德維特 (DVA) 2010 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by and welcome to the DaVita second quarter earnings 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 conference over to Mr. Jim Gustafson. Sir, you may begin.

Thank you, and welcome, everyone to our second quarter conference call. We appreciate your continued interest in the Company. I'm Jim Gustafson, Vice President of Investor Relations and with me today are Kent Thiry, our Chief Executive Officer, Luis Borgen, our Chief Financial Officer as well as LeAnne Zumwalt and Rich Whitney.

I would like to start with our forward-looking disclosure statements. During this call, we may make forward-looking statements within the meaning of the Federal Securities Laws. All of these statements are subject to known and unknown risks and uncertainties that could cause 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 do not intend to undertake no duty to update these statements for any reason.

Additionally, we would like to remind you that during this call, we'll discuss some non-GAAP financial measures. A reconciliation of these non-GAAP measures to the most comparable GAAP financial measures is included in our Form 8-K submitted to the SEC and available on our website. I will now turn the call over to Kent Thiry, our Chief Executive Officer.

Thanks, Jim. This was a tough quarter in which we were able to offset the revenue per treatment declines with operating cost management to deliver on flat operating income as we told you to expect last quarter. Luis will, as usual, offer more commentary on the quarter. I'll cover three topics. One, clinical outcomes, two, bundling, three, outlook.

First, clinical outcomes. We always present them first because that's what must come first. We're first and foremost a caregiver Company, now serving more than 122,000 patients. A, with respect to adequacy, which is essentially how well we're doing at removing toxins from our patient's blood, this quarter, 96% of our hemodialysis patients had a Kt/V greater than 1.2. This is 90-day data. B, with respect to vascular access, 66% of our patients have fistulas, which is the preferred form of vascular access as so many of you know, that's also 90-day data. Third, anemia management, physicians have managed 67% of our patients to hemoglobin levels between 10 and 12 over the last quarter. For these and virtually all other clinical measures, our patient outcomes compare very favorably to national averages consistently the best are among the best. Our quality clinical care we remind you not only results in healthier patients but also drives substantial reductions in hospitalizations and surgical procedures and therefore generate significant savings to the US taxpayer.

Subject number two, the bundle. CMS released it as I'm sure all of you know last week. I'll just make a couple of points and no doubt you'll have some questions during Q&A. It was very disappointing to see that CMS elected to keep the transition adjustment in the way they did. The 3.1% cut in reimbursement we believe is based upon bad assumptions and logic that takes us far beyond the 2% cut that Congress intended. This larger cut will increase our losses on Medicare patients and put more pressure on private insurers to subsidize these Medicare losses. However, there were many other areas where CMS did listen to the communities concerns and comments and we don't want to ignore or give short shrift to those. There's still a couple of the areas that came out in the bundle to which we're putting more analysis on the table. And so it will be some number of weeks before we're prepared to make our decision and to give 2011 guidance. Likely, we'll do that on our Q3 call. And independent of timing, we continue to work on ways to offset the overall cut. It is too soon to give precise estimates on how much that will be.

Third and finally, on our outlook, we have narrowed our operating income guidance for 2010 by increasing the bottom end of the range. That new guidance is for operating income of $970 million to $1.02 billion. We're also increasing our cash flow guidance to $725 million to $825 million. This is, of course, based on the strong first half and rolling 12 month performance. One other positive development that's noteworthy is that we have successfully established a higher level of stability into our go-forward private rates by signing long-term contracts with two large payors at reasonable compromised rates.

I'll now turn the call over to Luis, our new Chief Financial Officer.

Thanks, Kent. Overall, the second quarter was characterized by a significant revenue per treatment decline that was partially through solid cost management. Through it all, we continue to produce very strong cash flows. This past quarter, dialysis revenue decreased $9 per treatment from Q1 2010, $5 of the decline was due to a decline in revenue for physician prescribed pharmaceuticals. Primarily, a decline in utilization, with about $0.50 due to the previously-announced decline in ASP. Remember, a decrease in Pharma utilization impacts both revenue and cost, with costs offsetting much of the revenue decline. $2.50 is primarily a decline in mix, somewhat offset by commercial rate increases. The remaining $1.50 in decline from seasonally high Q1 lab revenue. The decline in Pharma utilization was driven by independent physician prescribing decisions. Physicians are also showing more conservatism with regard to hemoglobin greater than 12 and are reevaluating vitamin D dosing in response to [kadokey]. We expect pharmaceutical utilization to continue to decline in the back half of the year.

The mix shift continues a trend that we have been discussing for more than a year now. Our commercial mix now rounds down to 11% of patients. As a reminder, this shift is due to two main factors. One, declining commercial mix of new patients, largely driven by the economy and declining commercial insurance population. Two, improved mortality of our patients, which leads to a higher share of our patients on dialysis greater than 30 months. Dialysis operating expense decreased $5 per treatment sequentially. A majority of the decline was due to the utilization of physician prescribed pharmaceuticals. The remainder was primarily due to strong productivity and a decrease in payroll tax from seasonally high Q1 levels. Non acquired growth was 4.1%, while total treatment growth was 5.5% year on year. We added 23 centers in the quarter through acquisition and certified 18 de novos.

Q2 was a strong cash flow quarter. Operating cash flow was $296 million and free cash flow was $250 million. A two-day reduction in DSO to 64 days and the timing of other working capital items contributed to the strong operating cash flow. Our quarter-end cash balance was $575 million. This reflects the reduction of $200 million of senior notes as previously announced. We spent $91 million in dialysis center acquisitions in the quarter. Additionally, we repurchased $100 million of stock in the quarter.

