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DaVita Inc. (NYSE:DVA)

Q4 2009 Earnings Call Transcript

February 11, 2010 9:30 am ET

Executives

Rick Whitney – CFO

Kent Thiry – Chairman and CEO

LeAnne Zumwalt – VP, IR

Analysts

Darren Lehrich – Deutsche Bank

Kevin Fischbeck – BofA Merrill Lynch

Kevin Ellich – RBC Capital Markets

Andreas Dirnagl – Stephens Inc.

Gary Lieberman – Wells Fargo

Justin Lake – UBS

Andrea Bici – Schroeder

Unidentified Participant

So first I want to start just our Safe Harbor statement and forward-looking statements. For those of you listening in on the phone call, this is available on our webcast and please refer to the webcast to read the statements.

And now, I would like to introduce Rick Whitney, our Chief Financial Officer, who is going to start off the presentation.

Rick Whitney

Good morning. Okay. Roadmap for today. We’ll start with our comments on the fourth quarter performance, move on to an overview of DaVita, then we’ll have a discussion of the risks and opportunities of investing with us, on to a deep dive in our business fundamentals, financial review and then we’ll wrap up with a summary and taking your questions.

Q4 results. First of all, non-acquired growth continued to be solid at 4.8%. It was a nice bounce back from a low of 3.8% back in Q3 of 2008. The other comment I’ll make on treatments you may notice they are a little bit light sequentially this quarter and that’s due to two things. No. 1, the way the calendar fell, more Tuesday, Thursday, and Saturdays in this quarter, which tend to be light treatment days for us as well as the holidays.

Revenue, almost $1.6 billion, up 7%, on about 5% volume growth and 2% revenue per treatment growth. Revenue per treatment, as I said, up 2.1% from last year and then sequentially down $3.71, a little more than 1%.

A couple of factors drove that. First of all, lower physician prescribed intensities of pharmaceuticals. That was about 60% of it. About 20% of that change were rate changes. Most notably a reduction in ASP rates, medical reimbursement of drugs. And then the final 20% was due to a continued deterioration in our private pay mix.

Operating income, up 7% from last year’s Q4, up 8% for the full-year which was in line with our guidance and then sequentially down 3%. And that was driven by the revenue per treatment decline, the impact of the calendar on treatment volumes as well as a sequential increase in G&A spend, which is typical for us in the fourth quarter.

And finally EPS, up 13% from last year. That was driven by the operating income growth, the impact of our balance sheet leverage, lower interest rates and lower share count. And then operating cash flow continued consistent cash generation.

2009 results, very similar set of numbers. Revenue up 8%, operating income up 8%, EPS up 15%. Underlying cost trends generally stable as were margins at 15.4% in both periods. Revenue per treatment, the full year over the full year was up 2%.

Three components there. About a half of that was the Medicare composite rate increase as well as ASP rate increases year-over-year and then another 40% was due to commercial rate increases, partially offset by mix decline we’ve been talking about the last few quarters. And then finally about 10% of that is due to increases in physician prescribed pharmaceuticals year-over-year.

And then operating cash flow, $667 million growing in line with our operating income growth and above our guidance of $600 million as we indicated last quarter that it likely would be.

Okay. On to our 2010 outlook. Operating income guidance of $950 million to $1.20 billion remains unchanged from last quarter and that represents a range of 1% to 9% growth off of where we finished 2009.

We are launching our cash flow guidance, operating cash flow and free cash flow. As you can see generally expected to grow in line with our operating income. Growth CapEx plus or minus 250 million. Of course as we always say, the final number is dependent upon the availability of projects with attractive returns. Maintenance CapEx plus or minus $125 million which is pretty consistent with history. And on to the DaVita overview. Kent?

Come up I want to say one more thing and that is what we always say about Q1, we want to make sure you keep in mind Q1 is a seasonally weak quarter as a result of fewer treatment days, higher payroll taxes the beginning of the year and the impact of co-pays and deductibles. As is typically the case we would say that we would expect it’s quite possible that Q1 could be down a little bit sequentially. So please keep that in mind as you think about 2010.

Kent Thiry

Okay. Good morning. Good to see many of you again and it’s a new folks as well. Our objective today is the same as it is every year, which is to provide you with analytically thorough, intellectually honest characterization of our industry situation, our Company situation and hopefully in terms of meaningful dialogue about the risk reward relationship in those situations and also try to facilitate your ability to evaluate our coherence and competence in taking advantage of the rewards and avoiding the risks. So that’s the spirit in which we come here today and hopefully you will help us pull that off.

It is important for us to start with a mission particularly for those of you that are new, our mission is to be the provider partner and player and choice the way we think about it. And the way we think about is first is as if you were one of our patients. And it is our first priority to please you in that scenario, in that scenario which you are in one of our centers being taken care of first and then secondarily as shareholder.

In addition, the employer choice is our third and final component of the mission that we take a lot of pride in being able to provide 34,000 people with a suite of benefits and hopefully a life sustaining income. And so these are important elements of what we’re about and what our people are focused on while simultaneously bringing amazing intensity to our fiduciary responsibilities.

We also think over the long-term the fact that we are maniacally focused on providing superb care, ever improving care and compassionate care will rebound to our shareholders benefit, although in our system find that be a directly casual relationship in the short-term, but hopefully with the work we are doing in DC that will become increasingly so. In the meantime for the full disclosure it’s important for you to know that we always put the mission slide first, because that is in fact how we guide our decision-making.

This is a patient, for those of you haven’t been in our center being taken care of. The simple slide describes is just its worth going over quickly for those that are new. When you have kidneys all of us are going to go to the bathroom today and urine out the toxins that you are accumulating with the coffee you are drinking and the cream cheese you are eating and your bagels and things like that.

Once your kidney fails your body can’t urinate out those toxins, so we’re the substitute for that urination. We take your blood out, we take the toxins out of blood and we put the blood back in. If we don’t do that, you die. And this is I would say this is not a typical center. This is what a typical center would look like if there weren’t a lot of people working here all the time and we had it sitting around perfectly clean.

And this is worth about 1500 of these and here’s how an average one looks, to give you a sense of the decentralized nature of our service business. And then in aggregate, you can see that we have continued to gain share. We are now up to about three patients out of every ten patients in America as opposed to going back a decade ago and it was about, whatever, nine or so out of every 100. This is very, very good for our shareholders looking backwards and is very good for our shareholders looking forward and you know our equity market cap better than us.

On to investment highlights. So, what we are trying to do here is to try to help you characterize for your partners who aren’t here the pros and cons associated looking at the upside and downside in our space. First, from an industry perspective independent of us, the Company, what are some of the things one might want to say to summarize to your partners some of the positives around this space? First, it’s wonderfully stable demand growth. Looking backwards, looking in 2010, looking in the out years. And we will elaborate on each of these briefly. The steady cash flow, it’s in the numbers historically and also for a whole bunch of structural reasons which we will elaborate on in the course of the conversation today, looks awfully steady going forward.

The consolidation has been steady throughout the decade with some spurts of acceleration when people do things like our buying Gambrel and FMC buying RCG and it will continue. At the same time there’s going to be small independents for a very long period of time and that, in fact, is an important structural safety net for our shareholders, which we’ll touch on later.

The Government is uniquely accountable for this space. There is no other program like the ESRD program. There is no other program as uniquely carved out as the ESRD program in America. And therefore the government has differential accountability for that reason. It also has differential accountability because we are so discrete. And so our microeconomics, our clinical decision making are uniquely homogenous and transparent, which has a lot of pros for us in our mind, more consumers are demonstrating our superior outcomes and business acumen and forces the government to take more accountability because they can’t hide behind the myth of saying they don’t really know what’s going on and/or what impact their policies have.

