德維特 (DVA) 2011 Q2 法說會逐字稿

Good afternoon, my name is Allie and I will be your conference operator today. At this time I would like to welcome everyone to the DaVita second-quarter 2011 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). I would now like to turn the conference over to your host, Mr. Jim Gustafson. Sir, you may begin your conference.

Thank you, Allie, and welcome everyone to our second-quarter conference call. We appreciate your continued interest in our Company. I am Jim Gustafson, Vice President of Investor Relations. Here with me today are Kent Thiry, our Chief Executive Officer; Luis Borgen, our Chief Financial Officer; and LeAnne Zumwalt.

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 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, we would 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 will now turn the call over to Kent Thiry, our Chief Executive Officer.

Thank you, Jim. The second quarter was a strong one, as most you have no doubt noted, both in terms of our results and our momentum going forward, both clinically and financially. I will try to quickly cover four topics before turning it over to Luis -- clinical outcomes, government reimbursement, government inquiries and our outlook.

First, clinical outcomes, which we always present first, because that is what comes first. We are first and foremost a caregiver company, now serving approximately 131,000 patients.

With respect to adequacy, which is essentially how well we're doing at removing toxins from our patients' blood, this quarter 97% of our hemodialysis patients have a Kt/V greater than 1.2.

Second, with respect to vascular access, 69% of our patients have fistulas, which is the preferred form of vascular access. For these and virtually all other clinical measures our patient outcomes compared very favorably to national averages. This quality clinical care not only results in healthier patients, but it also drives reductions in hospitalizations and surgical procedures, and therefore bring significant savings to the United States healthcare system.

Second topic, government reimbursement. Luis is going to report on a bunch of the details there, but I will just make four contextual comments. A., no doubt downward pressure will be greater going forward than it has been looking backwards.

B., nonetheless dialysis centers are usually discrete within the context of the Medicare program, with 87% of our patients being either Medicare or Medicaid, and almost all centers being freestanding. Which means that if government reimbursement becomes inadequate centers close. There are virtually no parts of American healthcare where cause and effect is as clear.

Point C., with all the pressure on government deficits, there is always the chance that over the next few years MSP will be extended. And fourth, point D., is that we have significant hopes that the pressure on government spending and the government deficit will finally get us over the finish line in terms of the government implementing a bigger bundle than currently, where we are already have the proven ability to drive quality improvements and total cost savings for our patient population if they only put in place the architecture for us to do it on a scale basis.

Again, Luis will cover some of the government reimbursement details, but those are some of the broader perspectives.

The third subject, government inquiries. We did learn from the US Attorney's Office for the District of Colorado that it has opened up a grand jury investigation. I will make three specific comments and then three generic ones that you have heard before many times if you have been with us over the years.

But the first specific comment is it is clear that this is very preliminary at this stage. Second, however, we always take these things seriously, and we look forward to cooperating with the government. And we mean that literally when we say that, because we are eager to educate them as to exactly what we have done or not done.

Then point 3. It appears there is a lot of overlap with subjects covered, particularly physician relationships, by the old St. Louis investigation which has started in 2005. They look into those subjects, spend time with us, and it has been quiet for over two years.

But separate from the specific comments, I will make three generic points. And again I ask the forbearance from those of you that have been with us for a long time. We do thousands of transactions, including hundreds with physicians, and we work very hard to get everyone right technically and in terms of spirit. We are comfortable and confident with our business practices and these practices regularly go through extensive internal and external review.

Finally, none of those words would mean much of anything, except our track record of compliance over the last 11.5 years is exceptionally well-established and documented. We did not design the system whereby instead of having discussions, the review process starts with publicly announced investigations. But we have dealt very successful with that system for 11 highly public and transparent years.

Fourth, and finally on their outlook. As our press release indicated, we are raising our 2011 operating income guidance to be between $1.08 billion and $1.12 billion. Importantly, this guidance [does] include the non-cash goodwill impairment that we took this quarter. We are also increasing our 2012 OI guidance range. That new guidance for 2012 is $1.2 billion to $1.3 billion.

We recognize that this is an unusually positive adjustment to guidance. And, as always, there is risk we could be wrong. But also, as always, our guidance contains the overwhelming majority of probabilistic risk-adjusted outcomes.

In addition to the fact that there is some one-time bundling and other adjustments that are going positively for us, our base business, the operations and strategic initiatives are in fact going well, both in terms of near-term results and momentum.

I will now turn it over to Luis.