Our priorities for cash remain the same. With our first priority being investment in growth at attractive returns. In fact, we're currently in discussions to do a medium-sized dialysis acquisition. Finally, as you know, we have significant debt maturities in 2012. We're exploring our options and are likely to execute some form of refinancing within the next three to nine months. Operator, let's go ahead and open it up for Q&A.

(Operator Instructions). Your first question comes from the line of Kevin Ellich of RBC Capital Markets.

Good afternoon, guys. Thanks for taking the questions. Kent, I was wondering if we could start off with bundling, just wondering what you thought was positive in the final REG. You commented on the 3.1% transition being negative. Anything else that you thought was negative?

Well, I think the first part of your question was on positives, they significantly reduced the number of case mix adjusters. That was a positive. The transition adjustment was a negative. I'll flip it to LeAnne to list a couple of the other puts and takes because she will be more articulate than me.

Yes, thanks, Kent. As you know, the list of labs is now defined as 53 tests and we will be able to bill for other tests with modifier above that. Oral medication is probably one of the biggest areas of positive we are going to be providing oral equivalents. But not the expanded oral medications. Does that answer your question, Kevin?

Yep. That's what I was thinking, too. Nope, just wanted to confirm that. Then Kent, in the prepared remarks, you mentioned the long-term contracts that you signed with two large payors. Could you give us more detail on those payors and what type of rate increases we're looking at?

No. I don't think we can do that, Kevin. It just wouldn't be in your or the other shareholder's best interest to start discussing individual contracts and the results of the contracts are of course baked into our guidance. The good news is that it creates a lot more go-forward stability in that part of our revenue structure and of course, with increased stability means is that you eliminate some down side but you also eliminate some upside that's why the other side agrees. So, we think it was a good move for our shareholders but more detail beyond that wouldn't make sense. Suffice it to say, we trade off upside for limiting downside.

Okay. And then actually, could I ask it a different way? When you say long-term, are we talking five years or three years or ten years?

Fair question. We, again, won't disclose exact terms for individual contracts. But when we say long-term, that typically means at least two. And if we ever did one longer than five, we would let you know. And so I would just say that these two fall into that range.

Okay. That is helpful. Then last part of this question, on the contracts, is it safe to assume you guys have shifted to a bundle payment with these payors or not necessarily the case?

In both of those cases, it is a bundle.

Bundle. Got you. Okay. And then Luis made a comment about in discussion with the medium-sized dialysis acquisition. Just wondering if there is any visibility on timing of that transaction.

No. A deal is a deal is a deal. It may happen, it may not happen. We bring it up only because we anticipate questions about what we're going to do with the cash in our balance sheet and so we just wanted to give you that heads up but it is a normal deal with all of the vicissitudes around terms and timing and completion risk. I want to go back for one second. While the last -- those two big contracts that we signed were both bundled, I want to repeat it isn't a requirement of all our new -- in all our new pair contracts that they be bundled. It is a preference. But in some cases, our shareholder economics will be better served if we do not do bundled pair contracts. It just so happened, these two, it was in both parties' best interest to do it that way.

One last quick question, on the pricing, average revenue per treatment decline, Luis indicated the Pharma utilization was one of the main factors. And I think you said you expect that to decline in the second half of the year? Is that correct?

That's correct.

Okay. Can you quantify that or provide anymore color behind that?

No. It is going to continue to decline from what we've seen. Consistent with that pattern we've seen the last quarter or so.

Okay. Thanks, guys.

Thank you, Kevin.

Your next question comes from Darren Lehrich of Deutsche Bank.

Thanks. Good afternoon, everyone. I had a question just as it relates to the 3.1% transition adjustment and maybe LeAnne, you can provide us a little help thinking about this. I guess CMS made a variety of assumptions to get to that number and I'm just wondering in the rule making cycle, I guess this would be for 2012, how you would expect them to revisit that analysis and any thoughts there in just helping us thinking about the process to correct that number if it was an incorrect assumption on the part of CMS how we might think about that playing out.

Sure. In a rule, they didn't give us a specific process but most of us believe there will be a process as there is today, which is through the physician fee schedule rule or another independent vehicle, they'll address several components of the bundle and as it relates to updating that for 2012. Does that answer your question?

Yes. So, you think it may be in the physician fee schedule or separately promulgated I guess bundling rules again for next year, is that what I'm hearing you say?

Yes.

Okay.

In fact, in the rule, they made an affirmative comment saying they would review it.

Right. Okay. So, that's something we'll have to be on the lookout for. Next year. I guess just a question about the refinancing. You mentioned at the tail end of your prepared remarks, for us to expect something in the next three to nine months. I'm wondering if you can just give us any update at all on structure for the refinancing and how we should take that into consideration over the next few quarters. I don't think you would let the term loan B go current in Q1 of next year. So, any more comments there would be helpful.

Sure. The structure will be pretty similar to what we have in place today. Term loan A, term loan B with some sort of senior bonds. We may upsize depending on our capital structure needs in terms of acquisitions or share repurchase considerations. But it will be a very similar structure to what we have today. We do intend within the three to nine month period to refinance well ahead when we need to. We're valid in the market opportunities and we'll tap the market when the time is right.

And relative to the current interest costs that you have in your existing structure, any guidance for us just broadly on how much more expensive you think it might be in the current market?

It will be more expensive. Probably in the range of -- right now, we're LIBOR plus 150. The indicative pricing we've had is anywhere from LIBOR plus 300 to LIBOR plus 350 on the floating rate facilities. On the bond side it's around 7% or so. That's our current market information for the type of structures we're looking at.

Okay. That's helpful. And then my last question here, can you provide an update on the Amgen recontracting negotiation and whether you've reached an agreement for your ESA procurement beyond 2010 at this point?

