德維特 (DVA) 2016 Q2 法說會逐字稿

Welcome and thank you for standing by. At this time all participants are in a listen-only mode. After the presentation we will conduct a question-and-answer session. (Operator Instructions). Now I will turn the meeting over to one of your hosts, Mr. Jim Gustafson. Sir, you may begin.

Thank you, Joel, and welcome, everyone, to the DaVita HealthCare Partners second-quarter 2016 earnings conference call. I appreciate your continued interest in our Company.

I'm Jim Gustafson, Vice President of Investor Relations, and with me today are Kent Thiry, our CEO, Javier Rodriguez, the CEO of DaVita Kidney Care, Vijay Kotte, Chief Financial Officer of DaVita Medical Group, Jim Hilger, our interim CFO and Chief Accounting Officer, and LeAnne Zumwalt, Group Vice President.

I'd 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 the actual results to differ materially from those described in the forward-looking statements. For further details concerning these risks and uncertainties, please refer to our SEC filings, including our most recent annual report on Form 10-K, and quarterly report on Form 10-Q. 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 like to remind you that during this call we will discuss some non-GAAP financial measures. A reconciliation of these non-GAAP measures to the most comparable GAAP financial measures is included in our Form 8-K submitted to the SEC and available on our website.

I'll now turn the call over to Kent Thiry, our Chief Executive Officer.

Thank you, Jim, and welcome to all. We delivered solid adjusted operating income and strong cash flows in this particular quarter. The total adjusted operating income was $475 million as many if you've already seen which were driven by the strong Kidney Care results at $431 million and a disappointing DaVita Medical Group trajectory reflected with $44 million on a non-GAAP basis there.

Operating cash flows, another bright spot of $517 million, as we continue to successfully convert your earnings into your cash. We will discuss several topics here before we get into Q&A, number one is clinical outcomes. Number two is DMG results. Number three is US Kidney Care. Number four, a little bit of an update on international, and number five is just an additional financial enterprise level details.

I'll start with clinical outcomes as we always do, we are first and foremost a caregiving company and quite good at it. Now about 185,000 patients in the US alone, about 35% of all dialysis patients in America, one of the areas where we've increased our focus is in reducing bloodstream infections. A very big deal to our patients, a very big deal to their families, a very big deal to the taxpayer.

It's important because this keeps patients out of the hospital. Bloodstream infections are one of the top five causes of hospitalizations for these patients, and this impacts both QIP and Five-Star. We are now performing blood culture tests on more than 90% of the situations when a patient is present with signs and symptoms of bloodstream infections. We'll never get to 100%. But 90% is remarkably higher than where we were X years ago, and where so many dialysis centers are today.

Despite testing a greater percentage of eligible patients we've actually decreased our bloodstream infection rate by 16% over the last 12 months, and we're working both sides of the equation with tenacity and some success.

On the DMG side, the DaVita Medical Group year to date, we've outperformed on the focused HEDIS measures that CMS uses to track Medicare Advantage clinical quality compared to the same period last year. And as a result we are on track to achieve greater than four stars in all of our plan relationships. For some more detail on the DaVita Medical Group, I turn it over to Vijay Kotte.

Thanks, Kent. Turning to this quarter's performance, operating income is $44 million excluding non-GAAP items as detailed in our earnings release. Unfortunately year-to-date we have financially underperformed, relative to plan, and we expect this gap to increase in the second half of the year.

As a result, we are lowering our 2016 full-year guidance to $110 million to $150 million. The decrease in guidance had four primary drivers. Fee-for-service growth, prior year revenue reconciliation, Medicare Advantage growth, and rebranding efforts.

To provide a little more color let me walk you through those. First, our fee-for-service revenue growth has not met our expectations. Our target was 6% year-over-year but we're achieving 3%. Second, we made a mistake forecasting 2016 operating profit by overestimating expected reconciliation payments for prior year Medicare Advantage revenue. Third, while our in year Medicare Advantage membership growth has been in line with broader enrollment trends in the geographies we operate in, it is lower than we previously expected. Fourth, as we stated on our last call, we are rebranding from HealthCare Partners to the DaVita Medical Group. To accomplish this we expect to spend $5 million to $10 million this year that wasn't previously included in our forecast.

In addition, we will need to accelerate the non-cash amortization of $110 million worth of existing trademark intangibles associated with the legacy HealthCare Partners brand. This accelerated amortization has been excluded from our revised 2016 and long-term guidance.

