德維特 (DVA) 2012 Q3 法說會逐字稿

Good afternoon, my name is Jonna and I will be your conference operator today. At this time I would like to welcome everyone to the DaVita Q3 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. Jim Gustafson, please start your conference.

Thank you Jonna and welcome everyone to our third-quarter conference call. We appreciate your interest in our Company. I am Jim Gustafson, Vice President of Investor Relations, and with me today are Kent Thiry, our CEO, Jim Hilger, our Interim CFO; LeAnne Zumwalt, Group Vice President; and Matthew Mazdyasni, HealthCare Partners Executive Vice President and CFO. Also, Bob Margolis, HCP's CEO may be joining us later in the call as well.

I would like to start with our forward-looking disclosure statements. During this call we may make forward-looking statements within the meaning of the federal securities laws. All of these statements are subject to known and unknown risks and uncertainties that could cause actual results to differ materially from those described in the forward-looking statements. For further details concerning these risks and uncertainties please refer to our SEC filings, including our most recent quarterly reports 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 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 comparable GAAP financial measures are 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.

Okay, thank you, Jim, and thanks to all of you for joining on this call. And we are hoping that all of you and your families and friends are safe and are going to get through this storm okay.

The second quarter was a solid quarter. We did well both clinically and operationally. I will cover three topics -- clinical outcomes, our outlook and then HealthCare Partners in turn.

But first, clinical outcomes as we always do, because that is what comes first. We are at our most basic a caregiving Company serving approximately 151,000 patients now and soon many more when we close the HealthCare Partners combination.

With respect to adequacy, which is essentially how well we are doing at removing toxins from our patient's blood, this quarter 98% of our hemodialysis patients had a Kt/V greater than 1.2. Second, with respect to vascular access 71% of our patients had fistulas.

Third, with respect to phosphorous, 81% of our patients had phosphorous levels less than or equal to 5.5 milligrams per deciliter. We also did very well in vaccinations and a number of other areas. And for these and virtually all other clinical measures our patient outcomes compare very favorably to the national averages.

And this quality care not only results in healthier patients, but it also drives reductions in hospitalizations and surgical procedures and, therefore, significant savings to the US health care system.

Subject number two, for me, is our outlook. The good news is that both DaVita and HealthCare Partners have continued to perform according to our plans and expectations, perhaps even a little better than that, and the ultimate 2012 outlook reflects that trend.

In addition, we are initiating operating income guidance for 2013, and that is to be in the range of the $1.75 billion to $1.9 billion NOI, which of course includes the HealthCare Partners contribution. And this guidance incorporates a majority of the probabilistic outcomes.

We also have a significant number of headwinds and challenges to face on both sides of our enterprise. On the dialysis side some of the most significant risk factors that we had to take into account are a potential 2% cut to Medicare reimbursement due to sequestration; additional risk around additional Medicare reimbursement reductions as there is risk that the physician fix will take place and will be paid for by across-the-board cuts to other Medicare providers or not across-the-board cuts to other Medicare providers.

And then, third, the uncertainty around our commercial book of business, both mix and rates, because sadly we continue to lose money on Medicare treatments and have to rely on private insurance to fill that gap.

Despite these formidable risk factors the fundamentals of our core kidney care business remain noteworthy, both in terms of excellent and continually improving clinical care, a strong market position, steady volume growth and a history of strong, stable cash generation.

So as we look at the intermediate and longer term we are well-positioned in this essential therapy and we are eager to get the government's permission to expand our abilities to provide integrated care to more patients and families across America. We will improve quality and save money once we are unleashed and allowed to do that.

And my third and final topic is an update on the HealthCare Partners combination. We expect the acquisition to close soon. The integration process is going according to plan. We have started to work in partnership with HealthCare Partners management on enhancing their infrastructure to drive new market growth. This, will of course, take some time.

And throughout the process we have become ever more convinced of the foundational strength of HealthCare Partners' business practices in terms of, A., improving health -- demonstrably improving patient health; and, B., providing patient- and physician-centric services; and, C., controlling the long-term health care spend in a highly differentiated way.

Once the combination is completed our leverage ratio will be about 3.7 times net debt to EBITDA, which is only slightly above our long-stated preferred leverage range of 3.0 to 3.5, although we have also said for a long time there will be periods when we go above or below.

Thus through this combination we will have added tremendous upside onto our shareholder platform without much of a change to our balance sheet. And the combined enterprise will have a very distinctive potential for free cash generation as HCP is highly likely to contribute significant free cash flows in 2013 even after the initial debt cost to finance the deal.

I will now turn the call over to our Interim CFO Jim Hilger.

Thanks, Kent. Non-acquired growth in Q3 was 4.4% when normalized for days of the week, and US dialysis revenue per treatment was down about $0.74 from the prior quarter, primarily due to a decline in mix in the quarter. Note that this decline occurred after our mix had remained stable for the first two quarters of the year.