We haven't yet reached agreement with Amgen and we don't really have much comment beyond that.

Okay. Fair enough. Thank you.

Thanks, Darren.

Your next question comes from Kevin Fischbeck of Bank of America.

Okay. Thank you. I was wondering if you could talk a little bit about just the dynamics on the managed care pricing and I know historically, you haven't really given out a percentage bundle contracts but theoretically, if there is a bundle contract, if you improve efficiency, you can keep some spread under that contract whereas, if it is unbundled and you push down drug utilization or switch to more cost-effective drugs, you may not be able to capture all of that economics in unbundled contracts. How should we think about that dynamic when you look at your contracts of bundled versus nonbundled. Do you think the net net, those two factors equal out or is it is a slight positive or a slight negative? How should we think about that dynamic heading into 2011?

I think what we can offer for you is that our percentage bundle continues to go up. We're making progress there. And we remain comfortable with where we expect to be as we go into 2011 in terms of the percentage of our book that is bundled versus not. For sure, we'll go into 2011 with some that's not. But we think we'll be in a good position in terms of managing that balance.

Okay. And the -- it sounds like you guys have not yet decided how you're going to deal with the bundle whether you go all into the rate or not. But I guess if can give some thought around your decision there. Is it the potential that you would shift some of your business into the rate while others not or do you view this as we have to run the company consistently across the business so either everyone's going to phase in or everyone's going to go directly to the rate?

All options are available to us now. One thing that will always be the same is our approach to our clinical performance independent of the reimbursement format so that will be handled one way. But as to which reimbursement system we choose, that is subject to some more analysis.

Okay. And then when we think about the -- how you might deal with the bundle, certainly, we'll get more color next quarter, but I think in the past, you talked about several quarter adjustment period. To get used to the bundle. How do you think about that? Does that require investments from the SG&A line? How should we be thinking about what the transition period might look like. Is it more operating costs slowly evolving over time or is there investment being made?

At this point, we wouldn't anticipate any dramatic change in SG&A or any dramatic expenditures in Cap Ex. Having said that, they won't be zero either. The primary dynamism is going to be in the other category you mentioned which is just what exactly changes in operating costs and when, both as a function of any operating innovation and as a function of some of the inherent costs of managing this kind of massive change process. But a lot of those expenses will be people who will be redeployed to work on it from other stuff as opposed to a whole bunch of new people hired in a temporary basis. So, it is much more that third category of redeployment of operating costs versus any dramatic new cost. However, let me just be redundant and say that the cost will be nonzero on the operating side. They're just not going to be dramatic.

Okay. Then going back to the commentary about a potential deal, you guys have talked about looking at a regional change for quite some time. It sounded to me a little bit like your commentary is a little bit more definitive. Are we getting closer to a point where you feel like we'll have an answer around whether a deal happens or not or is a -- a sign [not to take away] that we're getting closer to a yea or nay on this?

I'm sorry. The answer will be inherently ambiguous because the reality is inherently ambiguous. It is little bit like if you're in a football game and you move from the 30-yard line to the -- your 30-yard line to the other guy's 30-yard line. Are you closer to a touchdown? Yes. Is it at all certain you're going to score one? No. So, we thought it was worth mentioning. Because it would be useful information for you to have on multiple levels. Having said that, we unfortunately have to immediately qualify it by saying we're not in the end zone yet.

Okay. Then last question, as far as the revenue per treatment being down sequentially, it sounds like the lab seasonality is one thing to kind of take into account. But as far the lower drug costs go, that $5 is a good place to start. We should actually see continued pressure on the revenue line from that as the year goes on. And then the mix, it makes sense to use that as the starting point for the rest of the year. Am I thinking about that correctly?

Well, the RBT goes up and down within a reasonable level so there may be changes to some of our commercial rates. The mix has been trending down. And the utilization has been trending down so I can't quantify exactly how much it will go up or down but I think within that range is a reasonable starting point.

Okay, great. Thanks.

Thank you, Kevin.

Your next question comes from Justin Lake of UBS Investment Bank.

Thanks. Few questions here. Just first on the commercial payor mix you mentioned down to around 11%. That's obviously declined from if I remember correctly 13% to 12%, now to 11%. I'm curious if you can give us some color there on how that trajectory looks over the last quarter or two. And whether you're seeing it continue or where you came out the quarter might be helpful. Then just give us some historical perspective on have you seen that type of payor mix change before in that short a period?

I would start with your second question first. The decline in the commercial mix has been steady and consistent. There was nothing unusual about the current quarter relative to the past one, it's been in that general trend. And what was your first question again, please?

I guess just looking at the 13% to the 11% coming out of the quarter, is there -- is it even -- I would assume that number is lower than the average for the quarter? Is that 11% a quarterly average; is it the end of the quarter? Can you just give us some perspective there?

It is a quarterly average. The ending number is right around that level. Not materially different than that.

Okay. Do you see that continuing to decline? Second half?

Our guidance assumes there will be some continued decline in that into Q3 and Q4.

Okay, great. Second question on bundling and Kent, you talked about the transition adjustment and you specifically mentioned that CMS's estimates on provider behavior likely have some error there. While this drives at a disappointing rate in 2011, I'm curious if you have an opinion on how much of that you would think might revert back to you given your opinion of what that error might be when CMS recalculates the adjustment in 2012.

Yes. Our hope is that they do good analysis and a bunch comes back if that's appropriate, which is what we would expect. This is all if they don't adjust it between now and then since their objective is to get a lot of providers in the bundle. And they're really getting in the way of that objective with the currently contemplated transition adjustment. But if it stays the way it is, we can only hope for a very high quality analysis on a look-back basis, the subsequent year. Handicapping that is so difficult. I don't know what qualitative adjectives to use. But I just kind of throw out -- I guess the use of the word hope is the best we can do for you.