Thanks, Kent. I would like to start with a few words about government reimbursement. CMS released a preliminary 2012 reimbursement rule, which includes our first market basket increase, which was proposed at 1.8%.

Also, the transition adjustment are bundled, phased and taxed, as we have referred to it, remains at zero in 2011, and for the remainder of the three-year transition period.

Under the terms of the recently signed government debt deal, there is a scenario may Medicare rates to providers could be cut up to 2% a year beginning in 2013. This, of course, depends on whether the super committee can develop an alternative proposal, which itself could also contain Medicare cuts.

In other government reimbursement nine states have already reduced Medicaid rates this year, and California has passed a budget reducing rates 10% across the board to all providers. This California cut will likely be approved by CMS retro to June 1.

We expect these Medicaid pressures to continue into 2012, as many states are looking at rate reductions, and some are even looking to reduce or eliminate secondary coverage for dual eligible patients. Also on the government front the Veterans Administration is still seeking to recontact at lower rates. We continue to talk to the Veterans Administration in an attempt to come to agreement on mutually acceptable rates, which will likely be below our current [EA] rates.

Now some discussion of our operations. We saw very solid trends in the quarter, reflecting strong treatment growth, improving revenue per treatment and commercial mix, and solid cost controls. All this resulted in continued strong operating income and cash flows.

Here are some specifics on the quarter. Non-acquired growth was 4.6% normalized for days of the week, an improvement from 4.2% normalized in Q1. Dialysis revenue per treatment was up about $6. The primary driver was the Medicare transition adjustor fix. Also we saw an improvement in commercial rates that were partially offset by declines in lab revenue following seasonally higher lab revenue in Q1.

It is notable that commercial treatment mix improved very slightly in the quarter. While this is good news, it is too soon to tell if this is the beginning of a trend. Commercial mix continues to be a swing factor, especially in light of challenging macroeconomics conditions.

Dialysis patient care cost per treatment was flat with the prior quarter as increased compensation and benefit costs were offset by seasonal declines in the payroll tax expense line. We took an after-tax non-cash goodwill impairment charge of $14.4 million in the quarter. This is related to writing down the value of HomeChoice Partners, our home infusion business.

We wrote down the goodwill because the performance of the business has declined over the past year, leading us to believe that at this point the fair value of the business was less than our book value. Risk accounting rules mandate that we write down the value of the business.

Despite this write-off, we have seen some positive trends in the business. The business continues to be profitable, and all of its growth has been funded with its own cash flows. Thus DaVita has not made any additional capital investments beyond the initial purchase price. We still believe home infusion is an attractive market and HomeChoice is a well-positioned asset.

Operating cash flow year-to-date was solid at $534 million. We continue to expect strong operating cash flows for 2011, and are raising our guidance range to $900 million to $980 million.

In the quarter we deployed $39 million on development CapEx, $70 million on acquisitions. And additionally we repurchased 3.5 million shares of stock for $302 million, $25 million of which settled subsequent to quarter end.

Finally, an update on DSI and international. On the international front we are pleased to announce that we are now dialyzing patients outside of the US. We are managing one center in Singapore, and we have a minority stake in a company with two centers in India.

As to the DSI acquisition, at this time we still expect to close in the third quarter. We're in the final stages working with the FTC on divestitures, and they have determined that we will have to divest approximately 30 centers. We still expect approximately 0 net OI contributions from DSI in 2011 after transaction and integration costs.

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

(Operator Instructions). Justin Lake, UBS.

The first question I had was on the guidance change. If you could give us some color there in terms of any specifics on what the improving outlook is for 2012 -- 2011? And then for 2012 maybe you can break it down between the expected DSI contribution and the improving internal operations?

I will give you the general -- the reason we raised guidance for 2011 and 2012 are the following. Obviously, we have three more months under our belt this year and we have experienced solid operating performance. We have an improvement in NAG of stabilization in our commercial mix.

The second factor was that we have more clarity in our 2012 reimbursement rate levels. Part A., of that would be obviously the elimination of the transition adjustor fix. And number two, we have a market basket increase of 1.8%. Those are two additional clarifying factors.

Third, is the change to the EPO label we believe will lead to lower pharma utilization levels as physicians respond to the new label. Those are the three main factors that led us to increase guidance for this year and next.

Great. If I could just grab onto that last piece, the impact of the new EPO label. I think Amgen has put out numbers that indicate they expect this new label and the QIP associated with it to drive about a 10% decline versus their previous estimates and EPO dose. I'm just curious your opinion on what that change might be.

