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DaVita Inc. (NYSE:DVA)

Q3 2008 Earnings Call

November 3, 2008; 12:00 pm ET

Executives

Kent Thiry - Chairman of the Board, Chief Executive Officer

Richard Whitney - Chief Financial Officer

LeAnne Zumwalt - Investor Relations

Analysts

Justin Lake - UBS

Gary Lieberman - Stanford Group Company

Darren Lehrich - Deutsche Bank Securities

Kevin Fischbeck - Bank of America

Mark Arnold - Piper Jaffray & Co.

Dawn Brock - JP Morgan

Bill Bonello - Wachovia Securities

John Ransom - Raymond James & Associates

Andreas Dirnagl - J.P. Morgan Securities Inc.

Gary Taylor - Citigroup

Operator

Good morning, my name is Clara and I will be your conference operator today. At this time I would like to welcome everyone to the third quarter 2008 earnings call. All line versus been placed on mute to prevent any background noise. After the speakers remarks there will be a question-and-answer session. (Operator Instructions) Ms. LeAnne Zumwalt, you may begin your conference.

LeAnne Zumwalt

Thank you, Clara and welcome everyone to our third quarter call. We appreciate your continued interest in our company. I’m LeAnne Zumwalt, and with me today are Kent Thiry, our Chairman and CEO; and Rich Whitney, our CFO.

I will start with the forward-looking statement disclosure. During this call, we may make forward-looking statements, which can generally be identified by the content of such statements or the use of forward-looking terminology and includes statements that do not concern historical facts. All such forward-looking statements are subject to known and unknown risks and uncertainties that could cause the actual results to differ materially from those described in the forward-looking statements.

For further details concerning these risks and uncertainties, please refer to our SEC filings including our most recent quarterly report on Form 10-Q and annual report on Form 10-K. Our forward-looking statements are based on information currently available to us, and we undertake no obligation to update these statements, whether as a result of changes in underlying factors, new information, future events, or other developments.

Additionally, our Press Release and related disclosures include certain non-GAAP financial measures. These measures should be considered in addition to the results prepared in accordance with GAAP and should not be considered a substitute for GAAP results. Also included in the Press Release is a reconciliation of these non-GAAP measures to the most comparable GAAP financial measure.

I will now turn the call over to Kent Thiry.

Kent Thiry

Thank you, LeAnne. Q3 was a good quarter and our near term operating prospects look solid. I’ll provide a review of the following items; first, clinical results; second, public policy; third, our COO transition; and fourth our ‘09 forecast and longer-term outlook.

Clinical results first, and we continue to present them first because that is what comes first. We are first and foremost a caregiver company now serving approximately 111,000 patients every week. Before getting into detail, its useful to state one fact, you can in a crude way divide the dialysis segments into three thirds; one-third is DaVita; one-third is FMC; and the final one-third is a lot of small providers.

The clinical outcomes of the first two-thirds, DaVita and FMC are better than the average of the final third which is not to say that there aren’t a lot of wonderful, wonderful outstanding providers in the third-third, but the average is the average. In addition, DaVita’s and FMC’s ability to report truly standardized clinical outcomes through a standardized methodology is also differentiated from the final third and a great asset that they bring to Medicare.

Now on to the specifics; first, with respect to adequacy which is essentially how well we are doing at removing the toxins from a patient’s blood, this quarter 94.3% of our hemodialysis patients had a Kt/V greater than 1.2, that’s 90-day data. Second, with respect to vascular access, 61% of our patients have fistulas placed to receive dialysis, which is of course the preferred form of vascular access, that’s 90-day data also. Third, on the subject of anemia management, where there has been so much noise for so long and we are trying to figure out the best way to categorize our clinical outcomes, we provide the following.

First, the percentage of our patients, where their average outcome over the last three months is between 10 and 13, that’s the hemoglobin of course and that number is 87% and the data suggests very strongly better than most in America; second, only 5% of our patients over the last three months were below 10, a very, very generally acknowledged threshold below which hospitalizations go up and people are less healthy.

I forgot one clinical outcome and in many ways it’s the most important. Our 2007 mortality rate was 17.0%, and that compares very favorably to the average to the rest of the nation and most particularly to the third-third. Second, in regard to public policy and legislation, Congress will be looking for savings in Medicare in 2009.

We hope for better position in most segments given we already have clear Medicare deficits and because major reform was passed earlier here in ‘08, it is legislated to be implemented between now and 2011, and it would be dangerous to muck around with the train already being redesigned. That said, no segment should think it’s immune to the physical pressures that exist.

Somewhat ironically for us, Medicare’s need for money increases the probability of a patient coverage extension also known as MSP. More congressional members and staff than ever realize now that our patients are the only citizens in the United States who can pay private insurance premiums for 15 years and then get kicked off private insurance when their kidneys fail shortly, thereafter. This policy also creates a big disincentive for private plans to invest in the same kind of prevention and wellness for these citizens as they do further chronically ill people. So enough on public policy, pending Q-&-A session.

Third subject our upcoming COO transition. After more than eight years, Jim Elva will be stepping down as most of you have already heard, his contributions are as obvious as they are big. The succession has been worked on over the last couple of years with Joe and the Board of Directors and myself, and others and Joe in fact is going to continue working full-time for six months after the hand-off and then part-time in a number of important functions for some time thereafter and we are excited to be adding Dennis Kogod, into the COO role.