Kent, you mention that there might be a process underway where they may reevaluate that. Can you elaborate there?

I don't know of any particular process. I just know the entire community is intensely disappointed.

Got it. Last question on commercial bundling. I think you told us at some point last year that you had a two-year plan to increase commercial bundling. The rate or percentage of payments going into 2011 and the bundle. I know you haven't given a number there. I know a lot of people are trying to squeeze that out of you but can you at least tell us whether you're on track to get -- to meet your internal target? Heading into 2011, whatever that might be?

I would use words comparable to what Rich used which is that we're comfortable with where we are which more or less means we're on plan if anything we're a tad ahead.

That's helpful. Thanks for all of the color.

All right, thank you, Justin. I will go back to the mix issue that's been brought up a couple of times appropriately. The reason we have a hard time forecasting it is the same reasons that economists have a hard time forecasting the economy. Once unemployment starts to decline and employment starts to increase, particularly if it is quality employment with benefits, then the number of people with private insurance will start to go up. And we don't have any particular expertise in forecasting broader employment trends and that's why we have to be so careful in our answers to your questions about our particular mix. It is very much a reflection of the macro environment.

Your next question comes from Gary Lieberman of Wells Fargo.

Thanks. Maybe one quick follow-up on the last point you made, Kent. Is there any way to quantify the factors on payor mix? Is more of it coming from fewer new commercial patients or is more of it coming from the increase in mortality or the decrease in mortality?

This is Rich. It is still about 50/50. As it has been in the past. No dramatic change there. And I should note because there has been confusion, over the last couple of quarters, but just to be very specific, in terms of how we define our government and private mix, that included in our government mix is both VA, Veterans Administration, as well as Medicare Advantage. So, when we talk about it -- a declining private mix -- it would, by definition, exclude those two things. If you're trying to compare us to other providers, that's an important thing to note.

Great. And then since you brought it up, maybe an update on where you guys are in terms of the VA contracts?

On the VA, we have reached a bunch of new agreements where we took a rate hit. And only time will tell if these agreements lead to a long-term relationship or not. If the VA wants to get even lower rates then we'll have to do what we have zero desire to do. But to turn down patients, particularly those in remote locations because we simply can't afford to take more patients at a loss and so we're hoping we've reached a new equilibrium and can move forward in a positive way from here.

How should we think about the agreements versus the rule that the VA could at some point put out, would the agreements take precedence over the rule or how do you think that works out?

They can decide that and so unfortunately, it fits into that category of time will tell.

Okay.

We know that a lot of people in the VA responded positively to our flexibility and we assume the flexibility of others that certainly the indirect communications that have been offered to us. On the other hand, we just don't know enough to be certain about what will happen next and we think they understand the reality of significantly decreased access for veterans if they put us in a position where just like the rest of Medicare, we lose money on virtually every patient.

Okay. Did those -- did the new rates have an impact on revenue per treatment in the quarter and is there any way to quantify that?

I think the most important thing is that the new rates are baked into our go-forward guidance without parsing through exactly what happened in this quarter or not.

Okay. And then I guess you've been talking about acquisitions for awhile. But, it seems like this is the first time that one might be done in the near term. What can you think about what impact the bundle is going to have on acquisitions going forward maybe for yourselves and even for the rest of the industry?

I think the uncertainty around change like this which, of course, is reduced in many ways now that the rule is out but still there because of all the things that might happen with the innovation that the rule will provoke. I think that will lead to more deals getting done. Particularly smaller ones and we, in fact, have done more small acquisitions in the first six months of this year than we have for some time. It is not a big enough difference to really move the dial from your perspective but that sort of trend might continue and so it is a nice little bump both in terms of current economics and long-term strategic positioning.

Okay. Then just final question, maybe, where should we think about stock repurchases in the scheme of doing the refinance and the acquisitions? Should we just assume those might be on the back burner for awhile or do you think you still have some fairly significant capacity to repurchase shares here?

We have remaining authorization as well as cash on the balance sheet to do so. So, the share repurchase is something we're going to continue to evaluate and execute as appropriate.

What I would add to that is our long-stated point of view on what's right for shareholders in terms of our capital structure has been to be between the 3.0 and 3.5 numbers and that point of view has not changed for a long time. Although at different times, we've been both above it and below it. So, I think that remains the best way for you to think about what we're going to do over the intermediate and longer term.

Okay, great. Thanks a lot.

Thank you.

Your next question comes from Andreas Dirnagl of Stephens Investment Bank.

Good evening, guys. Kent, I'm sorry, just to clarify on that last discussion about the VA, when you say you've reached a "bunch of new agreements" does that mean that the sort of the proposal that the VA was kicking around about a significant reduction in fees is sort of off the table for now and they may come and revisit that in the future or I mean how should we think about that?

Yes, I don't know exactly what words to use because they're not terrifically explicit. So, is it on the table or off the table? I don't know if we can use the metaphor. Maybe it is off the table and put in the cupboard for a moment but it could be put on the table at any time. So, we just -- we do not know -- it could be that they don't know yet. They're looking at the fact that they have achieved some substantial savings and they're looking at the fact that there could be widespread disruption in some bad clinical and economic things that happen if they insist on mandating even lower rates. Exactly what they're thinking about that trade-off literally we don't know.

Okay. That is fair enough. Kent, maybe you can just help me more from a philosophical perspective. Having spent a number of years following the industry, declining Pharma utilization were always sort of bad words to hear because it had an impact on revenue and then obviously an impact on profitability. As we head into the bundle though, if we would be under a bundled rate already, I mean technically, declining Pharma utilization would then be a positive, correct? In terms of your profitability.

