticals that we've alluded to as well as the change in the environment.

In your prepared remarks, you also mentioned that I think labor costs and payroll and workers comp declined. Did that contribute to this expense item or was that through SG&A?

It is in here. It's in primarily this number.

And when you reduce labor, is that at the patient center level or is that at corporate?

When we, I'm sorry, maybe you can be more specific. I'm not quite sure what you're asking

I want to get clarification as to where you, if you did reduce labor, where that came from, whether it was headcount at the patient center level, or whether it was back office or billing?

We had an improvement in the quarter end labor productivity but it wasn't a reduction in labor, but labor was more productive.

At the center level.

Okay, great. And then related to commercial payors, can you comment on how many paid based upon a bundled rate right now and what your experience has been providing care under a bundled payment?

Right now it's a minority of our private payer population that pays on a bundle basis, although it is growing and we use the same clinical guidelines for all care unless a payer were to prescribe something different and tell us what to do.

Okay, great and last question I had is one part of the House Bill was extending the MSP to 42 months. If that were to occur, would there be a correlation in a reduction in commercial pricing as a result of that?

That could happen.

Okay, thank you very much.

Your next question comes from the line of Balaji Gandhi with Oppenheimer & Company.

Thank you. I just wanted to follow-up on that last question about patient care costs. Maybe could you help us a little bit more? I know historically you've given kind of a range for growth in that metric.

I don't, I can't help you any more. I don't think with that number except to again emphasize what I've said earlier, which is that we face the pressures of increasing a labor price trends clearly.

Well and Balaji, it's certainly going to be impacted by physician prescribing patterns and that right now would be very difficult for us to project from quarter to quarter what those will be and we said overall that we would be on particular Epogen utilization would be down 2 to 5% so that trend will play itself through over the next few quarters, and beyond that, I don't think there's anything specific to say.

Okay. The other thing was, I'm actually having trouble getting to the $0.83 that you talked about. I think it's because I can't seem to find in the press release the benefit that you had from gain on sale of investment securities. Is that broken out separately?

It's $4.2 million.

So that was included? So basically if I take that out --

There's another income.

It's in other income, okay, $4.2 million. Thanks.

So maybe I could help you a tad more on the labor front. If you look historically, probably over the last four or five years, the net increase in labor costs per hours has gone up 3 to 4% a year in that range. It's moved around a bit and then it's been offset by anywhere from 0 to 1.4% increases in productivity and lately, we've had more trouble getting year-over-year productivity increases, so that's some empirical data to help you on that part. Lamont, could you go on to the next person, please?

Your next question comes from the line of Bill Bonello with Wachovia.

Hi, just a couple of follow-up questions here. The first one is super elementary. The '07 operating income guidance, is that with or without a gain?

Without.

That's what I thought but I wanted to make sure. Okay, and then you mentioned that you'd be in a much better strategic position in 18 months. Why?

Well I guess that's a fair question, Bill. I think we will have purchased and built some more units which will increase our geographic coverage and that's a good thing strategically. I think we will have further improved our clinical outcomes, and that is good strategically. I think we will have advanced the Village Health portfolio of value-added services, and that will be good strategically. I think we'll be better, even better at working effectively with parts of the Federal Government and that will be good strategically, and our IT systems will be better, having wedded the integration to move back into more value-added application development, both in terms of productivity, clinical outcomes, and strategic information, so those are five specific areas where I think over the next 18 months, the incremental change will be enough to be a material difference in our long term strategic position.

Okay, that's helpful, thank you. And then on the G & A, and I apologize if I missed this somewhere in the Q & A, but isn't G & A usually kind of the highest in Q2 because of the big meeting you have and whatnot and in light of that, why wouldn't we see it maybe track down actually a little bit in Q3 and Q4?

We've done a better job in spreading out G & A to avoid having that be a substantial impact, although it did have a minor impact. As we said earlier, we had essentially lower professional fees in Q1 that either were deferred or made Q2 look larger. And going forward, we are staying within our range of 9 to 9.5%.

Right, okay. I guess I get that. And then just the last question which is an EPO question. Is it safe to assume that the decline in EPO utilization that you saw was across all of your payer classes?

We don't even look at it that way because all of our physicians make decisions independent of payors, so I can't give you a factual answer because we never even look at it that way, but all my empirical experience says the doctors don't look at payer class before they write the prescription.

Okay, so then in light of that, I mean I guess it just seems like there's just been this incredible concern that a decrease in EPO utilization would destroy your profitability and I guess I'm just looking at it and say if you really went down 2.5 to 5% sequentially and your income went up $10 million sequentially, it's just not that EPO isn't important but it just doesn't seem like it's sort of the foundation of all your earnings, and I just don't know if you want to comment on that at all.

I think we'll let the numbers speak for themselves.

All right thank you.

And to clarify the gain is in the other income line, which is below operating income, just as you're looking at the financials.

Okay. Thank you.

