德維特 (DVA) 2009 Q2 法說會逐字稿

Good afternoon. I will be your conference operator today. At this time, I would like to welcome everyone to the DaVita second quarter 2009 investor conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (Operator Instructions), Thank you. I would now like to turn the call over to Ms. LeAnne Zumwalt. Ma'am, you may begin your conference.

Thank you, Gina, and welcome, everyone, to our second quarter conference call. We appreciate your continued interest in DaVita. I'm LeAnne Zumwalt with -- Vice President of investor relations and with me today is Rich Whitney, our Chief Financial Officer. Kent Thiry, our CEO, had a death in the family and will not be able to join us.

I'd like to start with the forward-looking statements 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 may 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 the risks and uncertainties, please refer to our SEC filings included in our most-recent quarterly report and on Form 10-K, our 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 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 measures -- excuse me, results. Also, included in the press release is a reconciliation of these non-GAAP measures to the most comparable GAAP financial measures.

First, I will review our clinical outcomes. We continue to present our clinical outcomes first because that is what comes first. We are first and foremost a caregiver company, serving now approximately 116,000 patients. First, with respect to adequacy, which is essentially how well we are doing at removing the toxins from our patients' blood, again this quarter 95% of our hemodialysis patients had a Kt/V greater than 1.2. Second, with respect to vascular access, 63% of our patients have fistulas, the preferred form of vascular access. Third, anemia management, physicians have managed 88% of our patients to hemoglobin levels between ten and 13 over the last three months. Most importantly, our gross mortality rate for 2008 was 16.5%, an 11% improvement from our 2005 mortality rate of 18.5. This means that around 2.200 more patients were alive at the end of 2008 due to our improvement. For these clinical measures our patients' outcomes compare quite favorably to national averages. Our superior clinical care not only results in healthier patients, but also drives significant savings to the US healthcare system.

I'll now turn the call over to Rich Whitney.

Thanks, LeAnne. Q2 was a strong quarter for DaVita clinically, operationally, and financially. In any quarter, a number of small things happen, some favorable, some unfavorable. This quarter it seems almost everything went favorably. Even excluding this, our fundamental operations were strong. I will come back to the details of our performance in the quarter in a moment, but first, let me begin by answering some key questions about the current environment.

Question number one, what is the status of healthcare reform? As you are all no doubt painfully aware, the discussions regarding the structure of reform and how it will be paid for are very much in flux. At this point we are not in a position to predict the legislative outcome or its potential impact on our industry. I will, however, say the obvious. Policies that are likely to decrease the number or rates of private patients are negative for our industry. Policies that are likely to increase the number of private patients would be favorable.

Question number two, what is the status of CMS' bundling rules? While we expect to see the preliminary bundling rule sometime in August and right now we and the rest of the industry do not have an ability to offset the 2% reimbursement cut in the bundle. And further, we're nervous about the bundle rate calculation and fear that it could effectively be a larger than 2% cut. And if so, we would be forced to close some centers. Additionally, the house healthcare reform bill includes a provision that would require oral medications be included in the bundle. This policy, if implemented, would hurt patients and, given that no one could accurately calculate the costs of oral medications, which are not currently reimbursed through part B, this number would be a guess at best. All this said, we are working closely with CMS and congress to ensure that the bundling is implemented as outlined in NIPA.

Question number three, how is the economy impacting our business? We have seen a slight decline in our percentage of private patients over the past few quarters and to date this has not had a significant impact on our overall rates, as the mix shift has primarily effected lower paying managed care patients.

Okay, now, back to the details of the quarter. The second quarter was characterized by healthy volume growth, stable private pricing, increased utilization of physician-prescribed pharmaceuticals, strong cost controls, and very strong cash flows. Compared to Q2 of last year, revenue was up 8%, operating income up 8%, and EPS up 13% on a 1.6% lower share count. Non-acquired growth was 4.5%, which is an increase from recent quarters. We are still experiencing significant delays in certification of our de novo centers, currently with 62 completed and awaiting certification. We continue to expect non-acquired growth to be in the range of 4% for the year, as the certification delays may weigh on our growth.

Dialysis revenue increased $3.62 per treatment from Q1. The main contributors to this increase were an increase in physician-prescribed pharmaceuticals, an increase in ASP drug reimbursement rates and these two items were partially offset by a seasonal decline in lab testing and the small private mix shift that I mentioned. Dialysis operating expenses increased about $2 per treatment sequentially and this is due to an increase in pharma utilization, higher health benefit costs, and the continued impact of the uncertified de novos. These items were partially offset by a decrease in payroll tax from the seasonally-high first quarter and strong labor productivity and cost control.

If you look at dialysis operating costs year over year, they increased about $3 per treatment, or 1.3%, and this demonstrates solid cost controls offset by annual wage inflation and higher pharma costs, primarily epo and heparin pricing. Dialysis G&A was at 7.3% of segment revenue for the quarter and was consistent with the full year of 2008 and with our expectations for fiscal 2009. During the quarter we modestly increased our bad debt reserve to 2.75% of revenue in the dialysis segment and this reflects a slowdown in the timing of payments from some of our non-government payors. As for cash flow, the latest 12 months operating cash flow of $705 million was exceptionally strong and was favorably impacted by higher operating income, lower cash taxes -- primarily resulting from bonus depreciation -- and the timing of various working capital items. We still expect operating cash flow for the year to be in the range of $550 million to $Q600 million as we expect certain working capital items to be a use of cash in the second half of the year.