Correct.

Correct. And if you recall, Andreas, you'll remember this. That going way, way back. We went to the government and said we would much prefer that you pick any system other than ASP plus 6 because we do not want the taint associated with having any kind of margin of that type, a cost plus margin on a drug, because it leaves us open to such suspicion. And so in that sense, moving to a bundle is philosophically wonderful. Now, we can't be naive about that. We'll now be accused of underutilizing so we will continue to do what we've always done which is have very transparent clinical protocols developed by physicians, most of whom have zero knowledge of the nature of our contracts and the subtleties of reimbursement because of the way we design the process, we want that to be a clinically pure decision.

Right. But again, just because we have to change what is really fundamental perhaps of our thinking, while it potentially is a negative impact for the next two quarters of this year, as soon as you shift in the bundle, starting with a lower utilization rate given the fact the rate is now set, it is clearly beneficial then.

No, that's absolutely true. One metaphor that I use is that if the government reimbursed nurses at average salary plus 6%, we would all have more nurses. Because you would not have anything to trade off against and you would want to play it absolutely safe. And so it is sort of almost ridiculous to ask and answer the question but if you take something that is useful like a nurse or a good drug, and make it free, then physicians who prescribe that drug or operating executives who decide how many nurses to have will err on the side of having more, up to but not anywhere near the point of putting anyone at risk of course. Once you move to a world in which nurses are not free and in fact, if you hire another nurse, you will have fewer technicians or have a tougher time renovating a center or a tougher time buying new chairs or a tougher time building a new center, once you're in a world of having to trade that off against other things, you'll end up finding some other things that are better incremental uses of time and money. And that same thing is going to happen in the Pharma utilization world. That there are going to be innovations that take place because it is no longer free.

Well, since you brought it up, I guess the assumption as you're seeing sort of decreasing Pharma utilization which I have to assume is a decrease in EPO utilization, are you seeing a tighter control of other measurements such as iron and vitamin D, is that sort of the genesis of Luis' comments on the reevaluating vitamin D?

Could you say the question again, Andreas so that we --

Yes, as you said, if you have something that's essentially free and the easiest clinical pathway is to use more of it, are you now seeing physicians taking different clinical pathways that might require a tighter control over differing things in order to reduce the need of EPO.

Yes. That's the rational thing for people to think about and lots of people are doing that. Exactly what answers will emerge that are clinically equivalent or superior, no one knows yet. But there is a lot of big brains working on it.

Great. And maybe just a couple more quick questions. Just in terms of this whole transition adjustment, I'm trying to put the logic chain together, Kent because clearly, you've stated you believe that CMS has made sort of an error in their estimates. And that's an error in estimating what percentage of clinics are going to transition and the rate is relatively high because I think the assumption is that what 40 some odd percent of clinics are only going to transition as opposed to going over -- I'm sorry, 47% are only going to opt in as opposed to going through the transition. So, in other words, what you're saying is CMS is underestimating the number of clinics that are going to opt in immediately, right?

I guess it is a little bit of a simultaneous equation. That when you come up with calculations like the transition adjustment, if you're not careful, you do dramatically decrease the number of people who go into the bundle. So, you kind of have to iterate back and forth between those two assumptions. If the transition adjustment were less onerous, you would probably get a lot more people in the bundle than you would otherwise see or than you will otherwise see. Did that answer your question?

But nevertheless, you've made some comments that you would be hopeful that CMS would revisit the transition payment in 2012 and the only way that the industry is going to see a reduction in the transition adjustment or even get money back from the transition adjustment is if more clinics than what they have estimated actually opt in, correct? So, we're looking for a higher number of clinics to opt in under that scenario.

Right. That is most likely correct.

Okay. Great. And then just actually, I have to ask the question, can you just provide some color and some thinking on the announcement about the new headquarters? It seems somewhat out of character for you.

Can you make the question more specific?

Well, in the past, you have not had a sort of single headquarters building and one of the reasons was that I guess economically, it was never worth spending what I think is now an estimate of $100 million on it. I'm wondering what benefits that you see or what changes have occurred that cause you to think about doing it?

Okay. Well, there's two different questions embedded in that. There's no change in our go-forward expense structure. We've got a certain number of people in corporate overhead, if you want to call it that. And they've got to be in a building somewhere and we're going to have to pay rent on that building. And so the actual P&L economics are virtually identical in this new world we're moving into where we put a lot of people in the same building and it is a dedicated to be a building so it can hold our DaVita University where thousands of our leaders will pass through each year, Which we think will yield some very healthy productivity, retention and capability benefits. So, on the P&L front, there's no change in philosophy because the economics are virtually identical.

On the philosophy front, it is a change where we just decided with our emerging size and complexity, the economic value intangibly of getting a lot more of us in the same building so that it is easier to remain tightly integrated as we have in the first decade that that was just a very big deal. And it is already -- even as we're moving more and more people into the interim headquarters, the economic power of being together more often and having some of our people travel less often already exceeds our expectations. So, two buckets. Economic. There ain't no change of any significance because you have the same number of bodies you would otherwise and the same amount of rent per square foot. Then you pick up some savings in airplane travel and things like that but we've never want to market that as being material. Then the philosophical side or the intangible side, we think the benefits are immense. If you think about it, just a tiny, tiny adjustment in our labor productivity per hour equals millions of dollars annually. And we think by consolidating more of our professional development, we're going to get that.

Great. And then final one for me, just Luis, on your comment, I guess you said that you saw an improvement in sort of labor productivity and I was just wondering if you could give a little color around that. Especially considering that I think that during the first quarter call, Rich sort of highlighted the fact that with mandatory tax certification, you might actually see some pressure on the labor line.

