德維特 (DVA) 2010 Q4 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the DaVita fourth quarter 2010 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question-and-answer session. (Operator Instructions). Thank you. Mr. Gustafson, you may begin your conference.

Thank you, Beverly, and welcome, everyone, to our fourth quarter conference call. We appreciate your continued interest in our Company. I'm Jim Gustafson, Vice President of Investor Relations, and with me today are Kent Thiry, our CEO; Luis Borgen, our CFO; and LeAnne Zumwalt.

I'd 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 the actual results to differ materially from those described in the forward-looking statements. For further details concerning these risks and uncertainties, please refer to our SEC filings including our most recent quarterly report on Form 10-Q and annual report on Form 10-K. Our forward-looking statements are based on information currently available to us, and we do not intend and undertake no duty to update these statements for any reason.

Additionally, I'd like to remind you that during this call we will 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'll now turn the call over to Kent Thiry, our Chief Executive Officer.

Okay. Thank you, Jim. Greetings to everyone. Thank you for your interest in DaVita. The fourth quarter reflected solid operating performance on two different levels; A) the results themselves, and, B) our work to prepare for the bundle. I will cover four topics; clinical outcomes, our recently announced acquisition, bundling, and our outlook.

Let me start with clinical outcomes. We always put that first because it must come first. We are first and foremost a caregiving Company, serving more than 125,000 patients. First, with respect to adequacy, which is essentially how well we are doing at removing toxins from our patients' blood, this past quarter 96% of our hemodialysis patients had a KTRB greater than 1.2.

Second, with respect to vascular access, 67% of our patients have fistulas which is the preferred form of vascular access. Third, with respect to anemia management, physicians have managed 73% of our patients to hemoglobin levels between 10 and 12 over the last three months. For these and virtually all other clinical measures our patient outcomes compare very favorable to the national averages, and this quality care not only results in healthier patients but also drives reductions in hospitalizations and surgical procedures and, therefore, drives significant savings to the US taxpayer.

Next, a few words about our recently announced acquisition of DSI. As always, we have received some questions about the price and expected return. The short answer is that there is a high probability that we will earn a satisfactory return. We applied the same return on capital discipline to this transaction as we have to the many, many large and small acquisitions we've done over the past 11 years. And one distinctive feature of this asset is that it has some particularly attractive geographies and physician group affiliations, as well as many, many excellent caregivers and other employees.

And we are very excited that we're going to be able to offer our much broader range of integrated services to these wonderful centers improving clinical outcomes, improving service offerings to patients and physicians, and reducing the overall cost of care for payers. As you know, this transaction is subject to antitrust review. We will have to divest a fair number of centers. We are already seeing strong demand for whatever divestitures we will make.

We've already been contacted by a number of potential buyers. There will be minimal operating income impact from this deal in 2011 because the transaction is likely to close in the second half of the year. And we will, of course, incur some transaction and integration costs in the first few quarters post-close and it will take some time to achieve the ultimate synergies.

Next subject is bundling. As of January 1, we are in the bundle as most of you know. You will also recall that we are being subjected to an annual cut of approximately $140 million in Medicare reimbursement for 2010. We are working hard to fill this gap and are making solid progress. There are still also a few uncertainties under the new reimbursement itself.

We do not yet know how the clinical changes that physicians are implementing will play out across our entire patient population. We will not receive our first payments for a couple more weeks and we continue to have to work on being able to identify and capture case mix and outlier adjustors. This is one of the frustrating exceptions to the otherwise collaborative process we have had with CMS in implementing the bundle. They were told by the entire community ahead of time that not only do we not have the data from any of the proposed adjustors, but also no one is obligated to give it to us, period, much less on a timely basis. And so these adjustors will create a lot of operating issues and will also mean we will not receive the reimbursement level that CMS has projected.

Putting all of this together, our current outlook is that 2011 operating income will be flat or modestly down. The cryptic summary of why a lot of the good things are offset leading to us that directional guidance is the following five items. A) the Medicare cut, just alluded to. B) Medicaid cuts. C) VA cuts, or more likely reduction in VA patient volume as we can no longer afford to take more government-paid patients at reimbursement that is less than the cost of taking care of them. D) commercial mix changes. And then E) an unusual surge in our G&A expenses driven by, primarily by IT investments and our investment in international growth.

One other variable that significantly affects the G&A, in fact, a third variable, is the growth of some of our non-dialysis units is well above our treatment growth rate and this drives the aggregate corporate G&A expense as a percentage even though it does not represent any unusual G&A growth in and of itself. Before I turn it over to Luis, a couple other thoughts. We continue to believe that our Company is well positioned to operate in the bundled dialysis world.

We still believe that if they fix the problems in the implementation the bundle will be good for patients and good for the overall system, and we do intend to hold our capital markets day in Boston on May 3, in conjunction with our Q1 earnings call and at that time we hope very much to be able to give you more specific 2011 guidance and provide more color about how the bundling transition is going. We hope to see many of you there and answer every single question you have. Luis.

Thanks, Kent. Here's some specifics on the quarter. Non-acquired growth was 4.4%. When normalized for the calendar our non-acquired growth in the quarter was 4.2%. This past quarter, dialysis revenue decreased $8 per treatment. (Audio difficulties.) -- 2011. Our effective tax rate attributable to DaVita was lower than previously expected this quarter, primarily due to non-recurring tax benefits associated with close examinations and statutes.