Therefore, it’s important in that context where the government is going to get differentially involved for the community to be differentially effective, and we are, obviously, in a highly imperfect and uncertain world we will talk a little bit more about that and the transparency I’ve referred to.

Let’s step through each in turn. This slide hasn’t changed much for ten years for the small number of you have been around. And that in itself is not a reflection of the fact that we are intellectually stale or just lazy. It’s because this reality hasn’t changed significantly in ten years, which is kind of the whole point. It is still the case that there is no clinical controversy of when your kidney has failed.

There’s no clinical controversy around extra kidneys for transplants sitting around not being used. So there’s no controversy around need unlike so many other (inaudible) where there is a controversy or uncertainty about whether or not it will be continued.

For most patients, it’s three times a week for the rest of your life unless you are one of the fortunate few that gets transplanted and if anything, there’s modest amount of upward pressure on this as there is more science that suggests that maybe getting a fourth treatment is a good idea. It’s not cyclical, it’s not seasonal. You need this multiple times per week or you get very sick and die.

There’s very strong center loyalty in every direction, us to the doc, us to the patients, the patient to the center, the patient to the doc, the doc to the center, doc to the patient, patient to the doc, whatever, very strong loyalty for a whole bunch of structural reasons and then just the human reasons of being so tightly engaged with one another in a life saving therapy. If you doubt this, visit some of our centers, in particular, and you will feel the kind of bond that exists.

We, in particular, are proud of the bonds between our center team mates and the physicians and have had situations as each of you know who’ve been around where the physicians have left a practice elsewhere and 90% of the patients stay with us. Choosing to stay with the people who are with them every time they visit, three times a week. There are very little therapeutic alternatives on the horizon although certainly if one looks out a number of years one hopes to a change to that bullet point, but there’s nothing dramatic going on there right now.

And then basic demography turns. Kidney failure is wildly disproportionately significant in the Hispanic, African-American elderly communities. These are all growing communities in America. This is again incredibly boring demand growth slide, where you wonder if we smoothed it out but it’s pretty much as if you plotted the individual points because that’s how regular the growth has been. It does tweak a little bit each year. Sometimes, inexplicably where you wonder if the government’s got the data wrong. That’s not reflective in what we see. But this is pretty much the trend line.

So moving on to steady cash flow. That second investment highlight. First of all, just driven by everything we just said about demand, the characteristics of demand. But additionally unlike so many healthcare facility segments, we are low fixed cost. If you’ve been to our centers, they’ll be in a strip mall; they’ll be next to an auto supply store. It’s very low cost space.

We don’t have to be in a hospital campus and we don’t need a dramatic set of leasehold improvements and high technology equipment, expensive high technology equipment, we have high technology equipment, but it’s a percentage of our cost structure is very, very tiny, compared to surgery centers, compared to hospitals, compared to most of the facilities that you are forced to invest in. So, very low fixed cost and most of our growth absent the periodic big acquisition like Gambrel is done through very small incremental capital investment expenditures.

So if you put all that together it just means architecturally for reasons that are nothing to do with our strategy we have a very nice cost structure and growth structure when you think about generating steady cash flow.

Onto this concept of unique government accountability which I submit to you is very important consideration as you compare this part of healthcare service to other parts. And I’ve worked in most of them over time. It is significant that about 87% of the dialysis centers in America stand by themselves. And they essentially do one thing, which means that for what is very rare, what is a very rare reality the government actually knows what our costs are to a very significant degree. We argue over small movements in the cost structure in a way that they never could for what is one surgery cost in a surgery center for the other, what one patient causes in a sniff versus others, what does one patient cost in a long-term care hospital versus other. What does one patient cost in a hospital versus others that’s all a mix, a jumble? Not in our case. 87% stand alone and they do one thing. And the government pays for 88%. About 82% Medicare, 6% Medicaid. And so, it’s a wildly different conversation and there’s some pros and cons to this between us and them and between other segments and them.

Importantly, we have about 1,000 independent centers X-years ago and there’s about 1,000 independent centers today because of basic growth in the market and it’s very important to know that these independent centers, many of them are onesie, twosies, threesies, foursies and they cannot go out of business. You cannot have Congress or CMS pass laws or institute regulations, which drive 300 of these puppies out of business. Because the political flash back would be immediate and intense because these are real human beings going in three times a week. And so there’s a governor on what can be done from a policy point of view with any prudence because the feedback loop is incredibly immediate, transparent, clear and harsh. And there have been closures.

There is a steady stream, right now a small stream but a steady stream of closures. Were that to tip up at all, it would be immediately noticed. So you put all that together and the bad news is the government is not going to be a dumb thing and suddenly dramatically improve our reimbursement like they did with sub-acute reimbursement eight years ago. The good news is they are not going to do something sudden that drives a whole bunch of centers out of business without some sort of quick reversal. The system can’t sustain it.

Therefore, this can be a net positive over the long-term for our shareholders, if we have reasonable coherence and credibility in Washington, D.C, which is a market that’s everybody, is efficient as the capital markets. We have one of the few legitimate community wide coalitions and we personally sweat bullets for a few years to help put this together and keep it going and it’s no secret that DaVitas were more involved in this stuff than anyone else as unfortunately sort of an industry utility and try to protect the aggregate communities economics and ability to take care of these patients.

And our coalition has been unusually coherent in actually having and there aren’t any other segments of healthcare that could talk about this, the legitimate leading patients group, the legitimate leading nursing group, the legitimate leading physician groups, the for profit providers, the not for profit providers, all agreeing on primary legislation and signing their organizational names to that legislation and advocating for it with their members of Congress. It doesn’t exist anywhere else in American healthcare.

There are now other people trying to replicate it. That is a very good thing. Because divisions across those groups and segments tends to kill any kind of coherent defense or offense because it gives Congress and CMS a free out, to say, since I heard different things I had to make my own call. So, you see there is a caveat. It’s as unusual coherent so far. Like all coalitions and they are inherently fragile. And so the fact that we pulled this off the last few years shouldn’t make any of us complacent and overconfident in thinking that it will continue. But it has yielded not only coherence, but distinctive positions that are pleasing to the government for good reasons and they would be pleasing to you as tax payers which is very, very unusual among coalitions, we are in favor of transparency on clinical outcomes and public reporting thereof. We offered up proposals on legitimate substantive pay for performance, tying quality to what people were paid. This doesn’t happen very often in healthcare.

We really worked out the mechanics and propose them. Some of the good things that have happened for our patients and the shareholders last few years are a direct result of the fact that we played ball with the dominant ideas of the day and even though the dominant ideas didn’t pass through, Congress, we got a lot of points for having played ball in a substantive way.

And we, as long as DaVita is involved, will work hard to try to maintain a long-term perspective, which is always the issue of the year, equally or more important is making sure that you are working every year to incrementally enhance the credibility that the community has with the membership at large so that over the long-term no one wins every year in DC, not even the leaders in DC as we’ve seen recently. So that we are well positioned to have a higher batting average than the average segment.

It would not be intellectually honest to not also give you the investment low lights hopefully in some reasonably cryptic, but accurate way to take back to your partners. We have significant reimbursement risk in the private and government side and we can talk more about that as day goes on. This is not exactly a new phenomenon and one can argue whether it’s more or less intense than the past, but it is there.

We have had some mix deterioration over the last six quarters. It is striking that the resilience of the business model has been able to absorb that and generate the results that you’ve seen in 2009 versus 2008, but it is there with 10% unemployment and everything else going on in the economy, this is not a surprise. It was anticipated and talked about six quarters and eight quarters ago. But there it is staring us in the face mathematically.

The treatment growth you can look at two different ways. 3.8% is pretty healthy and the stability of it is wonderful. On the other hand, you can say, gosh, there’s other places where you get more than 3.8% growth that has to then be nudged by acquisitions or de novos. And then we’re always going to get investigated. Just it comes with being a prominent healthcare service company in America.

