德維特 (DVA) 2014 Q1 法說會逐字稿

Good afternoon. My name is Kim and I will be your conference facilitator today. At this time I would like to welcome everyone to the DaVita HealthCare Partners first-quarter 2014 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 period. (Operator Instructions). Thank you. Mr. Gustafson, you may begin, sir.

Thank you, Kim. And welcome, everyone, to our first-quarter conference call. We appreciate your continued interest in our Company. I am Jim Gustafson, Vice President of Investor Relations. And with me today are Kent Thiry, our CEO; Garry Menzel, our CFO; Craig Samitt, CEO of our HealthCare Partners division; Jim Hilger, our Chief Accounting Officer; and LeAnne Zumwalt, Group Vice President.

I would like to start with our forward-looking disclosure statement. 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 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 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. And thank you all for your interest in DaVita HealthCare Partners. Q1 -- disappointing financial performance at HealthCare Partners, strong financial performance in Kidney Care. I will discuss this performance as well as we will update our outlook. But first, as always, I will review our clinical outcomes. We continue to present our clinical outcomes first because that is what comes first. We are, first and foremost, a caregiving company.

On the Kidney Care side we now serve approximately 165,000 dialysis patients in the United States, approximately 35%. And in this area CMS recently released the quality incentive program payment results for 2014 payments. I will remind everyone that the way they structure the quality incentive program is with penalties only; there is only down side. So that's why we will use the penalty word.

They had established four clinical measures -- central venous catheters, AV fistulas, URR less than 65, and mean hemoglobin less than 12. DaVita ranked number one in the industry in all four clinical measures. And if you look at the percent penalties in aggregate, only 1.6 of DaVita clinics said any penalties compared to 6% of clinics for the rest of the industry. This performance is even more notable, especially when you adjust for social economic factors, given we have more lower-income people and people of color in our patient population than the overall nation.

Nonetheless, we had to 59% lower rate of penalty centers versus the rest of the industry in poorer counties, and we improved our rural clinical performance year-over-year while the rest of the industry saw rural clinic performance decline. Moving on to HealthCare Partners and clinical metrics in that area, one of the areas of focus is reducing hospital readmissions. In the second half of 2013, looking at California and Nevada, we had a 14% readmission rate; that is, 24% below the national benchmark of 18.4%. This alone means outpatients avoided more than 700 readmissions over the last six months relative to the rest of the nation.

For these and other clinical outcomes for both Kidney Care and HealthCare Partners, we compare very favorably to national averages. And our superior clinical care results in healthier patients and lower taxpayer costs.

Now moving on to operating performance, I will jump right into discussing HealthCare Partners. I will discuss both Q1 and the lowered guidance for the year. Q1 was a miss. It was a big miss, and it was another in a series of misses. This is embarrassing for us and no doubt worrisome for you. So, legitimate and expected question is: what is going on? And the explanations for the quarter and the year are pretty much the same. So, I will discuss most of it in the context of the year.

Number one, the primary driver of the shortfall is the fact that in the first phase of the DaVita HealthCare Partners combinations there was a small group of new market new business deals done which have substantially underperformed plans. The deals fell into a few different categories including acquisitions and assuming some risk contracts. In aggregate, these deals explain about half of the $50 million reduction in the midpoint of our guidance.

Within this category the largest was Albuquerque, and on this front the new and incremental bad news is that the health plan acquisition of the Lovelace plan by Blue Cross Blue Shield has not yet been approved by the government, which means our globally capitated arrangement does not fully kick in, which creates incremental losses each month and also makes the post-approval, if we assume approval, recovery incrementally tougher as well.

A separate factor for the $50 million -- we mis-estimated the average MA rate we will receive by 0.8%, 8/10 of a percent, on our patients across our geographies, which equals $16 million for the year, $4 million per quarter.

Next, the third and final contributed to the decreased guidance, but it does not constitute underperformance, is that we have incorporated an expectation of $10 million in startup losses in our new Tandigm joint venture with Independence Blue Cross in Philadelphia. This was explicitly excluded from our guidance last quarter. So, while we incorporate it, it means that we go down another $10 million in guidance. It does not constitute any underperformance versus prior comments.

There is a potential offsetting upside to the scenario we just laid out. We have a contractual contingency in one of our new markets that could very well lead to our recognizing another $30 million to $45 million in revenue this year, of which $10 million to $24 million would be attributed to 2014 performance and activities, and the balance to 2013.

Now, the next question you might well ask: how can you possibly expect us to feel comfortable going forward, given the magnitude of this change? And the answer is we probably can't make you feel comfortable until we start doing what we said we would do. But we can tell you that the team that did those deals was displaced many months ago.

The next question might well be: when will the new markets get better? Assuming no contingency payout this year for us, we would be disappointed, very disappointed, if they did not do better in 2015.

Next question: how much better should we expect them to do? And on that front we are not comfortable estimating at this point. We fear it would be too unreliable.

The next question is: well, separate from the economic underperformance of this portfolio of early deals, how should we think about what that says for our overall value proposition? And here the good news is that in each of these situations we are adding to clinical value we are supposed to add. We are getting good physician leadership momentum, as we are supposed to. And we are advancing integrated care capabilities of our partners and affiliated physicians, as we are supposed to. So, we are fulfilling the fundamental value proposition in these situations, despite the underperforming economics.

