德維特 (DVA) 2016 Q3 法說會逐字稿

Welcome and thank you for standing by. (Operator Instructions) I would now like to turn your call over to Mr. Jim Gustafson. Sir, you may now begin.

Thank you, Joseph, and welcome everyone to our third-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; Javier Rodriguez, CEO of DaVita Kidney Care; Vijay Kotte, Chief Financial Officer of DaVita Medical Group; Jim Hilger, our Chief Accounting Officer and interim CFO; and LeAnne Zumwalt, Group Vice President.

I'd like to start with our forward-looking disclosure statements. During this call, we may make forward-looking statements within the meaning of 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 and quarterly report on Form 10-Q. Our forward looking statements are based upon information currently available to us and we do not intend, and undertake no duty to update these statements for any reason.

Additionally, we would like to remind you that during this call we will discuss some non-GAAP financial measures. A reconciliation of these non-GAAP measures to the most comparable GAAP financial measures is included in our Form 8-K submitted to the SEC and available on our website.

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

Thank you, Jim and thank you everyone for joining on our call. We will start, as we always do, with our clinical performance and then I will return before Q&A.

Within the DaVita Medical Group, we mentioned during our Q2 call that we outperformed in clinical quality compared to the same period in the prior year. Our strong performance has continued and we remain on track to achieve four stars or greater for our patients within each of our major health plan relationships.

Within Kidney Care, we continue to focus on vascular access where strong performance significantly improves survival and prevents unnecessary hospitalizations. The publicly-reported government data released just this October shows that we have significantly outperformed the industry in this important clinical area.

Let's now move on to the nonclinical subjects and I'll turn it over to Javier Rodriguez.

Thank you, Kent, and good afternoon. Since we spoke last a lot has happened. I will cover three topics: number one, Monday's announcement; number two, our Q3 Kidney Care performance; and number three, our outlook. So let's get started.

I hope that the release on Monday was helpful. I won't be repetitive here, but we've had a lot of questions so let me take some. And if I miss them, please bring them up in Q&A. As a forewarning, I will go into some technical detail because the subject matter requires it.

First, why did we announce the decision on Monday only two days before our earnings call? It's a simple answer. This is open enrollment that started yesterday and we needed to provide clarity to our patients and our teammates.

Second, is this a permanent change in policy? No, we have only temporarily suspended support for applications to the American Kidney Fund for patients enrolled in Minimum Essential Medicaid coverage. When CMS provides guidance, which we expect will be within a couple weeks, we will evaluate our future policy.

Third, does our announcement signify a concern over our historical practices? No, our historical practices were legal and compliant. That said, the language in the RFI may confuse some, so I thought it would be useful to clarify further.

The RFI had primarily three concerns. One, whether patients enrolled in Medicare purchased an ACA plan that was duplicative in coverage. None of our patients who were enrolled in Medicare enrolled in the ACA plan. The regulations cited in the RFI, which refer to Medicare supplemental plans, is not germane to the ACA plan.

Number two, whether patients lost their Medicaid coverage as a result of purchasing an ACA plan and, therefore, were exposed to additional costs. Our patients did not lose their Medicaid coverage as a result of purchasing an ACA plan and, as a result, were not exposed to additional cost.

Consistent with CMS' own educational materials, we educated our patients on the ability to purchase an ACA plan while retaining Medicaid coverage as a secondary. These patients did not apply for tax credits and subsidies.

And, three, whether patients experienced a disruption in continuity of care as a result of purchasing an ACA plan. Just a small portion of our Medicaid patients made the choice to purchase an ACA plan and they did so for their own personal reasons, such as to have access to specialists who do not accept Medicaid or increase chance of qualifying for transplantation or other reasons. We are not aware of any patients experiencing a disruption in care, likely because those patients who would have had such a disruption made the choice not to enroll in an ACA plan.

Lastly, there have been some questions around comparing our disclosure of 5,000 patients versus public information from other providers. I believe that the confusion is around some definitions.

When we refer to individual market plans, or ACA plans, we refer to the full universe of individual plans, whether they are sold on or off the government-run exchanges. A distinction between these types of plans is not relevant because both affect the same risk pools and are generally subject to the same regulations. If you are trying to compare us to other providers, it is important to clarify definitions to ensure that the comparison is an apples-to-apples one.

Now let's discuss our Q3 performance. Overall, DaVita Kidney Care had a solid quarter. We delivered adjusted operating income of $439 million. For US dialysis, our normalized non-acquired growth for the quarter was 4.4%, which falls within our long-term target range of 3.5% to 4.5%.

While we're on the topic of volume, we want to share that we signed an amendment to the agreement of Renal Ventures to acquire 100% interest in their dialysis centers for $360 million, which is $55 million less than previously announced purchase price. We expect the transaction will close in the first quarter of 2017.

Our revenue per treatment was up sequentially by $1.72 per treatment, primarily driven by an increase in seasonal administration of flu vaccines. Our patient care costs per treatment were up versus Q2 by $2.41 per treatment, driven by two primary factors: approximately 60% by an increase in labor and benefit costs and 40% by an increase in facility costs.

We have seen a tightening in labor markets leading to some increase in our labor costs. In the near term we may see these labor costs remain at higher levels. We expect our facility costs to come down over the next couple of quarters.