Despite these disappointments, we are making good progress on the key items we identified at Capital Markets. In terms of fee-for-service to value conversion we are progressing in contracting discussions with health plans while developing value-based care capabilities in our newer markets. Additionally, we continue to invest in the business which we believe will fuel our long-term success.

One example is our investment in seven new de novo clinics which are capital-efficient growth platform similar to what you are used to seeing in Kidney Care. Finally, as we look towards our long-term outlook, our 2019 OI target remains $250 million.

Now I will turn it over to Javier Rodriguez to speak a little bit more about Kidney Care.

Thank you, Vijay, and hello everyone. Before I talk about the quarter I'd like to highlight a recent development that we are very excited about.

At our Capital Markets Day we talked about the powerful benefits of integrated care for chronic populations, including our own ESRD patients. Since then, two new pieces of legislation that are supported by the dialysis community have been introduced in Congress. The first is called the Dialysis Patient Demonstration Act, and that provides for true integrated care model for Kidney Care patients. The second is called the ESRD Choice Act of 2016, and that would finally allow for ESRD patients to enroll in MA plans.

Both of these acts would be a great gift to ESRD patients and play to our long-term strategy of integrated care. We are hopeful about their prospects in Congress due to the strong bipartisan support and we will continue to work hard to pursue integrated care for our patients.

Now onto our quarterly results. Overall, DaVita Kidney Care had a strong and reasonably straightforward quarter, so I won't go into much detail here. As Kent said, we delivered strong operating income of $431 million due to a slight improvement in revenue per treatment over Q1 as well as a slight reduction in cost per treatment.

With respect to growth, our normalized non-acquired growth for the quarter was 4.3% which falls within our long-term target range of 3.5% to 4.5%. With the first half of the year now behind us, we are raising the bottom end of our 2016 guidance range by $50 million; this is consistent with our comments from last quarter that we are more likely to be in the top half of our original guidance.

With this change our new Kidney Care operating income guidance for 2016 is now $1.675 billion to $1.725 billion. As for next year, we plan to provide 2017 guidance during our fourth-quarter earnings call. We made this change last year because ACA plans have become a more meaningful part of our commercial mix. This has added some new drivers of upside and downside to our business and our industry, as well as some seasonality. Providing guidance on our fourth-quarter call allows us to incorporate the additional visibility we gain during open enrollment periods.

Before I turn it back to KT I want to close by saying we remain excited about the fundamentals of our business, the gradual shift towards integrated care and the fact that our teammates are recognized for providing the best outcomes and quality of life for kidney patients.

Now back to Kent to discuss our international business.

Okay, thank you, JR. International losses, $13 million in the quarter which is pretty much in line with our guidance of approximately $40 million of losses on the full year. We continue to maintain what we told you, I think about a year ago that we committed to try to achieve breakeven by 2018 in our current market portfolio, excluding any new countries and we are standing by that. And a number of you probably saw that we did in fact close the transaction that we had to announce four to five to six weeks ago, that being our JV transaction with Khazanah and Mitsui on August 1st.

Just to refresh your memory, Khazanah and Mitsui have each subscribed to acquire 20% share of ownership over time. At the closing each provided $50 million of funding to the JV in return for each receiving a 6.7% stake.

We are excited to have them as partners, we have a very long-term point of view about the opportunity in that part of the world as do they, and we think they're going to help us accelerate and deepen our growth.

Now I'll turn it over to Jim Hilger to cover some more enterprise financials.

Thanks, Kent. And just a little more about our Asia-Pacific joint venture, in regards to the JV with Khazanah and Mitsui, please note that we expect that this joint venture will be deconsolidated from our financials. And thus future operating results will run through equity investment income for our pro rata share of ownership in the joint venture.

Please note that we expect to record a material non-cash one-time gain in connection with the formation of this JV, and this gain is excluded from our guidance.

Now onto the overall enterprise. Our debt expense was $103 million in the second quarter, consistent with recent quarters. Next, the effective tax rate attributable to DaVita HealthCare Partners was 37.2% in the quarter when adjusted for the nondeductible goodwill impairment charge and recognition of a state tax income tax benefit. We expect the full year effective tax rate attributable to DaVita HealthCare Partners on our adjusted income for 2016 to be in the range of 39% to 40%.

Now turning to cash flow. We continue to generate strong cash flows. Operating cash flow was $517 million in the quarter, and $2.06 billion for the last 12 months. The last 12 months benefited from the timing of tax payments. We expect full-year 2016 operating cash flow to be between $1.6 billion and $1.75 billion. One thing to keep in mind when thinking about the cash flows of our individual operating segments is that DMG generates a disproportionately higher share of our cash flows than its share of our adjusted operating income. While the midpoint of our DMG guidance for adjusted operating income is $130 million, the business has a year-to-date annual run rate of $200 million in non-cash depreciation and amortization expense.