We expect our effective tax rates for 2011 to be in the range of 39.5% to 40.5%. We have entered into interest rate hedges that have effectively fixed our interest rates through September of 2014. As a result of these hedges, we expect interest expense in 2011 to be between $235 million to $240 million. Cash flows remain strong. In 2010, we generated $840 million in operating cash flow, and $597 million in free cash flow.

Looking ahead, I want to remind you of a few things for the first quarter. Bundling began on January 1, which means a sequential drop in Medicare revenue per treatment from Q4. The first quarter is shorter at 77 treatment days, which means fewer overall treatments and fewer days over which to amortize fixed expenses. Payroll taxes are higher in the first quarter, which is about $2 per treatment sequential increase to expenses. For these reasons you should expect a sequential decline in treatments, a sequential decline in revenue per treatment, and a sequential increase in expense per treatment, meaning a decline in operating income from Q4 2010.

You should also expect there will be some short-term collection delays as Medicare contractors and secondary payors process our initial bundled claims. This will impact our cash flows in the first half of the year. Operator, let's go ahead and open it up to Q&A.

Wait one moment, operator. We're getting some feedback that the phone may have blacked out for a short period. LeAnne, do you know--?

I think a few -- a moment or two of Luis' commentary was cut off and if that's the case I think what we can do is handle those questions in Q&A, so apologize for that. But understanding that there was a technical issue.

Okay, operator, could you please open it up to Q&A?

Certainly. (Operator Instructions). Your first question comes from the line of Gary Lieberman with Wells Fargo Securities.

Thanks. I guess going back to Luis' statements, I think he was probably cut off, it seemed for about 45 seconds, so, Luis, I guess you probably discussed the cost per treatment in the quarter. I don't remember hearing that. So maybe if you could go back and discuss your comments on that, that would be helpful.

Sure, [Vica]. I'm going to just reread it to you, it's a short paragraph. Essentially, dialysis operating expense per treatment decreased $8 from the prior quarter. There were three factors. Lower utilization of physician prescribed pharmaceuticals, savings in the unit costs for pharmaceuticals, and that was partially offset by some labor and benefit costs.

Okay. That's helpful. And then, I guess, to your comments about revenue per treatment declining further in 1Q 2011, could you provide some more color about that? Is that specifically from some of the issues that, Kent, you mentioned about the coding of the new patients or anything there would be helpful.

Primarily as it relates to the Medicare revenue per treatment as we entered into the bundled environment, coupled with the fact that the quarter is shorter by 77 days and payroll taxes are also higher in the first quarter. Those are the three comments along the Q1 sequential drop.

Okay. That's great. I'll jump back in the queue. Thanks very much.

Thank you.

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

Thanks. First question, just on the revenue per treatment, for some reason I still haven't picked up exactly what you were saying as far as the decline this quarter. Can you just give me the split between the different components?

Sure. The primary reason for the decline was lower utilization of pharma, and the commercial mix was offset by the decline in -- excuse me, by the increase in private rates.

Okay.

So the [cause of the] decline was pharma's.

Got it. Can you give us any specifics on the commercial mix and how it looked in the quarter? I think you had said it was actually accelerating the deterioration in the third quarter.

In the third quarter, we did say that commercial mix was decelerating. In Q4, we had a decline from Q3.

And was that decelerating even -- was it the same rate or did it look like you might be seeing signs of stabilization there?

Let me clarify. The decline or deterioration in Q4 was less than that in Q3.

So your mix was better in Q4 than Q3?

No. The rate of decline --

Okay, got it.

Thanks for forcing the clarification, Justin.

Thank you. Second, going into 2011, if I could just ask a point-specific question, is the revenue per treatment going to be down? Can you give us a ballpark as far as how much to help us model this? What is the expected revenue per treatment in the first quarter?

Yes, Justin. We're not providing detailed guidance, as you know, at this time. Safe to say, the Medicare revenue per treatment is going to be down because of the implementation of the bundle.

Okay. On the cost side, you had another decline in pharma. Should we expect to see that continue as we go through 2011?

Are you saying utilization decline?

Yes. Pharma intensity.

Yes, Justin, we are in the process of -- I think Kent mentioned -- of implementing various protocols and changes. How those will take effect when you have hundreds of physicians making daily decisions we're not yet ready to put a stake in the ground.

All right. Then I'll just ask one last question on the minority interest. Looked like it was a little bit higher than what we expected in the quarter. Can you just give us any color on how that's expected to look in 2011 and why that continues to grow?

Yes, it fluctuates quarter-to-quarter but it's primarily driven by more JVs and higher profitability of those JVs. We think that it's a reasonable number for Q4, heading into 2011. It will be in that range.

Okay. So this is a good run rate?

It could vary up or down.

You know, Justin, clearly it's going to vary slightly as we implement Medicare and the results of all that. It will fluctuate just with our forecast as you might expect.

Okay. Great. Thank you very much.

Your next question comes from the line of Shelley Gnall with Goldman Sachs.

Hi, thanks. I was wondering if we could go back to the comment on the VA rate cuts. Did I understand correctly that it's going to be more -- the impact to DaVita will be more in lost volume rather than an actual rate cut?