I would like to point out that our private pay population continues to grow in absolute terms, but its growth was outpaced by the growth in government programs, such as Medicare Advantage and the VA in the quarter. US dialysis patient care cost per treatment was up about $0.20 from the prior quarter, which is within the normal quarterly fluctuations.

Dialysis G&A per treatment was down about $0.35 from the prior quarter, benefiting from lower professional fee spending and a continued decrease in the DSI integration costs, as the DSI integration is almost complete.

Please note that G&A cost generally fluctuate from quarter to quarter and we anticipate higher G&A expense in the fourth quarter due to increased IT spend and the timing of legal costs. International losses declined to $8 million in the quarter, reflecting some reduced legal and professional fee expenses. We expect international losses to be in the mid to high $30 millions in 2012.

Debt expense in the quarter was impacted by the recently completed HCP-related bond offering in late August. This offering resulted in approximately $9 million in interest expense and related fees in the third quarter. This HCP-related debt expense reduced our earnings per share by $0.06 below where it otherwise would have been, and operating cash flow was $367 million in the third quarter.

Now a few additional points on our outlook. We are updating our 2012 operating income guidance for legacy DaVita to a range of $1.315 billion to $1.33 billion, excluding the second-quarter legal accrual and certain fourth-quarter transaction expenses related to the HCP acquisition.

Furthermore, the remainder -- for the remainder of 2012 we expect HealthCare Partners to contribute $25 million to $30 million per month in operating income once the merger closes. We are also providing 2013 operating cash flow guidance of $1.35 billion to $1.5 billion.

Next I would like to provide an update on the operating results of HealthCare Partners and some important effects of the HCP acquisition. HealthCare Partners continues to perform according to its plan, delivering strong results in the third quarter, reporting an EBITDA of $161 million.

These strong earnings were a result of two factors. First, seasonal Medicare Advantage revenue true-ups, which occurred in the third quarter of each year and have historically provided a boost to operating revenues and, two, seasonally low utilization. We do anticipate that HCP will see lower operating income results in the fourth quarter, as indicated by our guidance.

We now expect HCP to exceed their 2012 EBITDA earnout target of $550 million. And for 2013 we forecast HCP's segment operating income to be in the range of $400 million to $450 million.

The following are a few more details you should consider when modeling the impact of the HCP transaction this year and next. We anticipate total debt expense in the fourth quarter to be approximately $102 million.

We anticipate our total debt costs in 2013 to be about $425 million, but this could vary depending on any hedging we might do and the LIBOR impact of unhedged debt.

In addition, following the close, and subject to the finalization of purchase accounting, we anticipate HCP depreciation and amortization expense to be approximately $14 million per month, approximately $12 million of which would be amortization of intangibles.

We expect equity compensation for HCP to be approximately $1 million per month. And the effective tax rate attributed to income for the combined Company in 2013 will be in the range of 40% to 41%.

We will have a one-time deal costs for the HCP acquisition in the fourth quarter. We will call out these costs when we report the fourth quarter. And, finally, keep in mind that we will be issuing 9.38 million shares of DaVita stock upon closing of the deal.

And with that, operator, let's go ahead and open it up for Q&A.

(Operator Instructions). Darren Lehrich, Deutsche Bank.

Thanks. Good afternoon, everybody. I wanted to ask a few things here. I guess just in terms of the outlook, I would be interested and just getting your thoughts on sequestration in particular. I am familiar with your probabilistic language in terms of how things get baked in from the risk side of the equation, but I guess I would be curious as to know how probable or how high the probability is in the outlook relative to sequestration just to help us get our arms around that.

I think most of us have assumed in our models that is close to 100% probability. So specific to that, maybe, we would like to hear how you're thinking about that on the risk side.

We also ascribe a high probability to something like that happening.

Okay, so high -- greater than 50%? Just maybe if you could qualitatively help us think about how that is baked into your outlook.

It is KT, I think as you know, and significantly above 50%. We think it is highly likely that something like that will happen relatively soon no matter who is elected. It is not 100%, but we put the number up pretty high. And I repeat that either it or something like it will happen as scheduled or sometime soon.

Great, okay. That is helpful. And then if I could, with Matt on the line we would obviously appreciate detail, Jim, on the HCP performance in Q3. I would be curious to know what the year ago Q3 was. We are all still getting a handle on the seasonality of the business, so just what was the comparison in EBITDA.

Matt, specifically if you can just help us think about the seasonal true-ups and the utilization and what the order of magnitude was for those in the period.

Sure, utilization in the third quarter usually it is better and we had the same phenomenon happen last year third quarter. Also, there were true-up based on our risk adjustment factors. That is the time of the year that Medicare, CMS pays us and updates the RAFT score, so that exact thing happened also in 2011.

Any EBITDA number in 2011 on third quarter against the $161 million and was what?