Clearly it will depend on physician prescribing patterns, and how they react to the label, but we don't think that estimate of 10% is out of line.

Okay, great. Then just a couple of other quick ones. Commercial mix, you noted improved slightly in the quarter. Any other detail you can give us there. And what was the assumption here for the back half of the year in 2012, did you move the assumption to now being flat to improving, or do you still expect that to continue trending downward and this is just white noise in between?

Our outcome -- our operating guidance assumes a reasonable range of potential mix scenarios heading into the balance of this year and into next. It was slightly positive in the quarter, and that is all we can say. It is too early to determine that to be a trend.

Okay, great. And last question on other ops. Can you walk us through that? The losses seem to be increasing. I assume that is a lot of international investment. So can you walk us through the increasing losses there, and if you could spike out how much you spent on international on the second quarter that would be great.

Our second-quarter G&A was up. It was due to various factors. One factor was international, which had increased spend per our plan through Q2. Another factor was the 123R expense. And a third factor was some increased spend on the legal and compliance area. Those are the factors year-over-year.

I think your question was more specifically to the other operating breakout that we have in the supplemental data.

Right.

That $25 million there was primarily impairment charge. It (inaudible) that line item.

Well, sure, but you can ex that, it seems like it has gone up the last couple of quarters. I'm just curious, is this a good international run rate for the year now?

I would say no. We had guided earlier to about a $15 million operating income investment. Our best estimate now is that it is closer to $20 million for the year, and that is incorporated in guidance for 2011.

Okay, great, thanks (multiple speakers).

One more clarification. The international operations for dialysis are in the dialysis segment, they're not in the other operating line.

Got it. So international is not included in that other operating?

Correct.

Great, thanks for all the detail.

Kevin Ellich, Piper Jaffray.

Just a couple of questions. Luis, just to clarify, the guidance in 2012 does include DSI Renal now?

Yes, it does.

It does? And how much contribution did you bake in for 2012?

We are not breaking that out, but it does include a full year of DSI.

Got it. Okay, and then thinking about just going back to the Amgen discussion, have you guys finish renegotiating your contract for EPO yet?

No, we're in discussions with Amgen.

Okay, and have you given any color in the past about how long you would like to extend that contract?

We have not.

Okay, thanks. Then looking at the non-acquired treatment growth, it ticked up a little bit higher than what we have seen historically to 4.6. Is that just normal fluctuation or is there anything driving that, do you think?

We think we did a good job executing and we hope it continues.

Okay. Then, Kent, since I got you, what is your belief on the MSP extension? I know there is a lot of moving parts going on in Washington now, but what is the likelihood or what probability would you put on that, and I guess over what time frame?

I think it is pretty impossible to handicap, because employers are opposed for all the obvious reasons. They have benefited from this unique subsidy for a long time. On the other hand, in the last 20 years it has been extended a few times. So I think predicting is in current political and economic environment a little bit of a fool's errand. It is not predictable. So it might happen. It might not happen. It might happen to some degree. Anybody's guess.

Understood. Then just thinking about EPO utilization trends, Justin touched on this a little bit, but can you talk about how much lower you really believe it can go, maybe not getting too specific? But Amgen said 20% to 25%, so is that kind of ballpark where you think it will fall out?

We are making no prediction. Amgen knows a lot more than we do perhaps. For us, we wait and see what kind of prescription decisions our doctors made in light of the new label and any other emerging conversations and evidence. So for us we're just executing on physician orders.

Okay, thanks, guys.

[Matt Wade], Feltl and Company.

I am curious on your comments. Amgen has made the comment that they were not in favor of CMS' proposal to retire the Matrix and QIP of penalizing less than 10 grams per deciliter. How do you -- I am just interested in your comments in that regard.

Well, CMS made the clarification that they believed it was no longer consistent with the new label, so that is their rationale. We would tend to agree with that. I think the reality is that there will be a hemoglobin level and range that emerges over the next year or so as physicians adopt this label change, and we will wait to see what that is.

In terms of the proposed 2014 QIP, is there anything in particular of the new proposed seven metrics that give you cause of concern?

None of the measures specifically, but clearly our concern all along has been as CMS adopts standard definitions and account for lab donations and things like that, which they have yet to do. So we will continue to work with them to improve the methodology.

Okay. Last question here. Any update from last quarter -- you referenced difficulty in capturing all the case mix adjusters and quantified it as a $2 per treatment lost opportunity. Anything new that you can share with that?