It's impossible to predict until we know exactly what the VA does. They have the right now to assert Medicare rates but a provider doesn't have to accept a new patient. And so in a whole lot of cases in order to give veterans the access and quality that they will probably want to, they're going to need to negotiate a non-Medicare rate. And so given it's going to be -- there's going to be a lot of negotiating out there, it's impossible to predict exactly what's going to happen.

What is clear is we have a lot of centers that can't afford to take more patients where the reimbursement is less than the cost and particularly when that reflects a conscious decision by the government to do so, after being forewarned.

Okay. Thanks. If I could ask also on the managed care contracts, I understand in the third quarter there was a shift to move more managed care contracts to a bundled payment methodology. Can you give us any update on your progress on that front, any color?

We haven't been doing any kind of quarter-by-quarter reporting. Rather, what we've been doing for the last, oh, 15 months or so is saying that we are satisfied, on track, making progress, and that the net results are incorporated into our guidance and I think we're just going to stick with that for now.

Okay. Thanks. One more, if I could. Any update on your priority uses of cash now given this is going to be a pretty -- there's a lot of moving parts in 2011, any thoughts on repurchase?

Really no change in our long-standing philosophy that every single quarter we take a look at buying back stock, versus investing in growth, versus holding cash, versus paying down debt and those dynamics, as you just mentioned, change a lot and so we can't really predict. I guess, the only thing we can predict is we're going to put it through the same sort of analytical template we have for the last ten, 11 years and as the record indicates, that leads to a lot of different decisions at different points in time.

Okay. Thank you.

Your next question comes from the line of Kevin Fischbeck with Bank of America-Merrill Lynch.

Okay. Great. Thanks. Question for you on the guidance. I appreciate the Q1 color there. And it seems like a lot of it that you were guiding us to had to do with just the seasonality that we normally see. Obviously, the rate cut's involved as well.

When we think about the guidance of operating income being flat to down modestly is it right then to think that the first half of the year where you have the rate cut all of a sudden and it takes some time to get your cost structure in place, means that then the second half of the year is probably going to be flat to up modestly? Is that the right way to be thinking about it?

To be honest, we didn't anticipate that particular question, so I'll be speaking out of school a little bit here. But it is certainly the case that we take lots of the revenue hits immediately and it is certainly the case that some of the adjustments take time and so the net of those two big tectonic plates shifting would suggest exactly what you said, the second half of the year would be better than the first half.

Having said that, we've not reflected on everything else out there and I don't know if there's anything else that would cut in a different direction, so you're probably right but we don't have an analytical answer to that.

The thing that would jump out to me in the second half of the year item potentially would be the Amgen contract. Is there any assumption in your guidance around that?

Well, the uncertainty around the Amgen contract is one reason why you're getting the breadth of guidance that you're getting. In addition, one other variable that does push the other way, more second half dynamism than first half dynamism, is the VA. We have a lot of contracts with the VA.

Those expire at different times and so over time there's a greater cumulative effect of whatever is going to happen with the VA, and so that would be one example where you wouldn't want to rush too quickly to the conclusion that the second half will be better than the first.

Okay. And then, again, I think you mentioned in your comments that you guys were facing a $140 million Medicare rate cut, which if I do the math and assume 80% of your patient treatments are Medicare, that gets me about $9 per treatment. Is that the right way to think about it?

That's a reasonable way to think about it.

Okay. And then last question. I guess one of the comments you made at the beginning was that the quarter was good in part because of all the progress you made for bundling. Where do you feel like you are right now as far as what you need to do to prepare and to react to bundling?

Oh, boy. This is about 12 different initiatives under that category and to try to apply some sort of quantitative score on what percent is done with each one in particular, when you kind of don't know where the end line is, you don't know how much you're going to be able to adjust, so I think I just have to -- I have to punt. We're not 90% done. We're not 10% done. But I get pretty queasy about going a lot further than that even though that's not terrifically useful for you.

Okay. Understood. Thanks.

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

Thanks. Good afternoon, everybody. Just a few things. Really to follow up on your comments previously, Kent, on VA. Can you just help us think about what percentage of your VA contracts, or business, I should say, is contracted in 2011 and just maybe give us a sense for that? Because it seems like you have some visibility into the VA cuts given that there is a bunch of it that's contracted.

Yes. We haven't disclosed that and for competitive reasons, we don't think we want to. We'd feel more pressure to if we thought it would help you get to a better answer, but in this case it doesn't because even in places where we don't have a contract, it could very well be that the VA does not have a high quality alternative to our center. So it does not mean that that's going to move to Medicare if we don't have to keep that patient or take the next one.

I say all this, of course, because we would like to take care of every veteran in America with a warm embrace, but when the government intentionally implements a policy where they're going to try to force us to take reimbursement that they know is less than expenses, we have to at some point push back somewhat in self-defense. And so given it's not as if there's one clear result with a non-contract situation and the opposite result with a contracted. It's really of no analytical value for you to know the mix and for us representing you it's better than it not be known.

Fair. Okay. Next question, just relates to anemia management. We have seen a pretty dramatic improvement in your metrics that you're reporting now of 10 to 12 over the last year or so, even sequentially. But you've called out a number of times over the last few quarters just about the dramatic reductions in pharma utilization. So I guess maybe just help us better understand, have your protocols already begun to go in place and is that the result or is there still more to come relative to rolling out the protocols for 2011?