We did not see the pressure on that line. We just continue to see great operational execution by the folks out in the field.

Okay, great. Thank you very much.

Thanks, Andreas.

Thanks for bringing up the headquarters, Andreas.

Your next question comes from Gary Taylor of Citi.

Hi, good afternoon. Couple questions. But I think I can be quick. First, just thinking about this decline in the pharmaceutical utilization sequentially. I mean, it is a pretty steep sequential decline that rivals some of the impact you were seeing back in '07 when the FDA label was being put under a little more scrutiny. So, I was just wondering what do you think is driving that? Do you think that is increased visibility of some of the trials that have been out there for a couple of years now? Is it physicians actually proactively thinking about bundling? Anymore color on why that driver?

We actually don't think bundling has much to do with it. That it is much more a function of some of the increasing visibility around clinical issues surrounding some of the drugs. And that it is virtually 100% that. We just don't think a lot of physicians are out there thinking a lot about the bundle when they're deciding how much EPO to give you or me.

Okay. Good. On the mix issue, the $2.50 sequentially, is there an estimate on the year-over-year drag on revenue per treatment?

We don't have it handy. We'll see if we can dig it up and get back to you.

Okay. Couple other real quick ones. On the VA contracts, I know -- I guess you don't want to tell us exactly when those became effective. They are included in guidance. Guidance only goes through the end of the year. So, is it fair to say those new rates do take effect sometime in 2010?

Yes.

Okay.

And I don't want to be -- let me grope for the right words here for a moment because I don't want you to infer from that answer that they could be December 27th. The rates are either in effect or going into effect soon and so it is not some -- something that's delayed over four, five, six months that you have to worry that we're trying to do a head fake by saying they're incorporated in the 2010 guidance. The dominant economic effect will be felt soon and so our answer is not an end around.

Good. I guess maybe to press a little more, understanding there's still uncertainty around this. But, I think part of the investment community was always on edge, just wake up and see 2% of your revenue was down 40%, down to the Medicare rates and understanding that that risk isn't completely gone. It sounds like it is fair to say you feel a little better about it. At least in terms of this holding at these new rate levels for awhile.

Well, I am pausing because I think the literal answer to your question, which is a well considered question, do we feel a little better? The answer to that precise question is yes. We feel a little better.

Okay. Perfect. Two more quick ones. I'm sorry. On the long-term contracts with two big payors, I guess on the commercial side, I guess I'm not used to hearing you talk in those sort of terms. Is that a number of state and regional contracts, renewed under bundled structures with two big payors or has there been any sort of change in terms of elevating the level at which those contracts are being done? Are those national contracts?

Yes, again, very fair question. And they are above average contracts in size; otherwise, we wouldn't have brought them up.

But you won't say if that's different than how those contracts were constructed historically or not?

One of them was at a higher level of aggregation. The other one wasn't.

Okay.

But both well above the average size and so they did represent a -- a reasonable continuation of our trend towards longer term contracting, more bundled contracting. And since we've sometimes had to frustrate you necessarily the last couple of quarters by staying totally qualitative in our comments, we thought we would pounce on this opportunity to give you a more tangible sense of the fact that we're making good progress in reducing our risk profile.

Right. That's helpful. Is the increased level of aggregation a trend that -- I don't know that I fully understood that you've talked about -- seems like maybe a little bit of that historically, but is there any significant change there we should be thinking about in terms of level of aggregation of revenues to certain payors?

I would say over the long-term, that the trend towards aggregation which we've talked about maybe every year or so for the last four years will continue. Will it pick up in speed? I think there is a very reasonable chance it will. I don't know that that's going to lead to any material near-term difference in competitive dynamics of the business. But I do think the long-term trend that we've talked about over five years will continue and it might pick up a little bit and in general, that plays to our advantage.

Okay, good. Last question, I appreciate the long leash here. A lot of investors thinking about home dialysis, whether that's hemo, whether that's PD, some of the incentives that exist under bundling to do more home dialysis, a lot don't completely understand that you offer both home hemo and PD. So, maybe just 30 seconds on your outlook for trajectory of growth in both of those services?

Fair question. Again, answer will be highly qualified because we're not sure. Our PD population is growing. Modestly. We expect that to continue. Our HHD population is small and growing modestly and we don't really expect that to accelerate at this point and so that's a pretty narrow answer. Is that sufficient?

I think so. I mean it doesn't just -- it doesn't sound like there's necessarily a shift that's in mind. More of a that will continue to be a pretty small piece of the business going forward.

Exactly. So, I think it is enough for you to categorize it as not very material within the relevant investment time frame most likely.

Okay. Thank you very much.

Thank you, Gary.

Your next question comes from Mark Arnold of Piper Jaffray.

Good afternoon. I'll try to be short since most of my questions were answered. Just back to the payor mix question. As we think forward the next two, three, four years, let's assume the economy is going to continue to gradually improve, to what extent is the improvement in mortality something that we're -- that you expect to continue to see and do you think we can see 12% or 13% of your payor mix coming from commercial again?

Okay. Two parts. A, with respect to mortality. We intensely hope to continue to improve our survival rates and it is just gloriously wonderful how much we've done that over the last few years. We took a significant step back when we bought Gambro and then got right back on the same trajectory marching down. We hope that continues. It is very unfortunate that that means that we have a bigger Medicare cost deficit to fill. Until such time as anyone on this call has a relative on dialysis and then they're really happy that we have done that. Second, on the private side and the numerator part of the equation, history would indicate very strongly that an economic recovery will lead to a private insurance recovery, will lead to more private patients which will be a very nice bump for us. If it doesn't happen, then the pressure on the government to increase rates goes way, way up because when centers close down, real people get hurt and real voters get upset. So, there's a natural hedge there because we're talking about important stuff.