I don't think we want to go into history at that level of detail, because there is so many puts and takes, but suffice it to say that what is happening this year Q3, Q4 is comparable to what happened last year Q3, Q4.

Okay. And then just one last thing if I could. I would be curious to know if LeAnne is on the line or somebody if you could comment. We are obviously expecting a pretty important rule-making cycle for dialysis in this next year. And I just would love to get your thoughts on how robust you think CMS' data set is. I am sure you have had a lot of conversation with them, but specifically at it relates to the orals, how do you feel that CMS is prepared to include a thoughtful rule for 2014 on that?

Let me take a first pass, and then LeAnne is on the line and she can amend any misstatements. The good news is that CMS is working hard, because they know their data set is fundamentally flawed and incomplete. And so they know that and they are doing good work and good analysis and doing good listening to try to figure it out.

The tough reality is it is not easy for them to do that, and the dynamics of orals are pretty intense. And so we continue, since we are the leader by far in that arena in terms of providing a comprehensive array of orals to patients, we are unique in having the data that shows what well-managed utilization protocols and practices and conventions are that correlate with the best clinical outcomes, both for health and for macroeconomics for the health care system. And we are, of course, dutifully reporting to those -- those to them every opportunity we get.

So good news is they are working it hard and showing it the respect it deserves as an important and difficult issue. The bad these is that it doesn't necessarily mean they're going to get it right, and if they get it wrong it is really bad for patients. LeAnne, what would you amend?

I am thinking, Kent, that was well stated.

It is not often I get that comment from LeAnne.

(laughter). All right, thanks a lot. Nice quarter here.

Gary Lieberman, Wells Fargo.

I guess on the HCP front there was an announcement of an acquisition during the quarter into a new geography. Could you comment on how that is going, and maybe more generally on how you think about new geographies as you enter them and what makes them attractive?

That is -- acquisition is ABQ Health in Albuquerque, New Mexico. We consummated that transaction effective September 1. And we are now in the process of helping them to have all the core competencies that HealthCare Partners has and implement that for that market.

And what I would add is, as has been documented in the public realm, that we are in a bit of a spat with one of the other local organizations there and so right now battling it away, and impossible for us right now to predict what the outcome -- what the short-term outcome of that will be.

Okay, is it possible for you to give us any color on the spat?

No, it is pretty typical stuff when you can't agree on a rate between a plan and a provider that then you get into a bit of a tussle. And that is what is happening. So it is pretty normal as those things go. And, also, it is an intense exchange, and that is why we have to say we just can't predict how it is going to come out.

Okay. Maybe a couple of housekeeping items. I'm not sure if you said it, but what percent of commercial -- of total dialysis treatments was it?

10%.

Okay, and that is rounded, I assume?

Yes.

Okay, and then as you are negotiating the commercial book of business are there any updates? Does it continue to be the same back-and-forth or is it getting more difficult or easier?

I would say at this point it is the same, which is to say all is difficult, all is a big challenge. We are holding our breath a bit. And at the same time there are always some opportunities and it kind of nets out in the last couple of years to a relatively smooth trajectory. It is pretty misleading in terms of how it feels like to be in the boat, but there is nothing dramatically different going on right now in terms of things being harder or easier.

Okay, and then was there any impact from pharmaceuticals on the cost per treatment in the quarter? Did prices go up -- or net prices go up or downing meaningfully in the quarter?

Not really. It was pretty flat in the quarter.

Okay. And, then, if you could just update us on how you're thinking about the use or I guess the potential use of any of the competing drugs that are out there today.

Is there particular one in mind, otherwise, we might ramble too much.

Omontys was the one I had in mind.

Yes, that is what I figured. Well, for us, as you probably recall and many others recall, we made a -- established a serious partnership with Amgen with Epogen, which is the gold standard for anemia management. And so we have got our partner with a very well-established proven drug in therapy. At the same time, we are paying a lot of attention to, of course, what else is going on, and we will be very curious to see exactly what does unfold.

Okay, but you're not doing any kind of small demo or trial with Omontys, are you?

No, we're not.

Okay. Okay, thanks very much.

Kevin Fischbeck, Bank of America.

I will assume that is me then. This is Kevin Fischbeck. I have got a question for you about the guidance for HealthCare Partners for next year. I know that a lot of times Medicare Advantage plans talk about the selling season or their benefit design versus their competitors. I guess when you guys outlined your operating income projections for next year what factors are you looking at to give you comfort with that range for next year?

Well, Kevin, I pretty much -- Matthew and I would just list off the generic stuff -- to take it all into account -- what you think is going to happen with rates; what is going to happen in existing markets with non-acquired growth; what deals we are going to close; all the various components of the medical loss ratio. So -- how much expense we are going to add to ramp up our ability to go into new markets.

So can you come at us again, because I am worried that we being so generic we are not helping you.

I guess it is just that we have seen utilization be pretty low for quite some time. How do you think about utilization going forward and your ability to control that in the context of where your rates are selling out? What kind of assumptions you're making about membership growth in the plans that you guys are aligned with, if that is going to help drive your client base as well?