Well, certainly, what you saw in the fourth quarter was not a coincidence and certainly we are not done. Could you -- could you push the question further in some way where I can be incrementally useful?

Well, it just strikes me that your Epogen is coming down and your anemia management numbers are improving. I guess that's the point, maybe less of a question. I am curious to know if Amgen has indicated to large customers like yourselves whether they will continue to be on a biannual cycle with their price increases, do you have any certainty on that?

We would like them to go to a once a decade price increase or so and maybe skip a decade every now and then. (laughter) They've made no comments on that to us; don't know what they've said to others. They do know that there are a few more visible issues in healthcare than the price of that drug and that now providers have an absolute fixed Medicare reimbursement cap and so exactly what they're going to do only they know. But there certainly are a lot of people watching.

Yes. Last question, just I think you said yourself that the growth in G&A was maybe a little bit unexpected, maybe I just misheard you, but could you comment a little bit about what's accelerated in your G&A spending and maybe as a corollary to that, did we start to see any international investment in, I guess, the other segment in Q4, because you did slip a little bit sequentially, you were sort of break-even last quarter, so just curious about that.

Yes, thanks for bringing it up, Darren. First, on the IT, it is an unusual surge and a non-trivial one. Let me just give you two examples. One is we're putting in a new human resource system which we haven't done for, oh, eight years or so, and if you compare 2011 to 2010, that's going to be about a $6 million, $6.5 million incremental G&A investment which will then fall by about $2 million to $3 million in 2012, and then further in 2013.

Second material example, we're putting in a new clinical management system, first time in eight years, and that also is leading to plus or minus $6 million incremental spend in 2011 versus 2010 and there will be diminution of a couple million in 2012 versus 2011, and then somewhat more diminution in 2013 versus 2012. So those are a couple examples that explain a big chunk of the unusual surge which will then start to work its way down. Who knows what other investments we may decide to make but these two are big and very, very mainstream.

As to Q4 in international, I don't know the specific numbers, but certainly in Q4 we spent enough on the P&L internationally that it would have moved that dial a little bit, and if Luis (inaudible) certainly want to amend that, they can. It did play a role. I'm not sure it was a huge one.

Have you made any definitive decisions about your initial markets, geographies that you plan to pursue?

We have. We're still thinking it's in your best interest not to say what they are, but we are a multi-national Company now in the sense that we have expenses. We hope to move on to the second half of that equation as soon as possible in a couple carefully selected spots.

Great. Thank you.

Your next question comes from the line of Ilan Chaitowitz with Redburn Partners.

Good evening. This is Ilan Chaitowitz from Redburn Partners in London. Thank you very much for taking my questions. I've just got two. The first is about your cost per treatment.

I noticed there was about an $8 decline quarter-on-quarter and you gave a rather conservative estimate of about a $9 hit to your revenues from the bundle. Is it wrong to say that you've already nearly mitigated the entire impact of the bundle on your revenues before it's actually hit your P&L yet? That's the first question. Secondly, I was just wondering if you could give us some sort of probability or your best guess as to what the likelihood is of a transition adjustment revision or update within the first quarter of 2011?

First part of your question, it's LeAnne, I'll answer it. The year-over-year gap in Medicare is the $140 million number we gave you. As Kent said, and as you relate that to our entire forecast, there are puts and takes. The major offsets to growth include the specific things that you mentioned which was the Medicare bundle, impact from government reimbursement in the VA and Medicaid type programs, some increased spending in G&A and our international investment. Those are things that he mentioned. Does that answer your question?

It kind of pushes the question further out. It means that those other expenses that you're referring to, whether it's VA or other SG&A expenses, are going to be over and above any incremental cost savings you are likely to generate over 2011 because you've already neutralized much of that $9 hit that you quoted.

Yes, I think you can't look at that as a standalone. The $140 million is a revenue hit. We have been working on improvement in protocols and things like that as you saw in the fourth quarter. Don't completely offset it and, in fact, probably the $9 isn't quite right but that said, directionally we've offset some of it and we'll be working, obviously, through the year to continue improvement.

Thank you. And on the probability of a transition adjustment revision in the first quarter of 2011?

That probability is low, not zero, but low.

Thank you very much.

Thank you.

Your next question from the line --

Thank you for staying up to take the call. Go ahead, operator, could you please repeat that?

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

Gary?

Sorry. Too many (inaudible) in the bush. Too late for me. A couple questions, I guess. One, just going back to the transition payment adjustment, is there any color you think would be helpful for us to have? I know at one point last year you were hopeful there was a legislative solution, at other points you were, maybe hopeful isn't the right word, but hopeful of a administrative solution. Kind of where do we stand now and maybe more specifically as we head into 2012 and we head into the summer when presumably we get an ESRD proposed rule, what's your outlook on a correction of this mathematical error as we head into 2012?

Yes, let me take a cut at it. Maybe there's three buckets. As to a legislative solution soon, despite the fact we have a lot of support, it's unlikely because they're so dysfunctional. As to legislative pressure leading to a regulatory solution soon, not in the first quarter, but soon, we have a shot. As to an ultimate satisfactory regulatory solution, we've received positive indications but getting positive indications nine months before something actually is going to supposedly happen and all the processes they go through at that time is, while much better than getting negative comments, not nearly as reassuring as we would like it to be.