Now on to our outlook. Since we have now visibility to the end of the year, we are updating our 2016 adjusted operating income guidance for Kidney Care to be in the range of $1.695 billion to $1.725 billion. We will provide you with 2017 guidance on our Q4 earnings call when we expect to have additional clarity on several variables, including open enrollment and policy changes from CMS.

Now I will turn the call to Vijay Kotte for DMG.

Thank you, Javier. First, financial performance. We noted on the Q2 call that we would see accelerated non-cash amortization expense for the HCP brand during the transition to DMG, which would impact our reported operating income. This will run for 30 months at an incremental rate of slightly more than $2 million per month, or $26 million on an annualized basis, beginning September 2016.

Including the impact of this accelerated amortization, operating income for the quarter was $33 million. As we look at the full year, we are narrowing our 2016 adjusted operating income guidance to a range of $115 million to $145 million. This is effectively a slight increase as our guidance now includes the impact of the $9 million in accelerated brand amortization that was previously excluded.

A natural question is how to think about 2017. We are still in the midst of our budget process and open enrollment plays a big part in our outlook. That being said, there are some things we know.

First, $40 million in rate cuts which includes $30 million related to the Medicare model change and $10 million for Medicaid. Second, we have the $26 million of accelerated brand amortization; and third, we are continuing to make incremental investments in the business.

Despite these headwinds, the odds are that we will be roughly flat year over year, but there are reasonable probabilities on either side of that. We will go into further detail regarding our expectations for 2017 on the Q4 earnings call. As we continue to look towards our long-term OI, our 2019 target remains $250 million.

Finally, I want to provide a few highlights on the operating progress we are making at DMG. With regard to claims processed without the need for manual intervention: 2015, we were at 26%; and in 2016, 79%. With regard to services getting electronic authorizations: 2015 was 24%; 2016 is 47%. And finally, with regard to new tuck-in clinicians: in 2015 we had 18 and in 2016 we're at 44.

Now to Jim Hilger for some financial details on the quarter.

Thanks, Vijay. I will first address our international operations.

Our international operating income was $368 million in the quarter, which includes the gain on the deconsolidation of the APAC JV of $374 million. We are on track to meet our guidance for approximately $40 million in adjusted losses for 2016.

Our JV transaction with Khazanah and Mitsui closed on August 1. As you will recall, Khazanah and Mitsui have each subscribed to acquire 20% share of ownership of the joint venture. At closing, each partner made their first investment tranche of $50 million in return for a 6.7% ownership in the joint venture.

This joint venture has been deconsolidated from our financials. Going forward, our pro rata share of its operating income will run through equity investment income in our income statement.

As a result of this deconsolidation, we recorded a one-time, non-cash gain of $374 million. We are excluding this gain when reporting our adjusted non-GAAP financial results and excluding it from our adjusted operating guidance for 2016. We look forward to continuing our growth in Asia-Pacific dialysis with the help of our new partners.

Next, I'd like to talk about a few tax items. In the third quarter, we recorded an adjustment related to tax assets created through the DMG acquisition escrow provisions. This adjustment resulted in a $27 million increase in corporate G&A expense that was offset by an equal reduction in income tax expense and, thus, created no change in net earnings or earnings per share. We do not expect any ongoing impact from this adjustment.

Excluding this escrow provision tax adjustment and excluding the gain from the formation of the APAC dialysis joint venture, our tax rate attributable to DaVita was 40% in the quarter and 39% year to date. We expect our full-year tax rate attributable to DaVita to be approximately 39% when excluding all non-GAAP items.

Next, our interest expense increased slightly in the quarter to $105 million, due to an increase in the interest rate cap amortization as well as the impact of the deconsolidation of the APAC joint venture. This higher level of interest expense reflects our go-forward run rate.

Finally, turning to our continued strong and consistent cash generation. Operating cash flow was $536 million in the third quarter and $1.92 billion for the last 12 months. We expect full-year 2016 operating cash flow to be between $1.75 billion and $1.85 billion.

Since our last earnings release, we have repurchased 9.6 million shares for approximately $619 million. And through October, we have repurchased 13.3 million DaVita shares for approximately $868 million, which represents about 6.3% of the outstanding shares at the beginning of the year. Approximately $881 million remains outstanding under our Board repurchase authorizations.

We continue to have a strong cash balance with nearly $1.6 billion in cash and short-term investments as of September 30. While $212 million was used in October to repurchase stock, an additional $360 million will be used in the coming months for the completion of the Renal Venture acquisition. That still leaves us with over $1 billion of cash available before considering our continued strong cash-generating capabilities.

As discussed at our capital markets day earlier this year, we expect to generate well over $5 billion in free cash flow to use for growth and share repurchases from 2016 to 2019. Even assuming a reasonable baseline of $1.5 billion in growth spending for development CapEx and acquisitions, this leaves over $3 billion for additional growth or share repurchase.

Now I'd like to turn it back to Kent for a few closing comments.

Thanks, Jim, and I'd actually like to make several additional comments. Some will be a little bit redundant to what JR said, but it's such an important topic we think it's worthwhile in order to achieve good clarity.

Allow me eight different points, please. Number one, we fulfilled our regulatory responsibility to provide comprehensive education to our patients. This has been an industry requirement for the last 15 to 20 years and then ACA was added on to that standard and long-standing process and practice.