Unfortunately, it continues to be a challenge. We are continuing the dialogue with CMS to understand how they can help us obtain that data.

Okay, and then last one here. In terms of your patients can remind me what percentage of your patients are treated at home?

Yes, about 10% between peritoneal dialysis and home hemodialysis.

Okay, thank you.

Gary Lieberman, Wells Fargo.

Thanks for taking the question. Did the prior guidance include DSI or is it in there for the first time in both periods?

The prior guidance did include DSI for both periods.

Okay, was there any significant change from what was in there previously that you can share with us?

No, it would be no changes that would be material.

Okay, so it was about the same amount. Then can you talk about any pressure that you saw on commercial -- overall commercial reimbursement from any of the contracts that weren't bundled in the quarter due to former utilization or was that not an issue for you guys?

If you had a prior payer relationship that was not bundled, and so it was still fee for service, pharma separate from treatment, and if your pharma utilization went down, you would have revenue compression. But am I answering your question or not?

So let me ask it another way. So in the aggregate did that dynamic negatively affect you at all in the quarter?

Since we have some fee-for-service private revenue, the answer is yes.

Was the amount material?

I don't know. I guess we could get into a debate as to what material is or not. It is incorporated into our results. And of course, we have other private revenue which is bundled and so reductions in utilization benefit our economics. And so there are two different numbers and I think we'll just leave it that they are incorporated into our results. We are very glad that we bundled a lot of the business that we bundled over the last 18 months.

Okay. Then just on Medicare revenue per treatment, did it effectively go up for the change to the transition adjustment or were there any other notable changes to Medicare revenue per treatment?.

Just the transition adjustment.

Okay. Then finally, Kent, just your initial comments about seeing increased government pressure going forward, can you elaborate on that at all? It would seem like the proposed rule was generally favorable, and while I guess everyone is nervous about what Medicare reimbursement might be like, going forward, is there anything specific that led you to those comments?

No, nothing specific, just the same reality that we are all reading about in the newspapers.

Okay, great. Thanks a lot.

Kevin Fischbeck, Bank of America.

A question on your commentary in discussing the guidance. You mentioned that there were some one-time items -- positives related to bundling and other adjustments in your outlook. Can you elaborate on that?

By that I just mean things like one-time changes in pharma utilization, things like that, as opposed to acquiring businesses or opening up to de novos which recur every single year and lead to incremental growth, some of these other changes are recurring but they only happen once.

Okay, thank you. The cash flow guidance for 2011 was raised a little bit more than operating income. Anything in here that makes 2011 not a good base to think about 2012? Normally I just take next year's number and add free cash flow -- I mean, add net income to this year's cash flow to get the next year's outlook. And the reason why that is not a good analysis to do?

No, it is a good baseline. As we go into the year we may give you some more detail on that, but it is a reasonable starting point for 2012.

Okay. And the Company was very aggressive in share repo in the quarter, which is a good thing, I think. But you still have a lot of cash on the balance sheet even after DSI. Just to get at the free cash flow, I mean, do you look at the share repurchase in Q2 as a way to think about how you might deploy capital going forward, or is there something during Q2 that made you feel like it was a better time to be in the market?

It is a very fair question and we will give the same answer we have given for about 11 years now, that every quarter brings its own unique analysis to what we should do with our cash and with our net debt position, and all the generic factors go into it, what business opportunities we have, what business opportunities we anticipate, what we think is going to be happening with the capital markets, what we think is going to be happening with the government.

So every single quarter is unique. And we think that is the way we can serve you best.

Okay, and then, I guess, staying on the capital deployment side here. Any thoughts on the Fresenius field activity? Any opportunity to pick up some assets they would have to divest?

Certainly, they will have to divest some and we would hope that we would get a shot. Don't know if we will or not.

And I guess, what is the deal (inaudible) got some $70 million on deals. Is that a good way to think about it? Has the environment caused the one-offs to reconsider selling?

Could you say the question again please, sir.

Well, I guess, as far as the acquisition outlook, are you seeing any change in the one-off providers looking to sell in the face of all the regulations going on right now?

I think the data suggests that there is an increase in the number of people interested in selling. I would have to go back and take another look, and maybe somebody on the call will confirm it and we can come back and say that it is right.

But if you look at now in the last 12 months compared to the prior 12 months, and then in particular if you compare the last 24 months to the prior period, that the number of deals is up. And I got a number of people nodding their heads up and down. So I think the answer is yes, and a lot of that is because of the -- all the regulatory uncertainty and pressures.