All right. Fair enough. And you warned us last quarter on this. What's your -- when would you anticipate an ESRD proposed rule? Out of CMS?

For the 2012 bundle you mean?

Yes.

Yes, and same timeframe as we expect in most years, release of the preliminary in the June timeframe with finalization around November 1.

Okay. I'm sorry to go back to the G&A. I just want to make sure I understand it. So I understand there are some new IT initiatives having an impact on that, I understand there are new international operations having an impact on that. Are we to take from that, though, that this $158 million is kind of the right quarterly jumping off point for 2011 or is there still the possibility of some typical or maybe atypical, but some quarterly volatility in that dollar spend?

I expect there will be typical volatility in that spend but as Kent mentioned earlier we do plan on making some investments in IT and some HR systems as well as international.

And then moving to the DSI acquisition, given your comments about the geographies, et cetera, I mean, is there any reason to believe that ultimately you don't do a similar operating margin on that group of assets and if you can get there what's a fair assumption on how long it would take?

And, Gary, was this about stuff overseas?

DSI.

DSI. Okay. I apologize. I missed the first part of your question. So will DSI end up with a comparable margin to us?

Right.

I do not know the analytically correct answer to that question. I know what I said is true, that the probability that we get a satisfactory return is comfortably high. I know that math well. I actually don't know the margin math because, of course, you can't eat margin.

You can only eat long-term cash return on capital. So I apologize, but that's the best I can do. If I just sort of intuit you would think that if there is a gap it would narrow because there are some synergies, but become identical, I don't know enough in my head about the geographic mix and we wouldn't have necessarily taken a look at that because it wouldn't have affected our business decision.

Okay. Fair enough. Since you judge it on a cash return metric, any chance you could tell us what sort of return you think this generates?

No. That would not be prudent, not in your best interests. What we can say in the spirit of trying to be useful, however, is that the way we've thought about cash -- after-tax cash return on equity capital is that if you think of a spectrum and say at one end for a highly strategic deals you how low are you willing to go, and at the other end for pure vanilla deals, no strategic benefit whatsoever, what would you really like to see. That range for us is from eight to 16 and this deal falls within that range.

Okay. That's helpful. That's all I had. Thank you.

All right. Thanks, Gary.

Your next question comes from the line of Mark Morgan with RBC Capital Markets.

Good afternoon. Actually, it's Frank Morgan with RBC. A couple of questions. I was hoping I could get a little bit more color on the -- you mentioned early on the impact of having to deal with case mix and outliers. I was just curious about, if you could go back and give me a little bit more color on why that is an issue.

The second question is on this anticipated delay in payment from your intermediaries, could you quantify about how long you think that takes? Have they given you any feedback specifically as to how long they think the payment process may be slowed? Thank you.

Yes, hi. It's LeAnne. I'll take those questions. On the case mix adjustors, a couple of core issues here. Number one, the fixed acute and chronic conditions are required for us to give documentation from the source. So either from a hospital or a referring physician who's made those diagnoses. And unfortunately, there's absolutely no requirement that those institutions work with us to get the documentation.

So the set-up of the rule itself is quite cumbersome and really quite impractical and we kind of warned them of it. There are some other levels of issues within that between the original data that the CMS contractor did in the final rule, some of the codes and things have changed and became much more restrictive. Although we did a nice job of working with CMS to get the number of co-morbidity adjustments down, we did not make it all the way to get them to a policy that was really implementable by the dialysis providers. Does that answer your question on case mix?

Yes, and how about with outliers?

Yes, on outliers, that's just simply a matter of data capture and calculation as well as the details of the formulas in CMS. We've identified some pharmaceuticals and things that did not get included in the final rules, so won't count towards that goal, and some other issues of more of a technical nature that I think will prevent CMS from paying out the full [pool].

Does this investment you're making in clinical management in 2011, does that in any way help address all these issues with documentation for case mix or for outlier?

No, it really doesn't, it's an independent issue.

Okay. So what will the clinical management investment actually do and will it have a nice return on [net]?

It will help us improve the quality of care for 125,000 people and in some cases incrementally improve our productivity in doing so.

And then I think you had a follow-on question on billing?

Yes, just the delays you were -- you said you may be experiencing, have these fiscal intermediaries kind of given you any indication of how long this may be slowed down?

Yes, we're really early in the process. We bill monthly. That's how dialysis bills. So we just billed January, and so we're kind of waiting to see how that comes back. That said, a couple of issues have been identified and they're universal to all of the [MAC] that we deal with. It's been issues with the logic on paying the home claims, so those are going to get held and that will get corrected. We probably -- we anticipate some other glitches, CMS knows about the first one and is clearly working on it, so we'll keep you posted. Again, we think that's a short-term issue, not a long-term issue, so until, though, we really get a quarter or two under our belts, it's hard to predict.

Okay. One more and I'll hop off. In terms of just -- when you look at where you are you now with basically being a month end into this, are there really any long-term issues that you worry about with bundling or is it just this initial period, maybe, call it, two or three quarters? Do you see anything that's a structural problem that will be with you forever? Thanks.

Fair question. As long as they fix the stuff that needs to be fixed, then the system should work for everyone and, in fact, work better than the old one. It should save the government money. It should lead to some improved care and it should leave providers solvent. Operator, can you go ahead and ask for the next question because he indicated that was his last one.