Regarding our outlook, we are narrowing our 2009 operating income guidance range to $900 million to $930 million. As you look to the rest of 2009 and into 2010, it may be difficult for us to maintain Q2's operating cost performance. Also, there is a risk we could experience a more significant private mix decline due to sustained levels of high unemployment, and we face the risk of cuts from state Medicaid plans and other government programs, virtually all of which are looking for budget relief. Our expectations regarding these swing factors are reflected in our operating income guidance range. Longer term, our operations are solid and we continue -- and we expect to continue the trend of recent years, generating steady growth and strong consistent cash flows. The biggest longer-term risks that we face are the potential for a poorly-implemented bundling policy and potential reimbursement discontinuities from healthcare reform. If either of these factors cause the reimbursement on the government business to grow, this will put increasing pressure on private insurers to subsidize this business.

Overall, we are well positioned to offer significant value to patients, physicians, payors, and the government through integrated care management, specialty oral pharma delivery, vascular access care, and pre-dialysis disease management services. This is, in fact, what payors and the government want and something only the large national dialysis companies can deliver.

Operator, let's go ahead and open it up for Q&A.

(Operator Instructions). We do have a question from the line of Kevin Ellich.

Thanks, guys. Rich, just wanted to start off with that bad debt reserve increase to 2.75%, wondering if you could provide a little bit more color. You mentioned a slowdown on the managed care payer side, are there any specific payors that you guys are bumping into problems with?

Yes, I really can't point to any specific payors. It's almost across the board and it's a trend we've been watching for a quarter or two and it's obviously been offset by improvements in other areas because our DSO remains stable at 70 days over the last several quarters. But it's really just a little bit of a slowdown on the non-government payer side causing us to boost that provision a little bit.

And are those in-network or out of network contracts?

It would -- it wouldn't really make a distinction -- I don't think it's a material distinction.

Okay.

-- in this particular issue.

Got it. And then going back to your comments on the bundling rule, what's your expectation for market basket increases? I think that includes a -- well, the house bill included a provision for productivity gains?

Yes, the house bill actually now it's not applicable because, in fact, the dialysis segment was eliminated. Now, that could come back in the senate, but right now where we stand, we expect our market basket to be implemented as (inaudible) market basket minus one.

Got it. And then, Rich, could you help us -- provide an update on uses of free cash flow, how you would like to use that?

Sure. Our priorities in terms of use of cash remain the same as they've always been, and that is to serve three priorities in this order. First, investing in profitable growth opportunities, acquisitions and de novos. Second, share repurchases. And third, paying down debt. Regarding growth, as we have stated, virtually all of the MDOs, the midsize dialysis organizations, have offered themselves up for sale over the last 18 months or so and we are interested in acquiring should any of them become available at a reasonable price. So that is part of the dynamic in terms of growth. I should mention also, given the current environment as it relates to healthcare reform, the economic environment, capital markets environment, it may be that our appetite would only be for one such transaction instead of multiple transactions. But nevertheless, we're interested in acquiring and hopefully that will be possible.

Secondly, as it regards to share repurchases, again, given all the uncertainties that I just mentioned, we have not been in the market since the early part of the year and so that's our posture at the moment. We obviously, as it relates to all of these factors, in allocating our free cash flow, we evaluate them continually. And then finally, regarding debt paydown, as we've said in the past, we -- if we pay down debt now, we can't reborrow, certainly can't reborrow at our current rates. And so any cash that we currently hold costs us a little bit less of 2% pretax, so it's a pretty cheap option to ensure that we have plenty of cash to take advantage of whatever opportunities might present themselves. So hopefully that gives you a good sense for how we think about it.

Yes, that's helpful. And then just one last quick question. On the (inaudible) your still experiencing, a competitor mentioned this morning that it looks like Medicare's going to speed up the certification process. Have you guys heard the same thing, or what's your expectation on that front?

We haven't -- we, of course, are working at the federal level and at the state level and we've seen honestly very little progress at this point in time. There was sort of one glimmer of hope in that Texas, which is one of the bigger problem states and had previously said that they would literally not certify any dialysis centers for the balance of 2009, recently came out and said that they would certify 22. Only five of those are DaVita centers, but -- so it's a small glimmer of hope, but at least it's some progress. Really nothing else to report on that matter at the moment.

Got it. Thanks.

You're welcome.

And your next question comes from the line of Gary Limberman.

Thanks, good afternoon. I guess maybe just a follow up on the last question regarding the certification process just to get a little bit more background, if you guys understand it. What is it specifically? Is it just state budgets that they're constrained and they don't have manpower to certify the facilities, or is there something else going on?

No, it's exactly what you said.

Okay. And then maybe if you could give us an update on some of the new initiatives and where you are with regards to your expectations for the costs associated with them through this point in the year?

Sure. The short story is that they are -- halfway through the year they are on track with our plan in aggregate and individually, as well. The segment loss for the quarter was about $4 million and right now we're not changing our outlook in terms of what our expectations are for the balance of the year.

Okay. And then I guess just one final question on the cost side of the business, with regards to heparin is there anything that, that you guys are -- have done or are trying to do to try to mitigate some of the increased costs of the drug?

Yes. The -- first of all, I should note that the maker of heparin, [Cobbie], has recently raised its list price by another 30% and this is on top of four-fold increases from last year coinciding with their gaining a monopoly position on heparin and cumulatively this set of business decisions is one that's going to be, I predict, long remembered by the industry. And nevertheless, we continue to work on new protocols to further reduce utilization and in terms of new entry, there has been none yet, but we continue to expect that there will be other alternative suppliers over the course of the next couple of years.

Okay, great. Thanks a lot.

You're welcome.