He has been in dialysis more than eight years, five with Gambro with a senior spot and then at DaVita ever since we bought Gambro and his experiences are extensive, not only he has been running more than $1 billion of the base business, he’s also been in charge of de novos, he’s also been charge of purchasing, he’s also run clinical operations, he’s run compliance operations, he’s run recruiting, he’s run the vascular access business, he’s been responsible for DaVita Clinical Research and Medical Informatics and I could list other items, but the point is he’s had a very, very broad exposure now ever since he came to DaVita, and if anyone wants to ask any questions more broadly about the topic of the instances of planned succession in the C level over the last three, four or five years are looking forward, will be happy to provide that additional color in Q-&-A. We’ve had an awful lot of nice orderly planned successions over the last few years.

On to subject number four, our outlook. We do expect to be near the mid-point of our ‘08 operating income guidance range, which has been $800 million to $840 million. Our operating income guidance for ‘09 also remains the same, the same that we provided three months ago, namely $820 million to $880 million and this guidance assumes the loss of fair number of private patients in order to defined rates that allow us to subsidies the government deficit.

I’ll now turn the call over to Rich Whitney, the CFO who will share more details and analysis with you.

Richard Whitney

Thanks, Kent. The third quarter was characterized by solid and on plan operating income, lower reported volume growth, stable private pricing and strong cash flows. A few key details about these results; first volume, reported non-acquired growth of 3.8% was adversely impacted by the calendar and by two Hurricanes.

Normalizing for the number of Monday, Wednesday, Friday treatment days are non-acquired growth was 4.2%. Hurricane Gustav and Ike had a 0.2% adverse impact on our treatments in the quarter so further normalizing for this impact our non-acquired growth would have been 4.4% in the quarter. We still expect non-acquired growth in the range of 4% to 4.5% for the year.

Next revenue, dialysis revenue increased $0.44 a treatment sequentially from Q2. This is primarily reflection of improved commercial mix and rate as we continue to be successful in maintaining our price discipline with private payers.

Other revenue increased $3.10 per treatment sequentially due to the growth of our non-dialysis businesses including the continued growth of our specialty pharmacy. As for expenses, overall operating expense increased $3.62 per treatment sequentially. A majority of this increase was due to the growth in our non-dialysis businesses, which adds expense without adding associated treatment count.

Expenses for these businesses have been generally inline with their revenue growth, though they do as a group, have lower margins than our core dialysis business. The remainder of the increase was due primarily to increased labor costs driven in part by the two hurricanes as well as training related to the implementation of the new Medicare conditions of coverage. The impact of this implementation on our costs will continue into Q4, and the heparin price increases also had an impact on Q3 costs as expected.

Our G&A remained at 8.9% of revenues. As in prior years, you should expect somewhat higher G&A in Q4 due to seasonal spending trends. For the full year we still expect G&A to be approximately 9% of revenues. As for our cash flow, rolling 12 months operating cash flow was $595 million, which is above our expected go forward run rate. We still expect that 2008 operating cash flow will be between $480 million and $530 million. This is lower than our rolling 12 months number because Q3 of this year was about $50 million higher than expected due to the timing of tax payments and because Q4 of 2008 cash flow will not match the very high levels of Q4, 2007 due to the timing of various working capital items.

A few other comments, through September 30, we certified 61 de novos, and we have an additional 58 centers that are built and are awaiting Medicare certification. Based upon this pipeline we continue to expect to certify about 80 centers this year, although this number could vary depending upon the timing of Medicare certifications. Our growth CapEx estimates for both acquisitions and de novos combined is now $300 million to $350 million for 2008. This compares to $259 million spent year-to-date.

I will now hand the call back to Kent for a couple of closing remarks.

Kent Thiry

Just a few comments before we switch to Q-&-A. The quarter was solid; our strategic position is stronger than ever. Our organizational capability is the strongest it has been (a) because we are really quite done with the integration of Gambro (b) because a lot of our strategic new products and businesses are though the adolescent period where they tend to be more dilutive of management time. So, that’s good news.

Nevertheless, the new macroeconomic environment has got to raise questions. It is our thinking that the dialysis sector is better positioned in a downturn than most of the segments of healthcare not because we are differentially talented or anything, but because number one 87% of our patients are already government reimbursed, already at a deficit and if you cut you are at risk of significant center closures.

Second, we have a minimal uninsured population. Third, as a segment we advocate and embrace transparency. Fourth, as a segment we advocate and embrace accountability for levels quite unusual in American healthcare and fifth, the major player are willing to invest in creative and aggressive disease management with the Medicare program to bring down hospitalizations and improve the management of commoved conditions and we believe that we can do that within the current baseline of long-term Medicare ESA forecasted expenditures.

So, that’s just a whole bunch of differences. Having said all of that it would be foolish for anyone to assume that they are completely insulated if there is a prolonged recession and a whole bunch of radical change whether it is in the macroeconomics of the national or global economy or in government policy, but absent any massive discontinuity a lot of things are going right and we ought to be able to generate steady growth and steady cash flows. Clara, could you please open it up for Q-and-A.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from Justin Lake - UBS.