In addition, as you will recall, there is a cash tax reduction of approximately $100 million per year, which is the equivalent to a $167 million improvement in pretax operating income. This cash tax benefit is due to the tax basis step-up created when we acquired the Medical Group.

And finally, as the vast majority of DMG's business is capitated care, where we are paid before incurring expenses, it has favorable cash flow characteristics with low to negative working capital. Thus, DMG contributes more to our operating cash flows than is first apparent when looking at operating income.

We continue to have a very strong cash balance with $1.68 billion in cash and short-term investments as of June 30. We continue to weigh capital deployment opportunities across growth investment, share repurchases, debt repayment and holding cash.

Additionally, as disclosed in our earnings release, our Board of Directors just increased our share repurchase authorization from the remaining $259 million to now $1.5 billion. And with that I will now turn the call back over to Kent Thiry.

I'll just make a few summary comments before we go to Q&A.

Number one, with the DaVita Medical Group we are certainly sorry that we had to reduce the guidance, and the fact that it will take even more time to get it to where we think we can be regularly growing earnings, and we are intensely intent on doing. But it will take some time. Number two, DaVita Kidney Care, wonderfully solid results yet again. Probably even better than that. At the same time as JR has talked about recently, we could have some choppiness at the high levels. And we are maniacally continuing to invest in becoming even more differentiated than we are today in quality, and service and position experience in IT, etc. Third, of four, is the cash flow, your cash flow continues to be a powerful weapon to be deployed in your defense, and on offense.

And lastly, fourth, we continue to have a lot of belief in our overall business platform, everything from our geographic footprint to our capabilities by function etc., etc.

So thank you all very much, and Joel, could you please open it up for Q&A?

(Operator Instructions).

Operator, are you having any problems?

I just am waiting for the participants. (Operator Instructions). At the moment, we don't have any incoming questions. Let me just inform you again, participants, if you'd like to ask a question, hit star, followed by the number one. (Operator Instructions).

Joel, I show seven people in the queue.

Okay, one moment.

Joel, there might be something wrong with the equipment that you're looking at, so perhaps while the first person asks their question, you can do some checking with some of the other people there.

I will double check Sir, because those people that are on the queue, they pressed star one at the beginning of the presentation, but let me open up their line, hold on.

That's okay if you let them in, because we know there is a number of people that ask questions each and every call. So it's okay if you do that.

Okay. So we have the first question from the line of Mr. Chris Rigg. Mr Rigg, your line is open.

Good afternoon. Just wanted to ask about DMG here. I guess just with regard to fee-for-service revenue only growing at 3% versus 6%, is that tied to the Everett clinic or is that something completely different?

It's pretty much across the board, although of course the Everett Clinic is the biggest single source. We're just a little bit soft in the number of different areas, and the good news or bad news depending on how you look at it is we can operate some parts of that much better outside of the Everett Clinic, and within the Everett Clinic which operates so excellently, had kind of an uncharacteristic stumble. And so it's a mix of all of our fee for service locations, nothing really jumping out.

Okay. And then, just a little bit of forward-thinking on the ESRD choice legislation that you guys highlighted. How would that - at least at a high-level - work in your guys' opinion? Would you get better rates from the MA plans than you currently get on the fee-for-service side, is that the right way to think about it? Thanks.

There's a couple ways about it, and I'll chime in, this is Javier, and LeAnne, if you want to supplement. The main thing is that the lives would be attributed to the dialysis clinic, and so therefore the dialysis clinic would become the medical home sort of de facto medical home because we've had the patient for 12 hours.

The other important thing is that on the revenue side, instead of having a benchmark which is a little of a black box thing, that you get a number, it would be linked to MA, and so the revenues would be a lot more predictable. Does that answer your question?

Yes, thank you.

Thank you Mr. Rigg. The next question comes from the line of Mr. Matthew Borsch. Sir, your line is open.

This is Tejus joining on for Matt. Thanks for taking the question. There's been some recent articles about insurers focusing on third-party payments from charities like American Kidney Fund and even across other subsectors as well. I think it's been a long-standing practice for dialysis companies to donate to these charities, but for those of us less familiar, can you provide some color on how AKF fits into your overall strategy and any dynamics at play regarding increased focus.