When the government finds a new theory or scores and get some kind of settlement from one healthcare service provider they take that proven product, that intellectual property that they’ve created and immediately see if they can efficiently apply it to other comparable companies. That’s how it works. And the easiest way for them to do that is to start with a subpoena.

You don’t start by learning a whole bunch about the company and then deciding whether or not to the subpoena. You start with the subpoena is the most ruthlessly efficient way to find out if there’s anything there. We will talk a little bit later about our track record in this area. But those are the four low lights. Hopefully, a reasonable characterization and you will talk to us today if you think there are others or I didn’t characterize them fairly.

Moving on to DaVita. So within that, we think favorable industry context, how do we stack up? First, our clinical outcomes are wonderful. We are the best or among the best in every single category that’s publicly reported and we are very, very good and unique in a whole bunch of areas that aren’t publicly reported. So that doesn’t just feel good because it’s good for human beings. It also means that you don’t have to live in fear that you’re going to wake up some morning and find out that the stocks down 30% because someone found out that the company that you had invested in is delivering slack care, inappropriate care, undisciplined care.

Our market share nationally 30%. This is a big deal. It is very difficult for a payer to contemplate doing business without us, not impossible, I suppose, but very difficult. Our operating track record, Rick will be going a little more of the numbers later, but we’ve been solid in that regard on a consistent basis.

I’ll talk about our unique compliance record because it is so important in terms of managing the risk side of the equation. And then our integrated care model which is where the world is going in fits and starts, but it is where the world is going.

On a quality side I won’t bore you with the details, but if any of you have any questions of any aspects of our clinical care these are just some of the publicly reported metrics.

And the important thing on the clinical outcomes is we are very proud of where we stand now I’m not going to step to these, but these are specific initiatives that continue to drive improvement. We think four years from now we are going to be providing much better care in a documentable sense than we are today just as we are today versus four years ago. And so our operating initiatives on improving clinical care are disciplined and intellectually rigorous as our initiatives are on improving productivity or information systems or de novo growth.

And so the cumulative effect of all of these industry and DaVita specific trends is that we do have 30% as you know FMCs in the neighborhood of 33 and importantly, from a shareholder point of view other investor entities are an additional 13%. So you have a segment that is almost uniquely represented by investor-owned facilities here in kidney care.

This is just a quick historical characterization of our performance versus guidance on an annual basis, the ranges that were provided prior to the year starting. And the results in the subsequent year so far each year we have done what we said we would do or better.

This is the EPS slide. It’s comparable to some of the stuff that Rick showed you and will be showing you. But this has been a period for a whole bunch of reasons tied to externalities and in some cases, perhaps because of risks that we’ve highlighted where we experienced significant multiple compression it’s important not to confuse that with what’s going on with the fundamental business model through this period of time. You can see the flatness back in that period when we absorbed Gambrel, which if you recall, we purchased without featuring an additional share that would dilute share interests. It was all that in a very well constructed deal. And what we’ve done since that time year after year after year.

On the compliance front, we now have a ten-year track record. We don’t have any other scale healthcare service company that can put up a slide like this, certainly, none in our space, and there have been a number of large entities, not only two, but we’ve gotten our fair share of subpoenas. There’s no difference there. They’ve been very broad-based. We’ve had our share of four-year long investigations, which is what a number of these have been. You can tell by the dates. So these are very extensive and then you see the results, closed, closed, closed, expired.

We have the more recent batches, it’s almost like wine, there’s the vintage and so we don’t know anyone else who has gone through so many scrubbings and emerged paying zero and in one case, where money exchanged hands the government had to pay us $95 million, which they have withheld because they were so sure they were right, but the courts decided they were wrong, the administrative law judge, and we were right and they paid us, that’s why the $95 million has a plus sign in front of it.

Now, it would be really foolish for DaVita or you to get complacent or cocky about this because this is a very complex area. A lot of the rules is inherently ambiguous, there’s no way to send a note to the government, saying, if we do it this way, is it fine. Don’t get to do that. All you can do is choose of what you think is a sound policy knowing it’s going to be retroactively assessed in a very critical way. In some cases, playing it totally safe would be the same as unilaterally disarming and exiting the market.

And so this is not to say we predict we’re going to go the next ten years not having to issue a check that that wouldn’t be prudent rather than going through a couple year battle. Having said that, the data is the data and we bring incredible rigor and intellectual intensity to this task every single year and our Chief Compliance Officer is a person who used to prosecute companies like us with great energy I might add. And so we know how the process works and we work hard to be compliant in letter and spirit and prepared to defend that which we’ve done on your behalf.

On the integrated care front, the logos on the bottom represents some of the different new product lines and service lines that we’ve instituted and a number of them are the leader in America and we are the innovator. They are really good for patients; they are really good for taxpayers. I will talk a little bit more about them later. But the point is that the improved quality of care in very demonstrable ways and hopefully overtime that will become a powerful equation for shareholders.

It lowers total costs and a very important for us in terms of our public policy advocacy. It puts us on the right side of the fence in terms of segment that’s not just trying to make money on the current model, but actually innovate in ways that are consistent with what everybody wants, higher quality, lower cost. So this would be the summary of the investment highlights. I won’t recap the low lights because they are so painful to talk about but we’ll put that slide back up later, if you want.

Onto business fundamentals, first bundling, bundling the 4,000 pounds elephant in the room, much larger than a gorilla. The final rule is not out yet. You all know that. If it is a bad rule, centers will close and it will be quite the chaotic environment. Fortunately, they know that too so they’re probably not going to come out with a bad rule nor they’re going to come out with some dream rule that has everything we want. Where it’s going to be in between it’s really not a good use of time to speculate at this point.

The interim rule, they knew, needed a lot of work; they got 1500 comments or something, of a stunning number of comments. There was a remarkable consensus among the community on what some of the key things that were wrong. And CMS was absolutely listening with great intensity. That doesn’t mean they are going to buy off on everything the community said. Doesn’t mean they are going to agree on everything but we give them huge points for the intensity with which they listened to the community to try to get it right. Big Kudos for them.

In the short-term, if we opt in 100% that means a pretty dramatic transition, IT changes and other things. On the other hand we may decide to opt in over the four-year phase in which would mean a less dramatic transition period. But either way there’s going to be a lot of moving parts for a while in the operating front. And that will be a lot of work.

In the long-term, there is opportunity. Basically we’ve got $1.1 billion of stuff that used to be cost plus and now we have the flexibility to innovate within that. And biggest chunk of that, $800 million of that, there’s a monopoly sole source where there’s going to be competition soon. So you put those two things together and we are eager to try to outperform our competition in that regard because remember, the bar has to be set to keep dialysis centers open and then the art is to outperform underneath that bar and we think we are very well-positioned to do that as an independent person not owning any drugs so that we have the total, total secular attitude about one drug versus another driven entirely by whether or not it’s clinically equivalent and then economics as well as our scale.

And so, we are very attractive to the vendors who will be competing in this new role where they can’t sell their stuff cost plus any more and instead they have to compete on the quality of their drug. So we salivate at the prospects to outperform the rest of our space in this $1.1 billion of now liberated tax payer dollars

And there’s the market basket update with the pay for performance qualifier coming up. Market basket update for a couple of you in the room who are veterans like myself, we’ve been pursuing the market basket update for nine years and so it was quite a surprise in Washington, D.C. when we got it and in the context of what was going on legislatively that year and is a tremendous, tremendous incremental bit of security for our patients and our shareholders.

Four areas of concern, we talked about these on prior earnings calls and a lot of you have talked to Jim Gustafson and me and all about this one on one so I am not going to go through them, but if you have any questions about any of them we can come back to them. These have been fairly well vetted. And in each case we got to wait and see what they actually come out with.