Your next question comes from the line of Gary Lieberman with Wells Fargo Securities.

Thanks. Couple of follow-ups. In talking about the acquisition and the FTC review, it seemed when -- back when you did the merger, or the acquisition of Gambro, that even if there were relatively high concentrations in the market a lot of the acquisitions were allowed to go through, I think, primarily because of barriers to entry were low. Can you talk maybe about what you think has changed, if anything, in the way the FTC is looking at deals or if anything in terms of barriers to entry or anything has changed dramatically?

Very fair question and we simply have no visibility into that. There are people who claim visibility into it, and some say things are going to be stricter now because the industry's more consolidated. Others say that shouldn't be the case because of the rise of home modalities and the fact that there's a lot of proven interest on the behalf of the capital markets in this segment. So clearly, attracting new investment and new competitors. And so some very smart people end up drawing diametrically opposed conclusions and none of them actually gets to talk to the people that they're talking about.

So we just don't know. When we apply the more or less principles and practices of the past we end up with a range of outcomes that we found very acceptable in the context of the transaction, particularly because there's such healthy demand for anything we have to divest, and ironically the bigger the number you divest, the higher the multiple is likely to go. But beyond that, there just isn't much we can say because we don't know.

Okay. And then looking at the -- going back to the average hemoglobin number and the nice increase you've seen in patients between 10 and 12. Is it possible to get some color? Is that more patients coming down from above 12 or patients coming up from below 10 that gets you there?

It's more coming from above 12 because there's always such a small percentage below 10. So that's why the answer is what it is.

Okay. And it sounds like you're confident you can continue to drive that number higher. Can you give us any kind of rough range for a target?

No, I'm afraid not.

Okay. And then would you expect to give guidance at some point this year, maybe after you see the claims for the first quarter or should we expect that you probably won't give guidance for the remainder of the year?

We are hoping to be able to be a lot more helpful to you on May 3 at our capital markets day in Boston, which will be simultaneous to the actual earnings release for those who can't be in Boston live. So that is our hope that we can deliver that to you then.

Okay. The helpfulness being that you think there's a pretty decent chance that you'll be able to give us some guidance in May?

Exactly.

Okay. Great. Thanks very much.

Thank you.

Your next question comes from the line of Mark Arnold with Piper Jaffray.

Good afternoon. Most of my questions have been answered. Just a couple clarifying ones. Just back to the SG&A comment, maybe to ask the question a little differently, should we look at Q1 as the SG&A line being sequentially up or flat from the fourth quarter or is there enough variability there that that could be down?

There is enough variability where it could be up or down, but I think directionally it would be similar to our Q4 number.

Okay. And then I've asked this before but remind me. I think you guys mentioned at some point during 2010 that you were going to give merit increases this year. Can you remind me how those increases flow throughout the year, is it heavily weighted toward the beginning of the calendar year? And then, I guess, maybe as just a follow-up to that, can you remind me of or can you give us a sense for where those increases are likely to be this year relative to the last two years?

What we actually said was we're going to have higher merit increases in 2011 versus 2010. As to whether or not it's evenly spaced throughout the year or skewed, it is moderately skewed towards the beginning of the year. And was there a third question?

No, I think that answers it. And then one last question from me. On the VA, I think when you guys reported your second quarter numbers last year you talked about coming to agreement with the VA on certain contracts and I assumed that the commentary from earlier here in the call, should we expect then that at least a decent portion of those VA contracts will expire at some point either late second quarter or early third quarter?

A very decent percentage will expire in the calendar year 2011. As to the concentration, I am not sure how the mix is across quarters, so I can't go there. Perhaps we can provide some guidance on that on May 3.

Right. Thank you.

Your next question comes from the line of Frank Miller, a private investor.

Hi, my question relates to the DSI acquisition. Your comments indicated that you feel confident that some divestiture would be required on an EFTC review. I'm curious as to what geographical areas you think those divestitures might relate to?

Well, I don't have them memorized and I don't think it should affect anybody's valuation of our Company or its prospects, and so I think we'll probably stay away from that because it will cause much more trauma than it will add any value for you guys and trauma is not in your best the interests.

I appreciate that. Just one final question. The press release indicated that there would be a Hart-Scott-Rodino filing. Has that filing been made? If not, when will it be filed?

Your next question comes from the line of --

Hold on a minute.

Sorry, that filing has to be made within a prescribed statutory period and I believe that we have if we have not made it we will be making it shortly.

And that is Kim Rivera, our General Counsel. But the speaker phone wasn't close to her, hence the delay.

Thank you very much.

Next question, operator.

Comes from the line of Jeff Hoernemann with Feltl and Company.

Thanks. Just thinking about the case mix adjustors again, does the $140 million reduction include your ability to capture case mix adjustors or is that just kind of a top line number assuming you can capture all the case mix adjustors?

Can you repeat that. I'm sorry.

So $140 million cut for Medicare, does that include the assumption that you can capture every case mix adjustor or would it be more if you can't capture the clinical case mix adjustments?

Yes, it would definitely be more, depending on how we do there, so the exposure could be more.

Okay. And then, secondly, maintenance CapEx also took a pretty big bump quarter-over-quarter, and actually if you look at fourth quarter versus second quarter, it was pretty big. Is that also IT related and is that kind of a run rate or do you think it will decrease back to more traditional levels?