Okay, great. Then last question here. Congratulations on the international expansion. I just want to get a little more color there. I mean, one site in one market, and a couple of sites in another market, it seems like a small footprint. Obviously, it is a beginning. But is there some way to think about that if you put a flag in a market there is a backlog of X sitting there behind them, how quickly should we think about these markets starting to grow?

Again, a very fair question. I am afraid our answer is going to be pretty worthless. Because we are so new it is that while it is true we would not have started in either of those geographic areas unless we thought there was a lot more opportunity, we are not nearly competent enough adding it to start predicting exactly what is going to happen when.

So we continue to feel very good about the growth prospects, but we always have to immediately follow it up by saying this is a long-term strategy that is not going to start probably adding to shareholder value for quite some time. So time will tell.

Okay, fair enough. Thank you.

Ben Andrew, William Blair.

Maybe just if you could talk a little bit about the organic growth in the quarter for patients. It was a little bit above our target for the population generally. Was there anything in particular there that you saw that gave you reasons for optimism they could stay at those sort of levels or might we expect it to drop back down?

When you say organic, I assume you mean non-acquired growth.

Yes, sir.

We do think we earned the number. We don't think it was a fluke. We have been working on nudging it up. And so it is an earned number. Having said that, we are not sitting around saying that it is in the bag, that it is going to stay where it is. So we are continuing to peddle away with a lot of intensity. And so I'm afraid we can't offer up any distinctively bullish point of view going forward, although certainly our point of view is embedded in the guidance we gave for 2011 and 2012.

Okay, and then in terms of the cost side, we have had some checks in the field in terms of -- there is a view there might be an opportunity for some facility consolidation in particular markets. Is that a path that you move down regularly or that you see as an opportunity?

We are always open to consolidating facilities when it makes sense. It doesn't happen very often, only a few times a year. In a lot of those instances it's only because one center is quite old and would require a whole bunch of renovation. So I don't see anything that is going to lead to any material increase in that happening over the next year or two.

Okay, and then, finally, on the reimbursement side. You discussed the pressures kind of growing a little bit on the privates and Medicaid and the VA. Is there a time frame that you think about perhaps some of these issues can be clarified and you will have visibility, or is this more of a just terribly durable process there is no getting away from and you are just trying to manage it as you go along?

It is -- a fair wording of the question is it is much more of the second category than for the first. It is impossible to predict in some of these cases, not only what the resolution is likely to be, but when is likely to be resolved and we just persevere.

Again, on the private side, is there a geographic localization? Is it national? Because we have heard a fair bit of variability from market checks in terms of where it is growing -- and are you saying that spread? Thank you.

Could you go ahead and ask that one again, so I don't ramble in responding.

Sure. We have done specific checks, where certain geographies, say California, a private rates very close to Medicare and other geographies, like the Northwest, pay multiples of that in terms of the privates. So are you seeing the pressures on the private side expanding geographically the regions that historically have been strong, or is this a national issue that is growing in importance?

Well, first of all, when we talked about downward pressure we were talking about Medicare. I don't know that we opined at all about any particular difference in what is going on in the private side.

And on the private side I would say that the pressure we feel there is the same that we have always felt, no more or no less. Some years we do better in fighting it than others. But there hasn't been any demonstrable change in that sphere in this quarter versus other recent quarters.

Then, I guess, building on that, with respect to geography, while there are differences in average revenue per treatment across different geographies, even though within every geography there is quite a spread of rates, nonetheless the average rate for a geographic area can be quite different. We have not picked up on any sort of systemic new trend in any particular geographic area.

Thank you.

Darren Lehrich, Deutsche Bank.

A couple of things. I wanted to just ask about cost per treatment first. I think, Luis, you mentioned in your script increased benefits cost relative to maybe last quarter. I know the payroll tax starts to wane. But can you just maybe give us a little bit more there? Was that anything unusual relative to medical costs in the period, or is this a benefit cost that is going to carry with you in the next several quarters as well?

There was nothing unusual in that. We do have fluctuations quarter-to-quarter in how the claims come in, and therefore how much expense we have to book. But the patient costs per treatment was relatively flat as we had guided previously.

Okay. Then if I could just ask about Lifeline and DaVita Rx. One question I had just on Lifeline is we obviously had a big transaction announced yesterday in the access market. What is the business model that you guys have there at this point? Is it still a management model or are you tweaking that? I just wanted to get a brief update on that.

Then anything you could say about DaVita Rx by way of an update in terms of its performance would be great.