Before we do that, before Javier does that, this is KT, just coming back again. I want to make sure we cover all aspects of the previous questioner's question. In general, we do get paid more for an MA dialysis patient than a Medicare fee-for-service patient. It's totally intuitively to be expected because if you have MA risk, if you're in MA plan, you care a lot more about aggregate integrated care because you are at risk on the entire expense for the patient. And so, coming to us where you get some of what we provide, and therefore lower hospitalizations and happier repeat patients/customers, it is natural that given our more robust value proposition that the payor pays us more and in fact is happier than they would be paying less for fee-for-service type service.

Now on to the next question. Javier?

Sure Matthew, thank you for the question. First of all, it's probably worth stepping back and reviewing level setting here. We believe that it is vital for patients of all different disease states to have premium assistance, it is a critical part of our healthcare system and has been so for decades. And of course we've got to have appropriate rules. So, those need to be reviewed periodically.

In Kidney Care, we have been donating and still have all other providers to help patients with end-stage renal disease for decades in order to be assisted with their premiums. The OIG has reviewed that framework more than once and actually just did it over a year ago or so. And so that framework has been vetted, and of course we have to make sure that we all stay and abide by the rules that were outlined by the OIG. Did I get to what you're going for?

That was very helpful, thanks. And just a quick kind of follow-up modeling question. For the D&A in the quarter, looks like there was an uptick there. Was that associated with the accelerated amortization from the rebranding?

No, it was not. We have not started the acceleration, that's a forward-looking event, but we will keep you informed about that matter as we determine the final amortization periods.

Can you comment on the uptick though?

Why don't you give us --

It's primarily the Everett Clinic.

Okay. Thanks very much.

We will check, and if there's any answer that should be appended to, primarily the Everett Clinic, we will get it out in the next 5 to 10 minutes. The next one please, Joel.

Thank you. The next question comes from Kevin Fischbeck. Kevin, your line is open.

Thank you. This is actually Joanna Gajuk filling in for Kevin. So question here on the transaction that you announced with Tandigm, or rather selling the portion of it. So the question here is who did you sell the interest to, and we would like to know whether this was a strategic play or sold to potentially help save money there, or sold for financial reasons?

On Tandigm, what we did is sold a part of our stake back to IBC, Independence Blue Cross, who has been our partner in Tandigm since day one. What both sides agreed was to do this in order to create more alignment between IBC and Tandigm. Otherwise we're in a situation where IBC got 100% of the profits in their non-Tandigm business, only 50% in the Tandigm part of the business, and this lack of alignment was getting in the way of some of the glass breaking that needed to go on in order to move the entire organization forward, and so, we agreed to be bought out in part to get that alignment. And who knows, perhaps we will get to go back to up to a higher percentage over time.

That's helpful. Staying a little bit on that front and specifically on the reduction in I guess outlook for operating income for that part of the business HCP, DMG, specifically, how should we think about this reduction as it relates to the sale in the space and, also, the exit in Arizona market. So, is that the guidance change to reflect those two things, or is there change to a core performance as well, and if it is if you could please quantify the two different sort of buckets, the asset sales versus the core performance of the business. Thank you.

I'm going to turn that to Vijay, there was a part on Arizona and then perhaps in relationship with Arizona with Tandigm, and then core performance separate from those two if I heard correctly. Were those the three parts, please?

Exactly, yes.

So Joanna, I think the first question was related to does the guidance change, is that reflective or is that driven by the change in ownership in Arizona and in Tandigm. So it is incorporated, it is not a driving component. The four items that we called out are the primary factors that are changing our guidance expectations for the year.

So is there a way to quantify those? I heard you said $5 million-$6 million of these additional costs from rebranding, so I guess there are other, I guess other delta, the other part of the delta is FFS growth and MA, right?

One is the fee-for-service growth being only 3% versus our expected 6%, and then in-year MA growth, and the mistake in our estimate on the prior year revenue reconciliation amount.

So is there a way to sort of add up those four things versus the change in coming from the sale of Tandigm in Arizona?

Let me take a stab at the answer to the question I think you're asking. Those four factors explain the change in guidance, and the Tandigm and Arizona transactions had little to no impact on go-forward guidance.

Great, that's what I was getting at, yes exactly. Thank you so much.

Thank you. The next question comes from the line of Gary Lieberman. Mr. Lieberman, your line is open.

Good afternoon, thanks for taking the question. I guess maybe to stay with that last question for a second, is it possible to break out those four components to put a dollar number on each one of those for the impact? Because it was a fairly large change to the guidance.