Justin Lake – UBS

Just a couple of quick questions first on the economy since you just finished talking for that. Specifically Kent, maybe you can give us an update on what you are seeing as far as maybe your commercial mix in the quarter end, kind of walk us through how much visibility you have on the payer mix side, as far as patients may be losing their job and having the ability to move on to hover a little while and then move off of it.

Kent Thiry

We are tracking it very, very closely meaning patient by patient, and have not picked up on anything material yet, because it appears that even though some companies have gone away, most of the people are now working for someone else.

While the lay offs are really big from a macroeconomic policy point of view for the American Government and for the American economy, the fact is it’s not as if half the people are terminated or anything and in addition those who are laid off, it is very, very common for them to take cobra and so, those two qualifiers right now appear to explain the fact that we are seeing virtually no impact. We don’t anticipate that that is going to continue, but those are the facts so far.

Justin Lake – UBS

Okay and so it’s fair to say that you’re tracking us to a level that you would probably know six months in advance given the layback that most people can stay on cobra as far as when these patients will be falling off the commercial side?

Kent Thiry

It is kind of a unique situation, so, your words suggest a level of certainty that we are uncomfortable with, which is why I preferred to just stick to the facts that we’ve seen virtually no change so far and therefore you would think given we’re watching it patient by patient and we’ve seen no change so far that there’s a very good chance that we could have that kind of notice period you’re thinking of, but we’re all kind of in uncharted territory here and certainly any new administration or Congress is going to be hypersensitive to a world in much a lot of people are losing their insurance.

Justin Lake – UBS

And then just on the commercial pricing side, is there anything you can tell us as far as being potential for increased visibility into these. I think you kind of framed it as two or three contracts that are the most sensitive for the ‘09 guidance? Is there anything you can give us as far as maybe have any those contracts been completed? Do you have rates in place, things like that?

Kent Thiry

No, there is no new news. All of those conversations continue and from our point of view, we are unhappy that we are not getting better increases; from their point of view, they’re probably unhappy that they’re not getting decreases, and we are still mucking around in the middle.

Justin Lake – UBS

Okay, but that number at least hasn’t changed two or three. That is still kind of the number of contracts you are looking at as far as being problematic?

Kent Thiry

I think that’s reasonable, but at the same time, there’s a spectrum, there’s two or three that are bigger than others and you drop down a significant trench and size and there’s a few there and then you drop down and there’s some more there because do remember that the overwhelming majority of our book of business is renegotiated every year. So, there’s never been a quarter that we have reported to you where there weren’t a lot of negotiations going on. So, with that qualifier, it is sill the case that two or three are much bigger than the rest.

Operator

Your next question comes from Gary Lieberman - Stanford Group Company.

Gary Lieberman - Stanford Group Company

Thanks. This is maybe just a follow up on the last point on the commercial pricing. It sounds like some of those problematic contracts; were they unresolved or you resolved them but the rates you got were not the size you want?

Kent Thiry

They’re unresolved but life goes on in between. Again forget the big ones and let’s just pick out a normal typical renegotiation, typically spans a number of months and while the negotiation is going on, the rate stays the same if those are resolved or unresolved, I don’t know, but it is not as if there’s a battle going or something it just means that the two sides have a different point of view as to whether they should go up, down, stay the same or sub components should go up, down or stay the same.

In addition it is a little difficult when we talk about the two or three resolved or unresolved, because when you talk about the biggest ones they’re often national payer, with whom we’ve historically had 20, 30, 40 contracts and so when we talked about that being won, in fact in many ways it is more like 20 or 25 and there’s some efforts in some years to do some aggregation across those, and in other cases, there’s a decision to go back to just dealing with it as 20, 25, 30 different sub-contracts.

So yes, there’s a couple of payers that are bigger than everyone else, but it’s not clear whether the best way for they and us to work together is on a highly aggregated basis or on a more decentralized basis. Is that helpful?

Gary Lieberman - Stanford Group Company

Yes, that’s helpful and then I guess just a follow up on that is as you’ve said in your own guidance, it assumes that you can’t come to term on some number of those contracts so you lose commercial patients. Have you gotten to the point yet on any of those contracts?

Kent Thiry

No, we have not.

Gary Lieberman - Stanford Group Company

Okay and then just a quick follow up on the patient care costs. Richard you discussed the increase sequentially in the patient care costs and you’ve listed a number of reasons, going from the growth in the non-dialysis business, the hurricanes and heparin, is there any way to sort of quantify that 362 either a list of what had the most impact or if you could specifically quantify it, that would be very helpful.

Kent Thiry

More than ever it really is just of the math of the treatment equation. Our costs increases, our non-dialysis business rose and yet they’re not characterized as providing treatments. So in the phenomenon you don’t have the treatments growing at that same pace. So more than half of that route is relate to the non-dialysis business and that’s why per treatment costs were up $3.62 sequentially, so more than half of it non-dialysis.

The other half really is a mix of things but the most important would be the labor cost increases sequentially, again related to the hurricanes and just a bullish of training related today the implementation and the conditions and coverage.

Gary Lieberman - Stanford Group Company

So would it be reasonable to think that other half sort of other than obviously heparin but the other half, some of that subsides in the fourth quarter and going forward?