With respect to Lifeline, we are still primarily a management model. And with respect to DaVita Rx it continues to grow. It continues to have some profitability. And it continues to add a lot of clinical and service value for patients and savings for the taxpayer.

What is the run rate at this point in DaVita Rx?

I don't think we have disclosed that, so if I do it spontaneously I will probably get lectured after the call. So let us reflect and see if we need to start parsing that out for you.

Then as it relates to international, I think Kevin really got that at most of it, but in India with this minority stake in a company, can you just maybe give us a little bit more insight into who or what that local partner is? Do they have experience in the marketplace or is this a completely new entry for both of you into the country?

Maybe I will preface the answer by just saying that there isn't anything that is economically material that is likely to happen in India for our shareholders for a long time. However, if you look seven, eight, nine, ten years out, we think there is significant prospects for that, but it is a long time for all the reasons that you could list as well as us.

Having said all that, the answer to your specific question is it is a small startup company. And the primary owners of the company are experienced business people. And they're running a couple of very high quality centers, particularly in the context of the overall Indian reality. And some are looking forward to a -- hopefully some very nice growth there. But it is obviously coming off an incredibly tiny base and the revenue per treatment is quite a bit smaller than America.

Sure, I get that. Last thing, just LeAnne, and the anemia management metrics, we usually get those in the releases or these calls. I'm just wondering if you can help us with that?

We have been changing the label. I think we are definitely going to see some movement in mean hemoglobin, et cetera. The stat that we have historically provided is our percent of patients between 10 and 12, and that has remained pretty constant this year at about 79% of the patients.

79%. Thank you.

Gary Taylor, Citigroup.

A couple questions. I notice that bad debt ticked up a little bit sequentially in year-over-year. Would you just attribute that to general economic conditions? I am just a little curious why we didn't -- we haven't seen that maybe a year or so ago. But curious to your thoughts.

I missed. I am sorry, what ticked up a little bit year-over-year?

I think bad debt as a percentage of revenue ticked up maybe 30 bips sequentially and 20 year-over-year. Not a big movement, but it has been a pretty stable number for a couple of years.

Yes, we did increase that by 25 basis points in the current quarter. And that is our new run rate going forward. As we looked at the portfolio and how those receivables were coming we thought it was appropriate to reserve at a higher level, which is about 25 basis points higher than the prior quarter.

I know it is a small change, I don't want to belabor it, but it sounds like your commercial mix was a touch better, so I guess presumably in some of that commercial mix there is still movement toward higher cost sharing. Would that be a component of this change or am I overthinking it?

Could you run that won by us again. We all have quizzical expressions on our faces on this end.

Yes, I guess I am just thinking what would be the factors driving slightly higher bad debt? At this point you've had some pretty adverse payer mix shift for a couple of years. And now it sounds like you were saying your commercial mix was a little better this quarter. So I'm just wondering if even though commercial mix is getting better, within that mix is there higher cost sharing by the patient that is in part driving the higher co-pay or am I just overthinking 25 basis points here?

It is a long revenue cycle. We look at it as a big portfolio. We have a very thorough process in examining what the right level is, and we determined this quarter that the 25% to the 25 basis points increase is the appropriate level to reserve that. But it is a very multiyear revenue cycle.

(inaudible) I don't think we have any single hypothesis about a particular change in the environment or our mix or our operating performance. And maybe one will emerge. Right now all we have is that slight change in our aggregate outcomes reflecting -- and therefore leading to an accounting change. Maybe we will be able to say more in another three months, but in the meantime it was just clearly something we should do given the aggregate result.

Got it. My last question is just around this Colorado investigation. Can you help us maybe understand -- I know in some states grand juries are required, in some states they are not. It doesn't sound like there was just a subpoena from the US Attorney here initially, but kind of straight to grand jury. Maybe that will be the tool to compel some document production. But is there anything in your mind that differentiates why this is a grand jury investigation as opposed to just a subpoena from the US Attorney's Office?

Unfortunately, we have told you just about everything we know. It is very preliminary, and we are eager to get some time with these folks and find out more about what they're thinking, and let them find out a lot more about our practices and our compliance standards. But right now we pretty much know nothing.

Okay, do you happen to know if a grand jury is required in Colorado or is that -- or not necessarily?

I do not know.

All right, thank you.

(Operator Instructions). John Ransom, Raymond James.

Is there any interest at all from commercial pay at more of a global type of subcapitation? And if not today, do you think any time in our future that will start trending in that direction, that you would manage the whole patient and take the whole risk?