This just summarizes what I already said that there’s a $1.1 billion. And the bad news is that the price of admission to innovating under this $1.1 billion is a 2% reimbursement cut, which is a huge cut, if they get parts of the rule wrong it’s a bigger cut than that. So that’s serious bad news. The good news is we have a new sand box to play in and we look forward to that.

On to our normal dialysis trilogy which is to say in the end we do dialysis treatments. That’s the dominant part of our economics. From your point of view we do about 16 million, 17 million of those a year, and so revenue per treatment minus expense for treatment times number of treatments is sort of the wholly trilogy of dialysis economics for you and for us. And so let’s step through it this year as we have each year.

Starting with number of treatments, which, of course, is a function of non-acquired growth plus that which we buy. First, with non-acquired growth, this is a non-acquired growth normalized number since there are different numbers, Monday, Wednesday, Fridays in different quarters, we normalized for that, and this is the data. We are very happy with how the year trended. And for those who might be skeptical of normalizing that there must be something hidden, some kind of subterfuge going on normalization and you want the raw data, this is the raw data but you will see that the normalizing actually gives you a better business answer than the raw data.

De novos, there’s a lot of different elements to de novos and we’ve done more of these than anybody else by far in the community over the last five years, over the last ten years, over any period of time. Of course, first and foremost generating solid returns on capital.

We’ve done about 431 of these in the last X years. I can’t remember what X is. Five of them have closed. These add capacity for growth and capital efficient growth of that so that’s good. Importantly though, also in different areas strengthens the geographic network, which is very important to our physicians and are very important to our conversations with private payors.

In addition, it helps our affiliated physician practices grow, which is a very, very healthy thing for them. And sometimes it's part of an offensive competitive strategy so we could have situations where we have two centers and we would very much prefer not to open a third center in between those two. If we could pick, the scenario where we did nothing, that is normally we would pick.

But a worse scenario is if our competitor puts one in the middle and generates a satisfactory return on capital by doing that, it is better for us to preemptively put that third center in thereby reducing your return on capital on a percentage basis, but improving the long-term returns on capital in our aggregate profit per dollar of capital by retaining those patients. And so those are situations where we’ll have a spurt of additional de novos beyond which we might have otherwise and it’s very much in your best interest, but we would have preferred to have done nothing. So that gets to this point about offensive competitive strategy.

And is it the typical economics? Of course, there’s a distribution around this when you do 431 of anything in the competitive market. But the fat part of the curve of reality is represented by these numbers, couple million bucks, which is more than five years ago and the returns comparables to five years ago and the break even is about comparable to five years ago.

Importantly for those of you who are new a bunch of this capital isn’t irrevocable because if a center fails, although that hasn’t happened very often, we get to take the machines out and use them elsewhere and the lease goes away and the working capital, of course, is worked down until we get that back as well.

Here is the number of de novos, the number in '09 as you already know went down versus '08. Couple of reasons for that. The primary one being just a delay in certifications where the government got behind in certifying new facilities. We talked about that on earnings calls through the course of the year.

And second in a way 2008 was a bit of a spurt, in part, trying to do a lot of the preemptive work that I talked about in order to avoid losing share to competitors who would earn a competitive return on their actions. In 2010, we will probably do a comparable number of de novos that we’ve done in '09, something like that, the '08, '09 range.

On to the acquisition part of growth, we will continue, hopefully, to do a nice portfolio of small acquisitions to the course of the year in 2010, just like we did in '09 and '08 and '07. Maybe there’ll be a bump up of people concerned about bundling. Maybe not. If it’s a bad rule it could be a heck of a bump. The silver lining in a bad rule is we get to by a lot more stuff at attractive prices. But you can’t predict that. I don’t know.

The only other point to make on the acquisition front is, we, as we said a year ago we would like to buy another medium-sized company. We could not agree on terms with any of them. We are elated that we didn’t accept any of the sales prices that were offered to us 15 months ago and 12 months ago with where valuations have moved. So, much better to have the cash than to have bought at those prices and hopefully in 2010 we will get to buy one at a price that you will be happy with.

So summary on treatment growth, the non-acquired parts, 3.5% to 5% is probably the right way to think about that as we look at 2010 and then that percent or so that we’ve historically picked up in terms of doing lots of small deals resulting in that 4.5% to 6% range in total.

Moving on to the second part of the trilogy, revenue per treatment and starting on the private side of revenue per treatment where there’s rate and mix. This slide hasn’t changed much in years either other than perhaps the subsidy by the private sector to the government sector is even larger. It’s a little bit difficult to quantify exactly. But it is ironic when people talk about private insurance goes up more than Medicare and it shows private insurance can’t manage things.

It is unambiguously powerfully, inconvertibly true, in our space, private rates goes up in large part because the subsidy for the government side requires it. It is just black and white, fundamentally, significantly, materially, disgustingly true. And it is not the way we would design a system, but it is the system we’re in and that’s the way it’s worked for a long time and it’s the same for all dialysis providers. There’s no dialysis provider running around, breaking even, making money on Medicare and therefore doesn’t care about their private rates.

Lots of stuff go on in payer dynamics, of course, and I’m sure will you ask questions about some of the specific aspects of that. But when you net it all out, payors are larger, more sophisticated and have more coherent data and a more unified in terms of acquisitions they made X years ago. They are. At the same time so are we. So both football teams are better, both football teams bring all the right equipment to the game. And so anybody predicting victory, I think, you want to downgrade your assessment and their judgment. Anyone pessimistically forecasting defeat, I would say, the same. This is a worthy battle in the capitalistic sense with us and them on rates and terms.

What has not changed are a whole bunch of important things which give us a fighting chance to get rates sufficient to subsidize the Medicare deficit. That we are getting better and better at explaining and proving and them caring about the fact that differential quality leads to fewer hospitalizations, leads to significant savings and since dialysis is only about 30% of the total cost of a dialysis patient per year and the hospital costs are greater than dialysis costs that it’s penny wise and pound foolish to save on dialysis and give it up and more by having someone be in the hospital more often.

Second, it’s very delicate to start telling people where to go when they might die and when they’ve got to go some place three times a week. So this is not the most fun patient to start telling them what doctor they should go to or what center they should go to. Many referrals are network independent. The classic single payors is you say, okay, if you’re not give me a good rate you’re going to be out of network and you lose whole lot of business, because patients are going to go where they are in network.

When you told your kidney has failed and you might die you go to blow through all sorts of co-pay and deductible limits anyway and you care most about living the most robust life you can, first living period, second, the most robust life. And so many of our folks choose a dialysis center independent of whether that is in network or not unlike what they might do for a less significant procedure.

I talked about the bonds earlier. In addition, a payer has to have a certain kind of network adequacy, they have to offer a reasonable number of dialysis centers and most payers have relatively few patients per market. So, we go into these discussions with the payer, with a few substantive arrows in our quiver and they have a formidable array of those arose as well.

And then we fall back, on the reassuring fact that about three out of every four dialysis centers in America are owned by people who recognize that unfortunately the private sector has to subsidize the government deficit.

Final question that people have asked sometimes in the past, gee, should you be concerned that someone will try to do a bold move of reducing price in exchange for volume. There’s a whole bunch of reasons why in this particular space that tends not to be a very viable strategy. First, very low fixed cost and high variable cost, so it’s not a volume play. You run a surgery center, you run a hospital, getting another bypass in, you can do a heck of a discount, because a huge part of your cost structure is fixed, you are not going to redo that OR suite for ten years.

So from a cash flow point of view, incremental volume, it’s like getting another person on the plane. We are the opposite of that. We are almost pure variable cost. So it’s not a volume play. Significant stickiness as well so it’s not easy to switch patients around, it’s not easy to tell new patients where to go. And then of course, they only have to pay for these patients for 30 months as they go through a lot of hassle for a relatively short period before you are going to hand them off to Medicare anyway.