Kent Thiry

Well, you’ve got heparin of course that’s going to continue in the fourth quarter. In fact it might increase a little bit because we did have somewhat an offset by the use of lower priced inventory at the beginning of the quarter. We call the price increases effective July 1, so we did have some lower priced inventory around at the beginning of the quarter.

As you push into Q4 you will see that continuing and maybe increase a little bit, and then on the labor side, we expect to continue to have a somewhat higher training over time levels in Q4 as we continue to work through the conditions of coverage. So, I don’t think it would be fair to say that it would necessarily subside sequentially.

Operator

Your next question comes from Darren Lehrich - Deutsche Bank Securities.

Darren Lehrich - Deutsche Bank Securities

A couple of questions here; the cost per treatment increases which you just talked about, I guess two things I wanted to ask you there; first, what would be your threshold for materiality, I guess in terms of breaking that out on the income statement or the way you report in your press release. I know you are starting to list it out in the segment reports in the 10-Q, but I guess I just want to get your thought process there because it is having a big skewing effect on those results.

Then my second part of the question is if you can just comment a little bit on your hoop initiative and whether you’ve had any impact on heparin utilization and I guess in the early pilots of that and your expectations would be?

Kent Thiry

Darren, just to make sure that we understood the first part of your question, were you asking what our thresholds of materiality breaking out in non-dialysis business is in our press release?

Darren Lehrich - Deutsche Bank Securities

Yes.

Kent Thiry

We actually talked about that and thought that if we may be getting at the point in time where it would be helpful, obviously we reported it in the Q that way which was a new development last quarter. So we’ll take another look at how we adjust our, in particular our supplemental information to see if question provide you a little more useful information earlier in the process as opposed to waiting for the Q.

Darren Lehrich - Deutsche Bank Securities

That would be great. Kent, do you have any comments on heparin?

Kent Thiry

Well Rich, related to the current math and expectations of math and we’re eager to find alternative long-term sources to bring down prices a bunch and I don’t know where I can go beyond that. We have done a very nice job of implementing new protocols to more efficiently used heparin while maintaining the exact same clinical outcome. So those are probably the three points that I think are relevant and material unless you have any others you want to ask me about?

Darren Lehrich - Deutsche Bank Securities

Yes. I guess where I was going was, do you see any opportunity to bring utilization down beyond where you’ve been able to thus far? I think you have some opportunities perhaps and if you can just comment on what those might be; whether it is fourth quarter and into ‘09 from a utilization standpoint.

Kent Thiry

Yes, I think we are pretty close to the optimal level of utilization. It was a very comprehensive implementation across 1400 locations in five months. It was very impressive in its breadth and depth of success, but it is pretty much done now and so I don’t see a lot of incremental pick up. Although leading into this call didn’t ask the question of how much of Q3 had the full fixed as versus all of Q4 will have it. So you will get a little incremental quarter fold in but not enough to make a big difference.

Rich Whitney

Yes, particularly when you count for of the inventory issue that I mentioned. I guess the only other thing to note Darren is that our expectation in terms of the annualized impact of the heparin price increases that occurred this year, is still the same as the original range we gave, $20 million to $30 million annualized and in fact that range did include some estimates of our ability to rationalize on heparin utilization. So we still expect to be around about that range.

Darren Lehrich - Deutsche Bank Securities

If I could just follow-up, as far as the ancillary service, the other revenue, what was the segment loss in that division, I guess?

Rich Whitney

We will look it up for you. I just have to quickly check the info here.

Darren Lehrich - Deutsche Bank Securities

Okay. While you look that up I guess my last question would just be, if in fact it did increase as we saw a surge in sequential revenue growth, what are your views Ken on how and when you might see those businesses proving to profitability? Thanks.

Kent Thiry

Yes thanks Darren. Well, first I will do at an aggregate level that we talked about a couple of the big ones in ‘08 costing us about $32 million in OI. So a very, very large number. We said it was going to get better in ‘09 and we still think that’s the case and we would hope in ‘09 that that number would go down in the neighborhood of $20 million or so; so quite a significant drop.

In addition we are continuing to accumulate a whole lot of capability and track record in terms of improving clinical care in a way that reduces total costs which of course is the key to coming up with a long term arrangement with the Government where we get good reimbursement and they get overall savings and that’s the long term holy grail that we feel like we are on track for in a reasonable kind of way.

In addition, some of that money would have to be spent any way. In other words, even if you weren’t trying to do special needs plans or you weren’t trying to do a specialty pharmacy, you nevertheless would be doing some R&D working with others to try to reduce hospitalizations to try to improve pharmaceutical compliance etc, etc and so some amount of the 32 or 20 would be spent anyway and it just so happens we took the more aggressive route in trying to turn them into on going products that added a lot of value to the mother ship as opposed to just incremental R&D.

Operator

Your next question comes from Kevin Fischbeck - Bank of America.

Kevin Fischbeck - Bank of America

You talked a little bit about the impact of the negative economy on the company as a potential outcome in 2009. Were comments more about the implications for Government reimbursement being cut or is it more concern about patient shift from managed care and some Medicare?