All four are pretty significant meaty parts of it, and we are not going to attribute a dollar to each one individually. But each one is significant.

And I guess maybe going back to the explanations for the sale of Tandigm. Could you just walk us through that? In other words, I wasn't entirely clear kind of exactly what the driver was there.

Sure I can. In establishing Tandigm, where you know that IBC and DaVita together stood up a 100,000 member at risk HMO essentially in a year. And so, an exceptionally aggressive implementation. It is necessary for us to work for a lot of the home departments within IBC and also to be negotiating with the same hospitals that IBC is negotiating with for their other products.

And what we found is some IBC teammates, as you would rationally expect say, hey, an extra $1 of hospital rate relief goes 100% to IBC if I put it in this product, negotiate it for here, and only 50% if I negotiate for there.

Now the fact is those perceptions are going to change over time because of the offensive potential of Tandigm, and because more and more IBC people are becoming part of Tandigm. But in the meantime, rather than try to deal with some of that understandable organizational friction, we said the simplest way to deal with it in the near term is to let us be bought down, and so all of IBC could see that they had a significant majority of the profits in either case.

Okay. And then you mentioned the opportunity to potentially increase your ownership stake back-up. How would that work?

Correct. Without going into a lot of detail, we have some rights with respect to buying back up to our prior position.

So you're still committed to Tandigm, and it's going well compared to when you initially did the deal, or how would you characterize that?

We are still committed to Tandigm. And are doing well, I kind of hate saying yes or no to something like that. It's a young company, we are making progress every quarter. If you hit plan than it sounds like you're doing well, but it could've been you made too soft a plan. If you are missing it, it could sound like you are doing poorly but it could've been you set a good aggressive plan or had a little bad luck.

And so all I can say is that we are a lot better today than we were four months ago, we are better four months ago than eight months ago, we've got some new executives on board, and so we are feeling pretty darn good. But we also set out to do something that really hasn't been done very often. So we just don't have a lot of illusions about skipping up the mountain. We know we're going to skin our knees a couple times on the way.

Okay. And maybe turning towards the comments by some of the managed-care companies this quarter regarding the premiums from the American Kidney Fund, it sounds like some of them may actually be talking to state insurance commissioners, or pushing back in other ways to maybe get out of taking those premiums.

Can you talk about any conversations that you've had or your thoughts generally speaking about how any of this might transpire?

Hey Gary, it's Javier. And again, it's probably useful to step back a bit. And so in a world right now, where in 2014 the exchanges came into play, we've heard so much about the risk pools and how they are not well-funded.

And so, a new product comes into market, our dialysis patients and our social workers work really hard to make sure that they explain and understand their new product, and at that time the patient and the patient alone makes a decision on what's right for them. As you know, many of the chronic and high costs of these states have caused these risk pools to be challenging to the payors.

I think that they've, in some instances, have highlighted ESRD expense but the reality is that it's pretty much all chronic diseases. So CMS is evaluating third-party premium assistance to see what their stance is, but it's complicated around the healthcare continuum. So right now they are evaluating because the last thing they want to do is use a broad brush and then have consequences on one disease state versus another.

So right now what's going on is that in every state people are trying to lobby to get one thing or another. What we have found is that regulators, once they really hear our patients' needs and what they literally need as choice, they're quite sympathetic to the cause. And so it will play out state-by-state, and of course the patients and ourselves will do the best we can to make sure that they have rights to these products, regardless of the fact that they end up being expensive patients.

That's very helpful. And maybe final question just staying on the Kidney Care front, it looks like patient care cost for treatment was down marginally in the quarter. Any changes specifically on use of drugs, and to the extent you guys are willing to comment on negotiations or conversations with alternative providers of ESA or your current supplier. Thanks.

Gary, thanks for the question. No big change on utilization of meds. And there's nothing new to update. The negotiations continue, and all the dynamics that we've explained before are the same.

Okay, thanks a lot.

The next question comes from the line of John Ransom. Mr. Ransom, your line is open.

Nobody ever calls me Mr., so that's a nice honorary. A couple things.

A couple things - Kent, let's kind of step back and think big picture on HCP, now renamed; you've been in this for four years, clearly the numbers haven't been what we all hoped they would be. How much of that do you attribute to structural factors, and what I would say about that is maybe not as many markets were ready for this revolution as we thought, or secondly how much of it do you say, well gosh, maybe we didn't execute as well as we thought we could have, if it's possible to do that.

That's a very fair point. Maybe I would refer to four chapters.