And your next question comes from the line of Kevin Fischbeck.

Okay, thank you. Good evening. I wanted to follow up on your comments on bundling. I guess if I heard correctly, you said that you felt like there was not an ability to offset the 2% rate cut going into bundling in 2011? I wanted to just make sure I got that right.

Kevin, it's too early to tell right now. We have -- obviously we have clinical teams looking at various opportunities to potentially offset the 2% reimbursement cut without adversely impacting our clinical outcomes, but there is no magic bullet and as we sit here right now, we don't have the ability to quickly offset the 2%. And as you think about entering bundling, there are really both risks and opportunities. On the one hand, there's a 2% cut and on our Medicare revenue that's about a $60 million hit to DaVita and CMS could get the bundled reimbursement rate wrong, so the impact could be greater. On the flip side, while we don't yet know how to maintain clinical outcomes while reducing our costs, as we've said in the past it's our belief that any time you take something from the point that it is essentially free and there are no trade-offs, and make it an actual cost and require trade-offs we think that we will be able to innovate and find ways to maintain or improve clinical outcomes through -- and have at the same time lower resource utilization. And in fact, that's what CMS wants. So -- but as we sit here right now, we start out at least 2% behind, so there is certainly going to be a transition period.

Okay. And then I guess you mentioned, just thinking about the risk to the bundled rate, or certainly a proposed rate that might be -- have some issues with it when it's proposed, you mentioned the Part D drugs. Are there any other issues that as an industry that you're concerned about that you would highlight that people should be thinking about coming into the reg and that you want to make sure is fixed in the final rule?

Well, you know, of course we haven't seen the draft rule yet, so until we do it's difficult to say. We're generally just concerned about them getting the number right, using timely and accurate data. And then, in these kinds of rules there are any number of provisions that could create the opportunity for reimbursement leakage, so things like outlier pools, various risk adjusters and things like that. There've been a lot of different things talked about. We'll see what ultimately comes out in the proposed rule. And then of course there'll be a comment period and industry will work with CMS and provide its feedback and the rule will undoubtedly change from preliminary to final. But as we stand here right now those are the kinds of things that we are worried about.

Okay. No, that's helpful. And then your -- if I'm reading your guidance correctly looks like for the second half of the year you're looking for $443 million to $473 million in operating income and just taking Q2 simply and annualizing it, that gets you to the high end of the range right there. I guess you mentioned a couple of things that the quarter a lot of things went well this quarter. But -- and you mentioned some of the issues facing the second half of the year, but is there anything seasonally besides -- well, you mentioned about managed care rates or costs going up as the year goes on. I think seasonally in the business that would make Q2 not a good run rate?

Well, first of all, Q2 was higher than expected so that's where you start. We had a really strong quarter on cost controls and labor productivity and we just have a concern about our ability to maintain our momentum there, particularly in the labor area, so that's the biggest point. Seasonally there are a few things. One, there are more treatment days in Q3 and Q4, so that's a positive. And the flip side, our productivity tends to be seasonally lower, meaning less favorable as we move into Q3 and Q4. And then as you think about the lower end of our range, it incorporates some impact from an assumed declining private patient mix, as well as some rate pressure on Medicaid and other government programs, as I mentioned in the prepared remarks. That's how we get to the range that we're at.

Okay, and last question. Any reason why you didn't raise the cash flow guidance along with the implied raise in the operating income guidance?

Well, it's higher primarily because of working capital changes. If look at the last 12 months or you pull out the cash flow statement and look at the year-to-date six months versus the year to date from last year a big part of it is working capital changes, and as we look to the balance of the year, we think that many of those working capital items will be a use of cash. So that's the primary reason that we're not changing the guidance at this time.

Okay, great. Thanks.

Sure.

Your next question comes from the line of Darren Lehrich.

Hi, it's actually Sudeep Singh calling in for Darren. Thanks for taking my questions. First on just going back to the managed care environment, maybe if you could just talk about what you're seeing in terms of contracting, if that's changed at all, and how much of your 2010 book you have visibility into it right now?

Yes, nothing in our outlook regarding payors has changed. As you know, at the end of 2007, we had some private rate reductions in a couple of situations and then since then we've been achieving modest rate increases, generally consistent with the prior year's performance. And that said, we're still in discussions with a couple of large payors and there really are no material developments to report and, in fact, nothing is eminent either. I guess the final point I would make is that, as we've said before, we're absolutely willing to accept some losses of private patients in order to maintain acceptable rates.

Okay. And then just switching over to your ancillary businesses, could you talk a little bit more about what you're seeing with respect to your DaVita Rx business and the contribution you're seeing from that as it relates to just your overall ancillary segment?

Sure. DaVita Rx is our specialty oral pharmaceutical distribution business and it is continuing to grow nicely. It's about a -- roughly $150 million run rate business and we have said in the past that we expect that business to break even this year and it's on track.

Okay. And then with respect to Village Health, how's the experience been like there? And given everything that's happening down in DC and within CMS, do you really think that kind of Village Health model can be the payment model for the future in light of everything that's being discussed right now?

Yes, we certainly think that there are some interesting opportunities in that area. As it relates to Village Health -- and remember, there's been some confusion about this. Remember, Village Health has a number of different activities, including our special needs plans, including our capitated demonstration projects, both in ESRD and pre-ESRD, as well as our disease management operations for private insurance plans. So in Village Health one development is that we have set about a plan to discontinue our SNIPs, special needs plans business, at the end of the year. They've had low enrollments and high administrative costs, and we've just determined that the model is not viable. The demonstration projects and the private insurance disease management continue on and are really delivering some encouraging clinical results.