Number two, a very small percentage of our Medicaid patients determined that an ACA plan was better for them and Javier mentioned some of the very significant reasons why some of those plans were way better for them and/or their families. I won't repeat the examples, but important, and often beautiful, improvements in care.

Number three, nonetheless, if you look at the benchmark plan, an EGHP plan, you see that total ESRD costs, meaning dialysis and hospital-related costs, etc., was about 1.3% of the total medical cost. That again is total ESRD costs in the numerator and then total medical costs for the plan in the denominator.

In the ACA plans, we estimate right now that that percentage is only up to about 1.6% and so it is a low absolute number and it's a low increase number.

Number four, we were very sensitive to the fact that some of these patients choosing an ACA plan meant that we would be paid higher rates, commercial rates versus Medicaid rates. And, therefore, we created a very intense oversight process to make sure that we did everything possible to live up to the CMS standards around objective presentation of information and absolutely letting the patient choose.

Number five, we, nonetheless, got swept up in the current huge controversies around the sustainability of the exchanges and you are all sensitive to the huge political forces in play on that subject.

Number six, why did dialysis and, in part, DaVita become a visible part of that controversy? Well, A), we are national and so our numbers get added up nationally, unlike a lot of health systems which are regional or local. B), our patients stick out. They are very high cost, very easy to identify, very discreet.

C), there have been abuses by providers in other segments and perhaps some abuses even in ESRD and so upfront we started to be painted with that brush by some without data to support. D), some payers did have very large year-over-year increases in dialysis expense and it was originally assumed that this must be from the process that I described earlier. But, in fact, in many -- probably most -- instances it was driven by other factors.

For example, sometimes a plan had a differentially-attractive product and would gain significant market share. Literally, moving from having 50% of the ESRD patients in a market to 80%; thereby, guaranteeing at least a 60% increase in your cost, having nothing to do with anything else other than product design.

As we all know, this has been a very dynamic period, probably the most dynamic period ever in terms of alternative product design for insurance plans. And also, people have been struck by how smart the consumers are and how much shopping and switching they do.

A second explainer in several markets is when there was a bad actor in the payer world, meaning someone who did inappropriate steering of patients away from themselves, leaving one of their competitors with a disproportionate percentage. And again, we are talking about 30%, 40% shifts in market share in some instances.

A third driver out of probably a potential list of seven or eight, but I will stop after three, is areas with relatively poor Medicaid coverage because that would naturally mean that there's a higher probability that a Medicaid patient would find an ACA plan more attractive. This is just to give you a sense of what kind of things actually drove a lot of those year-over-year increases for particular plans, because as we mentioned earlier, the aggregate reality only moved from 1.3 to 1.6. But E) those high examples were taken to CMS and positioned as being reasonably representative of a broader movement. And at that point, CMS did not have the data of the 1.3 and the 1.6.

On to number seven of eight, CMS is now starting to realize, contrary to initial impressions that, A) some of the numbers were misleading. That's not to say they were inaccurate if they were from a particular plan; they were just misleading. And as you start to stare at a number like a 0.3 increase -- and again, this is our estimate -- but as you compare that to 22% rate increases on average, you can see that we were not a material source of the problem, nor are we a material source of the solution.

B), our patients made sensible choices and we provided lots of examples to CMS, as have other providers. C), the fact that enrollment of dialysis patients within the ACA plans looks to be flat or down, even without any change in Medicaid access in 2017 and 2018. And of course, would be down even more with any restriction on the Medicaid front.

D), CMS now is starting to see some of the reasons for the dramatic disparities in year-over-year dialysis expense increases and seeing how they have to do with product design, competition, etc. And lastly, E), they also have a better sense of how charitable premium assistance has been embedded in the ESRD economic and clinical ecosystem for 20 years with a lot of guardrails and with the OIG's blessing, including blessing the aspect of provider funding.

Number eight and final comment is, of course, the big question on everyone's mind, including ours: what exactly is CMS going to decide with respect to this portfolio of decisions? And we don't know; no one knows. I think, to their credit, they don't know right now because they are continuing to absorb information and we are incredibly grateful and respectful that they are doing that.

Moving on to DMG, just one happy announcement and that is that Chuck Berg is joining our leadership team as Executive Chair of the DaVita Medical Group. He will report to me in my role as CEO of the enterprise.

Chuck has been on our Board since 2007. He has a wealth of experience in the health plan world, including having been the very successful executive chair of WellCare Health Plans and prior to that the CEO of Oxford Health Plans, where I was his non-executive chair. This experience, combined with his brain, makes him uniquely suited to help us evaluate our long-term strategic alternatives at DMG. He will remain on our Board in the meantime and I and others look forward to working with him.

Operator, if you could please go ahead and open up the line for Q&A.

(Operator Instructions) Justin Lake, Wolfe Research.

Good evening. I guess my first question here is just the Company bought back $600 million of stock in the last four months at prices that are 15% above the current price. With full knowledge of the issues out there in terms of the concerns around third-party payment for ACA coverage, given the potentially significant impact on earnings here, the downstream impacts of just the government taking a harder look at third-party funding in general, managed-care negotiations, etc., potentially getting impacted, my question is should we take this as a sign of your comfort level with the potential downstream impacts on third-party payment changes, etc., on the earnings power of the business?