The increase is primarily IT related. We haven't given CapEx guidance, so we do expect to make additional investments to go along with the G&A investment on IT. So the P&L investment would go along with some additional CapEx. So I would think it would be more in line with the number you saw in Q4.

Okay. And then lastly, and then I'm done with my questions, the international plans compared to when you first announced your intentions, is there any change on the thought of whether your movement will be more gradual or potentially one quick entry into any given area? That's all, thank you.

We don't have any change in our thinking or plans since we last spoke about it.

Thank you. Operator, the next question.

Your next question comes from the line of Andreas Dirnagl with Stephens.

Yes, good evening, guys. Kent, as usual, I just want to clarify some of the comments you made to make sure I'm understanding what you're saying. I think you were pretty clear. I just want to make sure. Under the VA, when discussing the VA, were the VA to decide to move to Medicare pricing what you're saying is that you would be forced, therefore, to no longer be able to take VA patients, is that correct?

We would take them in some cases and not in others and I assume other providers would be the same.

Is the dynamic, therefore, that where the VA potentially has other, as you put it, high quality options, you would think that perhaps you might lose the patient but in those areas where they don't you have the ability to negotiate a rate that you would be satisfied with?

That's certainly one of the primary fulcrums but there are a bunch of other ones. Our institutional relationships, our physician relationships, what we think is going to happen in a year or two or three, so it's pretty situation specific, fact specific with one of the major fulcrums being the one you identified.

But then bottom line, it's really no different than any commercial payer negotiation that you enter into?

I guess it feels differently to us, because they are veterans, but that may be -- so I guess -- it is not the same, although I can see how some people might think it would be.

Okay. Okay. Fair enough comment. Kent, I don't know whether you will, but I'm going to ask the question anyway. Can you provide any color just sort of on the Amgen contract negotiations, and specifically it is perhaps a little bit unusual to just sort of extend what was a long-term contract by another six months and I'm wondering was that sort of at DaVita's behest, was it Amgen's behest, was it sort of a mutual decision you came to? Just any sort of color you could provide would be helpful.

Sure. It was mutual. That's the answer to the narrow question. And as to the broader question, the good news is I would characterize the discussions as intelligent, measured, thoughtful, constructive, that neither side wants to do something that benefits a lot in the short-term but creates huge chaos or uncertainty or all sorts of trauma downstream.

And so I think the quality of the discussion is among the highest we have had with them, which could be a reflection of us being more thoughtful or them or both, than the past, no finger pointing here. But I think the good news for the community is those are the right adjectives as opposed to either side having an excessive emphasis on some short-term victory that just creates a lot of risk and messiness for everyone. Is that helpful?

Actually, that was surprisingly helpful. Yes. Thank you very much. Is this the sort of process that is now ongoing in terms of negotiation or is this sort of a mutual decision where you said, okay, let's come back at a certain point in time and see where we stand?

Well, first of all, I'm not going to try to do a good job of clarifying things, even when I do it you act so surprised. (laughter)

Can you blame me?

But on that subject, I think both sides want a long-term arrangement and so that is the goal.

Okay. Great. And then just two more quick clarifications. On your pharma utilization, I'm curious, you're obviously making clinical and operational changes, preparing for the bundle and that was partially what drove or is what drove the majority of the decrease in utilization the in the quarter.

I'm curious, is it a factor of you fully were able to make some changes to all of your clinics to see that decrease or was it that some of your clinics have taken the changes or started to do the changes and you need to expand the number of clinics?

I would say that there are virtually zero clinics that have not done some changing. Probably zero. But the degree of change differs quite dramatically. I would also say the other end of the spectrum, virtually no clinics are done changing.

Okay. And then finally, either for you or Luis, in terms of the pop that we saw in the SG&A expense, was there anything in there that was unexpected in terms of, oh, we literally didn't expect that we needed to spend this money or was it more of a timing issue that perhaps it showed up a little bit earlier, more accelerated than you expected?

We were not surprised. G&A is something that we track very closely. Of course, there are some things that are timing related, but for us, G&A came in line with where we thought it would come in within a reasonable range. So --

Yes, I think, Andreas, we just did a bad job of thinking ahead and adding together a bunch of stuff that we were getting pretty sure we were going to do X months ago and it wasn't until the annual budgeting and forecasting that we said, gee, it really is going to add up to an unusual amount. And then we went back and stared again at whether or not we wanted to postpone any of it in order to smooth things out and we just decided that would be a dumb business decision and we hoped you would understand.

Okay. Great. And actually one more, if I could. In terms of the potential for any change in the transition fee, I'm just curious, does it sort of appear to be the situation that CMS is taking the position that in order to do something before 2011, that has to be legislated but once we get into 2011 it becomes regulatory and CMS can make the change themselves? Is that the dynamic?

You know, I didn't catch that.

Let me go ahead. You pretty much got it right, Andreas, that although we believe CMS could change the decision right now and we feel that it's a pretty clear rifle shot to their right to do that. Some of the important people there disagree and say we ought to wait until what they see is the normal window for them making the regulatory change, which is out there in the future a bit. Is that responsive?

Yes. Yes. Thank you very much.

So at least you didn't act surprised on that one.

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

Thanks. I've just got a few follow-ups here. First, on the case mix and the outliers, can you remind me -- I think the Medicare rate that was published was somewhere like the $239 range on average. How much of this is supposed to come from case mix and outliers on average?