That leads to your question about whether there are opportunities in DC. We do think that -- if you look at all the talk around healthcare reform there's been a lot of discussion about these management, cost management, accountable care organizations, et cetera, and we think that we are very well positioned to participate in those kinds of reforms within the dialysis business. And given the investments that we've made in integrated care management, whether it be within Village Health, whether it be our oral pharmacy business, whether it be our vascular access management business, et cetera, et cetera, and so we look forward to discussions with the government and other payors about how we can bring those capabilities to bear.

Great. Thanks a lot.

Okay.

Your next question comes from the line of Andreas Dirnagl.

Thanks, guys. First of all, our condolences to Kent, but, Rich, you should know you've been very Kent-like so far on the call.

He'll be happy to hear that and I'll pass along your wish -- you thoughts to him.

Great. Just a couple of questions. I just want to make sure that I'm hearing you correctly in terms of what you said so far in terms of what's going on with private payor rates. You said you're -- as you said for a couple of quarters that you're willing to lose some volume if rate pressure is too high from the private payors, but just be clear you haven't had that to date in a significant way, correct?

Correct.

Okay. And then also, we've been hearing obviously private rate pressure has been a concern for a while, but clearly given the results in the quarter so far I don't think there's anything you can point at and say that is specifically driven by that, but now we're starting to hear that maybe you're getting a little bit of a mix shift because of the economy. Is that less from current patients losing their coverage and more from new patients as they roll on, perhaps having a slightly lower private mix shift because of the fact that they don't have coverage?

Yes, more new patients.

Okay, good. Just quickly then on the de novos clearly it's a frustration, is it at all impacting your de novo development plans, or are you just continuing to go forward at the same rate and they'll get certified whenever they get certified?

Yed, Andreas, it certainly is factoring into our decisions that we make on our de novo development plan, but it's state by state because it's not an equal problem in all states. In fact, some states are certifying along the same time tables they always have, so we are taking it into account when we decide whether to move forward with a project or not.

So maybe you're basically seeing a little bit of a geographic shift in terms of where you're focusing?

Yes, and remember, the pipeline is -- from project planning and execution, et cetera, takes some time, so some of the centers we're opening right now have been in the planning works for quite some time.

Okay.

We are -- in terms of evaluating our investments we are taking into account our best view as to the time delay.

Sure. And then sort of maybe final question from me. In terms of that evaluation on investments, we -- the term often gets bandied around, Rich, can you define what you define an MDO as in terms of maybe patient count?

It is -- I don't have a specific definition for you, but there is about a half dozen of them. LeAnne, do you happen to know what the range of patients is? I would be guessing if I --

A guess would be fine.

Yes, up to 12,000 and as small as a few thousand.

Okay, so here's the question. The -- it's been clear that you guys have very clear parameters in terms of what you want to utilize your cash for and you outlined it again in terms of growth opportunities, share repurchases and debt. Where you're maybe hearing some frustration from me and from investors is, while that's good in theory you guys haven't done anything significantly on any of those fronts in a while. You've now got over $0.5 billion of cash on the balance sheet, which is enough to purchase one of those MDOs for 100% cash, which you likely wouldn't do. That's not even taking into account the ability to lever up that cash. So the question really becomes, this is not an issue that's going to go away. The cash continues to build and even with your more muted outlook for cash flow for the second half of the year, that cash balance is still going to continue to grow. Where does it hit a point where you've got to do something with that cash rather than just letting it collect a percent or two in the bank?

Okay, fair question. Again, the levels you're seeing right now I think are a little bit artificially high because of timing issues. Nevertheless, as you think about use of cash, why haven't we done a deal? Because we haven't been able to find one at a price that we deem to be reasonable and so we're being patient and disciplined and hopefully we will find a situation where the price we think is reasonable is viewed as reasonable on the other side, as well. So we continue to work hard on that, but we haven't yet found that situation that works for both sides.

As it relates to share repurchases, remember, we've bought back about $0.25 billion of stock over the last 12 months or so, and so it's not that we haven't been doing any. Our posture in the last four or five months has been more cautious, as one would expect given the amount of uncertainty down in DC, in particular. And then debt pay down, we could just pay down the debt, which wouldn't be a bad idea given that we have maturities coming in '11 and '12, but as we've said, we can't reborrow it at anywhere near the same rates and so for the time being, it seems to be sensible for us to hold the cash as opposed to choosing to pay down the debt. I don't know if that answers your questions, Andreas?

It certainly helps. As an aside, I think it's clear that debt repayment certainly is not an issue. Maybe just to end, can you remind us where your current repurchase stands in terms of what you can still spend?

I think it's around $150 million. We'll check the number and give you an exact one, although obviously those can be changed at any time, so I don't know that it's necessarily a meaningful number.

Sure. Okay, great. Thank you very much, Rich.

You're welcome, Andreas.

And your next question comes from the line of Justin Lake.

Thanks. First question just on the bundle, I want to make sure I understand. You outlined in your comment the bundle is going to include a 2% cut. Just want to make sure, is there anything in the legislative language that gives CMS the authority to go beyond that?

No. In fact, the -- it needs -- specifically needs to be budget-neutral.

Well, I would add to that, however --

Minus 2%.

Pharma utilization will be set at the lowest of '07, '08, '09, so in fact it could be lower as you enter bundling because of that adjustment on pharma utilization.

Okay, that's helpful. And then if you think about the rate that's going to come out, I think there's some concerns in the Market as far as the rate being somewhere below, let's just call it an average Medicare rate in the $240 range. Can you talk about the secondary pieces as far as maybe outliers or rural adjustments that might be included there and how that, could affect you?