And if so, any color you could share on why your level of comfort is that high would be helpful.

Thanks, Justin. I would not say that the reason we chose to buy back was because any particularly distinctive level of confidence in what exactly the outcome was going to be. Certainly if we could do it over again, we would have preferred to have waited and be buying back more now, but it's awfully difficult to predict things. There's a lot of different variables; not only with respect to the issues you mentioned, but other issues, both threats and opportunities.

Nonetheless, I would not say that we said, gosh, there's some distinctive near-term downside and we're going to go ahead and buy anyway. I wouldn't make that claim.

Okay. Then maybe we could just talk about your commercial mix in general, given this has been a big area of focus here.

We look at the changes in the growth in the commercial mix, and if we back out these 2,000 patients, it looks like it's been flat over the last several years. But looking ahead and just thinking about the changes, looks like from USRDS data there hasn't really been much incidence growth in the pre-65 population over the last 10 years. When we couple that with the aging of the Baby Boomers into Medicare from commercial years, there's the indication that it could put a fair amount of pressure on commercial mix over time.

So I guess my question is can you tell me whether this is a reasonable view? And if so, how should we think about this factor in relation to your typical mid single-digit long-term growth algorithm for the dialysis business?

I think it's a very fair question, Justin, and I think if you wanted to identify other worrisome long-term trends, you would also look at improved treatment regimens for diabetics and hypertensives. Commercial patients are more likely to benefit from improved treatment regimens.

On the other hand, there are also things pushing in the other direction. We continue to be quite successful with our non-acquired growth and some of these hard times could lead a lot more small providers to sell or even shut down.

In addition, we are very hopeful that Medicare Advantage continues to grow, because we radically prefer a customer who cares about total value and we tend to do much better in terms of both adding value to the system and getting reimbursed for it. In addition, as you know better than most, to the extent the mix ever starts to put too much pressure on all the independent centers, the government has the easy option of doing that which it's done three or four times before, and that's extending the MSP provision from originally zero to 12, then 12 to 18, then 18 to 30. And so that's a safety valve that's never far away.

Yes. Kent, if you give me one more chance, I would just ask it -- like does this mean that should we think about within the 6 -- let's just call it mid single-digit CAGR that you look for for the dialysis business, this mix looks like just the likely pressure that's going to be on commercial mix over the next 10 to 20 years. Is this in that number or could this have a negative impact on that number in the way you are looking at it?

Yes, fair question. I would say at the time we did the last capital markets we incorporated all variables, although that was a three-year outlook.

When we refresh our capital markets outlook at the next one, it will once again incorporate everything. And while some of the stuff that you are citing is most likely not going to be economically material within the near term, perhaps we should, for the first time in a long time, take a cut at the four- to seven-year time frame and stare at some of the upsides and downsides, the puts and takes, not only on mix but on cost structure, etc. Also modality mix and some other things that can have a big impact on cash flow and return on capital.

We don't have anything distinctively thoughtful to say to you today from an analytical point of view, but that's probably a good assignment for the next capital markets.

All right. Thanks, guys.

Kevin Fischbeck, Bank of America Merrill Lynch.

Great, thanks. I have a line of questions kind of similar to that, but I guess -- I appreciate all the color about the AKF change. I think that was very helpful and I think I understand those parameters, but I guess the question that I'm still struggling with is what the real growth rate of the Company has been over the past three years in the dialysis business.

Because if I look at operating income growth over the last three years it's been about 5% per year, but if I was to say that this $140 million was either not sustainable or one-time in nature, then I get more like a 2%-type growth in the dialysis business over the past three years. So how do we think about that -- and that's the low end of what you guys think you are going to do over the next few years going forward.

And when I think about the next few years versus the last few years, Medicare rates have been under pressure and likely will be in the same range. So why is the right way to think about growth over the next three years not the low end of that 2% to 7%? What would cause you to do better than the low end of that range or is the low end the right way to think about it?

Right now, I would say if you wanted to weight the probabilities between the low end, middle, and top, you would find the probabilities skewed to the low end but it's not by a huge amount. And then, in addition of course, unit volume is, for us, in many ways of secondary importance with commercial mix and the nature of commercial mix of primary importance. And that number has got a lot of dynamism to it right now as you well know.

So at this point, we are not revising that guidance, but we do look forward to a very intense analytical discussion at the next capital markets about the next generation of three-year outlook.

Okay. Then I guess if we look at commercial mix and take out this maybe 1% that's related to the ACA, it looked like mix has been basically flat over the last five years, maybe down a little bit, during a time when the economy is improving. So do you think that that's really reflective of what the industry has been seeing?

I know from time to time you've raised flags about potentially competitors getting aggressive on pricing. Has there been anything where you feel like you've purposely walked away from market share because people got competitive? Or is that how you think mix overall for the industry has looked over that time period?

Our guess is that our trajectory of commercial mix is quite similar to others. We have not experienced any example of someone, in our mind foolishly, seeking to gain share through price reductions in an industry of almost pure variable costs and very sticky volume and high likelihood of economic retaliation. So we haven't seen any of that go on and so our guess is that competitive performance is comparable.