I think as far as our utilization is concerned, we are pretty comfortable with our projection. By October 15 usually we have very good visibility on all the benefits that all the health plans have filed. So from that point of view we are able to incorporate that to our projection. And I think on enrollment we have looked at our rate of growth for the past few years and incorporated that into the projection.

Okay, and then if you just remind me here, you mentioned deals and I think you guys have talked about doing a [distinct] number of deals each year, so in your guidance you are assuming a certain number of deals. Do you just assume that it is prorated over time? And if you can just remind me how to think about the EBITDA contribution from deals each year.

I think what we did emphasize in the capital markets is that they didn't flow evenly, not like dialysis where we do 20, 30 deals a year, huge numbers of de novos, that HealthCare Partners, the new business in terms of deals comes much more in chunks, and some of them have a lot of potential for post deal ramp-up and others down. So it is going to be chunkier than what DaVita shareholders are used to.

Having said that, we are very confident that in the next few years we will be getting some exciting or attractive deals done. We just right now wouldn't be very good at predicting when. Is that responsive?

I thought that the guidance at the capital market day was something like $80 million of deals a year, and then chunky, bigger deals on top of that. Is that not the way to think about it, and if it is then what is $80 million of transactions mean from a contribution perspective?

As to your question about what prior guidance was provided, everyone in the room is telling me that, no, we did not say what you thought you heard.

And then as to the second one, generically what does $80 million in deals buy you? Boy, it really differs so radically because sometimes you might get an asset with no earnings, but tremendous potential. Other times you get one with nice healthy earnings at a solid multiple. And other times -- well, I won't go through more scenarios, but I think you see from the announced transactions that there are deals that get done in the 6 to 7.5 multiple ranges captures a high percentage of transactions that are actually completed with some odd cited on either end.

Okay, I'm getting confused. Maybe you are assuming debt pay down in your worst-case scenario, maybe that is what I was thinking about.

Okay, then last question. I think you gave the international losses for 2012. I didn't hear 2013. What are you assuming for 2013 in your international losses guidance?

You are right, we didn't provide that. It is, of course, incorporated into our broader guidance, and why don't we provide that next quarter.

Okay, thanks.

Matt Weight, Feltl.

First a question on the guidance for HCP. Can you confirm does that include the two most, I guess, recent acquisitions, ABQ and I think the other one was ARDA?

Yes, it does.

Okay, thanks. And, Matt, I appreciate the color on the risk quoting adjustment that you guys received here in the third quarter. When you look back historically what kind of a contribution has risk quoting done in terms of percent of growth from your revenue PMPM?

That level of detail -- first of all, it moves up and down quite a bit. And, second, that is not a level of detail that we have provided up to this point. I don't know that we ever will, but certainly aren't doing it now because it does move around a fair amount.

Fair enough, thought I would ask. And then the other one with ABQ, I am wondering would you be able to provide any sort of breakout with the membership? I believe they had about 26,000 in MA members, in total maybe 180,000. Could you break the rest out between commercial and Medicaid at this point?

Yes, the 26,000 is MA, and then they have about another 20,000 Medicare regular fee-for-service, and there is about 60,000 Medicaid, and the rest of it commercial book of business.

Okay, thanks. And then, also, I missed the explanations in terms of the G&A expenses. They looked like lower than what we are estimating here for the quarter. Can you provide that again please?

G&A expenses in the quarter benefited from lower professional fee spending and a continued decrease in the DSI integration costs, but it was $0.35 per treatment improvement.

All right and --.

This is Matthew Mazdyasni. I want to go back to your earlier question about the coding. I think what is most exciting to our organization and our physicians and caregiver is by appropriately quoting and documenting it really helped us to do the disease management, the population health, the treatment of these patients. So the fact that we are very good at it I think mostly is because we are looking at it from a clinical point of view and using that information to help us treat the patient more effectively. So I just wanted to add that.

Okay, I appreciate that. And last question, it looks like for the quarter your provision as a percent of the dialysis revenues kind of ticked up a little bit there. Was there anything that you guys want to point out to the increase?

That was primarily driven by changes in bad debt recoveries in the quarter. And as a result from changes in the new bad debt -- Medicare bad debt rules.

Right.

And we expect that to be sustained.

Okay, thank you.

Kevin Ellich, Piper Jaffray.

Just following up on the G&A question to Jim Hilger, is this level sustainable? Is this a good run rate or is there anything where that would push back up?

Well, we have been given specific G&A guidance for 2013, and we are not prepared to do that yet as we are still putting together our budgets for next year, but we do expect G&A expense to increase in the fourth quarter. And again, that is due to IT spend and the timing of legal costs.

Got it. And, yes, the legal costs, is that related to the closing of the deal or something else?

These are not related to the transaction costs. These are other legal costs that related -- compliance and legal spend costs.