Chapter 1 was huge reimbursement cut. $200 million of OI lost because HealthCare Partners was more adept than others at capturing the acuity codes, which we knew going in but didn't anticipate the dramatic change in policy. We knew there would be some softening there, and some compression. And we knew it wouldn't be small, but we did not expect it would happen so much and so quickly. Therefore we own that.

So Chapter 1 was breathtaking reimbursement cuts for $200 million annually.

Chapter 2 was pretty much total displacement of the leadership. California, Nevada, Florida, the three markets -- potentially 100% change. And that took time, and of course while you're doing it does get in the way of things getting done and it does create some transitional trauma.

Chapter 3 is bring in the new infrastructure. You can buy the house on the best lot with the best architectural bones, but if it needs new heating, ventilating, air conditioning, you've got a lot of work to do, it doesn't really start showing up until it's done, but it makes a hell of a difference as to the experience that's going inside. And so that's the chapter we are in the midst of right now.

Chapter 4 is the one we're just starting to feel in some places where we are bringing a new level of operating excellence, a new level of innovation and an enhanced value proposition, new levels of creativity and contracting. But these are just little saplings breaking through the surface right now.

The good news is they are there, and we are ready to take care of them. So, I would divide the world into four chapters and then I would offer up my empathy for the fact that so many of you shareholders have had to live through the excruciating burden of chapters 1 through 3.

That's a great answer. And I have a follow-up for Javier. Just to push back a little bit on this foundation issue, these patients would be covered by Medicare. It's not as if they would be bereft of health insurance, and I think I've read 5,500 or so patients are now on exchanges being paid for by the foundations. Aren't you arguing that United Healthcare and Anthem should take, I don't know, $5000, $10,000 in premium and have a care cost of over $100,000? How can we make that argument to these plans when they could be covered under the public plans?

And I would assume you guys have your proportional share of the 5,500. Just stepping back from kind of a public policy standpoint, at a time when the plans are losing money in the exchanges, how do you argue to them that they should cover people that could be covered for a fraction of the cost under Medicare?

A couple of things. If you're on Medicare, you are not eligible to go on the exchange. And so that is the benefit that you have. For the patient that switched I don't if the number you cited is right or not, we have not disclosed those numbers.

It is a very personal decision that is based on access to specialists, drugs and other things. So the patients actually do get differentiated care, and so the reality of this thing is that the system set it up for individuals to make a choice as to what their best coverage is. And so, patients made that choice. And it's a very personal decision that I can't decide whether that's right or wrong for the system, but rather they get to make the choice.

Okay, thanks. That's it for me.

One might also ask the question how appropriate is it for plans to make multiple times the magnitude of profit on MA patients that all the providers in America do combined. That might be another philosophical question to ask.

The fact is it gets so interesting. There's pockets of profitability within healthcare and you have pockets of loss, for example, for us. About 80% of our patients are Medicare fee-for-service, and we lose money on every one of them. It really doesn't make any sense. And so you end up having to kind of think of it as an ecosystem where the plans have what might look like excessive margins somewhere, and then have losses elsewhere, where we take care of some patients at an absolute significant unambiguous loss and in other cases have higher margins than you expect us to. So you sort of have to end up looking at it as an ecosystem and see if any one part of it is getting out of balance, because it's hard to get each individual part of it exactly right.

Operator, go ahead with the next question.

We have another question from the line of Mr. Whit Mayo. Sir, your line is now open.

Good afternoon. Maybe I missed this, but can you go back to the prior year revenue headwind within DMG? Was that prior year issue in the quarter or was it something that you expect to hit in the second half?

It was something we expected to receive and recognize in the second half of the year.

Maybe help us understand the process around identifying and truing up those claims and what specifically this is.

This is not related to claims, this is about revenue and the finalization of revenue with CMS. And you typically bring that in on a cash basis in the second part of the year, and our estimate of that was higher than what we now believe that amount to be that we will receive in the back half.

And if you just look at for buckets that you've outlined, I guess the sources of underperformance, if you will ,within the DaVita Medical Group, the rebranding doesn't seem to be an issue that's probably going to recur until 2017, maybe it does to some extent. The prior year revenue that this stuff happens but I would imagine it's probably something that doesn't recur next year.

So how much of the guide down would you call to be more from transient factors?

I think the way you are thinking about it is about right. And I don't want to go any further into what 2017 would look like, but I think the way you're thinking about it is right.

I'll go a tad further than that. Because you are right on the mistake we made in forecasting, and fortunately caught it before we were into that forecasted period, we certainly hope that that doesn't recur. We, like everyone else, hope that MA enrollment growth is higher the next couple of years than the last couple. That's not entirely under our control of course, it depends on what government policy comes on in terms of rates to a great extent.