Moving on to the mix part of private, what are the negatives when you think about what’s going on with mix? The big thing is unemployment. And people losing insurance and not being able to afford insurance. So we are now in the worst period of time, the last 12 months with regard to this issue, than any time in the last decade.

In addition, in environments like this payors tends to change their product mix and consumers change their selecting and get somewhat more skewed to HMOs versus PPOs although that hasn’t happened nearly as much as some might have thought over the last 12 months.

And then third, good news, good news for our patients but it does change the percentage of our patients that are private pay is we’re getting better and better at keeping people alive longer and longer. By definition those are all Medicare people because they are past their 30 months. And so for very nice reasons tied to our reducing mortality that’s another mix, the percent of patients that are private will continue to go down as we improve our mortality overall.

On the positive side, separate from the obvious positive of the recession flattening out and any recovery beginning or the government, saying, gosh, the public option is dead, we want more people to have insurance and we’re going to somehow provide subsidy for people to buy private insurance which would be a good. Separate from that we have the fact that our patients are the only ones in America who don’t have the right to keep private insurance, if they want it. It’s better for them and their family. They are the only people in America that don’t get to keep private insurance. A bunch of people in Congress don’t think that’s very rational. We haven’t been able to get that passed legislatively. It is good policy for the patient. It is good policy for society.

We hope in the years to come we get this changed. And, of course, in Washington DC, the world has changed dramatically in the last month and the need for pay for is, which this is, a CVO documented pay for is much higher going forward than it was in the last year when they were printing money with reckless abandon.

So if you want to wrap up the all important private revenue side with your partners we’d probably say three things that one, six quarters mix deterioration. Then you say kind of striking that they were able to navigate through that as they have, but big fact. Second, on the payer side, it’s their fight. Awkward to predict one way or another how that nets out, probably the best indicator is what’s happened historically, but can’t really drive too much comfort from that.

And then third, where there is this powerful thing out there, the notion, the growing notion that our patients should have equal rights with respect to being able to stay on private insurance and/or the government deciding they want more people to have insurance, private insurance and subsidizing that in some way.

On to the government side of revenue per treatment, here’s just a factual update for those who haven’t looked at us for a bit. It is a very important one. Separate from the Medicare fee for service monster, the big mass of our patients, we have Medicare advantage. We have the VA, we have Medicaid. They are small parts individually, but in aggregate, they are significant, they are 50%, it’s $900 million plus or minus in revenue.

And each of these areas has serious rate pressure stuff going on. So, as you think about the next year, two years, three years, we think if you got to incorporate into your thinking a scenario where 5% of this revenue goes away, that may not happen. May happen. And so you got to incorporate that math. Attaching a probability to it, very, very difficult. In each of these three areas, a lot of stuff going on. But there is more rate pressure in these three areas today than in any time in the last eight years. That is just factually true. And we want to present that to you and so you can probably most quickly assess it in an objective way and incorporate that into your model over the next couple of years.

On to expense for treatment and this story historically has always been kind of the boring part of the story, that all changes in a year or so with the bundle. But here is the actual metrics.'07 to '09. And you can see what happened with labor, where we typically have rates go up a few percent a year and we offset part of that, a percent of that with productivity improvements and that’s an ongoing, ongoing initiative for us. You can see what’s going on with pharma, this is holding utilization constant, so this is purely what we pay.

And then other operating expenses is the outlier. We rarely had something going up like that over a couple year period; it’s primarily driven by increases in physician fees and rent. And the skew on this was tied primarily to the delay in certification of new centers. So, we are incurring the expenses of the rent and the physician fees and we are not getting the benefit of the treatments because we weren’t authorized to bring the patients in. That doesn’t explain 100% of it, but it’s the dominant consideration. We would expect that to moderate going forward. And then you see that we’ve been successful in leveraging G&A. However, with respect to leveraging G&A, we failed in 2009 versus 2008.

Now on to strategic initiatives, why do we do these first of all? Three reasons. One is the offensive reason that in some of these service lines we think we can make a very nice return on your invested capital or they help us attract a lot more physicians to do work with us and we’ll get a very nice return on the dialysis center business that’s affiliated with those physicians.

The second is our mission that we do want to transform kidney care in America and it will not happen unless we invest in this kind of innovation in the same way that great device companies do.

And then third is defensive. It is wonderful that we can put on the table this kind of value-added. And, in fact, this year we literally circulated in some quarters a white paper that showed that we made in 2008 $300 X million of after-tax profit. We paid $160 million in taxes.

In addition, we saved the system about $350 million through reduced hospitalizations and reduced surgical procedures and/or lower rates on surgical procedures through our vascular access centers, through our specialty pharma, through improved clinical outcomes, through our integrated care. So we were able to circulate an analytically legitimate document going line item by line item and you can, of course, disagree as to specific assumptions but the directional truth is very clear for those who want to be intellectually objective about it, which, is only, of course, is a subset of the people in Washington, D.C.

And that is that we are a net profit center for society, because the benefits of our taxes and our innovation savings for the system exceed the profits that we take out. And we also take the profits that benefit for society as well. But even if you assume that the cost to society, we are a profit center for the American people and the government, in part, because of these innovations. That’s a very important marketing point.

Legitimate, incredible marketing point that protects your shareholder investment in Washington, D.C. And it’s one that most companies either can’t say or don’t bother to invest to save. We would submit that fundamentally alters the risk reward profile of our company and derivatively unfortunately without us being paid for it our entire community.

It’s tiny, by the way. But 0.3% of 1% of revenue and it will be comparable in 2010 as we have some young parts of the portfolio and some old parts.

Here’s some of the primary components of that. Vascular access centers, our life line business, we’re the absolute leader in America in doing this. It’s been profitable four out of the last five years, just one year there was some significant reimbursement changes and then we got that set right.

It’s a relatively mature business. We’re the leader and it’s been profitable for the last five years. Our specialty pharmacy is, once again, the unambiguous leader. It’s a very good space to be in, especially pharma for patients that take six drugs to eight drugs, $6,000 per year to $7,000 per year, per patient. In the bundle if that happens, all the more important to have this capability in-house. And we moved as we told you we would into the black slightly, slightly, slightly in 2009. So you could call break even. And technically it was in the black, but it hit that on schedule as we told you.

And then an area of significant investment still is our integrated care model. The ability to take that $90,000 a year and managing it down to $70,000 and so doing liberating amazing amounts of tax payer money, while at the same time improving quality and that we are still investing in with great enthusiasm.

And on that one we came close in 2009 to actually having inserted into the healthcare reform bill, a very substantial pilot, a couple billion dollars pilot of globally integrated care of the same type that we’ve been doing smaller demos as well as (inaudible) has, proving that we can’t move that 90 down in a highly transparent way while improving the quality of care.

This is just a vascular procedure. This is a center, doesn’t look any different. But the value proposition is very powerful. It’s higher quality, but lower cost. Patients love it because it’s more convenient. The doctors have integrated data which they never get when stuff goes into the hospital and it does lower overall cost because our complication rate is a fraction of what the normal complication rates are.

On the pharma front, eight to ten oral meds per patient. That’s the norm. Some of you probably have patients who have cardiovascular diseases, diabetes, hypertension; most of our patients have a couple of those as well as their kidney condition, so this is the average. And so the value of integrated data and the value of integrated coaching of a patient is stunning. It’s really a beautiful thing and we got more and more data that shows that the improved adherence reduces hospitalization rates. So our data is very important to the pharma companies and the savings are very important to the system.

So the value proposition is very powerful in DaVita Rx. You can see the growth in prescriptions in DaVita Rx. We crossed the million mark this year in total and did about $160 million in revenue, which is a high fixed cost business, low margin business, so that kind of volume was important and necessary to get us to punch our nose into the black finally.