Yes, sure. CMS does have some flexibility in the area. We know that they'll develop an outlier policy. They could expand the case mix adjusters, so there's patient elements and those two would be in the category of patient adjustments. They also have the flexibility to implement some facility adjustments. One that they'd have to implement is low volume, high cost -- that was defined in the MIPA legislation -- but they could divide some other adjusters. So we're going to be careful to watch those and analyze how those pools of money are set aside and how they might impact any base rate that comes out. So I think it's going to be all of us doing a little bit of work to just understand how the different adjusters interact with the base rate.

And if you think about those adjusters, is there anything about your subset of facilities as far as whether it's low volume, high outlier facilities that might look different than the rest of the -- versus the average in the country?

Well, with 116,000 patients we're probably generally going to be, patient wise -- patient characteristic wise probably pretty similar to national averages. However, on a facility basis, I think there can be some differences. We operate in California, a very high cost state. There's a geographic wage adjuster that's existed and will continue to exist. And so some of those things can favor one organization versus another. But in general, we'll just have to take a look at it and see how we come out.

So rural facilities, things like that, you have a similar --?

Yes, we do.

Okay. And then just lastly, on this subject at least, the comment period. How long do you expect that to run for?

Well, most comment periods are 60 days.

Right.

We have asked for a longer period and so we will hope that CMS will grant that. This is a very complex rule and so I think it's going to take probably longer than 60 days for most organizations to be able to get their hands around it.

Okay, great. One last question on the payor mix shift. Can you -- to the extent that you're seeing it occur in new patients rather than existing I would assume any change there is going to take a while to really get into the run rate as far as affecting your overall mix. Is that the right way to think about it?

I think so, yes.

Okay. So can you give us an idea, if we think about the 13% that you report as private pay how much different is that number on new patients that you're seeing right now?

Well, let me come at it a different way. The -- just to give you a sense for magnitude of what we're talking about. Our mix of non-government patients used to round up to 13% and now it rounds down to 12% so it's -- that's sort of the magnitude of the shift that we've seen over time. And again, up until now it hasn't been a significant -- hasn't had a significant impact on our revenue per treatment because the mix shift has really been focused on the lower paying end of the business.

What period of time is that, Rich?

Last few quarters.

Perfect. Thank you very much.

And your next question comes from the line of Mark Arnold.

Good afternoon. Nice quarter. I just have a few follow-up questions as most of mine have been answered. But just back to the cash balance question, maybe to ask it a different way, what level is too much cash on your balance sheet, Rich?

Well, I don't know how to answer that because we are constantly evaluating our -- the different opportunities to utilize our cash and so what might be an adequate level at one time could very well not be an adequate level or be too much theoretically at another time, so I'm not really sure how to answer that. As we sit here right now we are comfortable with the level of cash that we have on hand. in part because it's higher than we expect it to be as the year progresses, and secondly, because as we look at our opportunities our view right now is that it's more prudent for us to hold on to our cash as opposed to paying too much for an acquisition or buying back more of our stock ahead of a fair amount of uncertainty in Washington. And the good news is that it only costs us a little bit less than 2% pretax to hold onto the cash and so it's just a very cheap option on liquidity. And again, we have to remember that our debt structure is at -- we almost top ticked the market in terms of the financing bubble, if you will, and so our rates are very attractive and we wouldn't want to pay down a bunch of debt and then have to reborrow it at higher levels or have to redo our financing structure in order to allow for reborrowing.

Understand. The bulk of your senior debt doesn't mature until I believe it's 2012 so is there -- to what extent are you able or willing to look in -- or to lock in your floating rate debt at those low LIBOR rates -- the low LIBOR rates we're experiencing today?

Right now we are -- just to give you a couple of facts. Right now we are 64% fixed and if you net our cash, which is a natural hedge, then it's more like 79% or 80% fixed, so we are willing, obviously, to fix some amount of debt. The percentage of our bank debt that's swapped right now is about 30% and we have a little less than $190 million of swaps that roll off in the back half of the year. So our percentage of fixed, absent doing any new hedging transactions, would trend down over the course of the year. So that's just a little bit of background facts. In terms of our posture on hedging, we feel like the mix of fixed versus floating right now is fine and obviously you can't lock in today's whatever it is, 40 basis points of LIBOR forward, the curve obviously goes up from there.

Okay. I just--

Further, I guess the last point is that we're not that many years away from the maturity on the bank debt and so our ability to hedge is limited. We could -- literally could only hedge until 2012 and that would come with some risk because you never wait until the maturity to refinance your debt, so that's kind of a limiting factor on how much hedging would be prudent to do, as well. But we've generally had the posture of having a mix of fixed and floating as opposed to trying to predict whether rates will move above or below the forward curve on rate -- on LIBOR rates.

Okay. One last clarifying question. There's been a number of questions about the bundle and I guess just the way that you phrased it in your prepared remarks where you said that the concerns about the impact from the bundle of being greater than the 2% mandated cut, is there anything there that makes you -- I think this is the first time you guys have really talked about concerns as it relates to that. Is there anything that's happened recently that makes you more worried about the cuts extending beyond just 2%, or is this just we're getting closer to the point where that proposed rule is going to be released and it's one of the areas of concern for the industry?

It's really the latter. So any time you have a big reimbursement change like this it's always a risk that they get the number wrong or that there's leakage because of some of these provisions that LeAnne mentioned earlier. And so I think that's generally a concern when reimbursement changes the way it is or when you move to a perspective payment system. So we've always had the concern, it's just getting closer now.