This is Kent. In our dreams, yes, in our plans, no. That may happen. Because of the 30-month rule and, therefore, prior payers ability to have these patients shift to Medicare, their incentive to invest in the kind of things that could significantly save money and improve quality are really limited.

And so, yes, we continue to talk with some people about it. But the fact that the patient base is so small, so fragmented and so short-term means that they typically end up wanting to allocate their management resources to other tricky deals, not ours.

I want to go back to the first thing I said. We have hopes and we're getting better and better at proving how much value we could add on both the private side and the Medicare side every single year, but unfortunately, I don't think there's anything material and imminent for you guys.

Right. My second question would be if you were some sharp young analyst at CMS and you were looking at the bundle, what would you think you would say prescription use is with the new label and with the industry behavior changes,, how do you think prescription use has changed relative to the assumptions that went into the bundle when they were designing it 12, 18 months ago?

All right, now, say that question again. Are you asking us how we think the actual results have matched up to what they predicted a year and a half ago?

Yes, in terms of -- it seems to us like pharma uses a good 10% or so -- 10% to 15% or below maybe what was predicted, particularly with the label change, and not just DaVita, but industrywide. So the concern would be that they take another bite at the apple and redesign it based on reality today versus what was predicted. But I don't want to tilt at windmills if that is an unreasonable concern.

I think the only honest answer to that one is we don't know how they are thinking about that. And we do know that no one knew what was going to happen and that there was an incredible confluence of a policy change, meaning a move to bundling, and a whole bunch of new scientific evidence and new clinical debates and, in many cases, conclusions. So there was this totally -- not totally, but largely confluence of major changes.

And trying to separate out what happened for one reason and what happened for another reason is pretty impossible. And I would also go back to saying no one knows exactly what they predicted. I doubt that they could have had any basis for really making that prediction.

So I think it is just unknowable. The fact is as long as Medicare revenue is less than Medicare expense, they have got to be very careful about cutting Medicare reimbursement, because centers will close. And so independent of what is going on with any one variable, they have got to end up looking at the aggregate. And it remains the case that if it was only Medicare reimbursement out there, you would have hundreds and hundreds -- well, literally thousands of dialysis centers closing.

Okay, thank you.

But a very fair question. We just don't know the answer.

I guess my -- I don't expect you to answer this question, but maybe conceptually how you're thinking. If I am DaVita, why would I have any managed care contracts, assuming you get through the cycle and things are always moving? But if I looked a year out, two years out, why would you have any managed care contracts that weren't bundled, so that the incentives are all in the same place between private and public payers?

Because there is some payers who don't want to bundle or who don't have the ability to bundle, and they don't want to allocate the IT resources or operating resources to change to a new system.

So it would be more resistance on their end than your end this point, I assume?

Oh, absolutely. Sometimes it is differences in data. You talk about bundling with someone and they think they're paying a certain amount and we think they're paying something else, because it is spread across different states and different billing systems and all the rest. So even if you agree conceptually on neutrality, so to speak, you can't achieve it because you have different definitions of what reality is. That would just be another real-world answer to the question that you asked.

Okay, thanks so much.

Andreas Dirnagl, Stephens.

Kent, actually, I just want to follow up on one of those questions just now in terms of -- you know, given your experience with CMS over the years and insight into how they think, have you ever seen them be concerned with specific fluctuations in margin or are they more concerned with specifically what they are spending, in other words, the budget?

In other words, are they going to look at margins and the industry may be going up or are they going to look at the fact that they are spending went down 2% year-over-year?

Andreas, a very fair question. My experience is they periodically look at both. So they will look at aggregate results. But they know that the average margin for a Fresenius or for a DaVita or for anyone is different from their distribution of margins.

So we're still sitting here with -- I am not going to get the number exactly right -- 150 centers that are losing money. And at some point if Medicare economics become worse, we have to give up on a fair number of those.

While at the same time clearly on average we are profitable. So A., they do look at margins overall, but they recognize that margins are an average.

Second, they do look at performance versus budget. And the fact is the new science, combined with the incentives and innovation prompted by bundling, have led to some nice savings versus the baseline they used to be on. And that does make them happy, as it would make you and I happy if we were in their shoes.

Is that helpful?