Moving onto integrated care, for those of you who are veterans you’ve seen comparable things like this before. The way to really go to the next level in terms of shareholder value or one of the ways to do that is to crack the code with respect to delaying the onset of dialysis, reducing the incidence of inefficient crashes into dialysis, which are very expensive and lead to a lot of clinical and economic waste or reducing hospitalizations, which on average about 14 days per patient, per year once you’re on dialysis.

So this is one of the ways to take shareholder value to the whole next level. I’m just repeating what many of you already know, you could say hospitalization is a huge chunk of expense many of which are avoidable and this is not theoretical we’ve proven that we can do it in specific real world scenarios. And just a quick update on some of our demos. We have a globally capitated demo, where we reduce nondialysis cost by 10%, we got a whole bunch initiatives and we know we’re going to make that a better number in 2010 than it was in 2009.

We got another demo we’re focused on delaying onset of dialysis and you can see that literally with a control group, all this data similarly scrubbed by CMS, we are reducing the percentage of patients who gone out by a certain time by 19%. The math of that is huge. The familial and societal benefit is huge and restructured this expensively, but powerfully in a way where statistically significant, where there’s a control group plus by Medicare.

So this is a kind of thing where you could construct a new focus DRG that everybody who has certain clinical characteristics, black and white define, specifically defined according to lab values could go into a pocket with reimbursement focused on delaying the onset versus the norm. It’s not going to happen this year. But we are four years into this. We expect that 2010 data to be even better than this. We’ll see. So these very powerful stories from a marketing point of view have significant net present value potential not in 2010, not in 2011, probably.

So, overall it’s an evolving portfolio. We’re always going to do some of this R&D for the offensive mission and defensive reasons I cited. In the meantime they give us a lot of differentiation with physicians and payors and they create a societal benefit that exceeds their after-tax profits, which we think is very, very important insurance for you as well as very, very fulfilling for us. Rick, are you doing this?

Rick Whitney

Okay. Into the financial review. Going on a couple hours here so I will try to zoom through this and get to the Q&A. Okay, starting with revenue. About $6.1 billion this year, three year CAGR, about 8% which is consistent with the performance in the current year 2009. If you look at revenue per treatment we’ve been on a pretty steady CAGR of about 1% for the last year. If you wound that back a few more years, very similar story.

And as I mentioned before, 2009 did a little bit better than that 1% trend line the reasons that we mentioned. Patient care costs, similar. About a 1% CAGR over that time period. Again, wind it back, doesn’t change that CAGR, does not change that CAGR story very much. And then like revenue, we had a little bit higher cost trend in 2009 versus 2008.

Operating income, margins pretty stable given that the cost from the revenue, CAGRs are pretty comparable and you can see that we’re right around 15.4% operating income margin. Earnings per share growth – you’ve seen this slide already a couple of times I think. Five-year CAGR, 14%. That’s consistent with the 15% in 2009. Of course, we’re benefiting in the last year or two from a low interest rate environment. Okay. Strong cash flows. Consistent, growing. And the other point I would make is that in each one of these years our free cash flow is more than 100% of our net income. So from a quality of earnings standpoint we turn our earnings into cash. Okay.

Okay. Move over to our balance sheet. We have on a net debt basis, net of cash about $3.1 billion of debt. That’s a leverage ratio of about 2.6 times debt-to-EBITDA you can see the components of that debt on the slide. And we exited the year at a blended, all in blended rate of 4.7%.

Okay. This is how our leverage has proceeded overtime. Of course, we leverage balance sheet to buy Gambrel and that’s the time we would delever back down to our target range and, in fact, we have and right now sits a little bit below our target range of 3, 3.5 times debt-to-EBITDA.

Okay. When does that all that debt mature? About $150 million over the next two years, which will obviously pay out of cash flow and then our senior (inaudible). I bet no one in this room has a blackberry. Okay. So in 2012 or senior credit facilities mature and so you should anticipate that sometime in 2011 we will be looking to refinance that debt. That debt is priced at LIBOR plus 150 so it costs us about 1.7% right now on the variable portion. So, we’d like to hold on to that as long as we can or as long as is prudent. But, however, we’re continually monitoring the capital markets looking for opportunities to refinance that debt earlier.

Okay. About $390 million of our credit facilities are hedged. Rates are fixed pursuant to swaps. This is how those swaps roll off. They all roll off in 2010. They have an average all in interest rate right now of 5.8%. And so, you would expect we have a little bit of an interest rate benefit as those role off, which is good because we would anticipate that LIBOR rates are going to go up. And so hopefully this will pride at least a partial offset and a rising interest rate environment.

Okay. What about your exposure to rising interest rates? What’s your fixed floating rate? Your total amount of debt? $3.6 billion of total debt not counting the cash and you can see right now we’re just about 60% fixed.

And then on the right hand side what you see is pro forma for the roll off of the swaps, just the roll off of the swaps. It doesn’t count any deleveraging throughout the course of the year and doesn’t count any principal repayments of which we will make some during the course of 2010. Just for the swaps, that would bring us down to about 50-50.

Final point, if you count the cash, look at this on a net debt basis, which is how we look at it because the cash is a natural hedge since the rates we earn on cash are directly moved with LIBOR rates. If you look at the cash as well, pro forma for the swaps falling off, we would still have about 60% of our debt fixed. I think the number is 58, 59. So, we don’t typically like to take a position on interest rates until we have a pretty balanced fixed floating ratio.

Okay. So you notice we have a little bit of cash on our balance sheet and so the question is, why do we continue to hold on to some cash? I think the way to answer that question is to step back and say, what is the context of the last 18 months during which we’ve had a reasonable amount of cash on our balance sheet. And the reality is that that last 18 months has been pretty unprecedented in terms of its uncertainty and turmoil, three primary areas, the credit markets with unprecedented seizing up of the credit markets that you’re all very familiar with.

Of course, we’re weighting on a bundling rule and now we have a preliminary bundling rule. Don’t yet, of course, have the final bundling rule and then healthcare reform you all are familiar as we’ve been tracking the progress with healthcare reform. So, if you look back over this 18 month period, some are these are coming into a little bit sharper focus now although there’s still uncertainty on at least the last two. But, if you look back at these last 18 months, think about that, probably not too surprising that we’ve been a little bit conservative with our cash. Now, in spite of that we have used some of our free cash flow to return capital to shareholders and you can see almost $400 million over the last two years.

Okay. That’s a look at our performance or how has the stock done over that time period. And on a relative basis, the answer is pretty well. This is a comparison, the top line is DaVita from 2003 and you have that indexed against two relevant index indices, the S&P 500 and the S&P healthcare index. And you can see what our performance has been relative to those indices, including, in the last couple of years, during this turmoil, you can see that gap has widened a little bit so we even in the more recent years have outperformed those indices. Hopefully, we can continue to do so.

Okay. What about going forward? What is the future look like? Well, as we did last year, we would like to share with you what we think is a very reasonable scenario for EPS growth over the next few years. We start at the top-line with revenue growth. Normal level of same-store non-acquired growth, 4%, 4.5%. Add on top of that the normal level of acquisitions we do in a typical year and then add on top of that a little bit of revenue per treatment growth, very consistent with the long-term trend that we’ve shared with you. And you get 5% to 6% top-line growth.

Okay, from there, we get a little bit of fixed cost leverage. As Kent mentioned, our business is dominantly variable cost, but we do get a little bit of fixed cost leverage and that yields operating income growth of 5% to 7%.

The financial leverage on our balance sheet translates into a little bit higher net income growth, 7% to 9%. And then we generate a lot of free cash flow depending upon how we use that free cash flow to pursue additional acquisitions beyond the normal or to buy back stock, that adds a little bit more leverage to the bottom-line and you see EPS growth range of 9% to 11%. We think that’s a reasonable scenario.