Got it. Okay, that is helpful, thanks. And then going to HCP, in nd the press release you guys talked about the $275 million of earnout payments that will be paid this year and in 2013. Is it split evenly between the two years and will it be paid upon closing or how should we think about that?

It is split evenly across the two years, and it is based on the completion of the 2012 results and then the 2013 results and would be paid shortly thereafter. I don't know the precise definition of shortly.

Got it, that is helpful. And then as we all look to incorporate HCP into models is there a good way, Jim, to think about modeling the revenues? Do you want us to just use what HCP had provided in the S4 or is there a more defined or a greater level of detail that you can help us or walk us through?

I think what was in the S4 is a good thing to base your modeling on. I would just remind you that HCP's reported revenue is not -- does not represent the full amount of medical funds under management, and it is a higher number.

Okay. Okay, good point. Thanks. And then --.

When we say under management we mean the dollars where we are coordinating the care.

Right, right. And then you gave us the amount for amortization -- DNA per month of $14 million. Was that the same as what was provided in the capital markets presentation where you gave the guidance of $550 million to $600 million for EBITDA?

It was the same that was in the S4 filing that we did. We did not -- I can't recall the dollar amount we actually put in the capital markets day presentation, but it is the same as that we had in the S4 filing, and we do expect to update that number once we complete our purchase accounting.

And if you give us a follow-up call we can let you know exactly what we said in the capital markets session.

Got it, got it. And then just lastly on the international front you guys have been slowly moving there. Is there anything -- any new markets that are looking interesting, maybe some south, Latin America, anything like that?

We are looking at one or two new countries, because they look distinctively attractive, and we have specific opportunities that are differentially attracted to us. But I think it is probably in your best interest to keep them quiet until we see if we get something done.

Got it. Okay, thanks, Kent.

Gary Taylor, Citigroup.

Unfortunately for me I missed about the first 20 minutes, so please just refer me to the transcript. I don't want to ask something again. But I just wanted to confirm one thing. On the $14 million of D&A per month, that includes both the modest depreciation that HCP had and all of the deal amortization, correct?

Yes, it is the depreciation expense, which should be similar to what HCP had incurred, as well as the amortization of the intangibles. That does not include goodwill, which you do not amortize.

Got it, thanks. And on the 2013 operating income guidance does -- do both ends of that range include sequestration or is that -- can you hit the top end of the range if sequestration stays in place?

The model, of course, is a combination of our assessment of the probabilities across a wide range of variables and not just picking one number for each variable. So could we -- if theoretically we said we had the full impact of sequestration, but did well everyplace else could we hit the high end? I don't -- none of us around the table know the answer to that specific question, because we wouldn't have run that specific model. There are so many swing factors and we play with lots of different probabilities.

So I'm afraid we can't answer that specific one. We can just say the obvious that if you do the math, and sequestration alone has a very big incremental impact, but it is a little bit -- we would be a little bit I think tenuous to say that something like that is going to happen and everything else is going to go really well. That is just not usually how the world works. There is usually more of a distribution of outcomes across the swing factors.

What is the dollar amount you would roughly put as the sequestration impact?

It is 2% of the Medicare revenues. Medicare represents about half of our dialysis revenue, so roughly 1% of our dialysis revenue.

Right, okay. Last question, Kent, when you think about 2014, I know you just gave 2013 guidance. I'm already asking about 2014, but just conceptually, when you think about three big moving parts for the dialysis business in 2014, any potential rebasing -- obviously, the oral is coming into the bundle and where the final payment amount will be for that. And then, obviously some opportunity presumably with EPO going off patent.

When you look at the combination of those three factors, what is your confidence level that those three factors are a net positive to DaVita, a neutral or a net negative versus 2013?

A very fair question, and I think I'll disappoint you in the answer. And there is also, I would throw exchanges into the mix, as another big new development potentially or not. And so there is really four of them. And each one a pessimist would find comfort in being pessimistic and an optimist would find some comfort in being optimistic. And it is probably going to end up being a mix of outcomes across those four.

So right now we don't have a tilt in any direction, other than that much change always feels on a net basis scary when you have got a successful operation that is doing good things for patients and society. So maybe the only leaning I could give you is we would prefer not to have so many big swing factors kicking in 15 months because that is scary stuff.

Okay, any new developments on any of those coming out of NEDC to -- any color to add or not at this point?

Nothing, I think, that would help any of us predict the outcome.

Okay, fair enough, thank you.

Ben Andrew, William Blair.

Maybe for a change of pace, Kent, can you talk a little bit about your latest thoughts on integrated care within the traditional dialysis business? It sounds as though perhaps there is a greater impetus towards an RFP early in 2013 of some size.