Next question might well be, as you stare at the numbers and reflect on this explanation, would be: given the explanation of the shortfall, it seems to imply that the three big legacy foundational markets -- California, Nevada and Florida -- are performing solidly. And the good news is that answer is an unambiguous yes. If you were to strip out what we might call legacy HCP from the poor deal portfolio, they generated approximately $76 million NOI and $116 million in EBITDA after allocating all corporate overhead and a couple of minor nonrecurring item adjustments. And those numbers, as you well realize, would put us right on schedule.

Next question: what does this series of events due to your confidence, my confidence, our confidence in the team and the business? And our answer has a few parts. The new team, the new HealthCare Partners leadership team, does deal with traditional DaVita disciplines. Having said that, we are doing new things and there will be an experience curve.

And as to the broader question or a broader question about the industry, our views have not changed. Integrated care and population health management will grow. We are good at doing that with physicians in the lead. Thank you. I look forward to your questions. And now on to LeAnne Zumwalt with an update on policy issues.

Thanks, Kent. I will cover two topics: one, the recent ESRD legislation and, two, the 2015 Medicare Advantage rate notice. So first, as part of the recent physician SGR legislation, Congress partially addressed dialysis reimbursement underfunding. The key legislative highlights are, as in the 2014 ESRD rule, the 2015 rates will be essentially flat with 2014. The good news is that the remaining dialysis cuts were reduced and stretched over three years. In 2016 and 2017, our bundled payment rate will be updated by market basket minus 1.25%, and in 2018 market basket minus 1.

The bundling of additional oral drugs was delayed until 2024. This is positive outcome as there was substantial risk that CMS would have significantly underfunded these drugs in 2016, resulting in a de facto rate cut. Overall, this is a good victory for the kidney care community, as these changes were scored by the Congressional Budget Office as putting about $2.2 billion back into the dialysis payment system.

Having said that, we still, on average, lose money on our Medicare patients. The absence of full market basket increases over the next few years means Medicare reimbursement will be further below our cost of providing care. As a result, we will expand only in geographies where there is a healthy subsidy from the private sector. In geographies without the private support, we will remain flat or see a contraction in service, as we will be forced to close some centers.

Second, in April CMS announced the final Medicare Advantage benchmark rates for 2015. Based on the final rules, we expect 2015 rates to be roughly flat for us compared to 2014. We and others benefit from the rollbacks in the planned risk recalibration in 2015, although this presents uncertainty in 2016 and beyond as CMS still moves forward with the new model. Rolling back, the risk recalibration is [deferred] (inaudible) for beneficiaries, as it will help prevent more dramatic benefit changes in 2015.

Moving to the new model could create adverse selection or encourage payers to take steps to avoid serving higher-end cost patients whose health needs are the greatest. It's encouraging that CMS is not to protect MA benefits and acknowledge the clinical improvements that Medicare Advantage program is making, saying, and I quote, enrollees are benefiting from greater quality. Half of enrollees now in plans with four or more stars, a significant increase from 37% of enrollees in such plans in 2013.

Note that at HCP we have over 80% of our patients in plans that are four-star-rated and above for 2015, well above national averages. I will now turn the call to Garry.

Thanks, LeAnne. I will walk through a few more details on the numbers. First, some additional comments on our Kidney Care operating metrics. Kidney Care adjusted operating income of $387 million was up $1 million from the prior quarter. Non-acquired dialysis treatment growth in the quarter was 5% when normalized for days of the week. Dialysis segment profitability was down $21 million sequentially due to two negative factors offset by three positive factors.

The two negative factors were: one, three fewer treatment days in the quarter; and, two, an increase in patient care costs of $4.42 per treatment, which was due primarily to an increase in EPO unit costs in the quarter and seasonally higher fixed center level expenses per treatment because of the fewer treatment days in the quarter.

These were largely offset by three positive factors: a 2% increase in treatments per day as a result of strong non-acquired growth; two, $0.77 increase in dialysis revenue per treatment; and, three, $4.19 decrease in dialysis segment G&A, $1.50 of which is due to impairments that were recorded in the fourth quarter and the remainder is a combination of tighter G&A controls and normal quarterly fluctuations.

During the quarter we lost $6 million in our international operations, in line with our prior international outlook of $25 million of losses. However, at the time this is specifically included any costs for our Saudi Arabia expansion. As our planned ramp up in Saudi Arabia will create $15 million in additional operating losses in 2014, we now expect to lose $40 million internationally, which is included in our increased Kidney Care guidance.

Kent has already discussed in detail the performance of HealthCare Partners, so I will next review some key metrics for the overall enterprise. First, our debt expense was $106 million in the first quarter. Second, the effective tax rate was 40.5% in the quarter, in line with their expected range of 40% to 41% for full-year 2014. Third, we continue to generate strong cash flows as operating cash flow was $419 million in the first quarter. We still expect operating cash flow to be between $1.45 billion and $1.55 billion in 2014, excluding any payments associated with the potential settlement of physician relationship investigations.