Kent Thiry

Yes, I’d say it is 50-50; it is so hard to know what’s going to happen. The more obvious trend is the fact that the Government is going to have big deficits and it’s going to look for savings, so that’s an easy one and the whole Medicare program faces it. We think less so than others for the reasons I cited, but in addition if there’s a long sustained recession, you just know at some point that’s got to affect the ranks of the commercially insured and the decisions they make. It doesn’t happen quickly but at some point it would have to.

Kevin Fischbeck – Bank of America

Can you give us a little bit of historical perspective about what happened within the last downturn and how that impacted the patient mix?

Kent Thiry

Well I can and that is it didn’t affect it much at all. So, the question is, is the world different or is what’s happening worse, because in the past since 1991, these kinds of dislocations have not led to any change, but I wouldn’t ever for a moment, submit to you that this dislocation is the same as the other ones that have taken place in the last 17 years.

Kevin Fischbeck – Bank of America

Okay, that makes sense. Are you factoring any patient mix shift in your guidance besides depending on the managed care pricing?

Kent Thiry

I would say that all risk factors have been probabilistically included into the analysis.

Kevin Fischbeck – Bank of America

Okay and then a last question, tell a little bit about your cost structured to the extent that the economy does worsen. Is there anything in there that you feel you have the flexibility to adjust down or any cost like labor where you might expect the benefit from such an economy?

Kent Thiry

I will take a stab at that. You could argue this one either way; if it becomes easier to unionize, that could create more labor pressure. On the other hand, historically what’s often happened when unemployment goes up is more nurses return to work and there’s fewer jobs available for the people that pursue technician jobs and social worker jobs and dietitian jobs. So I’ve heard people argue it in either direction and I think we just have to wait and see how the macro economic forces play out; it could cut either away.

In addition, we buy a whole lot of stuff as you know and a whole lot of the suppliers that supply to us and a whole lot of the landlords who have buildings; those segments are also under a lot of economic pressure. So, we are hoping that we pick up some very nice opportunities on purchasing both services and products and renting and leasing things over the next 18 months, but none of those markets are immediately fluid of course. You don’t suddenly move a dialysis center because you got a better rent offer some place else.

On the other hand, when you are building 75 de novos a year and doing a bunch of other stuff, the math can start to make a difference. So, those are some of the puts and the takes if we had a more definitive analytical picture with more upside, we would have said more about it. It’s pretty early in game and we are all over it.

Rich Whitney

And if I can take one second to get back to Darren’s question and segment loss, the non-dialysis business you’ll see broken out in about Q is around $5 million in the quarter and that is down from 10 in Q2. So, you can see there’s been some improvement, which is more or less what we expect for the balance of the year.

Operator

Your next question comes from Mark Arnold - Piper Jaffray & Co.

Mark Arnold - Piper Jaffray & Co.

Just a couple of questions here; just to clarify, I think in the last conference call, Kent you gave a run rate on the specialty pharmacy being close to $100 million, I was just wondering if you can give us an updated number there.

Kent Thiry

I will get back to you in a minute. Whether I don't have it.

Mark Arnold - Piper Jaffray & Co

Okay and then, you have opened a large number of de novos so far this year; to what extent have your existing facilities been capacity constrained leading up to these new openings and is it likely we could see a bit stronger non-acquired growth, over the next few quarters because of the new capacity.

Kent Thiry

I would say there has not been a material change in our weighted average utilization over the last quarter. Is that the, is that the answer to the question you are asking?

Mark Arnold - Piper Jaffray & Co

I guess, what I’m curious about is whether you’ve had to turn away any patients as you wait for some of the new capacity to come online with the de novos or whether you are looking at that as more of a growth opportunities, with capacity not being in the existing facilities, not being in the issue.

Kent Thiry

Yes, I would say that and that situation is rare. If over the last four months we had to turn patient as way, it’s for one of two reason; either the payer mix is so bad in that area we can’t afford to build a new center and that would probably be half of the situations, but the other half is when we blew it and then they started building a center in time, which typically also means that the center is not opening this month to relieve us of that pressure.

So, while we always make some mistakes and there are always some markets where we don’t want to have capacity because we can afford to, there’s no change in the amount of that going on now versus what was going on a year ago and so there’s no big upside or down side on that front.

Mark Arnold - Piper Jaffray & Co

Thank you. Just one more question. LIBOR rates are now going to back down to where they were a couple of months ago; can you guys give us a sense for the timing of when some of your larger term loan trenches resent and kind of how you’ve decided to reset them using the variety of interest rate options available to you?

The reason I’m asking that is, I’m just trying to get a sense as to whether you guys have to lock into some higher rates here in the beginning of this quarter in Q4 or whether you kind of maintained your flexibility there with your prime rate option or other means to kind of mitigate the big spike that occurred here at the beginning of the quarter?

Rich Whitney

Okay. Well, the first thing is the good news in that is that in the quarter we weren’t impacted by the spike in LIBOR rates, just because we had already reset our LIBOR rates before the spike. Since then, as you know, LIBOR is back down and as of Friday, I think it was at 2.6%, which is back down to where it was for Q3 of ‘08. I think, the average rate for Q3 '08 was right around 2.6%. In fact, down a bunch from last year when we were more around 5.5% at this time last year in terms of average LIBOR rates. So, we don’t anticipate from the recent dislocation we don’t anticipate much of an impact at the current rates of LIBOR we estimated that Q4 and be impacted by about $0.01 of basically as a result of the impact in October of those higher rates on our unhedged credit facility.