Yes, several dollars of that.

Okay. So something like $3 or $4?

Yes, that's about the range.

Okay. And given -- it sounds like you're fairly concerned as far as not knowing how CMS is going to treat your documentation. Do you expect not to accrue for that in the first couple of months until you see how they do it or will that not be a problem for the first quarter, you'll know one way or the other?

Let me be more specific. The documentation requirements are quite extensive and in the rule, well, in the supplemental transmittal. So they expect us to have original diagnosis down to a very specific set of ICD-9 code. And then as to your revenue recognition, no, we will not recognize revenue for something where we're not sure or certain that we have proper documentation for.

In other words, Justin, in most instances you know when you submit the claim because if you know you have to have documentation for something that you know the patient has but you don't have the right documentation you submit the claim for the lesser amount, and then if and when you ultimately get the statutorily required documentation you have to rebill which is part of what makes this just a huge administrative morass.

So do you think you're going to get that $3 or $4 right off the bat?

We're saying no, Justin.

Okay. And then on the Medicare revenue cut, you mentioned the $140 million was kind of a year-over-year estimate. Given I think your investors would be more interested in the current run rate of earnings, I was hoping you might be able to give us comparable cut estimate using the fourth quarter Medicare reimbursement per treatment as a starting point?

Justin, we think the right way to look at it is year-over-year and that $140 million was the year-over-year number, so we're going to stop with that.

Okay. And just a couple more. The hemoglobin between 10 and 12, just curious in terms of the quality oversight from CMS on hemoglobin levels can you remind us what kind of metrics they're going to be checking? I believe there's a certain percentage that they're going to allow you below 10 and over 12?

Yes, actually the performance standard comes into play in 2012. And you're right, they're measuring two aspects of hemoglobin, the sub-10 population and the greater than 12. The benchmarks for performance are this. You use the either/or, your own individual average in eight compared to actual performance in 10. Or the national average in seven compared to your actual results in 10.

Okay. Can you tell us where those numbers are supposed to be? Like how much is allowed to be below 10, I guess, would be the question?

Justin, it's going to be on a center by center performance.

Okay.

So I can't give you that data.

What percentage of your patients are below 10 right now?

Justin, we don't have that number right here with us. So -- and we didn't disclose it, so just focusing on the percentage of patients between 10 and 12.

Okay. Just last question, looking ahead to the Investor Day, there are a lot of moving parts obviously in 2011, like the transition adjustment which is a pretty big headwind, and then you've got this DSI acquisition which probably doesn't impact you much in 2011 but should be pretty beneficial to 2012. So when you get to that Investor Day on May 3, in addition to giving us more color, putting a range of outcomes around 2011, will you be able to tell about what you -- the expected earnings power of the Company should be in 2012 and 2013 when the transition adjustment should get reversed and DSI earnings start showing up in the P&L?

Justin, as you know, for a lot of years we did give a three-year rolling forecast with all the appropriate qualifiers, but as a way of helping you identify the most significant swing factors so you could maniacally focus on those. We would hope to do that in May with the qualifier that if we don't think we can do it well enough to be useful we'll wait longer before we start doing that again. But we prefer a world in which we do that just as you do.

Okay. Great. Thanks a lot for all the help.

Thank you, Justin. And on the $3 to $4, it's not that we're thinking that every single difficult case mix adjustor will never be billed or collected, Justin, it's, we think, a relatively realistic prediction of the instances in which we'll never be able to get the quality documentation to justify that which is true.

And as you all know, that have been around, at some point we're all going to get subpoenas accusing us of playing games with case mix adjustors. So even if I know you're right-handed, if I can't get all the right paperwork because the hospital doesn't have to give it to me then I can't bill for the fact that you're right-handed. And in some cases, unfortunately, that's just exactly what's going to happen and it's not what was intended but until we get the system fixed it's what's going to happen. Operator, next question, please.

Your next question comes from the line of Kevin Fischbeck with Bank of America-Merrill Lynch.

Hello. Yes, just a quick follow-up question here. I think at the beginning you might have said it but if you did I missed it. You said at the beginning, capital deployment was going to depend on share repurchase and acquisitions and cash on the balance sheet and those things that move around from time to time. Did you give a baseline number for what you think you need as far as cash on the balance sheet just to run the business, and then the cash number might grow off of that, but how much do you need just to run the business simply?

Cash on the balance sheet, about $100 million to $200 million would be sufficient to account for the seasonal variations in net working capital in the business, Kevin.

Okay, great. So anything above that might be deployable, then?

Correct.

That's all I had. Thanks.

(Operator Instructions) Your next question comes from the line of Andreas Dirnagl with Stephens.

Yes, Kent or LeAnne, just out of curiosity, when it comes to the outliers and the underlying diagnoses, are those diagnoses that are made by the nephrologist or is that made by another physician in the majority of cases?

In almost all cases it's made by an oncologist or hematologist or GI physician, that's the problem.

Okay, yes, okay, that's helps explain. Thank you very much.

Thanks for asking that question, Andreas. It's a very important fact.

There are no further questions at this time.

All right. Well, thank you all for your time and attention. We'll look forward to seeing many of you in person on May 3 and talking to the rest of you again. In the meantime, we will do our best.

Thank you for joining today's conference call. You may now disconnect.