Finally, we have updated our 2014 operating income guidance. Our updated enterprise operating income guidance is $1.725 billion to $1.84 billion. This includes, one, reduced HCP guidance of $205 million to $260 million; two, increased Kidney Care guidance of $1.52 billion to $1.58 billion. Note that this Kidney Care guidance includes $15 million in 2014 losses to ramp up operations in Saudi Arabia which were not included in the prior guidance. So, combined with the $10 million loss for Tandigm, that means we are including $25 million in expenses previously excluded.

Therefore, on an apples-to-apples basis the bottom of our consolidated guidance range is up $25 million and the top is up $5 million. I will now hand the call back to K. T.

Thank you, Garry. I'd like to add one editorial comment on the policy front. The ESRD kidney care victory was a big one. And once again, we led the community to a thoughtful strategy and through a formidable campaign. I'd like to step back for a moment and just think about our two primary businesses, Kidney Care and our medical group, and think about each of them across four parameters as we look out over the next two to three years -- rate minus expense times volume and then factored by execution risk.

On the Kidney Care side, rate -- there's more downside then upside, although we do have somewhat of a reimbursement safety net as the government cannot afford to have many centers close.

On the expense side, things look relatively stable compared to historical norms.

On the volume side, things look relatively stable, probably a bit slower than the rate we have enjoyed the last few years.

With respect to execution reliability, Kidney Care looks pretty solid.

On to HealthCare Partners, our medical group. As to rate, there is more downside than upside. As to expense, there is probably more downside than upside, but hopefully we can make those words not true. As to growth, unit growth looks very promising. And as to execution reliability, the legacy markets look solid. The new markets look poor.

Now, if you step back and look at the aggregate enterprise for a moment, we still think it is a differentially solid platform for the long term. The strategic position is good. The market positions are strong. The talent trajectory is good. And our capital structure, our capital efficiency, and our cash flows are all solid.

Thank you and let's move on to Q&A.

(Operator Instructions) Justin Lake with J.P. Morgan.

First question -- you mentioned operating income for HCP. And you gave us a number of metrics that basically allow you to back into these recently acquired practices are losing about $80 million for the year, in your guidance. Can you tell us what the plan is for turning this around, Kent, and how much we can expect to improve for 2015?

Justin, could you repeat the numbers you threw out, please?

Sure. You said the legacy business was running $76 million positive. The reported numbers for HCP are $54 million positive. So you basically back into these newly acquired centers running at about $20 million a quarter of losses or $80 million for the year, so obviously a very big number in terms of losses there. I'm curious what you are doing to turn that around and how quickly you think it can turn around.

Yes. First, without getting into a lot of complexity, you can't just subtract the two and take the difference and then attribute all of that to new markets because there's some other stuff going on like the MA rate predictions, et cetera. So there's some issues that cut across the two categories. It's not quite as clean as that.

And in addition, some of those losses were absolutely planned and intentional, part of establishing ourselves in new markets. But separate from fine-tuning the actual number, what we are going to do to make it better is going to sound pretty vanilla on our call. We are working on the rate side, the expense side, and the unit side. But the biggest single swing factor is having the transaction in New Mexico be approved by the government.

Can you give us a number on the swing factor for that?

I don't think that would be in your best interest, Justin, so I think we have to hold back from that.

Okay. And then on HCP again, last quarter you mentioned you were working with plans to try to get the contract structures that were a little more reasonable in terms of times when there was pressure on reimbursement. Was just curious if you can give us an update on how those negotiations are going and whether you are feeling more comfortable going into 2015 than you did in 2014.

I would say we made a tiny bit of progress in the quarter. That's actually not really disappointing in the sense that a lot of contracts aren't appropriate to change until they are up for renewal. And we don't necessarily want to precipitate an extensive renewal conversation with everyone at one time. So it's not disappointing when I say tiny, nor is it impressive. It's kind of a tweener.

Okay, thanks. I'll jump back in the queue.

Kevin Ellich with Piper Jaffray.

Kent, just wanted to clarify again. You said the three big legacy foundational markets was doing -- was at $76 million of operating income or was it $176 million?

It was $76 million. It's actually right in that $75 million to $76 million range. And the other number was $116 million in EBITDA after allocating all corporate overhead.

Got it. Okay, that's helpful. And then can you give us a little bit more color on the potential upside? Is that all dependent upon the deal, the Blue Cross deal in New Mexico going through? Or is there something else that's attributing -- that you are thinking about that you don't know about yet?

We can't disclose exactly where that contractual contingency sits because of some confidentiality agreements. And so it's just -- all we can say is that the contractual contingency exists within our new market portfolio, and there is a good chance, better than 50% chance, that it will in fact be triggered.

Okay. But we don't have any idea on the timing?

Since every production on the timing has been wrong so far, I think we will shy away from venturing into predicting again.

Okay, fair enough. And then as per the Medicare Advantage, obviously pretty positive news on that front. But I'm just curious. How close are we to achieving parity between -- the move to parity? Isn't that a year or two out?

Most of our counties are in the two-year or four-year phase-down period. So 2015 will be the final year for our counties in the four-year. We do not have any membership of significance in the six-year phase-down counties.

Okay. So 2015 really is the last year? Okay, great.

And the last one, on HCP -- looking at the decline in the ratio of operating income to care dollars, it's gone from 10% a year ago to 5%. What's your long-term objective? Where could this go and what's going to get us there?