We are working hard to nudge up that fee-for-service growth so we don't want that to be recurring, and we don't expect it to be recurring in the long run, but we don't know how quickly we are going to be able to either bump it up or take out some of the expenses associated with not having higher growth. And I am missing the fourth one, but I think you also nailed that one. Enough said.

And maybe just remind us, Renal Ventures. Is this included in your guidance at this point, and it feels like maybe this deal is taking a little bit longer than maybe we anticipated, just an update with the timing of that.

Sure. The answer to your first question is that it is not included as to the timing, we are equally as frustrated and are moving as quickly as we can, we anticipate back end fourth quarter closing. But as you know, that is a moving target.

Got it. Any specific reason just for the hold-up on the deal, or is this just one of those things that's out of everyone's control?

It's normal process, but slow. I can't exactly tell you why. It's just the normal process but it's just gone slow it seems at every step of the process.

Understood, thanks.

Thank you. Our next question comes from the line of Mr. Gary Taylor. Your line is now open.

Good evening. A couple questions. First on California, California - I'm sorry, the Arizona divestiture. Will that close in the third quarter?

That closed within Q2.

That's included in the cash flow statement proceeds for six months, which is not very much. Can you just remind us then of in that market, what the revenue model was and the membership?

We don't typically disclose our numbers on a market basis. So, I refrain from giving you that level of detail. Is there a more specific question you can ask?

Well I guess I'm trying to understand what it was you sold and who you sold it to, and what the revenues come out for HCP. Obviously you said it won't have much impact on operating income, so apparently wasn't that profitable. But we do need to model HCP revenues on a go forward basis, so any help there would be good.

Gary, absolutely fair questions, and we didn't think of that one ahead of time. And we don't want establish, on the one hand we don't want to establish a new precedent for disclosing things, and on the other hand, we don't want to keep you from being able to take care of your models. So we will work on it and say hey everybody there's a follow-up call can figure out what we can say or not say about the years on particulars. But for us to do it spontaneously is a little too nerve-racking.

Okay. On commercial mix, improved about 100 basis points last year, I believe. And I didn't know if the revenue per treatment growth slowed this quarter year over year. So I didn't hear you call anything out, so I'm presuming you're just comping that growth of commercial mix, and are we right to think that maybe commercial mix is pretty stable year over year? Is it down?

So I think you're alluding to 2014, we disclosed 10% and revenue per treatment was $342, in 2015 we disclosed 11% and revenue $348. As you saw we're $351, we haven't disclosed mix, so it's fair to say that it's stable with a slight bump.

Okay. On the HCP side question, are any of the rates contractually tied to the health industry fee holiday? In other words we've heard from some plans that as they get released in 2017 and not have to pay this industry fee holiday, some of their capitated groups contractually get a bump because they effectively had to eat, as you did, some rate cuts over the last few years. So this is effectively a net rate increase to the plans to not have to pay this fee. Will HCP benefit contractually from that in 2017?

Again, as it relates to our contract, it's a mixed bag. Some of our contracts will have a flow through, others won't. But in those where it does flow through, there may be some slight hiccups there for the one-time period as you know all the details are.

And last question, I believe at investor day you had sized a $25 million Medicare headwind for HCP in 2017, I wonder if there's any update to that. Obviously we are thinking about potential negative impact of the dual risk model change in some markets, but positive in others and maybe a little bit of benefit from this industry fee holiday. At this point is that $25 million still the best number?

That is still the best number, including all the things you just described.

All right, thank you.

The next question comes from Lisa Clive. Your line is now open.

Three questions. The HCP Arizona sale, could you talk to the rationale for that? Second question, just on the write-downs that we've had on HCP over the last few quarters, are we at the bottom here, or are there potentially more to come and it just depends on what your accountants say, but just help them think through that. And the third question is on the international business, you mentioned a goodwill impairment charge. Just wondering what the source of that was.

Let me first start on Arizona divestiture. In short, we got a good offer that was presented to us, and as we looked at the alternative in a way that we could invest and deploy our resources for a greater value, that was the right trade-off. So we decided to accept that offer and divest. Jim, do you want to touch on the other question?

In regards to the goodwill impairment that we took during the quarter, as we look forward there is a chance that we will have another impairment. As we disclosed in our 10-Q, we have a negative cushion in our Nevada and Florida markets, and there is a very kind of nuanced and detailed accounting rules around impairment accounting, and so when you have a negative cushion, that means that your fair value is less than your book value. And so if there is any further deterioration in performance or in outlook in those markets, we could see further impairment.