Now, this is pretty much the same slide we showed you last year, but you might say, well, you’re going into bundling now in 2011, how does that change the basic financial model of your business. And we think the short story is it probably doesn’t. So we’ve bundling coming in 2011. Depending upon the final rule 2011 could be a little bit choppy. So Medicare revenue is going to come down. We know that. But so are costs. And I say it could be a little bit choppy is because the timing of those two things may not match up perfectly. But, as we look beyond 2011, as we think about the opportunities and the risks related to bundling we think that this scenario is still a very reasonable growth scenario.

This may be my last slide. Let me check. It is. I guess I’d make one or two more points on this slide. And that is as you think about bundling it’s our belief that the scale providers and this is a little bit repetitive of what Kent said, the scale providers are likely to do better than most, under a bundling rule. And market consolidation is likely to accelerate. I think the net of those things means in our view that the basic financial model of the business should be intact and this should still be a very reasonable multi-year scenario. Okay. That is the last slide for me. Kent, you want to wrap up?

Kent Thiry

Okay. So, summary for your partners, the reasons not to invest, gosh, rates could come under more pressure. There’s no way to dismiss that risk. And we already know there’s a rate cut coming up next year on the Medicare side and if the economy gets worse or sustainably this bad what might that do to people planning up for private insurance.

Good news is clinical outcome is strong and getting better and that’s increasingly relevant from a shareholder point of view. The demand and cash flow looks awfully steady. So, boy, what a floor that puts under the downside scenarios. Hard to have a much better market position, although we have every intent to making it better over the next few years, and ironically, if there is some bad news, the fact that we’re a buyer with cash is over the longer-term, medium-term and longer-term a big positive.

And then the markets increasingly thoughtful about the value of integrated care. Our data for establishing the value of it is cumulatively getting a lot better. And so, we are not only well-positioned for the current system, but we’re very, very well-positioned to both facilitate, accelerate and take advantage of the new system.

And final slide, bundling is this big thing, but as Rick indicated, bundling is a one-time discontinuity, that has some bad news in it, and then has this stunning opportunity to innovate $1.1 billion of costs which $750 million is currently sole source with $600 million of gross margin and it’s not going to be sole source. So, gosh, that’s a nice offset to the fact that the rate cut hurts.

And the good news is the rate cut applies to everybody in the space so in some ways might, might intensify our competitive advantage. So that’s the Ying and Yang of bundling. But it’s a discontinuity, very, very significant one and hard to exactly calibrate, but then your back to the fundamental business reality which starts with the industry structure, where you got a 1,000 small units where you can’t have a lot of them close. It’s not acceptable. There’s no capacity for it. And it will be totally transparent if it starts to happen within the feedback loop.

And so, in that environment our continued ability to outperform other folks in whatever the new environment is suggests that perhaps EPS scenario that Rick described could sustain itself where there’s going to be centers open, we’re going to be better than some of those other centers, it does mean units will grow, it does mean there will be operating income, it does mean that we can leverage our operating income on the fixed cost line and it does mean we can leverage the cash flow through stock buybacks or whatever to get to the EPS line.

And so if you look at the last decade with lots of stuff going on, good and bad in individual years, our performance good and bad, what’s happened in Washington, D.C., good and bad, what’s happened in private insurance, the resilience of the business model is striking. It is not clear why that should change going forward once the discontinuity resolves itself. And I guess we’ve talked about that enough. So that’s our summary.

And now it is time for as many questions as you all want to ask or advice you want to provide. It’s good to introduce yourself, please before you go ahead.

Question-and-Answer Session

Darren Lehrich – Deutsche Bank

It’s Darren Lehrich with Deutsche Bank. Thanks. I just wanted to ask a few questions about your volume growth which has been quite strong and if you compare your numbers versus your large peer, you’ve been outperforming, that’s been fairly consistent, but it seems like you’re in fact taking share. And I remember years ago you presented medical director turnover as a headwind.

Maybe if you could just help us think about some of the things that you think are driving that out-performance and the market share gains that you’re having and maybe if you could just help us assess the risk of some of the joint venture strategies that we’re starting to see with some of the smaller players and how that may play into the competition on the volume growth side?

Kent Thiry

Could you first elaborate on the risks you’re starting to see in the joint venture strategies with some of the smaller players?

Darren Lehrich – Deutsche Bank

Sure, I think the risks that I’m asking about is do you see an increased activity of joint venture strategies with smaller players and do you think that is a legitimate risk factor to your ability to grow market share?

Kent Thiry

Okay. Let me take a cut at this and then Rick will correct my mistakes. On the small players doing joint ventures, the fact that there are a few small players and that they are aggressively out there is a competitive reality and it does mean we’re going to lose some deals to them, particularly, sometimes when you have a very strong position in the market that can make someone else more attractive to a small group, because they’re worried about being a second-class citizen, with some affiliated with the big group. So that’s a reality. We’ve done very nicely against them.

We’ve done more joint ventures than anybody else by far and so there’s nobody that has our track record in duration nor in depth, no small player, no big player in joint ventures. That also probably saw that spurt of 86 de novos in 2008, because the part of it was that preemptive element that I talked about. Getting out there and reducing your return on capital, your shareholder return on capital versus what would have existed in a perfect world, but improving it versus if we hadn’t been preemptive and gotten out there and done a bunch. And so, we feel very comfortable that with our heightened level of intensity as is reflected in the math for the last 18 months that we’re going to do very nicely versus the small players, who will still get some victories.

And then as to the broader non-acquired growth question, we are thinking we still can hit in that 3.5% to 5% range. But, we are monitoring very closely that which you should also monitor closely which is, my gosh, if FMC is going to do more de novos and the small guys are doing de novos and we’re going to do de novos at some time there are too many de novos and what does that do to weighted average returns. So I think that is an issue and all we can do is continue to track the data quarter-by-quarter. As you can see we, in fact, turn it up this year when on as opposed to holding constant. So we got back to gaining more share again.

And, in general, our weighted average returns are holding up. We told you all a couple of years ago that we had too high a return on our de novos, which is to say, we were being overly selective and that was going to put at risk market share gains that were at acceptable returns on capital. Hence the spurt that you saw that will also mean we will have more centers that fail than we ever had before. So, that will be a good thing, because, again, before our batting average was too high and that meant we were leaving acceptable opportunities to others. So put all that together, we don’t see any dramatic discontinuity out there. We’re still generating these numbers and we can just track it together quarter-by-quarter to see if anybody is getting a leg up against us.

Darren Lehrich – Deutsche Bank

And I will ask just a question on the cost side and turn this over. You mentioned in your comments, Kent that you failed to leverage G&A in 2009. So I’m just wondering if you can help us think about the ability to leverage G&A going forward, what types of things do you think led to that failure as you said in 2009 and how should we think about better cost management on the G&A side going forward?

Kent Thiry

Yes. Two things led to the failure and they are both relevant to why we don’t know exactly what’s going to happen in 2010 at this point. We’re not going to put a stake in the ground. One was inadequate management by us. The second was conscious decisions around making some investments which we think are very much in your best interest in terms of protecting our revenue per treatment and our unit growth. And then the changes in the IT system and some of the things around integrated care.

So, those are the two things that caused it in '09. Hopefully, we will address the inadequate management side of it that I own. But on the other hand we are playing with a bunch of things that we think are quite powerful once again in the IT sector, in particular, and then some stuff in integrated care. And so, right now we cannot commit that we’re going to leverage it more in 2010.

Darren Lehrich – Deutsche Bank

Do you think the –

Kent Thiry

Because you said one more.

Darren Lehrich – Deutsche Bank

Well, this relates to the G&A question.

Kent Thiry

(inaudible) quarter numbers, I can change mine.

Darren Lehrich – Deutsche Bank

The headquarter move to Denver, does that do anything at all for corporate G&A over the long-term, do you think there will be some ability to consolidate the costs there?