Can you go ahead, Kevin, and say the question one more time, please?

The ratio of operating income to care dollars under management this quarter came in at 5%. A year ago it was 10.4%. Is that just contingent upon improving operations and what not at HCP, or is it -- I guess I'm trying to get some idea as to what a normalized ratio should be.

Yes. I think I'm hesitating because there's a bunch of variables that could push it one way or another. For example, we will probably be doing more joint ventures with payers. And that may very well be low margin business because we are splitting the equity and the upside. But, on the other hand, it could be incredibly capital efficient. And in the long run, as we've talked about for 15 years, it's cash on cash, return on capital, that ultimately determines a company's long-term future. And so in some cases we may be actively seeking what looks like low margin business but is incredibly attractive in terms of risk-adjusted return on capital.

And then looking at it from a different perspective, we will also begin some of the good old traditional global cap business where we and our physician leaders take the entire bolus of (technical difficulty) and manage it with ever increasing capability. So how those different factors are going to net out, combined with just, in general, increased competition in the space, is pretty hard to predict. So I think what we will have to get good at doing is just parsing out these different variables so you can see where any movements in margin are good news, bad news or neutral news.

Got it. Okay, thanks.

Brian Zimmerman with Goldman Sachs.

I was wondering if you could give us some updated thoughts on potential closing of centers. The CMS rate has been improved. And just curious if you are still planning on going ahead on closing centers.

Unfortunately, the answer is yes. And we are probably going to be closing in the neighborhood of 20 in the near to intermediate term, as much as it breaks our heart. When the government cuts our reimbursement, and holding it flat constitutes a cut, given there are certain cost pressures we face that we simply can't get down to zero, that in some geographies where there are not enough privatizations to subsidize the federal government, we and other people are going to have to close down some centers. We will do so with incredible care and respect and oversight in order to take care of our patients and our teammates. But in the end we are carrying a lot of money losing centers, and we can't continue to carry that many if, in exchange, our rates get cut.

Okay. And then on the patient care cost side, I understand that they went up for treatment. But you did a pretty good job containing costs in the G&A side. Can you give us a bit more detail on what those G&A cost controls were? And do you see additional opportunities in the next couple quarters?

I do not think we are going to see a continuation of the tremendous accomplishments in that sphere that we pulled off over the last year. We started thinking about it and planning for the full 2, 2 1/2 years ago, when we expected the government to be squeezing reimbursement, and so it was sung with a lot of foresight, with a lot of warning and planning so as not to disrupt people's lives nor our Company's operations and, of course, most importantly, our patient care.

Having said all that, there's limits to how much can be done there. So I think you're looking at pretty much the end of that run of progress.

Okay. And then my last question is on capital deployment. You are sitting here with $1.1 billion on the balance sheet. Can you give us an update on thoughts towards acquisitions or potential repurchases?

Well, we are hoping, although it sounds funny to use that word, that we will be taking a big chunk of that cash to execute on our settlement with the federal government. And that would be about $390 million or so. And at our new size we certainly want to keep a certain amount of cash on hand.

Having said that, we don't need to have $1 billion in our wallet. And we will go through our normal exercise, consistent with how we've thought the last 15 years, in comparing at the time, our business opportunities, our repurchase opportunities, and our debt reduction opportunities. And so right now we don't have a position on that. And of course, we welcome any input from all of you on what you would prefer.

Okay, thanks a lot.

Darren Lehrich with Deutsche Bank.

So I wanted to just maybe ask a little bit more about some of the deals that you are referring to. And if you could maybe help us think through where you think you miscalculated the most in terms of entering these new markets and the types of structures that you had. It's clear, in Albuquerque, you miscalculated with regard to payer landscape and the ability to forge a better relationship there with Lovelace. Hopefully, that changes. But can you maybe help us think through how else you've miscalculated and how the strategy maybe pivoting so that you can avoid that?

Yes, Darren. It's the right question, but the correct answer to it is that the team that did those deals was not thoughtful, did not do the right kind of rigorous analysis, reflection, did not weigh the relative merits of partnership versus fighting. And in particular, in one instance, didn't correctly calibrate what would happen after fighting a battle. And in Albuquerque, both Lovelace, the hospital and the plan, and us, both sides, came out significant losers. The only ones who benefited were our collective competition.

The new team has since turned relationships around in that market, and we are ready and poised to work collaboratively with both Lovelace and the new plan, the way these things should work, assuming that we do get government approval on that transaction. So rather than go through what would sound like a relatively vanilla characterization of the types of mistakes, the root cause was the team that was working on it did not bring the right discipline and thoughtfulness. And those people are not doing deals with us anymore.

Okay. Well, that's fair. I guess maybe that turns me to the next most obvious question is you just announced a fairly significant transaction, this Tandigm joint venture. So maybe, just given that there's a new, more thoughtful team, I guess, that put that one together, give us some background on how that deal came about, what the model looks like. And maybe talk about how that strategy will be different.