I should probably go back, because someone asked, I don't know if it was you, Bill, or Andreas about the bundling and any differences there. Your question provokes another part to the response to that question which is our doctors don't know which patients are bundled and which patients are fee-for-service. That's just separate from that and most cases probably not knowing the payer class and maybe in almost all almost all not knowing the payer class but beyond that they have no idea who would be bundled and not for the most part unless they are a very usually involved physician so it's just not really possible for them to behave differently because they don't have the information even if they are so inclined.

Your next question comes from the line of John Ransom with Raymond James.

Hi, I have to ask a dumb question, so this is mine. You guys sit on a lot of cash, I mean almost $400 million. Is that the amount of cash you need to run the business or is there a strategic reason that we haven't figured out why your cash balance is so high? Thanks.

That is not the amount of cash that we need to run the business; however we do have substantial swings in our cash flow on an intraquarter basis. That being said, as I mentioned earlier, when we think about cash, we think about not only our leverage and repaying debt, but share repurchase but our highest priority is investment in growth opportunities, and as I said earlier, there are times where we may hold cash because of potential growth opportunities.

Okay. So are you hinting at something there? Because I have in my mind if you pay a half a point or a third of a point on an unused revolver that sure would have a negative 400 basis points cash versus your borrowing cost, so I'm just not sure I understand the capital efficiency there.

Yes, we're certainly well aware of that point, and unfortunately, our growth opportunities don't always correspond to the timing of our cash flow, and I'm not hinting at anything. That's just the normal way that our business operates.

Okay and then my other question, thank you for that. My other question is, you talked about a conversation you were having with United Healthcare as they were trying to impose a new standard. Is there any update on that negotiation?

Yes. Well, first, I wouldn't call it a negotiation. It was a conversation and yes, United has implemented some standards for oncology, but not for the ESRD clinic, and also for CKD patients so CKD patients and oncology they implemented some guidelines and ESRD in center administration they have not.

Thank you, and has anybody else tried to change any other large payors tried to change their policies around the assays?

The only ones that I know of are oncology related, and I'm looking around the room. Does anyone know of any that are ESRD related? No, so we really don't know but the only ones we know of are oncology.

Okay. I would take that as good news then.

I would too.

Okay, thank you.

Your next question comes from the line of Justin Lake with UBS.

Thanks. A couple questions. I guess first, I just wanted to make sure I understood the EPO utilization impact. You said 2.5 to 5%.

That's our guidance was 2 to 5% and we say we're in that range.

Okay. So the guidance is 2-5% and you're in that range for the second quarter already?

Correct.

So that could go up from there or down from there, but okay, so when you look at the impact there and then you add-on the impact of the declining ASP in the third quarter, what's offsetting that from a positive standpoint, to allow you to take up guidance for the magnitude you have?

Well, obviously, it's a variety of factors. It's growth, continued growth in the business and the impact of the Medicare composite rate increase, and as we discussed, the timing of payer compression.

Okay, the first two would have been mainly known, right? The growth is basically around what you guided to in the 1.6% was known awhile back, right? So is it mostly the payer compression just being pushed out?

It probably is mostly payer compression.

Okay. And on the payer side, I think somebody asked a question about the MSP. I'm curious if you have been able to identify, and might be willing to share with us, most of the language appears to be around an extension for large employers. Can you give us an idea of what percentage your commercial revenues would be impacted by this extension?

Why don't you go ahead and repeat the question?

Sure. I believe the MSP extension is for large employers at this point what they are talking about?

Can we stop there for a second? As was the 1997 extension.

Right. So what percentage of your patient mix on the commercial side would be impacted or maybe the commercial revenues would be impacted by this? Come from large employers?

So you're asking the question, the second part of the question is how will private rates be impacted?

No, I guess, if you could tell me that, that would be great. I guess I'm more just asking, I would assume that not every commercial payer comes from a large employer. Is that correct?

Correct, but the legislation doesn't refer to large employers. It refers to large group plans which have a lot of small employers in their membership.

Oh, okay. So I've misunderstood the writing there. So is there, is it close to 100% of your commercial revenue that would be impacted under that type of law? Is that how we should think about it?

All we know is it's the same language as 1997, and so we d educe that it would be virtually the entire book of business, but we don't know that, so we've been unable to get any specific clarification. Suffice it to say, we've been told the language is exactly the same and the last time this happened it did.

Got it and one quick follow-up on the patient care benefits from payroll and workers comp. I apologize if I missed this but is there something that you expect to continue or is that sort of a one-time benefit for the quarter?

It does fluctuate, but it tends to be higher after the first quarter of the year.

And if we think about the $4 decline sequentially, how much of that was made up by the lower payroll and patient care revenue?

We won't break that detail out for you.

Okay, thank you very much.

Your next question comes from the line of Gary Lieberman with Stanford Group.

Thanks, good afternoon. To follow-up on the last point, I guess, could you indicate with regard to the MSP extension, did you include I guess some probability of that going through in your guidance for next year?

The guidance explicitly excludes any speculation about Medicare legislation, good or bad because there's just so many moving parts on it, it's impossible to do in a constructive way.

Okay and would it be possible for you to give us what the estimated EBIT impact would be of an MSP extension?