Okay. And then just one last question. On HCP, it looks like the number of physicians and clinicians was up nicely sequentially but we still saw a deceleration in revenue in that business from Q2 to Q3. Wanted to see what maybe was going on there; whether the increase in clinicians was a good sign about a ramp up in revenue over the next couple quarters.

Over the long term, you should see a positive correlation. Right now, in some cases we were understaffed with physicians and by adding them we actually think we can reduce our MLR, the quantity that exceeds the incremental costs that we are adding. In other cases we are adding because we are doing some de novos and other work where we think, by adding physician capacity, we are going to get more lives. It's just that there's some lag time.

We are very sensitive to the fact that, at a time when the revenue trajectory is what it is, our physician recruiting is ramping up. The good news is that shows what an attractive place we are for physicians and our hit rate in recruiting is very high. The concerning news for you is we are adding to costs at a time when revenues aren't going up at the same trajectory and so we hear you and over time you should see the positive correlation you expect.

Is there any way to think about that as like a couple quarter lag or a year lag? How long do we think about these doctors adding to the earnings?

Unfortunately, I don't think we are good enough yet to give you an empirical answer for that and so I won't hazard a guess. Suffice it to say, we know you'll be watching each quarter.

You are right. Okay. Great, thanks.

Gary Lieberman, Wells Fargo.

Good afternoon, thanks for taking the question. I guess just sticking with the topic of the day, I think there's a broader concern by some investors that potentially the AKF would be restricted more broadly from making premium support payments to historical patients that they would have been doing it for COBRA or for other factors. Can you talk about that? Do you think that is a risk and why or why not?

It is a risk but the two big facts on that big issue are that for private plans to do a broad prohibition of charitable premium assistance is an exceptionally heavy lift, because there are hundreds of such organizations all over the country and thousands of hospitals that like those foundations and charities and the rest. And to try to deploy one that's focused on our patients would be discriminatory and subject to really intense lawsuits.

And then separately, CMS does not have authority over the whole EGHP realm. They, of course, have authority over lots of other realms, but not that one. Is that responsive, Gary?

Yes, that's helpful. Any chance you could tell us what percentage of your commercial patients, if you know it, receive premium assistance from the AKF?

I think at this point we've decided that disclosing that is not in your best interest, although we will continue to stare at that each quarter. But that's our current thinking. Of course, we incorporate all variables into our forecasts, but sometimes some of these swing factors are difficult to calibrate.

Okay. And then on the same topic, I think there's some investors that believe that in fact it's illegal for the Medicaid patients to have been given premium support. Can you just talk about that and your understanding? I assume, from your perspective, it's not illegal. Can you just help us think through that?

Sure, appreciate you bringing it up because we certainly heard the concern. On this, the very explicit references by CMS to how it is legal are multiple and really clear. The RFI referred to a part of the statutes that did not apply to the subject at hand, so was literally not germane to the critical questions that you and others are worried about.

And so we have continued to point to the very explicit language supporting our position. We have been in meetings with senior CMS officials and referred to the fact that it's very clearly legal and have never run into a single objection from anyone.

Okay, great. That's very helpful.

Let me add one other thing, Gary, that might help clear it up. It is the case that Medicaid patients cannot have federal subsidies. And so it's not that there aren't some rules that apply, but it is very clear that there was a conscious decision made to allow Medicaid patients to make the choices that we made available to them.

And I will even add one other element. Back when the Affordable Care Act was being rolled out, we were encouraged by the administration to promote exchange products. We were even asked to put up signs in our centers promoting the ACA plans. Now, of course, it's four years later and a lot of things have changed, but that's the actual historical context.

Great, that's very helpful. Then, Jim, can you just remind us at what point you would have been restricted from purchasing your stock after the end of the quarter?

Well, we typically enter a restriction period near the very end of the quarter and we would be restricted throughout the period of time after the quarter ended until -- through this call.

Got it. But I thought you guys did, in fact, purchase some stock after the end of the quarter.

Yes, we did and that was subject to a plan that we had put in place before we were blacked out.

So you had a 10b-5 in place before it was blacked out?

That is correct.

Okay. Okay, great, thanks very much.

Chris Rigg, Susquehanna.

Just wanted to again come back to the AKF issue. Obviously, you are pointing out $140 million of OI this year, that being the potential headwind for next year. But can you give us a sense for how that ramps during the first two years of the coverage expansions? Thanks.

How the $140 million ramped up?

Yes, what was it -- what was the exposure in 2014, then in 2015, and now you are at $140 million for this year, in roughly 2,000-ish patients?

Okay, I know we didn't calculate that number prior to the call. Why don't -- the people around the table here will see if we can and should generate that and share it before the call is over? But we don't have it at our fingertips.

Okay. And then sort of another qualitative-type question here on the AKF issue, but obviously getting to some of the -- at least what's been suggested from the managed-care side is that by shifting some of these people from, call it, 100% Medicaid to Medicaid as a supplemental there may have been some out-of-pocket exposure here.

I guess when you guys did your look-back and reviewed the 2,000, whatever that may have been in 2015 and 2014, what did you do? I guess I'm just trying to get some comfort here that you guys feel pretty comfortable that in no material way were the individuals harmed financially. Thanks.

I will take a first stab and then other people may want to add on. First of all, we dedicated a huge amount of time in developing materials and training our people so that our historic discipline of presenting objectively was on steroids for this process. We present very complete information that encompasses premiums, deductibles, co-pays, out-of-pocket stuff, potential federal tax credits, potential charitable premium assistance, individual versus family, high income versus low.