Mark Arnold - Piper Jaffray & Co

Okay and I just want to follow up. Have you historically used three months LIBOR as your benchmark?

Rich Whitney

We have at times used three months, at times used one months, at times gone a little bit longer, on the un-hedged potion of our credit facility. We always do have the prime rate option you mentioned and so if we have to see another dislocation like we saw in October and in fact we were poised to implement that prime rate option. We do have that ability that still exists in our credit facility.

Then, in terms of what part of our debt is hedged right now, about 70% of our gross debt is fixed both through the bonds that we had as well as the hedges we haven’t place on our credit facility. If you net that against our cash balances since more like 78% fixed and then, as you look out through 2009, that fixed rate will trend down closer to 60/40 as the existing portfolio of hedges rolled on and off. So, absent any additional hedging activity you will see our fixed percentage on a gross basis before cash have move down towards 60%.

Operator

Your next question comes from Dawn Brock – J P Morgan

Dawn Brock – JP Morgan

Kent I wanted to touch upon revenue growth for a minute. Really, to talk about how you are looking at it going forward, based on the two primary components of pricing and volume and specifically I think we all know there’s been a market and quite frankly a welcome shift after years of concern on the commercial side; that should be a nice driver. Yet, you commented in your remarks earlier that you anticipate a fair loss of patients embedded in the 2009 guidance.

Could you clarify at all net of de novos in acquisition patient growth, what that range assumes as far as total patient growth is concern; I guess what I’m trying to determine is within your 2009 range where’s volume set.

Kent Thiry

Okay. Let me take a stab at it and first of all, the last thing we want to do is eliminate concern about private rates, so we are not set there. Second, in order to help on trying to figure out volume that’s assumed we do have a guidance range for our non-acquired growth and we expect acquisitions to be at a comparable level to what they’ve been this year and last year absent the discontinuity of buying one of the medium size chains, which could happen and also may not happen.

We also provide reasonable ranges around our expectations of increases in cost per treatment and so given all of those guidance ranges you can end up with inducing a reasonable estimate of what we expect on the revenue front and the volume front. So, does that work, the non-acquired growth plus the normal acquisition amounts gives you a pretty narrow band on treatment volume?

Dawn Brock – JP Morgan

Yes, I mean I can go back and look at the guidance ranges I guess. Maybe a different way to ask it is from a development and acquisition perspective are you looking for 2009 to replicate 2008, which was a bit stronger and then we should be taking our own level of discount from there?

Kent Thiry

Yes, okay a fair point. We are in a very active debate in deciding the number of de novos we are going to build in ‘09 and 2010, right now. As of today, it looks like the ‘09 number of de novos will be comparable to the guidance we provided in ’08 and our expectation for 2010 is less clear, because we are going to know a lot more; five or six months from now than we do today, but for ‘09 it looks comparable to the range we guided to in ‘08.

Dawn Brock – JP Morgan

Is it fair so say that you are tracking ahead of that so far in '08?

Kent Thiry

No. We are pretty much right, where we expected to be. Let me amend that actually. We are doing better than what we guided with respect to the number of de novos, so I miss to answer that question. We actually hoped to beat our guidance and so I was answering that question. It is where I wanted us to be, but we weren’t all sure we would get there and so the fact is we are doing better than what we guided in term of number of de novos.

Operator

Your next question comes from Bill Bonello - Wachovia Securities.

Kent Thiry

Bill, before you go, if I can just slip back to a question about ten minutes ago. In the second quarter we reported that DaVita RX our specialty pharmacy operation was at about $100 million annual revenue run rate. The answer to that question of what is it now, is that it is at about $110 million annual revenue run rate. So, the run rate increased by about $10 million quarter-over-quarter.

I will add that we’re seeing some very exciting data in term of clinical outcome improvements and hospitalization reductions now that we’ve enough patients and enough maturity in the data, too soon to publish but not too soon to be excited that we’re adding value to the system, but Bill back to you.

Bill Bonello - Wachovia Securities

Actually I will follow-up right on that. Is there any more color you can give us in terms of what that represents in terms of penetration of your patient base or what you think the potential revenue of that business is?

Kent Thiry

I think the short answer is no, Bill. We are pioneers here, we have been learning a lot every quarter and it’s too soon for us to put any big space in the ground about what it could be.

Bill Bonello - Wachovia Securities

Okay and the second question, is just it looked like there was nothing new in the final position rule; is that a correct reading?

Kent Thiry

Yes.

Bill Bonello - Wachovia Securities

Okay and then finally just in the past you’ve talked a little bit about some of the issues where you are out of network and I’m just curious if you’ve seen any changes on that front. In particular, are you aware of anyone doing anything on a benefit design that would penalize a patient if they were out of network or are you seeing anymore aggressive efforts on the part of the managed care payers to keep patients in network?

Kent Thiry

I’d say there’s been no change in the quantity or intensity of activity on that subject.

Bill Bonello - Wachovia Securities

Okay and then the follow-up to that is a long chat, but in the past you were willing to disclose the amount of your revenue that was out of network; any chance you would do that now?