Maybe just to ask that a little differently. Over the last couple of years, I think you guys have been very consistent in saying that about half of the deterioration in payor mix has been a result of improved mortality. So, what you're saying, I think, is that you hope to see some improvement in that payor mix but getting back to where we were a few years ago is unlikely as a percentage?

Actually, we would make no prediction as to how far it could bounce back. I would not discount the probability it could go back to what it was in the old days. Depending on how healthcare reform moves forward. It could have a tremendous impact as to the number of people on private insurance. At the same time, we're not predicting that it will bounce back to those levels. So much has to do with what happens with healthcare structurally over the next four or five years on top of whatever the economy does.

Understand. Great. Thank you. I guess the next question -- can you just remind us of the process of how innovation, I think as you defined it earlier, in patient treatment protocols kind of works its way to your medical advisory board and how those new protocols are kind of processed?

Do the question once more, please, Mark?

Can you just maybe explain to us the process of how any innovations in patient treatment protocols, particularly those coming out of physicians in your centers working on different ways of treating patients that may or may not include changes in Pharma utilization. But can you just talk about how those protocols, how those innovations that may come through, work their way to your -- I don't remember the term. Your Medical Advisory Board of Medical Directors and how those things are processed at that Board level.

Got it. Thanks for repeating it. If you had a piece of paper, just picture four different circles. One picture -- one circle is the office of the Chief Medical Officer which is a group of very senior, experienced docs that work for us 50% or 100% and are the architects of new ideas and the trials and tests in order to compare those new ideas analytically. Second circle would be a P&T Committee which has not only physicians, nurses, pharmacists and others that study the alternative clinical protocols with respect to any impact on device use. The center level of operations, things like that. The third circle would be our Physician Counsel which is the set of physicians who don't work for us and are active practicing nephrologists who then debate and discuss all of the observations, evidence analysis, et cetera from the first two circles. The fourth circle is DCR, DaVita Clinical Research which is either the leading or one of the two leading clinical research organizations in the world in terms of kidney focused Pharma, biological and device trials as well as medical informatics, which is to say the statistical analysis of all sorts of trials. They're the fourth circle that does a lot of the work to guide the conversations of those prior three. It is also an entirely separate profitable subsidiary. So, it is market tested in terms of its quality and rigor. So, the process moves through those four groups iteratively. All of it under the watchful eye of our compliance team to make sure that everything that is done is documented so that clinical validity and clinical motivation is not only pure, but is well-established, written down and documented.

Okay. And then I guess just a follow-up to that. Has there been any recommendation from those groups to suggesting lower Pharma utilization recently that would maybe support the lower utilization you've been seeing here for the -- particularly here in the last quarter?

Short answer is no. There is a lot of experiments and pilots going on but they're not of enough size to explain any material part of the change. Hence, our earlier answer to a related question saying that the change that's going on is physician driven and all of the data that we have suggests it is physicians responding to a lot of the journals and articles and data that is being discussed particularly surrounding some of the drugs. So, the short answer is no and those are the subpoints underneath that short answer. I would also add that the fifth group that's involved in this process throughout is all of our nephrologists in the community. So, when the office of the Chief Medical Officer or the physician counsel starts seriously looking at ideas, those ideas are shared with hundreds of nephrologists out in the community for open comment periods and so that every idea is very, very thoroughly vetted by nephrologists across the nation.

Great. Thank you. Just one last question. Related to the debt. What's the amount of interest rate swaps that are still outstanding and when do they expire and at what rate?

We'll look that up for you momentarily.

Let's go ahead and go on to the next question and then Mark, we'll come back with the answer in a minute or two if you can stay on the line be.

Great, thank you.

All right, thank you.

Your next question comes from Chuck Ruff of Insight Investments.

Hello, good afternoon. Back in February Investor Day, you talked about long-term earnings per share growth of $9 to $11. Now that we've seen the bundle does, that still seem like a fair number to think about for the long-term?

That is still our goal. That has not changed. You please have to give us more than a week to absorb this new regulation before we calibrate how it affects our probability of reaching that goal.

Okay. A similar question, I think back then, you talked about big providers likely to fair a little better under bundling. Does that still seem fair or is it too early to say?

We still think it is fair.

Okay. You mentioned earlier your target range for leverage. I think part of the reason you were under that for quite awhile was the uncertainty of the healthcare reform and the bundle. Are there some reasons that I'm not thinking of as to why you might still want to stay under that target for quite awhile?

The short answer is no. One of the factors, just to repeat what you said, that there were a number of factors that led us to be below and a couple important ones were uncertainty around the bundle and uncertainty in the capital markets and in those areas, there is less uncertainty now. Those weren't the only two factors but those were two of the big ones and they are different now. You are right.

Okay. And there's no new ones to take their place? That you can think of right now?

None that I can think of but I'm look around the table to see if -- no one has any to propose.

Okay, great. And lastly, did you buy back any stock in July?

We are practice -- our practice is to disclose up until the date of the press release when we bought any stock back and the answer to that is no and that's why it wasn't in the press release.

That's all I had.

Okay. Thank you.

The answer to the previous question was $350 million expires at the end of Q3 and the average rate is around 4.3%. Regarding swaps.

Okay. Operator, next?

Your next question comes from Kevin Ellich of RBC Capital Markets.

Just a couple follow-ups. Starting off with the acquisition spend this quarter. Kent, you mentioned that the environment is improving or at least you expect it to close on some transactions. So, you guys spent $90 million this quarter. That's the most in the last three years. Is that correct?