And so we are thorough and it's presented to the patients in ways that leaves most of them exceptionally grateful for the help and the clarity. Then they choose. One can never say that, theoretically, you couldn't have a patient choose something that was foolish. I'm sure out of 2,000 patients there were some, but we have to respect the fact that it's their choice.

In general, however, just as we've seen in the exchanges over the last three or four years, the average patient demonstrates a lot of economic common sense in how they move around between different products, particularly when they are helped.

Chris, this is Javier. I'll just add one important point is that they never lose their Medicaid. Medicaid was in a secondary position, so the patients actually didn't incur additional costs.

Okay, okay. Then just one last one here on Kidney Care operating income for next year. You made reference in the Monday press release that there could be some theoretical offsets to the $140 million.

If there are, could you give us a sense for what they are? And then just can you just give us some general headwinds and tailwinds beyond the AKF issue? Thanks a lot.

Well, first of all, on mitigation, we will be able to do a good job on that the next quarterly call if we are in the scenario where that's the topic of the day.

Separate from that -- and then someone else may want to add -- on the plus side, we have our wonderful recurring unit growth. We have the potential accelerator of continued Medicare Advantage growth. On the cost structure side, we have the opportunities in the ESA area and on the capital deployment side, we have the opportunity for more small operators feeling a need to get out of this ever more complicated and challenging business.

On the headwind side, I think we've laid them out with painful detail already and so I won't list them again.

Thanks a lot.

John Ransom, Raymond James.

I did one day of law school and ran out in horror, so my pea brain isn't wired to understand all these fine points. But to make it simple, one of your competitors said that the no-no, in their opinion, was to switch people off Medicaid, but the ambiguity was when the new patient came in eligible for both Medicaid and an ACA plan that's where you could present both.

Is what you are doing just in line with that? That new patients that come in are fair game that don't have insurance, but existing patients on Medicaid you are no longer going to try to switch them? I know I am oversimplifying, but is that a helpful way to think about it or no?

I think you are confusing two things, so let's talk about -- patients who signed up for ACA coverage made that choice and retained their Medicaid in the secondary. I think that answers the first question.

There is no -- we are not substituting ACA coverage for Medicaid. If they are keeping them, they are having both of them and it's not subsidized by federal tax credits.

Does that answer just the first half of your question, John?

Well, not really, but I'll follow up. I think it's -- there's so many crosscurrents here, I don't want to drag this out on the call.

What about the second scenario where a patient comes in without any -- maybe they are eligible for Medicaid, but they just never signed up. How does that work? And is that something --? Again, your competitor said we expect CMS to clarify the rules on that patient B that comes in without any insurance at all. Is that a useful way or again was that a misleading comment by one of your competitors?

No, I think we do have patients that come to us that are uninsured and our education and process with those patients would be to find out all the avenues to which they could purchase coverage, whether it be Medicare, Medicaid, a commercial plan, an ACA plan, etc. So our counselors' job is to make sure that each of the avenues is presented to that patient and then the patient chooses what is best for them in their particular circumstance.

Okay, thanks. LeAnne, hadn't heard from you in a while so it's good to hear your voice.

The second question I had was -- obviously in some of the comments there were allegedly comments from either current or former DaVita employees who talked about being pressured to sign people up on commercial plans. I'm sure you saw all that stuff. Just internally what kind of controls do you have in place to investigate those kinds of comments and what's your general view on that: true, not true, out of context? That'd be helpful.

John, thank you; this is Javier. First of all, we'd like to highlight that the numbers are small, but of course, regardless of the size of the number we take each and every one very seriously.

We did some huge, huge oversight here. We had to train a lot of people in a very short amount of time and so we had heavy oversight. And for a small number of people they might have experienced that as negative.

What we do is, of course, if we have any concerns we give it to a third party; we give it to our compliance department and they look into it. And we rectify if there are any mistakes. But the bulk of what we've looked into has not materialized and actually, when we've gone into some sessions, we've literally asked for evidence to be provided of our wrongdoing -- alleged wrongdoing -- and we have never been given any specifics. Because of course, we would want to correct any mistakes if they were brought to our attention.

Okay, that's great. Then let's switch gears and two more quick ones. Let's say we are in a scenario of a little more austerity on a number of fronts. There's obviously a big gap between your total CapEx and your maintenance CapEx.

In a more austere scenario -- and I'll just make up a number. Let's say, revenue per treatment is $340 to $345 for a bunch of reasons. How should we think about the likely reaction of the Company? What levers would be likely to be pulled? Again, CapEx is one that would appear to be one where you have a lot of discretion over.

Again, I ask this because there's a debate on the Street about should we look at DaVita on earnings per share or we should look at it on free cash flow? And free cash flow requires the assumption that CapEx is closer to maintenance than it is to actual.

Yes, we hear you. The answer right now would be fairly generic. In a world where we would suffer some serious revenue compression, we would do what any responsible businessperson should do and very systematically go through every line item on the P&L and every aspect of cash in and cash out. We would enter into that process with the expectation that we would find some savings on the P&L side and we would find some reductions on the CapEx side.

At the same time, we haven't quantified those, but we certainly do have some serious ranges of discretion.