So let me go ahead and take a quick stab. And then Dr. Samitt they want to add. But this is the type of arrangement we might end up doing in other places. And we certainly have a lot of major payers who are talking to us about types of arrangements like this. IBC is the leading payer in that market with a very strong market position and a good reputation as a citizen in the healthcare community. So, we like that type of partner. The way we structured it is that the new venture is incented to succeed. So neither parent company, so to speak, can get in the way because of any other considerations. The new management team and the board of directors are incented structurally to deliver success for patients, physicians, and shareholders through that venture. And that's the only way to attract the kind of talent you need to tackle the challenge in a market that does not have any significant integrated care penetration.

And lastly, I would say, the way it's structured, although it will not lead to any quick profit drop through, is very capital efficient because we're not having to make any large acquisitions and because of the way the economics are structured the upfront operating losses are quite modest, in particular quite modest relative to the long-term market opportunity.

Craig, is there anything you would like to add?

Sure, K.T. Just four additional points. The first is that the IBC Tandigm transaction allowed us to review lessons learned from the prior deal that K.T. described in the past and focus on avoiding risks that we were faced with some of the other deals from prior to 2014. The second is, as you can see, this is our new pilot in forging a team of equals relationship between a payer and a renowned delivery system. And so we are optimistic that this shoulder-to-shoulder partnership will be highly effective.

In terms of structure, we are, through Tandigm, enabling primary care physicians with supports from both the payer side, which is very data and analytics rich, and HealthCare Partners, which is clinical care model and population health rich, in managing the transition of Philadelphia marketplace from volume to value. And fourth is the reason why this is a prime market for us is that Philadelphia is one of the highest cost-of-care marketplaces in US. With, in fact, the highest admission rate per thousand in the country. So our expertise is very much needed in that market.

Makes sense. And then my last question, about Tandigm -- what is your enrollment target if we think about this a couple years down the road? How many lives do you think you will have an arrangement?

It's a fair question but there's just too much uncertainty at this point. So giving you a number would be tantamount to just guessing. If we succeed, the number could be significant. But succeeding is not going to be easy. There are reasons why markets have high admit rates, and part of our challenge is to establish a collaborative, constructive relationship with the leading hospitals in order to collectively bring quality improvements and appropriate savings to the table shared by everyone.

Okay, thank you.

Gary Lieberman with Wells Fargo.

Going back to Albuquerque specifically, it would appear that there was a meaningful decrease in performance sequentially. Can you give us any more details around what was worse than you originally expected just over the last quarter or so?

I think, Gary, we don't want to go into any more micro detail on individual market. So if you could just allow us to stick with having disclosed much more than we typically do already on an individual market because we felt we needed to, in order to answer the legitimate questions -- but I think we had best leave it at that.

Okay. I guess maybe, then, little bit bigger picture on the underperforming deals. Can you maybe discuss how much risk you feel is still there? Is there still some meaningful downside if things don't get better or are on the same trajectory? Or do you feel like it has bottomed out?

I would say we are much closer to bottoming out, and so the ratio of upside to downside is attractive, a breath of fresh air in an otherwise stuffy room. So that's good news, I would say.

Okay. And then do you have any concern that the Blue Cross deal does not close in Albuquerque? Or is it just typical stuff that's making it take longer?

We do have any insight, really. The Department of Justice keeps those things close to the vest. Certainly, empirical evidence would suggest that the deal will get approved. But you never know for sure. In particular, if in the government's mind Blue Cross Blue Shield is unwilling to agree to reasonable conditions, then all bets are off. So, we don't know enough to handicap other than these things typically, as you know, get closed.

Okay. And then does any of this change the guidance you had given on the acquisition pace at HCP, which I think was two this year, more next year, then a lot the year after?

I would say at this point we are not changing anything.

Okay. Maybe one question on the international comments that were made -- the losses, I think, Garry, you said were $40 million in that change. What was it before?

$25 million. Sorry, Gary.

Okay, that's very helpful. And then maybe the last question, on dialysis -- what did you guys think of the revised parameters around the accountable care demo with ESCOs?

Before I answer that, Gary, let me go back and tweak my response to your question about the expected pipeline of significant deals in HealthCare Partners. I think we probably should dial back that expectation a bit because we need to prove quickly that we can reliably deliver on what we say we are going to do before we should run around deploying any more of your capital. So probably we pull that back a bit, and can't quantify that right now. But at least directionally I think you should think about that way.

On the ESCOs we know that -- we are incredibly passionate and bullish on our capability to dramatically improve quality and substantially reduce costs and deliver incredible patient experiences in an integrated care globally capitated or anything like it would for kidney care. And we have proven it. We have proven it at significant scale with breadth and depth. And so we so much want to bring that value to America, and in so doing, forcing others to invest and get better and better at the same time.

And we are very grateful that CMS has put so much time into trying to figure out a way to introduce a vehicle for making all that come true. Having said that and being very appreciative of some of the changes they made, we were disappointed in what they came out with. And I think I will just stop there.

Okay. Would you say they are headed in the right direction and just need some minor tweaks, or is it still significantly off-base for what you would need to really ramp up your involvement?

We think there's just a couple very reasonable changes that would open up the gates to a beautiful pilot, a beautiful pilot. So, we think it's very doable and very reasonable.

You can't share any of those specifics with us?

I don't think that would be good to get into in a big public forum. We are sharing our thoughts with them and we are incredibly grateful that they are listening.

Okay, great. Thanks very much.