I'm not sure about the three years but something like that. It is certainly a high quarter. I'm just not sure about the three years.

In part, it was a slow start to acquisitions as we mentioned last quarter. So, you sort of need to look at it on a year-to-date basis.

Got you. What type of evaluations are you seeing on the deals you're looking at?

Very consistent with what we've seen historically.

Okay. And then just wanted to get your views on home hemo. I think you said recently you made another investment in next stage medical or have some warrants now. Lastly, thoughts on alternative forms of ESAs, after you had some news out a few months ago, just wondering where you stand on hematid now.

On the second question, other ESA,s, we're eager for there to be more ESAs for us to choose from. Any rational customer would be. Even though EPO as it now is constituted is a wonderful drug for our patients. So, on ESAs, that's what we like. We're not very good at predicting how stuff unfolds in that space and so you can find other people far better than I at handicapping what will happen when. And then on HHD, on next stage, I wasn't clear on what the question was.

So, if you could throw that at us again, please? I guess has your views changed on home hemo? We know you're the leader in terms of the largest home hemo provider in patients on PD at home. Just wondering, what -- if you can provide any color on the investment in next stage medical?

Our views have not changed.

Okay. That's it. Thanks.

All right, thank you.

Next question comes from Darren Lehrich of Deutsche Bank.

Sorry to belabor the call. I just have three number questions. First would be the mean hemoglobin this quarter and the mean hemoglobin last quarter.

We've not historically disclosed that and we won't do it here today spontaneously. I'm not sure that's the right number for our shareholders to be thinking about nor our physicians quite frankly. So, let us think about whether or not that's a number we should start publishing each quarter.

Okay. Yes, I guess the extent that we get new parameters, maybe above 12 might be useful. If mean is something that you're not willing to disclose at this point. But just thought I would ask. The exact percent of revenue related to the VA business, I think you've been using this sort of 2% number and on $6 billion of revenue, it seems like a pretty round number. So, I'm wondering if you can just be a little more specific for us with regard to that.

I think we're going to have to disappoint you on that one, Darren. That's to disclose more would create more risk for shareholders as that would offset any value in terms of incremental insight. Particularly since we've disclosed it for amount and we have incorporated recent developments into our guidance.

Okay. That's fine. And then revenue per treatment for nonESD labs, can you just give us a rough estimate of how much revenue you think you derive from the labs not, you know, discreetly identified in the list?

Yes, this is LeAnne. I don't think we're prepared to give you that number right now. Thanks.

Part of the problem was we didn't know how much we would -- how much those lab tests that were proposed to being put into the bundle would cost. That's part of the reason why we commented we needed a defined list.

Right.

Let me elaborate further just so you don't think we're totally evading you on all three of your questions, part of the difficulty with some of those other nonESRD things is different doctors have different practices. Not only in terms of what they order but who they order it through and from and different payors handle those things differently and so it is such a moving target, it is hard to know which is why it would have been terrible for them to put it in the bundle and perhaps in the years to come, there will be a lot more clarity on what that is in aggregate more or less of what our piece of it is ours. That's all we could ever know is what piece of it is ours. I wanted to go back on the mean thing, too, Darren just isn't we didn't think we were being evasive there. We try to use clinical numbers in our conversations with you and other shareholders that are as close as possible to the ones we use internally. And mean is not one that gets much attention here. Aggregate mean. If we start to use it a bunch, for helping monitor what's going on in our Company, then the odds that we'll start showing it publicly go way up.

Okay. Well, you have provided in the past and it is something that was pretty consistently disclosed. I'm not saying it is the right number to focus on. But just that's why I ask.

Very fair question. I know we have said it sometimes in the past but it has been a one off thing and we literally calculated just to answer the question as opposed to calculating it as something we use to run the Company or communicate with our physicians and again, as much as possible, we try to avoid using different metrics and numbers with all of you than we do with ourselves.

Your final question comes from Justin Lake. I'm sorry?

Go ahead.

Okay. Comes from Justin Lake of UBS Investment Bank.

Thanks. I just wanted to throw out a couple of quick questions on the longer term outlook for at least until next year. Kent, I think at the investor day, you said that given what you knew at that point, it was likely that it was going to take somewhere in the neighborhood of two to four quarters for you to drive enough efficiencies in the business to offset the expected Medicare cut. Can you tell us given what you know now, if that still holds true?

Well, first of all, I wanted to amend your word choice slightly. It was two to four quarters to implement the changes that we end up thinking are prudent. Whether or not that's going to offset exactly or fully or not was and remains an open question. So, with that amendment in mind, we would still say the adjustment process, the operating change process will take about two to four quarters. We have not yet decided when that begins. But it is either going to be at the end of the year or a bit before the end of the year and then the clock starts ticking.

Got it. Given what you know now, is there any way to tell us whether you think, there is a probability -- give us a probabilistic scenario under which you think you can actually keep operating income flat, grow it or do you think it will decrease 2011 versus 2010?

We're not prepared to answer that. Having said that, we don't want it to be some huge uncertain abyss. We are confident that there are going to be some innovations that will offset some of the cut.

Great. And last question, when do you -- I would assume that you expect to give guidance with a typical range and some of the moving parts with the third quarter earnings?

Correct. That is our intense goal because if we don't, you will be very upset.

That is all I needed. Thanks a lot for the time.

Thanks, Justin.

At this time, there are no further questions. I'll now turn the conference back over to management for closing remarks.

All right. Thank you, all for your thoughtfulness and good questions. We will work hard between now and our next call to add some value. Thanks.

Thank you, this concludes your conference. You may now disconnect.