Yes, yes, actually, quite. Maybe building on that, sort of moving back to DaVita for a second then. If you look at the work that you, and even the rest of the industry have done, a lot of it -- and a lot of investors' questions are always centered around EPO utilization. I am wondering can you gave any color on other areas that you're potentially looking at? Are we going to see potentially some slight margin increases coming from putting pressure on other drug manufacturers? Are you looking at labor productivity improvements that you can push through now that you're really motivated with this fixed-price reimbursement?

Well, on the labor side, if I'm understanding the question, we were bundled before, since all our labor costs were captured in the bundle of the prior dialysis treatment amount. So I'm worried that I might be misunderstanding the question. Can you come at it again?

Well, I am just thinking clearly you and the industry and are spending a lot of time thinking how can we reduce our costs across the board. I'm wondering whether that focus, whether it be on other drugs beside EPO, whether it be on labor or even some other things I'm not thinking of, whether that sort of renewed focus is bearing any fruit in terms of saying, okay, you know what, we could be more efficient here?

Okay, thank you. I would say, yes, there are other areas where we have been able to innovate. And those successes or the expectation of those the successes has been baked into our guidance which we discussed earlier. And this is also why at the top of the call I talked about one of the four important government contextual factors being our desire and the increased chance of getting an even broader government bundle that would start to incorporate things like vascular access or some other items that are outside the current dialysis bundle, but where we are confident that if we were given that revenue and that accountability we could come up with better ways of doing it.

So, yes, there are some successes, and they are baked into the guidance. And, yes, we hope the bundle gets broader yet so we can do more of that.

Okay, great. Then just maybe before I move on to Luis, quickly. I am just curious, Kent, again in the international arena, again a single management of a single clinic in Singapore. You've got two footprints in two clinics with a minority interest in India. I'm kind of curious, first of all, A., who you have chosen to run the operation and run the investigation. Are you taking someone -- an existing DaVita person and moving them to Asia? Are you looking to local talent so to speak?

Then, quite bluntly, at this rate how do you expect to spend $20 million on this this this year?

Yes, we do recognize the ratio of overhead dollars to treatment is a little hefty right now. We have hired a local executive based in Singapore, a former American Express executive. He starts -- I think he started yesterday or the day before. And we have other people on the ground in a couple of different places around the globe, including that equity investment in India.

And so right now, of course, we have -- we labor under tremendous diseconomies of scale. Not only because the operations are small, but the legal expenses and compliance expenses are very, very high as we get to know each new market and its regulations.

So it is going to be pretty grossly inefficient for a while. And this new executive is hopefully going to drive enough growth so that in X number of years we can manage the fixed cost infrastructure to your satisfaction. Am I giving you the information you want or am I missing the boat?

Well, I think so. I think mainly let me restate it and see if I'm understanding it correctly. Basically, you have an infrastructure and are building an infrastructure that is disproportionate to the number of clinics that you are either managing or have an interest in at the moment and it is not just people on the ground in Singapore and India.

That is true. But one big qualifier, most of the losses that you are seeing are not because we've got legions of people lined up taking care of a small number of patients to in one center in Singapore and two in India. It is because of very high legal regulatory and compliance expenses associated with getting started.

So a lot of those expenses are not recurring in that sense once we get our local entities set up an illegal fashion. Once we get our deal templates down. Now those nonrecurring deal-related, legal-related and compliance-related expenses will go down. But at the same time, assuming we're adding a whole bunch of centers, the actual recurring operating expenses and G&A expenses will go up. But the good news is they will be going up because we're running dialysis centers, not because we are paying a lot of attorneys for a lot of hours of work.

Great, that is actually clears it up quite a bit. It is very helpful. Just one quick one or two for Luis then. Luis, whenever you talk about the guidance for 2011 and 2012, you have been very clear that your estimate of zero OI contribution from DSI for 2011 is net of transaction and integration costs. Have you made a decision as to whether or not you're going to be breaking those out? And if so, were there any one time transaction or integration costs in this quarter?

Our plan is to break those out next quarter once we firm those up. We have very little that we have taken in so far. So not really material to the results.

Okay, great, and then finally in your discussion about the government reimbursement outlook you talked about a number of states reducing rates, including potentially in California of 10%. You also talked about the VA rates. Can I assume those are incorporated in your guidance with your normal sort of probabilistic outlook?

The answer is yes. We have been very thoughtful about the range of outcomes. For both 2011 and 2012 on that point.

Okay, great. Thank you very much.

Sir, you have no further questions at this time.

Okay, well, thanks to everyone for your attention to our enterprise. We were very content with the quarter, both in terms of its results and its momentum, both politically and financially. And we will do our best in the quarters to come. Thanks again.

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