Jason Gurda with KeyBanc.

Kent, if we think about a deal that actually works out as it's expected to, how should we -- or how should we expect to see the multiyear impact on margins play out? Is it one to two years of initial losses followed by ever-increasing margins after that?

Yes, it's a tough one to answer, Jason, because in Healthcare Partners every deal could be quite different, depending whether we are primarily partnering with a hospital, or a physician group, or a payer, or all of the above, and whether or not they already have risk or whether or not we are just starting a new risk contract. And so, unfortunately, given, unlike dialysis, every deal could be quite different, you need to stare at our track record in order to draw the right inferences and extrapolations.

This is where we've made your life very difficult by having a lousy track record of doing new things. And so, we recognize the torturous position that our performance has put you in and we hope to make amends over the next couple of years.

Putting aside the Albuquerque decision, you are facing more Medicare Advantage rate cuts in 2015, making additional expansion investments. Should we expect operating income growth at HealthCare Partners next year?

At this point we think we ought to stay silent on 2015 until we get a little more time and experience under our belt. We are not comfortable saying OI is going to go down. We are not comfortable saying it's going to go up. We are not comfortable saying it's going to be flat. We need a few more months under our belt before we can give you a value-added estimate.

Okay. And my last question would be I think you have warned in the past that the exchanges offer more downside than upside, I think is the way that you put it. Is there any early read on your relationships with the payers on the exchanges, any takeaways from the first quarter?

Although it's very preliminary because, as you understand, there's a lot of lag time in finding out exactly who is in an exchange and what that exchange is going to pay and all that kind of stuff -- so with a big caveat on the fact that it's preliminary, the early results are positive in the sense that we thought it was going to be quite bad. And so far it is not.

Thank you.

Kevin Fischbeck with Bank of America Merrill Lynch.

I guess a few questions on the HCP. You mentioned that -- I think you said half of the issue was related to some deals in new markets. You mentioned contracts. What was that comment related to? What was the other issue there?

There are three drivers of the shortfall, Kevin. Half was the new market, new business acquisition portfolio. The second was the Tandigm $10 million previously excluded, so it doesn't represent underperformance. The third component was a mistake; we were 8/10 of a percent off in forecasting our actual MA rates across the markets. And that 0.8% equals $4 million a quarter, $16 million on the year, right off the bottom line. It's, of course, embarrassing for us to make a mistake like that, but we did.

Yes. I guess, though, in that first bucket where you said the deals fell into buckets of new acquisitions and then taking on new risk contracts -- I just wanted to understand what you meant when you said new risk contracts as opposed to deals being new market entrants.

Got it. I'm sorry, Kevin. I understand the question now. There is one example where we just took over a network for a payer. It was an unsuccessful MA network that they had been running by themselves with some others, unsuccessfully. And we took it over from them with no exchange of capital involved.

Okay. So you basically assumed a new risk contract?

Correct.

In that market? And was it a new market or an existing market?

This was a new market. And while we expected losses because we knew what their current economics were, and some of that we were cushioned from and then some not, the problem is the actual losses have exceeded the expected losses in the assumption of that contract.

Okay. And then broadly, because that sounds -- it's hard to tell, I guess, sometimes. Maybe they are hard to differentiate. But when you look at HCP, would you say that it is more a cost issue or more a contract issue? Because it feels like one might be easier to solve in a short period of time than another. I just wanted to get your thoughts around that.

Our primary problems there have been from that unthoughtful contracting, non-thorough due diligence and one very bad business decision, not our ability to drive integrated care, not our ability to work with physicians in the community to drive quality improvements in savings and utilization, etc. The news on those scores is positive.

And so I think your diagnosis is correct. The stuff that was done wrong is easily fixed, and we think we are there. Now, I also want to add, again, we are doing new stuff and different stuff. So there will still be an experience curve and there will still be a batting average issue. But we already are way, way, way better on the dimensions that caused us the problems a year, year and a half ago, today.

Okay. And then I guess I understand the shortfall this year makes you reticent to make predictions about next year. But I think at the analyst day you were thinking that you could be flat year-over-year in HCP, depending on how the final rate came in with the risk adjusters. It feels to me like the final rate for 2015 was better than one might have thought at the time. This year's numbers are lower. It sounds like you feel like you understand to some degree that there's a contracting opportunity into next year and yet you are not comfortable to say that you will do better next year versus this year.

When you think about the swing factors, if it's not your ability to manage costs, and that feels like it's in control into next year, what are the factors that you've got to understand going into next year, generally where the rates are, generally what the contracting issues are that it stop you from growing next year?

It's very good logic, Kevin, as usual. And I think the honest answer is just that if you are sitting in these chairs, having been wrong now a few times, we simply don't want to represent until we've done a lot more work, analytical work on every aspect of the business, before we start talking about stuff that's a year or two out.

Okay. And I guess just last question -- California duals -- do you have a sense there of how you will be participating in there and what the revenue opportunity might be for you?

We are in active discussions with multiple payers who will be participating in the California duals program. We hope to be able to participate the program, but don't know yet if we well, with which payers or for how many patients we will be providing care for.

Okay, all right. Great. Thanks.

Ben Andrew with William Blair.