Yes, it does. I don't know, at some point you just worry about losing all credibility, although I think we always hedged with sufficient clarity that we are not actually wrong. But it does seem that in the next six to nine months they are certainly intending to come out with something. And they had hopes of doing it in 2012. That was their own goal, but I think it would be unfair to criticize them for not hitting it, because it is very tricky. And the good news is that they're asking a lot of the right questions and soliciting a lot of the right input.

So I would be quite surprised if we got through -- unless the election results or some other external factors throw everything into disarray -- I would be very surprised if by six months into next year we didn't have an RFP to react to -- a comment period.

Are we wrong to think it could be of significant scale, even as much as a 10% of the overall market?

You know, we do not know and so some of someone would have to have better intelligence than us in order to answer that question. I just don't know how confident they are going to get in the end. We are so confident that we can give a great clinical and economic gift to patients in America if we are given a fair shot, but as to how risk-averse they will be in the end, I just can't say.

We, of course, try to point out, as opposed to the risk of something going wrong by trying a new approach like that, right now we have the reality of things going wrong for a lot of patients because it doesn't exist. And so it is really hard for us that are caregivers to deal with all the constraints on providing such a powerful gift.

But, I got to go right on back to say they may be too risk averse to do something anywhere close to that. We just don't know, and I don't know that they have decided yet either.

Thank you.

Andrea Bici, UBS O'Connor.

Congratulations. Just a couple of questions, Kent. First, as you move towards the bundle and you said CMS is working really hard, has the discussion come up that one of the orals that will be put into the bundle goes generic in the first quarter of 2014, which is ostensibly the first quarter the bundle is being implemented?

Second, when you look at the HCP opportunity and look back as you, Renal Care Group and a few others really consolidated the dialysis industry, how would you characterize almost the running room that HCP has versus the running room DaVita, Gambro -- that you all had probably in the mid-2000 timeframe, like 2005 or so?

Let me answer that second one, and I will turn to LeAnne for the first one regarding early 2014 patent situation. On the issue of market fragmentation, if you will, and the potential for a few key players to emerge as leaders and do a fair amount of consolidating.

On the one hand the population health management industry or community -- that is a more complicated operation compared to pretty unidimensional kidney care. Although within kidney care there is a lot of richness, at the level of your question there is quite a difference.

Having said that, we do believe the dream of DaVita HealthCare Partners is to do the same thing there that we have done here, which is be different enough, to be credible enough for the capital markets, and be aggressive enough to in fact become not just a leader in the field regional markets, but a national leader with differentiated value proposition for patients and for the taxpayer and premium payers. So over the long term we think that there can be a parallel story, even though it is more complicated.

Thanks. And next question is also for LeAnne.

LeAnne, did you want to handle that?

Sure. As you know, Roche and Amgen entered into a marketing agreement that would allow them to bring their product to market at the end of May in 2014. I am not familiar with where they are with respect to actually introducing their commercial product.

Okay. Also, on the bundle, how do we think about it -- the bundle coupled with the orals -- do we think about it is some sort of neutral transition, as an uplift to revenue per treatment just based on how the discussions are going or is that to forward of a guidance to give?

LeAnne, you want to take that one?

Sure. Obviously, right now we don't have specific visibility into the answer to that question. CMS has not announced their intentions specifically whether they are going to rebase the entire bundle or not. And they obviously have not yet given specifics around how they're thinking about the oral policy and the introduction of that.

We are having good conversations with CMS. They understand the magnitude of the challenge of introducing these oral drugs, and at the same time doing it in a way that allows clinical quality to improve, while the economics are reasonable for providers. So that is certainly something that will be the subject of continuing discussion between the industry and the agency as we move forward in 2013.

Great, and one last question. I'm sorry to be such a pest. How do you think about labor inflation? If next year is a make or break year we will either be in a recession or the economy could turn around and improve. How -- and obviously you have done scenario analysis modeling and just maybe have do you frame it or how have you been thinking about it?

Let me take a first stab at it and then you come back at me if I am missing the point or someone else here on the table wants to add. And by the way, LeAnne is in another city, so if some of the handoffs are little awkward that explains most of it at least.

On the labor front, two things. If a bunch of the bad stuff happens -- sequestration, using some of our money as part of the physician fix, et cetera -- then we and other health care service providers are going to have to ask our teammates to help absorb some of that burden, because it would be quite a blow, and so that is one factor.

The second factor is the impact of those kind of measures as a part of broader government policy are pretty difficult to then translate into a forecast for how overall unemployment and wage movements are going to behave.

And separate from industry-specific things, like sequestration or dialysis-related cuts to fund part of a physician fix, we have got the big just macroeconomic forces where we know those ripple through into what happens for our people. And so those are the two big influencers of what happens next year.

We, of course, are hoping that we have a strong year and can do merit increases and profit sharing with our team that we like to do, but in the face of lots of other bad news that may not be possible.

Thanks, that is helpful. And can you maybe provide in your guidance what percent of your cost structure is labor, just so we know what number to work with as we are incorporating all these scenarios?