Okay. Was the reduction in price for Renal Ventures driven by the new thinking around ACA plans or was it something else?

No, it was something else. There was a part of the transaction that was contemplated at the beginning and, after further dialogue, we are not going to acquire their infusion business. So that's why the price was changed.

I see. Is that -- do you still think you might get that done? I know that's been dragging on for over a year. Is that still to be done by the end of the year? Or maybe you never said, but that's our assumption. Is that a reasonable assumption?

No, we think it will -- there's some chance of Q4, but if you were betting I would probably go with Q1 because there's some regulatory stuff going on. So I think Q1 is (multiple speakers).

Good Lord. 18 months, is that a record? I would think 18 months might be a record.

It is. It is a new record for us anyway.

And, lastly, just thinking about potential good guys, ESA costs. Do you have a view -- you've got your current contract with Amgen obviously, but if you do a market check on what other folks are now paying for ESAs, what's your view on your apples-to-apples cost versus what's currently -- if you were free of that contract, would that be a good guy that could be called out? Thanks. And I'll stop there.

It is LeAnne again. I think you have to put it into two buckets. Obviously, I think the public announcements by FMC as to their cost reductions associated with their using Mircera gives you one category. So clearly I think they are enjoying a price that is better than the rest of the marketplace.

Then you take the rest of the marketplace that is on Amgen products. I think there was a lot of buzz about the move to Aranesp lowered the independence in the small providers' costs. Well, that's correct; it did.

But that's a relative lowering and our ESA cost has been historically the best. I think that holds true and so -- if you want to ask it again in a different way, but I think that should give you the answer you're looking for.

So in short, probably unless somebody opens up that contract, it's probably reasonable to assume not much movement on that line item through the terms of the contract?

I don't know if that's necessarily the right conclusion. Of course, when you enter into a long-term contract, both parties will look into it as things change. Amgen, of course, is interested in seeing that we are a customer post contract renewal and we want to be talking to all the parties that are out there.

And so what we are trying to make sure is that we have the right term solution for the long haul. We are looking at this -- you seldom get a chance to look at an $800 million cost line and so we are very eager in deploying the right level of rigor and resources to make sure that we get the right relationship going forward post 2018.

Thanks so much.

And I've got an answer for the question that Chris brought up, which is this $140 million; how did it build over time. It won't be very precise, but it will give you directionally what you are seeking and that is that the bulk of the growth came in 2015 and 2016.

In 2014 it was a small number. If we had to estimate, in the $20 million or so range. In 2015, the range is probably somewhere in the -- I don't know, double that, give or take. We don't have very precise numbers, but we just wanted to give you directionally that the bulk of it was in 2016, with some growth in 2015.

Gary Taylor, JPMorgan.

Just a couple things. Given some of the reports that some of the health plans have already attempted to identify patients with AKF subsidies and even potentially terminate some of those contracts, I just wanted to check in on commercial mix.

I know you disclose it annually, not quarterly, but I do think last quarter you did acknowledge that it was still trending higher year over year. So I wanted to see if that was still true for 3Q 2016 versus 2015.

I'm sorry, Gary; your question is commercial mix what period to what period?

Just year over year in the third quarter. Is it still trending higher year over year in the third quarter?

It is up year on year, Gary.

And sequentially probably hasn't done a lot, is that fair?

We have seen it go down slightly in the last quarter.

Okay. And then back to Renal Ventures. Is that still, ballpark, 2,300 to 2,400 patients and then anticipating some divestitures? Is that still ballpark?

Yes.

Okay. Then I just wanted to go to the patient care costs which you called out. I think you talked about 60% labor, 40% facility cost, but that was in the context of a couple dollar sequential change. Given that ESRD OI was down year over year and the cost jumped about $6 year over year, is that still the same -- would that still be the same ratio if I look at the year over year that more than half of that is labor and the rest is facility costs?

Yes.

And when you say facility costs and you said it's coming down, what exactly is driving that up temporarily?

It's a bunch of miscellaneous line items; none of them particularly stick out, so it would just be giving you a very long list. They just cumulatively added up to something this time and so we are working on it.

Last question. I believe you were talking about HCP's OI potentially being flat into 2017 and you made no comments on consolidated or kidney. I just wanted to confirm that; that that was correct.

That's correct. We will be providing guidance on 2017 in the next quarterly call. For Kidney Care, for US Kidney Care.

Okay, thank you.

Whit Mayo, Robert W Baird.

Thanks, I'll try to keep it quick, but maybe one more on the AKF. It doesn't appear that you implemented this exchange initiative until 2015, at least according to the RFI submission. So, one, just looking to confirm that.

And the ACA was obviously implemented in 2014 and you knew about it many years prior. So was there something that made you apprehensive about pursuing this strategy with patients and why perhaps it wasn't implemented in 2013 or 2014 open enrollment? Just looking for any additional color.

There was no conscious delay on our part.

Okay. And then maybe just one last one. With the MA Star ratings published, how would you characterize how your health plan partners are positioned next year? What do you think this means for DMG and maybe the conclusion when you see -- when you look at scores like Humana's?

Yes, this is Vijay. Just to be clear, the 2017 numbers are already fixed so we don't see much of a change between 2016 and 2017. The Humana numbers were for payment year of 2018.