A couple things, I guess, to start, Kent. Is there some sense that the window of opportunity for transactions is tightening on you, given both the lag between when you have been able to announce large transactions, and that is perhaps what is being manifest in the need to move towards more partnerships than outright acquisitions?

But me take a stab, Ben, and see if I get it right. There aren't very many mature, proven MA risk management entities that are around and independent anymore. So there's not a lot of eight-point bucks out in the forest. And the good news is those that are out there are differentially interested in us because of our legacy and our reality of physician leadership. So that's the bad news and good news on that side.

But we do these other partnerships not out of a sense of need or not because of some notion that they are second-best. We actually think that they can be absolutely as good and effective as the conventional acquisitions; and in fact, the deal in Philadelphia is starting off with a very collaborative partnership with the leading physician IPA in the market. It's not just a payer-DaVita partnership. The leading doctors who want to bring the improved quality and savings that comes from integrated care are very much on board with the effort.

Okay. And then, looking at that Pennsylvania opportunity as your first big foray in the Northeast, are there other obvious markets in that region that make sense for you all, assuming that you are able to prove out the performance with this one?

Yes.

Excellent. And then the only other question is on the international dialysis side, the Saudi Arabian contract -- and you have given us some good details on the start up there. How quickly can that be a material contributor? Is this really going to be a multiple-year process to bring that to something that moves the needle for the dialysis franchise internationally? Thanks.

It's going to be a couple of years, just because there's so many centers involved and so many patients that we will be in a constant state of having a bunch of young, immature centers where we have got operating costs but not many patients or zero patients, as we build them, and then just the classic issues of having overhead that's disproportionate to the revenue until you have enough centers up and running. So it's going to be a couple years.

Thank you.

We will, of course, work very hard to provide analysis that allows you to gauge our progress and not just force you to sit back and wait three years until the portfolio matures.

Gary Taylor with Citi.

A few questions -- one, I just wanted to follow up on the California duals. Maybe I'm incorrect, but it was my understanding at LA County the plans were enrolling the dual eligibles already. So I would have thought they put have had provider networks in place. But it doesn't sound like that's the case.

That is correct. The first phase of enrollment has begun. Again, we are in active discussions with multiple plans and do hope to be able to participate in the program. We are not enrolling to date at this point.

And, therefore, the plans do have lives that they are accountable for that they don't have organized networks for, and people just keep on going to their existing provider with whatever management the plan itself can overlay. But it, for them, is a highly imperfect but pretty normal way to get something like this started.

So there's no revenue, no operating loss, income or loss expectations associated with this in the guidance or there is a little probability-weighted something in there?

Right now the premises that there's nothing big that's going to go on, good or bad, with duals. And if we cut a deal that we think is material, we will get back to you the moment it happens.

Got you. On the other and corporate drag on the gross Kidney Care operating income, which typically runs $22 million, $26 million a quarter. It was actually zero this quarter and the gross Kidney Care operating income was down. Was there a re-class? Or was there some unusual benefit this quarter?

Would you just repeat the question, please, Gary? And then either Jim Hilger or Jim Gustafson can hopefully nail it for you.

Yes. I'm just looking -- year-over-year Dallas's operating income a year ago, $408 million. You had $22 million of losses in other and corporate to take you to a net $386 million operating income. This quarter the gross was $387 million and you had zero net other and corporate to get to a net $387 million. So it's up $1 million year-over-year. But obviously the losses from international, ancillary, and corporate were much lower than they typically are. So I didn't know if there was a re-class between those or some unusual benefit in the other and corporate lines this quarter.

Got it. Can someone give a good answer?

Well, the improvement is in DaVita Rx and international, year-on-year. I think that accounts for almost all of it.

Is that recurring?

Why don't -- Gary, you give us a minute because I just sense to too much tentativeness in the answer. So give us a couple minutes and we will get back to you.

Okay. So on a related, though, Kent, you had said that you characterized the dialysis performance as strong. So the gross dialysis operating income was from $408 million a year ago down to $387 million. So how does that translate to strong?

Very fair. And by that standard it wasn't strong relative to our guidance and our fears about what 2014 might look like. We actually feel -- on our side we are feeling very, very good. But compared to the standard that you just set forth reasonably, you are right. You could then say it was just -- I guess you could say whatever you want.

Okay. Last question, and maybe I will reveal my ignorance here. You said treatment days down three days year-over-year. And I calculate weekdays the same and Saturdays the same. So was that weather related or am I just not understanding how you calculate treatment days?

This is Jim Gustafson. That's sequential, Gary, from Q4 to Q1, not year-over-year.

Okay. Okay, that makes sense. Okay, that's all I had.

All right, thank you. I will point out one -- I think it was mentioned earlier in the call. But we did have a significant increase in some of our costs, including EPO, which is part of why you see the OI number on the dialysis side that, Gary, you were talking about.

Okay, operator?

John Ransom with Raymond James.

I just want to demonstrate my grasp of the obvious. The deal in Pennsylvania, just to think about expectations for that division -- you are probably going to have to do five to 10 of those deals, and it's probably going to take a couple of years before we start seeing some material EBITDA from that strategy. Is that a fair way to think about it? Is that a reasonable pipeline?

Yes, sir.

Yes on both?

Say again, please.