Kent Thiry

No chance and I will say because I think my tone of voice demonstrates my excitement about the DaVita specialty pharmacy business and the good stuff it is doing and it could do, and that just needs to be tempered by the fact it still loses money, which is a real problem. So that’s the Ying and Yang of that.

Operator

Your next question comes from John Ransom - Raymond James & Associates.

John Ransom - Raymond James & Associates

Hi. I was wondering if on your private contracts approximately what the mix is of bundle contracts versus unbundled contracts and will we expect the mix of bundle contracts move higher as Medicare moves to our bundling?

Kent Thiry

The percent that’s bundled will continue to go up as it has for the last couple of years. I don’t think we’ve ever disclosed what that percentage is, we are all looking at each other across the table. Maybe we were going forward because it is not a religious issue to us, but hate to do it spontaneously, but suffice to say it’s not a tiny percentage and it‘s been growing steadily and we fully anticipate it will continue to grow and we’ve had the same position now as we’ve had for a couple of years. As we are totaling agnostic on bundling versus not bundling, it’s all about what the rate is.

John Ransom - Raymond James & Associates

My clever trap didn’t work to trick you into more disclosure. The other question I had as you look out three years, toward perhaps diversifying your supply on the non-innovative drugs like the Vitamin D and Iron and heparin and then maybe you look to look at some strategies to reduce utilization, what is the outer band of what you could save if you’ve had some time as you need to work on that on a cost per treatment basis? Is it bigger than a mousetrap?

Kent Thiry

There’s a wide range of potential outcomes.

John Ransom - Raymond James & Associates

Would you care to elaborate?

Kent Thiry

I’ll turn it over Rich or LeAnne, but for me I’m too fearful to go beyond that because in fact it is a reasonable summary.

Rich Whitney

It is possible that you might be reference the note that came out earlier this quarter about suggesting that there can be rather large reductions in utilization?

John Ransom - Raymond James & Associates

Well I guess there’s a debate about how much of the population could be moved to sub Q and how much diversification we might see in the heparin supply a couple of years out, how many alternative suppliers could come into the Vitamin D and our market if any and that sort of thing. I know there are a lot of outcomes, but maybe just describe some of the things you are thinking about and what might be possible?

Rich Whitney

Okay. So you are looking for a little more color around the dynamics around all those areas.

John Ransom - Raymond James & Associates

Yes.

Rich Whitney

I think, as it relates to the potential for lower utilization, as Kent has said many times before, once you turn a reimbursement system from a situation where pharmaceuticals are effectively free from the standpoint they don’t have to be traded off against other cost inputs.

It’s reasonable to assume that providers will find ways to innovate clinically and achieve the same outcomes for the least amount o pharmaceutical utilization. However that takes time and we would caution that people shouldn’t assume that there are the opportunities to make simple practice changes and achieve substantial reductions in utilization.

So, it’s the sub Q thing has been talked about for decades now and dialysis and it’s just not as easy as being able to switch large numbers of patients to subcutaneous administration or clinical and risk issues related to it. There are numbers of patients depending upon their dosing that it is just not feasible to administer the subcutaneously etc, etc. So it is quite a bit more complicated I think than just a simple practice change.

Similarly with the often talked about tradeoff between iron and EPO. We don’t believe that there is simple changes that can be made there that have a material impact on our EPO utilizations. So, with that said, a tenth of these go down when we are forced to make tradeoffs against all of our other cost inputs. Likely over time, providers will find ways to maintain outcomes and reduce utilization.

As far as some of the other drugs, EPO and heparin are really the two that are sole sources and so in the other areas, we obviously will have some opportunities to work with suppliers to find the best combination of pricing and clinical outcome achievement and on heparin we really don’t have any news in terms of new insurance and other alternative sources of supply at the moment.

Kent Thiry

Let me break in, because I misunderstood the question and I thought you’re focused on non-EPO pharmaceuticals and biological. On EPO, there are some people who are dramatically wrong in estimating the changes that could occur in EPO can assumption for the reasons as Rich said. Sub Q has serious issues around it, the iron thing has played out we think clinically it’s very thoughtfully already over the last five years and could at least one or two other examples and so it is inappropriate for anyone to think that there’s a couple of simple things to do and EPO use goes down a bunch. That is simply wrong.

John Ransom - Raymond James & Associates

And then just last question, we’ve had going from this grandee discussion, their very picky question. Rich, is the share count number for the fourth quarter as simple as taking in the inner share count and factoring in your buyback just for the Tom, weight of that or is there anything else going on there?

Richard Whitney

Yes, there’s nothing else major going on in the share count.

LeAnne Zumwalt

In the absolute count versus the fully diluted count. So, which are you referring to?

John Ransom - Raymond James & Associates

Fully diluted?

LeAnne Zumwalt

Yes. Fully diluted you would be taking into consideration as always the option grants and implications there.

Operator

(Operator Instructions) Your next question comes from Andreas Dirnagl - J.P. Morgan Securities Inc.

Andreas Dirnagl - J.P. Morgan Securities Inc.