All right. Thank you. Nice quarter.

Thanks.

And your next question comes from the line of John Ransom.

Hi, can you hear me?

Yes, John.

Hi. You made a comment in your prepared remarks about some concern about Medicaid rates. Could you perhaps give us an update on which states have not yet set your rates for the state fiscal year beginning July 1?

Well, there's a laundry list of states that are considering -- actively considering cuts and some of which have implemented cuts. I think it would be fair to say virtually every state has budget pressures,, so I don't know that it'd be productive to go down the list because it's literally well over a dozen that are in very active stages of proposed cuts.

Great. It's a little odd because most of the companies who've reported seem to be fairly satisfied with 2009-2010 rates have been set and that states they (inaudible) 57% matching funds when they start cutting Medicaid and then some states providers have successfully sued for below cost rate increases so it's unusual dialysis will be singled out among all the other single services?

Yes, I don't know. If you want you can catch up with us afterwards and we can take you through the list of states that have pending proposals, some that have had implemented proposals and others that are considering. We obviously have a very active state legislative team that works on all these issues. And as well, in addition to the state Medicaid programs, there's other government programs. Literally every government program is under budget pressure, so to give you another example, the Veterans Administration, for which we have a reasonable number of patients, has bantered back and forth on the potential cut and it's unclear whether that'll actually happen or not, but that's -- I have to throw that in with the Medicaids as being an area that is of some near-term concern.

Okay. Are you--

I should reiterate, as I think I've said that our view on these matters is incorporated into the guidance that we have for the balance of the year.

Right. So in terms of what might get "worse" from the second quarter -- because obviously you guys put up a wonderful quarter -- you mentioned state Medicaid and you mention maybe the cost containment -- the cost control efforts may not be there in such intensity. Is there anything else that we should think about back half of the year?

I would say those are the two primary -- it's maintaining our cost management momentum, in particular labor productivity, which was strong this quarter and Medicaid and other government programs. And I guess the third thing that we did mention was to the extent that we see a more significant erosion in the private --?

Okay.

Yes, if that trend continues and/or gets more significant that that would be the other factor that would lead to us be more cautious about the back half of the year than to just say take the current number and grow it from there.

Right. Just wanted just to drill down on some of the things you said historically about the private market. In the past you've mentioned pressure from midsize chains in certain markets forcing you to go in-network or take network pricing at lower rates. Has that pressure abated at all, or is that still something you guys wrestle with daily?

I don't think that we've ever said that. It -- we certainly have competition in lots of our markets, but I think that our view is that literally every significant provider understands that the -- there is a significant deficit in terms of the reimbursement versus our costs on the government side. That's 87% to 88% of our business. And the private rates on the balance have to be sufficient to offset that government deficit in order for the business to work. I think everyone pretty much understands that. So I don't know that we've said in the past that we've had pressure from competition to do one thing or another with the payer.

That was a big comment at the capital markets today and I just didn't know if that was one of those things that had abated recently because you guys have not mentioned it. And have the losses from Village Health and specialty, have they -- has your view changed on that midyear from where you were at the beginning of the year?

No. We're on plan.

And do you think -- one of your competitors talks about a global dialysis bundle where you take all of the costs of dialysis patients. I know you have the demonstration project, but what's your longer-term view on a global Medicare bundle and do you think the government is serious about that or do you think that's more theoretical at this point in time?

I think it's possible. I think that it would be -- it seems to us it'd be a sensible way to manage this patient population, both from a clinical standpoint and economic standpoint. Obviously there's a lot of challenges to get from where we are today to there, but the bundle -- the implementation of the bundling system is in some ways a step towards more integrated care. So I know we think it's -- you have to have a longer-term view, I think, but within the context of a longer-term view I think that it's quite possible that we could see movement towards that area. And in fact, dialysis may be one of those segments that's best positioned to ultimately deliver on the promise of the integrated care. People have been talking about this for two decades now.

Right.

But this is a business that's highly consolidated and mature and has a couple of significant companies that have the scale and where with all and are increasingly investing in the capabilities to be able to deliver on integrated care. So, no, we think that's real. Does that mean that something would change with Medicare, which is obviously the biggest customer and the one that would have to make a move for it to ever be significant? Do we think that would happen this year? That seems unlikely.

Well, okay. Thanks a lot.

You're welcome.

Your next question comes from the line of Gary Taylor.

Hi, good afternoon. I missed the first three or four minutes, so, Rich, I don't know, did you quantify the payor mix shift in terms of impact on the revenue per treatment in the quarter, or did you just give it in terms of the percent of patient mix?

Gary, the first three or four minutes is when we gave all of the pertinent information.

I know,, I missed everything.

We did not quantify it. We've characterized it as having a small impact and the reason why to date the impact has been relatively small is that the mix shift appears to be disproportionately impacting the lower end of our non-government mix, lower end meaning lower rate end. And as you know, we've been mention -- we've been saying for, I don't know, three quarters now that this is an area that we're watching and an area that is -- in our view is a risk if, if the US continues the period of sustained high levels of unemployment and people continue to lose their insurance.

Is -- the disproportion impact on the lower rate, is there something intuitive about that being service industry job loss and the benefits being less rich or the rates being lower? Is there something intuitive there about that or just coincidence?

We have a number of hypotheses, but we don't really know.

Okay. On the G&A, I think my model only goes back ten or 12 years but I don't think I've ever seen a 9.5% of revenue in G&A and it jumped about $16 million sequentially. Did I miss something on that, did you talk about where on a dollar basis you think that number goes?