The only place where we saw a potential drop was in one market and, as you know, the Star scores are related to a number of factors. But our clinical quality was at a four-star and above and we believe that in partnering with our health plans, there's some administrative opportunities to help neutralize some of the impact of the potential hit for 2018 for Humana in that one market.

Okay. That's it; we are past the hour mark. Thanks.

Feel free to ask another question if you'd like.

I'm good, Kent. Thanks.

Patrick Wood, Citi.

Thank you very much for agreeing to squeeze me in at the end. I will be very quick and they should be fairly yes-or-no style questions. I have three, if I may.

The first would be I was very interested to hear about the apples-to-apples comparison in terms of patient numbers in relation to the CMS RFI submission. I'd be curious to hear what you guys think is an apples-to-apples number vis-a-vis what your competitor submitted. I would be very curious to hear that.

Equally, the second question would be when I back off from your operating income sort of impact, you guys gave us the $140 million, I get to about a $715 or so dollar revenue implied per treatment for the exchange funds. Is that a fair back out or is there other noise in that that means that revenue per treatment number that I got it wrong somehow?

And then, finally, I'd be curious to hear, of your commercial business, what percentage do you guys feel is out of network? That would be very helpful, thank you.

Let me tackle number one and number three and then someone else can take a stab a number two. On out of network, we don't disclose exact percentages but we've successfully dramatically reduced that number over the last five years. And strategically and from a relationship point of view, we'd much prefer to be in-network. At the same time, of course, the payers got to make a reasonable offer for that trade-off. And so that's the answer on out-of-network.

On the patient count issue, the apples-to-apples issue, all we know is our number and our definition. We provided, we think, the right definition for you to be able to assess the economics associated with this issue. Then if other competitors slice and dice it in different ways, we can't really opine on that. You'll have to really talk to them about why they think it's the right way to do that.

Hopefully, we were pretty clear about why we think batching on and off exchanges is the right way to look at it, for our shareholders at least.

And then on the second one, can somebody --?

On the implied revenue per treatment, you are doing -- you are about right and, of course, there's discrepancies geographically and by payer and product mix, etc. But, yes, you are in the ZIP Code.

That's absolutely fantastic. Thank you very much for your help, guys.

Justin Lake, Wolfe Research.

Thanks for letting me back in for one more. I wanted to touch on the -- I think people are trying to figure out the other $90 million of potential pressure here. And so I just wanted to walk through is there any way to think about where those patients came from?

Specifically, you've got 3,000 patients that are ACA; about half of them are getting AKF assistance. I assume it's a lot less likely CMS does something to stop people who came to you with commercial to keep what they have or having AKF help them keep what they have versus maybe those that come to you uninsured and are just waiting for the three-month Medicare period. Maybe CMS steps in on that.

Is there some way to think about that $90 million and how to think about the risk and maybe break it down to those two pools: keep what you have versus uninsured?

Let me take a little bit of a stab here, Justin, but I'm not sure we're going to be able to give you what you want.

In total, there's three buckets. There's the Medicaid bucket, which of course is getting a huge amount of attention and discussion. Then there are the uninsured, but that label is kind of misleading because a very significant number of them came from state high-risk plans that shut down as part of the Affordable Care Act. So while they didn't have classic insurance, they were funded and they were typically funded at rates more like commercial than Medicare or Medicaid. And so, for the system, there's no increase in cost from their emergence in the second bucket of ACA plans.

Then third -- the third bucket, which is substantial, are people who were on private plans before. Before ACA existed, they had individual health insurance plans and once ACA was there they switched over. And so these are people who've been buying insurance for -- in the same way that everyone on this call buys insurance, only they are doing it individually as opposed to through their employer.

So those are the three buckets and then within that second bucket there's some subsets, but at some point, continued parsing, you get to pretty small numbers.

Okay, so maybe I'll just ask the question this way and jump off. There are people that are to come to you that are uninsured that can qualify for Medicare for three months. If I were thinking about the potential risk bucket here, that would be the one where potentially now you're signing up for ACA plans where before they would just have to wait three months uninsured and get Medicare.

Is there any way to think about how CMS -- could CMS address that? Or effectively they are uninsured and they can buy an ACA plan like anybody else, so how do you stop it? Is there --?

I mean just looking around the table. I do not have an answer to that. Does anybody?

Justin, if I understand you correctly, I think what we're having a little disconnect in the room is we have a population that does not qualify for Medicare or Medicaid because they haven't worked in the requisite number of quarters or even if you are here and working through the visa process, you have to wait five years before you're eligible for Medicare. So I think there is a genuine population when we discuss this that cannot access the government coverage. Does that explain it for you?

Right. So you are saying there's not really much of this 3,000 population that just had to wait three months for Medicare before and is now getting ACA? (multiple speakers)

Right, he specifically -- yes, I hear you, Justin. You are specifically asking about that three-month waiting period and is anybody -- is anything going on there. Not -- does anyone --?

I think, Justin, we will have to get back to you and the rest of the shareholders on that, because it's not a question that I've heard asked and answered.

Got it, appreciate the time.

Thank you very much and thanks, everyone, for your sustained interest. We look forward to talking to you on all these topics in 90 days. Thank you.

And that ends today's conference. Thank you all for your participation. You may disconnect at this time.