I think people are going to give you a couple of numbers to make sure we get the right definition between field versus corporate or SWBs versus related, and so why don't we fire that exact number back to you in a couple of minutes.

Sure, thank you.

Whit Mayo, Robert W. Baird.

I guess first just a quick technical question on the earnout. I am just trying to figure out exactly how that works in 2013. It doesn't appear that it is in the guidance, so I guess I'm trying to get an idea of how you accrue that cost. Do you approve it at all? Is it one time in December, and to what extent you will provide transparency around that?

This is Jim. The earnout is actually put on the opening balance sheet as a contingent liability, and then each quarter the probability of achievement of that is reassessed, and if it increases it is run through as an expense, if it decreases it is a negative expense effectively. That would go through the 2013 financials, but there will be a probability of achievement already on the books, on the closing financials.

So implicitly you are including part of the earnout based on various probability and assumptions here for 2013?

Yes, that is right. We will make an assessment -- a probabilistic assessment of the likelihood of achieving the earnout in 2012 and 2013 as part of our purchase accounting. And we will record that as part of the assets acquired and also a liability, which as Jim said, may fluctuate and run through the P&L as the actual results are achieved.

Okay, and I wanted to go back to ABQ for a second. As you look at that deal in hindsight can HealthCare Partners be successful in that market without Lovelace? And does that dynamic at play or, I guess, the spat as you call it, does that in any way reshape the thinking on entering new markets or the development strategy at all?

I will take this one, then Matthew might want to add. Number one, it does not affect our appetite for new markets. Number two, yes, we can be successful without Lovelace. And, at the same time have no particular desire to, but that is the answer to the question.

And, number three, I didn't want to try to minimize it when I used the word spat, and so when you replay it for me it makes it sound like I might have been trying to trivialize it. It is a very, very intense competition going on there, and so please forgive me if I in any way was interpreted as trying to minimize it.

Within the context of that market, within the context of HealthCare Partners overall, the EBITDA and run rate there is -- it was about 2% of total HealthCare Partners' EBITDA, so in that context it is quite tiny, but I did not mean to minimize the intensity of the competition in the market.

That is fair. I guess I was just trying to get a sense of do you think about relationships with payers and providers any differently after dealing with that contractual argument at this point in time?

No, not at all. And over at HealthCare Partners 30 years of consistent success, there have been other times where they have gotten in battles and standoffs and the rest with different payers. However, while that is a true statement, the overall track record, and one of the areas where our philosophies blend well, is that is not what we believe in. What is far more noteworthy than the 2% of EBITDA that has these battles going on is the 98% where we have worked constructively with payers for years and years and years, both sides benefiting, and then both sides helping the patients benefit.

So that is the dominant element of our philosophy and our strategy. And it is just unfortunate that Albuquerque is an exception to that general rule. Matthew, would you like to amend that at all?

Yes, it is truly an exception, because when I look at what we are hearing from payers who want to partner with us, and really ask us to go to different areas, it is -- it is very much they want to work with us. It is very much they are interested in partnering with us, so it is truly an exceptional situation that exists. When we look at the opportunities on all of the other markets, the payers are more than interested for us to grow with them.

That is fine. I guess one last question. We have covered a lot. But Kent, back to your point on looking into 2014 and some of the risk with exchanges, I presume you're referring to the unknowns of the small group market and the individual market and whether or not MSP does or does not apply there. Can you just elaborate a little bit more on how you are thinking about that dynamic and what conversations -- whether it is LeAnne is having in DC at this point in time?

And the conversation on which topic, please?

Looking at the unknowns around exchanges and whether or not we will see the small group market compromise and the individual market grow, and the questions around whether or not MSP applies to the individual market in the exchanges. I thought that is what you are referring to when you said there were some risks around the exchanges, maybe we are talking about two different topics here.

Okay, let me take a stab at it, because we just got a note that LeAnne's line got cut off, otherwise I would have turned to her. I'm going to go back to Albuquerque one moment, just to dive into the weeds in one way, given you asked a broader question about what that suggests or implies for other payers elsewhere.

One of the unusual elements of the Albuquerque situation is Lovelace has a plan in a hospital that are in one organization, so as opposed to lots -- most plans across America that have a real strong interest in improving quality and reducing cost, they have a very strong interest in keeping hospital costs up. And so that made it a lot less surprising for there to be a difficult time in reaching any kind of quick agreement.

We are just feeling really good about what our model does for society and patients as opposed to one that is quite focused on maintaining high hospital admissions and high hospital rates. LeAnne is back on. I will take a cut at your exchange question.

No, there is nothing that we know that should create any concern beyond what you had before in this area, nor any good news beyond what you would have already heard. It is just the uncertainty about the actual architectural detail of how they are going to operate and the mechanics means that we still don't know if we are going to have lots of new patients with insurance at good rates or we are going to have fewer private patients at good rates.