No. If they end up doing something, we'll do our best to provide some sort of health, but it just doesn't really make sense to be so speculative now.

Okay, and then if I could just ask a follow-up question with regards to the margins, which look like they were strong in the quarter. Is there any I guess still spread between the margins at DaVita, and the Gambro facility that you were able to close in the quarter, specifically, and if so, what were they?

The answer is yes there's still some gaps, but they are much smaller than before.

Okay, and then just with the comments you made on the third quarter as starting off strong, would you characterize that as being continued strength on the margin side or an acceleration of strength on the pricing side?

We were just referring specifically to operating income period without providing any detail because we could end up being wrong on a bunch of the subpoints and we hope we're not wrong on the headline point. There's always that possibility too, but the comment was particularly in reference to operating income alone.

Okay, great. Thanks a lot.

Thank you.

You do have a follow-up question from the line of Art Henderson, Jefferies & Company.

Mark, the gain on the sale of investment, is that related to Next Stage?

Yes, it's -- the $4.2 million gain is related to the sale of Next Stage shares.

Kent, has your sort of feelings about home dialysis changed in any way? Should we read into that sale? Is any sort of indication as to how you're feeling on that issue?

Nope. It had absolutely nothing to do with it. Investing in the Company was part of a negotiated transaction, and it was always our expectation and it was communicated to them, that we thought we would most likely sell our shares relatively quickly.

Okay, fine, and then in your script, you talked about the aspect and the Bill related to the rural and inner city issue. Could you elaborate a little bit more on that just kind of what the issue was there and provide a little bit more color on that? I want to make sure I understand what's going on there.

There's a provision in the current draft, which came from the Health Subcommittee at the Ways and Means Committee that would reduce EPO reimbursement essentially for FMC and DaVita and no one else, and we think perhaps that some of the people who advocated for that, thought that they were protecting rural and inner city providers, while just burdening those in between in the suburbs or whatever who could afford it. The problem with that assumption is that FMC and DaVita take care of two-thirds of all the urban and rural patients in America, and so it just doesn't really make sense to have those centers, which in those areas tend to have very few private patients to subsidize the Medicare deficit to have a couple of those centers half a mile apart, one getting paid significantly differently than another, it just is sort of puzzling as public policy, and we and I repeat, we and the rest of the Kidney Care community because virtually everyone, patient groups, doctor groups, small providers, et cetera, do not think that that is a sensible policy path to go down, so it's not just us. Does that answer your question?

Yes, no, that's perfect, and then the last question I have is bundling is obviously another issue that's been brought up I guess in the House Bill as well. Do you get the sense from talking to people that they are expecting that by the time something like that were to get put into place that there would be a cost survey done and the elements that go into that bundle would be updated appropriately?

Okay, I'd like you to do that question again because I'm worried I'm going to give too [lamby] an answer.

Well I was just curious if we move to bundling down the road here, between the time that's been sort of proposed for MSP and getting out to bundling whenever that should end up taking place, do you get the sense from the people that you're talking to in Washington that they would expect to do a cost survey or to evaluate what the components are that go into that bundle to make sure that you're being paid adequately on a go forward basis?

Short answer is yes. CMS takes very very seriously the responsibility they would have in nailing down the design of a bundle and how many different reimbursement rates it would be and what would trigger what category each patient fell into, and they take it real seriously in part because they take everything seriously but even more so, because they have tried in the past to design a bundle for ESRD, and not been able to because of the difficulty in predicting prospectively exactly what resources different patients will consume, and the danger, when you've got a thousand small centers with 60 patients out there that if you get it very wrong, you could put a center in serious trouble very quickly, unlike other segments of American healthcare which have been bundled where they've got a much greater mix of patients and there for, DRG's tend to average themselves out even though any subset of them might be incorrect. We're a one DRG healthcare segment with lots of small centers and lots of variability in resources consumed by patients.

Okay, that's great. Thank you.

Thank you.

We do have a follow-up question from the line of Andreas Dirnagl with JP Morgan.

Kent, just a question. Just given your current market share domestically in the U.S. And the relative small size of potential acquisitions out there, is there sort of a safe assumption to say that if there is something that is a growth opportunity that requires you to be building up cash that that's likely going to be more in the international arena than it is in the domestic arena?

I'm trying to figure out a way to give an optimistic answer, but unfortunately, you and me and a question that's optimism/pessimism neutral. The short answer is the way you word the question is no. Slightly more useful answer is we are seriously considering international kidney care. Will we do it? Who knows, but unlike the past, we are looking at it seriously, all the right qualifiers and appreciating the difficulty of the task for a pure service company, and then second, we also are looking at related service businesses here in the U.S, those where there would be good potential for lots of long term growth, and those which require some of the same core competencies that we like to think we demonstrate. Once again, very hard to handicap, but those are two things that we are seriously talking about and looking at in a way that's different from the past.

Okay, that's helpful. Thank you.

At this time there are no further questions.

All right thank you very much for your interest in DaVita. We'll look forward to talking to you again in three months and we'll do our best in between.

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