I think you may have missed something. Our all-in percentage was 8.7% in Q2 and that was down from 8.8% in Q1. We also reported for the dialysis segment, which is often more meaningful, and in Q2 that was 7.3%, down from 7.4% in Q1.

Okay.

So, as we've said before,we continue to focus on getting leverage at that line item and we've actually been making some pretty good progress over the course of the last few years and we'll continue to work away at it going forward.

Yes, just an error in my model. Sorry for that. And then on the -- again on the gross margin, you talked -- it looked very, very good, much better sequentially, which seems a little atypical and you really just talked about labor productivity driving that. Nothing else there really unusual helping you there?

Yes. If you -- when you say gross margin, if you mean patient care costs?

Yes, or the inverse of that, so yes.

Yes, the trend there was that patient care cost were 68.6% in the quarter of revenue and sequentially that was down from 68.8%, so it was a small improvement. And on a per treatment basis it was actually up about 0.9% sequentially. And then year over year, which is usually the way we look at it, it was up about 1.3% from the same quarter last year and that's reflective of, obviously, labor -- normal labor rate increases, as well as higher pharmaceutical costs. So we had epo price increases and heparin price increases during that time period.

Okay. Last question--

And a lot of that was offset by some solid cost management.

Last question, when would this Cobbie price increase impact you? Do you have -- I was thinking you had price protection through the middle of this summer, so would the next couple quarters be impacted by that rate increase?

Yes, it was -- yes, it will. It was effective June 30th and, no, we don't have price protection that extended beyond that.

Can you refresh us on what your quarterly heparin spend is on a dollar basis?

Yes, we have -- we've never disclosed that. We don't typically disclose line item expenses such as that.

All right. I thought I --

I can say -- let me try to be a little bit helpful, though. I can say that since the significant price increases were implemented last year we've made very good progress in driving down utilization in that area, and so while it's still a negative for us it's nowhere near the, that kind of impact as it was the first time around when the price increases came through.

[Persenious] is talking about potentially using [citrusaid] as a substitute for heparin. Is that -- do you guys have any comment on that yet? Is that something you've looked at that may be in the bucket of opportunities here?

Yes, in fact, LeAnne is very close to that so LeAnne, why don't you --

Yes. So we are working with FMC on a pilot to test adding citrusaid to the dialysis, which could lower our dependence on heparin, but it wouldn't eliminate it completely. But it certainly has the potential to make a nice reduction and we'll work with them to see if we can get it implemented.

That would be one example of the things we're working on. We have a number of initiatives that we're working on to try to continue to make progress in that area.

If that pilot was successful, is -- will we be talking six months from now, nine months from now where you might actually be in a position to benefit from that? Any thought on the timeframe?

I think it's too soon to speculate.

Okay. Thank you.

Sure.

Your next question comes from the line of Art Henderson.

Hi, thanks for taking the question. Most of them have already been answered, but I was just curious, are you planning on having a conference call when this proposal -- this bundled proposal comes out to discuss it, or what should we look for from you during that point in time? Are you just going to hunker down and figure it all out and respond to the proposal and that's it, or is there going to be something more active with the Street?

We don't have any plans for a conference call right now and we don't really know when it's going to come out.

Right.

So maybe it'll be partly dependent upon that. It would take us some time to be able to say anything intelligent or semi intelligent about the rule so we'll just have to see when it comes out and how that falls with our normal scheduled communication with the Street.

Okay, that's fair. Rich, in your opening remarks -- and I kind of caught the tail end of what you were saying -- you were talking about the bundle and the oral medications and I was wondering if you could just go back over that one more time just in terms of what that issue is?

Well, the house bill -- this is LeAnne.

Hi, LeAnne.

-- includes some expansion of oral medications -- or allows for the expansion of oral medications into the bundle. The difficulty that we see is for CMS really to be able to properly size that opportunity and see current patient trends with respect to orals. A number of issues I could go through, but the top couple are, one, as you know, only a fraction of the Medicare beneficiaries are in the Part D program, so they don't have data on everyone and they'd be bringing in and covering a benefit for people who are in the private sector today or don't have coverage so they'll have a limited universe. They'll look at older data, most likely they don't have the current data, and both compliance rates and penetration rates, and in fact, even the price increases from the manufacturers themselves over the last year would make the review challenging and actually the answer quite different if you had current facts versus old facts. So that's our concern. And if you short change that, it really doesn't -- well, let me put it the other spin. It really will have a negative impact on patients.

Okay. Okay, that's helpful. Okay. And then lastly, the MSP extension talks, are they pretty much off the table with what's happening, with reform on capitol hill, or is it still kind of out there loosely being discussed?

I wouldn't say that it's off the table or on the table as we sit here right now. I think if you step back from it, we think that it's very good policy, [a significant pay fors] at a time when the government needs significant pay fors. It's also go policy -- I think we've said this in the past, but it's worth repeating, it's also good policy because our patients are uniquely discriminated against.

Right.

If you think about it, you'd paying your insurance -- private insurance premium for years or decades even and then at the time that you need it most, you become a dialysis patient, then your benefit only lasts for 30 months. So we think that's a -- really a form of discrimination that does not make sense and it's really not fair. In addition, in extending the time private insurers are responsible for dialysis patients we think would encourage more investment in preventive care and wellness programs and the like, and just provide more incentive for payors to want to engage in disease management-type of activities with providers and others. So, it's difficult to predict the politics in any one year and so we usually stay away from it. But we still think the likelihood is reasonably high that it will happen over the next few years.