It is impossible to predict now how many uninsured people will become insured and more attractive from an economic point of view versus how many private pay patients that paid a certain level today will be paying at a lower level then.

And you can create very, very feasible scenarios in either direction, and right now no one knows the answer. That is why I list it as a fourth significant swing factor around which we still have a very neutral stance in terms of predicting. Does that answer your question?

It does. I guess I was trying to dive a little bit more specifically into the individual market and whether or not -- if it is complicated because MSP doesn't apply here, and if you begin to see the small group market compromise over time. I guess it is a longer-term question that we all have.

Yes, we think it is -- well, I will let LeAnne go ahead and comment.

I do think what -- Kent's remarks were correct that yet most of us do not know how this will play out. A couple of things that we can offer, which is that the benchmark plan do cover dialysis, so that is a good fact.

It is a fact today that individuals do pay out of pocket and maintain their commercial insurance. Hopefully within the exchanges that same type of level of policy would be reasonably affordable. I don't believe we can yet make predictions about what the policies will look like more specifically or who will purchase them. I think that is just not knowable at this point in time.

Okay, that is helpful. Thanks a lot.

Thank you, and it is certainly the case, just to add on, that if government would start taking a lot of people who are on private insurance, start taking their insurance away, that would be unpopular with a lot of folks in a pretty intense way.

Operator, is there another question?

John Ransom, Raymond James.

I just wanted to dive into the weeds of Albuquerque. Is the MA a global capitation or is it just a physician capitation at this point?

If you are talking about the MA that we have with Lovelace it has been based on a discount on the fee-for-service payment, not decapitated.

But does it cover the whole spend or just the physician spend at this point?

The numbers with ABQ is only the physician spend.

So is there potentially an opportunity to expand that to the global health care spend and is that likely in your view?

That is what we want in every market over time.

But just to be clear, when you ran the economics on that deal, you ran it based on the business as is, which is just the physician piece of the spend?

We never get into any market without the intention and goal of moving to a coordinated care position where it is either globally capitated or some form of shared savings coordinated care, so that is always a part of our motivation.

Okay, thanks.

(Operator Instructions). Darren Lehrich, Deutsche Bank.

I just had two really clarifications. One, Jim, you guys mentioned just with regards to the earnout the accounting treatment for that. I just want to confirm that you plan to expense that as a contingent purchase price expense. I guess that is the accounting treatment that we are used to seeing now for earnout. So essentially you take the $275 million and just divide it by 8, and that is what is in your OI guidance as an expense. Is that generally speaking the right way?

No, that is not correct. What we will do in purchase accounting is estimate the probabilistic outcome of the total earnout. So if the total earnout is $275 million we will record as part of the purchase price some amount that is less than $275 million, because there is some probability that they won't achieve their earnout in 2013 or 2014.

And then as the earnout is earned and as things progress, quarter by quarter we will reassess that probabilistic outcome and the change in those estimates will then result in either a P&L charge or a reduction of expense in the quarter of that change in estimate. So I would not expect significant quarterly swings here unless there is a significant change in the business.

Okay. And so the starting balance sheet for that contingent liability, what will be the number that we should just be thinking about or expect to see when that balance sheet is set up?

We haven't finalized that yet. But my guess is it will be in the range of -- and I will give you a broad range, but just to try to size it -- $225 million to the $275 million, somewhere in that range.

Okay, that is helpful. And then the last thing, really just this one is for Matt. Can you give us the average star rating across all of your health plan partners for 2012 and then to the extent you have any visibility, on 2013, what you think that average will be?

Sure, the average currently is 3.5. And as you know, the star rating, it is not only based on what we do. HEDIS, which is the measurement that we contribute, it is part of that star rating. The rest of it, it depends on how the plan does business, and how good they are in responding to the patients' calls and lots of other things.

So we are working with certain health plans to see how we can improve upon that. That is now a bigger item, if you will, with -- when health plans come and we have monthly or quarterly meeting with them, they are paying a lot of attention to it. And they are asking us to help them also.

We believe in the long-term it is going to also incentivize and encourage these plans to really work with the groups who really are effective in those measures. And some of the smaller groups and IPAs, unfortunately, they are not investing and have not invested in those infrastructure to improve the HEDIS criteria.

And any sense for whether you think that will improve from 3.5 next year? I am just trying to understand that as a possible swing factor for next year.

I can't predict what the number is going to be, but I think it is an opportunity as they are finding out that we can help them and others cannot perhaps bring some more enrollment to us.

Okay. Thanks.

Andrea Bici, UBS O'Connor.

Sorry, just following up, did you get the labor number?

Yes, labor for dialysis is in the range of 36% to 38% of revenue.

Okay. Thanks so much.

That is fully loaded.

Okay, perfect. Thank you.

There are no further questions at this time. I will turn the call back over to presenters.

All right, thank you all very much for your consideration of our enterprise. And once again we hope that you and your families are and continue to be safe in the Northeast. Thank you, take care.

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