Most of my questions have been answered, but just a couple of follow-ups maybe Kent, on some comments you made. You did mention that sort of a fiscal environment as we see it in DC probably bodes potentially better from MSP extension. Would you care to take a shot in terms of early handicapping on whether you think though go for a six or 12 month? I mean we should had both last time around?

Kent Thiry

No, impossible to handicapping Andreas, but I was worried I wasn’t going to be hearing your voice again. So, it’s Nice to hear it.

Andreas Dirnagl - J.P. Morgan Securities Inc.

Thank you very much; it is good to be back. A question on the repurchases, I guess for Rich and you Kent. Rich, I guess from a numeric prospective, can you confirm are you about 220 million through the current 250 authorization? Is that right?

Richard Whitney

Yes, I think that’s right Andreas, I am just looking back to check.

Andreas Dirnagl - J.P. Morgan Securities Inc.

And Kent, if you approach as it is clear you are probably going to at some point soon, completing that authorization, would you expect a sort of normal course to just go back to the board for an additional authorization?

Kent Thiry

Absolutely. In my mind it’s prudent for us to always operate with a significant authorization in order that the authorization decision itself is never proceed as a signal one way or another and that management with the right guidelines and trust in the board, is always able to own some of the opportunities that are good for shareholders.

Andreas Dirnagl - J.P. Morgan Securities Inc.

Okay good and then another comment you made Kent, which maybe it was in the one conference call that I missed, but I think it is the first time I’ve heard you say it specifically recently. In term of DaVita potentially acquiring one of the medium size chains you said it might, might not happen obviously. Is there anything in the current environment and I’m thinking specifically the sort of the credit crisis that we’ve been seeing might made from more motivated sellers in that space?

Kent Thiry

Well, the short answer is yes, but at a very macro level because each of these are individual companies and there are several of them, and they make all their decisions on around; nevertheless, the question is are the probabilities higher lower because of what’s happened. I would say they are higher for a couple of reasons; one is because the financing market has changed so much and bunch of more private equity backed and second, the big payers are now subjecting those medium sized change to the same kind of rate scrutiny and our network scrutiny that they put us through over the last 18 months and that will be a new thing for some of them.

Andreas Dirnagl - J.P. Morgan Securities Inc.

Okay and then just finally, I think it’s probably pretty clear and inherent in the fact you’re just were even discussing it, but I just want to confirm because there seems to be a little bit of brief for out that given the fact when you did the Gambro acquisitions, there were some acquired divestitures. I mean sort of a FTC issue is not something that would preclude a mid size acquisition, right?

Kent Thiry

The only one we can’t buy is the one we divested.

Operator

Your final question comes from Gary Taylor - Citigroup.

Gary Taylor - Citigroup

Hi, good morning. Just want to follow up on one question, commercial bundling, and your agnostic. Does that introduce any new risk into the equation or in your view; it is just the same systemic renewal risk, that’s always inherent in the pricing negotiations?

Kent Thiry

My intuitive answer is it reduces risk, but to be honest we haven’t had a debate of that specific twist of the question, but I don’t see any reason why it would increase any risk.

Gary Taylor - Citigroup

So historically as you’ve seen contracts move you have been able to preserve your total economics then?

Kent Thiry

Say that again. Please.

Gary Taylor - Citigroup

Historically as you have seen contracts move from all occurred into a bundled payment on the commercial side, if generally, you have been able to preserve the total economics of that contract?

Kent Thiry

It has been a while since we have run that number because in a way it doesn’t matter, at least is contract specific. What we’re trying to figure out is given the situation we are in, is it better to bundle or go or stick with a fee for serves and we are confident in each individual case we pick the one that is better, but comparing an aggregate all the times we sticking with fee for service versus pick bundling is not something we have done. My guess is it’s probably a distribution where in some we’ve done better, many are the same, some worse, but I should leave it at that because I don’t know that data.

For us again, it’s not a pattern of decision-making. It’s not like we go out to do one of the other. It’s very situation specific and us picking the one that we think makes the most sense with that payer and some times payers come in with a significant head of steam is because I can’t, my system’s not really supported, I’m too worried I won’t get the number right I care more about other things and conversely other payers come into the conversations saying they only want to bundle and if a payer’s monocle one way or another because we are agnostic, so that would skew the data too.

Gary Taylor - Citigroup

Are there situations where you present an option to the payer? You have it that way.

Kent Thiry

It’s more and more common for us to have an open discussion about which both sides would prefer. That’s going on in a few places right now. Two years ago, three years ago was much more often, but a bundle would only happen if one side came in with the very intense to make it happen. Now, it is much more common for us to be a “Gee, which way should we go?” both sides carefully watching others trying figure out to their advantage to go one way or the other.

Gary Taylor – Citigroup

I guess on a forward basis then you don’t see payers kind of following Medicare and using a movement toward bundling as a source of renewal pressure in and of itself?

Kent Thiry

We think more private payers will want to bundle because Medicare is doing it. We don’t really see how that translates into any change in leverage one way or the other.

Operator

There are no further questions in queue at this time. Do you have any closing remarks?

Kent Thiry

No, just thank you for your consideration of our efforts and we will work hard between now and three months from now when we get to talk again. Thank you.

Operator

This concludes today’s conference. You may now disconnect.

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Source: DaVita Inc. Q3 2008 Earnings Call Transcript

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