Yes, okay. All right. That's fair. And then last question and I'll jump out. On the de novo certification, obviously you're waiting for that, but I think you mentioned in your commentary that perhaps that could slow your velocity of doing those. Your guidance on that issue from a CapEx perspective hasn't changed as of yet, that's correct?

Correct.

Okay. All right, Rich. That's all I had. Thanks very much, LeAnne.

Thanks.

Your next question comes from the line of Chuck Ruff.

Hello. Forgive me if I missed this. Did you give CapEx and acquisition expectations, dollar amounts for the year?

We have not changed them from the guidance we gave earlier in the year and that guidance was $100 million -- approximately $100 million for maintenance CapEx and approximately $250 million for acquisitions and de novos combined. And of course that second bucket, in particular, is always -- the caveat always is it's really depends upon the availability of attractive investment opportunities.

Okay.

But nevertheless that's -- we're on track for both of those numbers right now. As it relates to de novos -- following up on the last question == our guidance there is to do around the same number that we did last year, which was 87. We haven't changed that guidance as we sit here right now and we opened 41 through the first six months of the year, so we're, roughly speaking, on track with that original guidance.

Okay. The -- one of the big reasons you're not buying back stock or interested in making a number of midsized acquisitions is the uncertainty with healthcare. Why then are you willing to invest $250 million in acquisitions in de novos given that uncertainty? In other words, why wouldn't you pull way back on those, too?

Yes. Well, we are interested in continuing acquisitions, both in normal onesy-twosy acquisitions, as well as the possibility of acquiring a midsize dialysis organization. The comment we made was that given the uncertainty it may be that we would only be interested in one as opposed to multiple acquisitions of midsize organizations. And that's really reflective of the cash that we have on hand, the maturities that we have and our debt structure, as well as the uncertainties in the capital markets and the economy and healthcare reform. So it was a bit of an off-the-cuff comment, but I think it's accurate in terms of capturing the way that we're thinking about acquisitions right now. And that's probably --

Okay. I guess my point is that you're interested in doing some acquisitions to some extent ,you're interested in continuing to do de novos, so you're willing to spend $250 million there, but yet you're not willing to buy back stock. I would think that the uncertainty of healthcare reform, if it's applicable to buying back your stock, would also be applicable to that. So why spend $250 million on the one, but not the other?

Yes, well, we're always evaluating the different alternatives, both in the absolute and against each other and typically we are -- we lean more towards spending capital, all else being equal, on acquisitions than we do on buying back our own stock, although we have historically done a lot of both. And the reason why the priority is in the order that it is, is because acquisitions not only presumably deliver a financial return, they also have an impact on your strategic position, whether it's improving your local market position or network, or whether it's generating regional scale of economies or whatever the case may be. So that's why it's in the priority of order that it's in. I don't know, have I answered your question?

Partially. I guess what I'm trying to get at is, the uncertainty which is keeping you from buying back stock I would think would apply just as much to acquisitions and de novos, so why are you still willing to do acquisitions and de novos with the big uncertainty of healthcare reform?

Yes, because it's not an all or nothing thing. It's an on the margin thing about how aggressive you're willing to get on one or the other.

Okay.

And once again, I think it's important to note that we did spend $0.25 billion buying back our stock not that long ago, so it's not that we haven't chosen to use some of our cash for that activity, and we've also chosen to use some of it for acquisitions. And we've chosen to hang on to some of it in the hopes that we'll have good opportunities in the coming quarters.

Yes. The great thing about DaVita is the cash just keeps coming, so the $250 million that you spend on share buybacks, we're right back asking you for more because the cash just keeps pouring in.

Yes.

Are you -- have you slowed at all the de novo process? In other words, I understand that you have to go out there and it takes a while to find the right site to get one up and running, it's not something you decide to do a month before it opens.

Right.

Has there been any slowing in the process? I know you're not going to give 2010 guidance, but should we expect there to be any slowing in the de novo process, or no?

I would say that given that we are placing more emphasis and scrutiny on our investments in light of the certification delays, again, it is very state-specific. But nevertheless, because of that I would say it's fair to think about there being some decline in that trend, although right now I wouldn't predict it would be meaningful. Okay. Good quarter. Thanks, Rich, and thanks, LeAnne. Thank you.

And you have another question from the line of Andreas Dirnagl.

Hi. Yes, guys, just quickly, just to clarify. There's been a lot of chatter in the Market about the bundle and that it might be released eminently, I wanted to make sure. Is there a timeframe that you're thinking of? I know it's hard to predict the exact date, but is it a sooner rather than later event, or --?

For the announcement of the rules?

Yes.

We gave that answer in the first three minutes, Andreas. We think it's -- our belief is that it's going to be an August event, but we really don't know. There were rumors it was going to come out a few days ago, there were rumors it was delayed until mid-August, so we really -- we don't know for sure, but it is our anticipation that it will be coming out before the end of the summer.

Okay, great. Maybe this is a naive question that I just need to be educated on, but how do you set a rate when 2009 isn't done yet and 2009 is one of the years that is going to be included?

Great question.

We wondered the answer to that one, too. I'm sure that they'll, with the final rule, be updating for the most current trends. It's clear that they -- it would be difficult for us or CMS or anyone to estimate 2009 utilization, for example, so we'll have to rely on the fact that they do update the bundle as they should and we'll certainly work with them to help them understand those trends.

Great. I just thought I was missing something. Thank you very much.

You're welcome, Andreas.

And you do have another question from the line of Justin Lake.

My call has been answered. Thanks a lot.

Okay.

(Operator Instructions). And I'm currently showing no questions at this time.

Great. Thank you, operator. Thank you all for your continued interest in DaVita and we look forward to talking to you again in three months.

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