Yes to both questions? So you need five to 10, and it's going to take a couple years?

Okay. Maybe you'd better say both questions again so I'm not being -- I'm not too cryptic.

No; I'm saying it looks like it would take a couple years, by your own reckoning; and then maybe you would have to do five to seven deals like this in a couple years before you start to see some material EBITDA to the enterprise. Is that a fair way to think about it? And is this the new template going forward?

Well, if we are successful, the Philadelphia joint venture could be of pretty serious size, just like HealthCare Partners in California and Florida and Nevada. And so the numbers could be substantial. Therefore, you don't have to do lots and lots of them if you succeed and they grow at a nice steady pace.

Having said that, we do want to do more than one. We do not think this will be the last time we use a model like this. In many other instances, however, we will still be a majority owner. In this particular case, the payer had such a strong market position and, because of some other aspects of the agreement as well, 50-50 just seemed like the right thing to do.

Now, the other question -- you have a fairly small percentage of their MA lives, in total. What's the trigger to get more than what you have? Or in the short term are you just limited to these 300 primary care doctors? Or is there a trigger to expand this beyond what I would call kind of a pilot stage into a broader relationship with their other MA lives?

John, I'm sorry. I missed the beginning of the question. Can you repeat that again?

Sure. I'm sorry. You have a fairly small percentage of their MA lives. I'm talking about the Blue Cross plan. What is the trigger to get a bigger percentage? Are you limited in the short term to just these 300 docs?

We are beginning to venture with the 300 physicians. But the hope and expectation is that we would expand the contracted network with Tandigm beyond the 300 physicians through this year and into next year as well. So our expectation is that our membership, both MA and commercial, will grow in this venture.

But it's not you have to wait a year or you can grow it during the year and into next year? There's no like we are going to try this for a year and see how it goes and then maybe we will expand it? So you can grow this as it happens?

There is no specific trigger before we can expand this network.

Okay, thank you.

I will add you don't want to take too many lives if they are being cared for by physicians who are not committed or positively interested in the new model. Okay, operator, thank you.

Lisa Clive with Sanford Bernstein.

Just one question, going back to integrated care on the dialysis side. Your VillageHealth business has been going along for several years. And obviously, with ESCO not quite exactly the way you want it, what should we think about for the outlook of integrated care on your non-Medicare fee for service patients?

So the question is what kind of growth can we expect on the VillageHealth side? Is that a reasonable paraphrase?

Well, I guess -- yes, and maybe not specific growth. But what are your long-term plans there? Is there a way to move into integrated care without the ESCO program? Or how are you thinking about that? Clearly, DaVita Rx is a big platform for you. But what else should we think about as opportunities there.

VillageHealth -- we can grow it outside of the ESCO program, not as cleanly and as aggressively as we could if there was an attractive ESCO program. But yes, we can continue to nudge it along and push it along. In addition, one of VillageHealth's great benefits is it adds value to our fee-for-service clients, who then can take that value into account when we are negotiating dialysis rates. So just because we are not capitated or at risk with them doesn't mean that they cannot appreciate the impact on quality and total cost and have that reflected and monetized in part through conventional fee-for-service rates.

But to the first part of your question, we will continue to strive to grow VillageHealth everywhere we can. It just won't be rapid without a government program that works.

Okay, great. And then maybe actually just one last question on the ESCO program itself. Under the current or ESCO 2.0, it seems like the size is still pretty limited. Assuming you can get over your or you can reach an agreement with CMS on the few outstanding issues that you have, how many patients would you ideally like to enroll in this pilot program?

Oh, if we like the program, we would like to take the whole program to ourselves. I think they are putting a cap of 15,000 or 20,000. And of course, they would never allocate more than X percent to us, and we would take that in the second and double it, if we could, if we would just get a couple of changes.

Okay, thanks very much.

Whit Mayo with Robert Baird.

You guys gave the OI for the legacy HCP markets. But can you also share the revenue and how margins would have compared versus the prior year?

We can't do it spontaneously. And we will think about doing it for the next call. Let us sort that out. We want to make sure there's reasonable boundaries on how much market-specific stuff we talk about because in general it's not in your best interest for us to go too deep, market by market. We have violated our normal policy because we felt we had to do it in order to be responsible in discussing our current performance to you. But I'm not at all sure we are going to want to go where you are going.

No, I can appreciate that. But I guess maybe directionally, can you confirm that margins were higher this year versus the prior year? Anything to point us in the right direction without divulging too much specific data.

I think not. And let us just reflect after the call. And if I'm making the wrong game time decision, Jim and Garry will correct it.

No, that's fair. Thanks a lot.

At this time I show no further questions.

All right. Thank you all very much. We will -- wait a minute, we have some late-breaking information.

I just wanted to respond to Gary's question. Gary, the answer to your question is we had better overall results in our ancillary businesses, which includes international. And the management, the corporate charges were down because we are allocating corporate costs among our various operating segments. And that is a change on the corporate charges.

Okay. So hopefully, Gary, that took care of that one. And our early answer, we apologize, was misleading. So, I'm glad we were able to correct it quickly. And thank you all very much for your interest in us. We will do our best to do what we said we were going to do, going forward. Thank you.

Thank you. This concludes today's call. You may disconnect at this time.