Additionally, the FASB is looking at changing the rules around accounting for goodwill impairments. When they do that, there may be an effect related to the adoption of those new rules. And then the final part of your question was an international impairment, we did have a small international impairment last year but we did not have one this year.

Thanks for the clarification. Just one follow-up on the Arizona deal. Who did you actually sell to?

I don't know if we are authorized to say. Does anybody around the table know for sure? I don't know the contract by heart. So if you could call in we'll check if it's fine, it's also relatively commonly known in the market, in case you know anyone there. But we would be happy to give the answer once we confirm that we were legally allowed to.

Okay thanks. I was just sort of curious as to what sort of entity would give you a good deal to take it off your hands.

For us it was better for us to focus on other markets than that one.

Thanks for that.

We have another question from the line of Margaret Kaczor. Your line is now open.

Good afternoon. I was hoping to start off with exchange plans, over the last couple of calls this has been a popular topic for you guys. But now that we are in August, halfway through the year, are you seeing the regulatory environment improving, stabilizing? Are patients receiving adequate access to care, especially near term? Any trend data that you guys may have would be helpful.

We actually don't have any significant change. The patients are receiving great care, and right now, as we stated earlier in the call, there's a lot to be played. So a lot of rules and enforcement is still to be played.

But right now, there's nothing different to report on what we told you on Capital Markets day.

I think the way I would put it is that regulatory agencies? capacity to enforce the regulations with respect to exchanges remain weak. Either by virtue of lack of motivation because they're worried about the Exchanges' financial liability, or because they just don't have the resources.

Is that something that can change at some point in the next 6 to 12, 18 months?

Yes, it could change and it's likely to change some. But one wouldn't want to pin one's hopes on it changing a lot.

Okay. And then on your international ventures, how is Asia developing - some of these other countries like Saudi Arabia developing, and then how do you compare those businesses versus some of your clinics in Germany both in terms of patients, investments going forward and profitability profile?

We are in 11 other countries now, and the microeconomics and growth trajectory are different in every one. The good news is that, in virtually every one, the microeconomics work at a very reasonable market share position, so even if we are losing money now in a country, just by increasing our scale with the existing achieved microeconomics of our current centers, we know we are on the path to the promised land of first being profitable, and then, second, having an adequate cumulative return. But the differences are quite large. And Germany and Saudi are two of our more successful markets from many perspectives, including the microeconomics.

But am I getting to your question?

And part of it becomes how do you guys bridge to the profitability gap you talked about at the Capital Markets day, and what impact, or how many years really will it take for China to either be material as well as profitable?

I don't know is the answer. With respect to China, that day is almost certainly outside your investment time horizon. And yet the only way to become a leader in China is to get into China and learn it. Very difficult to try to transplant your way in X years later. In China, we will probably end up with a few partners is the right way to do it.

Just as we concluded in Asia despite the fact that we were doing well in Southeast Asia, partnering with Khazanah and Mitsui we thought was going to help us grow faster and better, everything from helping us recruit more talent, helping us oversee what we have, helping us interact with the government more and the regulators, so in all sorts of ways we learned important lessons which should make the next five years very different from the last five.

But having said all that, in China in particular, you want to be very careful before you start talking about any bullish forecast because it is one tough place to do business.

Okay, and then one last question. We're trying to balance some of the growth within dialysis against some of the other companies we cover, and what we are noticing is as some of the acute-care demand at least for equipment is growing a little bit faster, you are seeing PD grow a little bit faster.

So maybe what are you guys seeing in the field? Are you actually seeing acute-care patients improve in PD and how does that end up benefiting you guys? Thank you.

We are seeing our PD grow similarly than our non-acquired growth in in-center. So we are not seeing disproportionate growth there. And as it relates to our acute business, there's nothing that stands out to our historical trends.

So it could be that equipment, of course, is misaligned line with services in that equipment could be old or someone decides that they want to do some treatments in their hospital, and/or change staffing ratios instead of having a room where they conduct dialysis, they want to go bed to bed in the hospital. So it's really hard to predict the alignment there. But we are not seeing anything different in our business.

Thank you.

At the moment, speakers, we have no more questions over the phone.

Alright thank you very much, everyone, for your interest in DaVita. We will do our best for you in-between now and our next call. Take care.

Thank you all, speakers. That concludes today's conference. Thank you all for participating. You may now disconnect.