Kent Thiry

Yes, in general, it won’t be material for a long time. In the short-term there will be a miniscule incremental G&A cost over the intermediate term there will be some savings. But it’s not going to be material. Economically, on a microeconomic basis it’ll be very powerful for shareholders in terms of improved decision-making.

As we’ve gotten bigger we never really had a corporate headquarters in the sense of having most of our executives in one place and as we became bigger and more complex it was no longer the right, the distribution of executives across America, which worked very well for us, for the first decade, is not right for the second decade. So, the move to Denver will be the one of the best decisions for shareholders for the second decade, but it’s not going to lead to a material savings.

Rick Whitney

Darren, back to your joint venture question, just to give you some specifics for context, about 16% of our business right now is joint ventures, and if you look at the pace of which we’re adding about a third of the center that we have are joint ventures. And so as Kent pointed out we do like some of the other players we do a fair number of joint ventures.

Kevin Fischbeck – BofA Merrill Lynch

Okay. Kevin Fischbeck from BofA Merrill Lynch. And just first to Darren’s defense, you did say we could ask as many questions as we want, which is kind of dangerous to say to, so. I guess, Rick, when you mentioned that sequentially the rate was down and you mentioned 20% of that was due to commercial rate pressure, was that actual rate pressure or were you talking about mix shift. I just want to get clarity on that given that you are talking before about it –.

Rick Whitney

It’s worth repeating three pieces. The biggest was declines in physician prescribed pharmaceutical intensities and that was 60% of the sequential change. Second part represents 20% of that change were rate changes and the biggest one there was change in ASP pricing on Medicare drugs. Okay? And then the last 20% is the commercial mix, not rate mix. That’s the phenomenon that Kent was talking about, which is about, I don’t know if we mentioned the breakdown, but is about 50-50 due to retaining patients longer on the one hand and on the other hand the actual impact of the economy and the declines in insured lives that I’m sure you all are tracking with your other HMO managed care investments.

Kevin Fischbeck – BofA Merrill Lynch

Okay. And then you talked a little bit about the transition of the bundling cut and whether to go full in or go in overtime and one of the considerations was IT spending as potentially a headwind. I just wanted to understand how real of a headwind that is given that it sounds like an IT spend you are going to have to make anyway at some point over the next four years and the cash flow certainly doesn’t seem to be a headwind. Maybe give a sense of what kind of a cost that might be and how much of a headwind do you think that might be?

Kent Thiry

A lot of IT work required for the bundle because you have to change the way you submit every Medicare claim. And we don’t know exactly all the ways in which we have to change it until they come out with a final rule. So as much as it were a one DRG entity there’s a lot of line items in that DRG.

Rick Whitney

And we’re going to have to do it on an accelerated basis because of the timing of the rule.

Kent Thiry

Correct. On the exact math of it we won’t know until we see the final rule. But when you think about leveraging G&A it doesn’t take that much math of stock different going from 7.4 to 7.3. We can’t have a specific number until we get the final rule. But it’s enough to tweak that G&A.

Kevin Fischbeck – BofA Merrill Lynch

And I guess you said we don’t have the final rule, but I guess one of the numbers that we don’t have which I don’t know if you have a perspective on since they’re going to be setting the rate base upon the lowest drug utilization in 2007, 2009, do you have a sense of what kind of headwind that might be to the rate?

Kent Thiry

I will defer to LeAnne. I do not have a number in my head. LeAnne, do we have a number in our head as to they’re probably going to go for 2008, right? And what kind of cut that represents from the industry? I doubt that we have industry '09 data yet so we probably don’t know.

LeAnne Zumwalt

I’d just say '08 looks like it would be the year, but we don’t have all the data and neither does CMS. And it is built-in cut for us because just mathematically if you take the lowest of three years of which '09 was one of those years and we’re going to have a cut as it relates to that. And then in addition to that our pharmaceutical intensities and by the way our clinical outcomes are higher than the average. Now if you compare with the other large provider, Persinues [ph] who virtually identical when you compare to the overall industry average they are higher, so for those two reasons, we have a bigger hill to climb as it relates to that issue.

Kevin Fischbeck – BofA Merrill Lynch

My last question, I think it is the last question, the demand growth slide that you had before, demand growth slide being stable and this is the same slide we’ve had for the last ten years, what are your thoughts about it being the same slide ten years from now, you mentioned therapies potentially in the works, but it sounds far off, what do you think the biggest risk of having to change that slide is and how far away do you think that is?

Kent Thiry

Over ten years if treatments for diabetics and private insurance significantly improves, while that will not have a large effect on aggregate demand it could have a material impact on that portion of demand which subsidizes most of our population. So that’s the most significant negative on the ten-year front or any other comparable advances that are disproportionately taken advantage of by that segment. The most significant positive over ten years would be if science emerges that more and more people should have more than three treatments.

Kevin Fischbeck – BofA Merrill Lynch

You are not worried about medical technology like portable kidneys or things like that, that sounds like it's way too far from the future.

Kent Thiry

At this point, what I’m told and this is a function of me listening to people whom we think know a lot, who either work for us or work for others, that the portable technologies, I guess if you go to the ten-year timeframe that is feasible, Kevin. However, it’s not all clear that that’s a bad business model for us. Just as we have more home patients anybody in the world today. I think that’s why I don’t have it on the short list. It’s not clear to me that’s a negative. In addition, the way it works now if you are a company with new technology, who is the first person you go to in the world? Us.

Because Persinues is a wonderful company, is going to be your competitor and so if it’s anybody other than Persinues they come to us first so there’s a tremendous opportunity to partner with new technology and if it is Persinues they come to us because we have a wonderful working relationship and we can drive an amazing enhancement on their return and there’s salacious antitrust consequences not coming to us with a proprietary technology. So for shareholders that space that you brought up, probably has more upside for us than downside, and in part because it really could change the capital intensity of growth to the extent that you don’t have to build all the centers. So that would be an answer to a different question that has nothing to do with demand change, but structural change which we think is good for us.

Kevin Ellich – RBC Capital Markets

Kevin Ellich of RBC Capital Markets. I had a couple questions. Starting off, Rick, I was wondering if you help us understand why non-acquired treatment growth increased faster than total treatment growth in Q4. It was 4.8% for non-acquired and 4.5% for total.

Rick Whitney

If you look at it on a treatment per day basis you wouldn’t see that same relationship treatment per day growth year-over-year with higher than non-acquired treatment growth, so that’s part of the problem now. What you say why would that be the case? It has to do with the way the calendar falls on treatment days. The sequential growth in treatment is actually lower than it typically would be for the reasons that I mentioned and as we look at January we see the effect of that bouncing back. So, I think may just be the number that you’re looking at. If you look at treatments per day growth it does have an increment above non-acquired growth. It’s a smaller increment than it was earlier in the year and that relates to the timing of the acquisition with the way they’ve rolled out.

Kevin Ellich – RBC Capital Markets

Does it have anything to do with the center closure or the five centers that were merged?

Rick Whitney

No, Jim or anyone else, correct me if I’m wrong, the center closures are baked into the non-acquired growth calculation.

Kevin Ellich – RBC Capital Markets

And then thinking about DaVita Rx and the bundle, Kent, I was wondering if you give us your thoughts behind opting in or what you plan to do if CMS doesn’t change the oral medication payment amount of $14 per treatment and how much would you like them to include in the bundle?

Kent Thiry

To fully fund accepted clinical protocol of orals in the bundle at current economics would be something like $43 or $45. Are those the right words, LeAnne? And $14 is a ridiculous number. And they are stuck and working hard to figure out what to do because since there are so many patients right now who don’t get what they should get, how do you estimate what that number is when you don’t even have the data so you don’t know for sure how many patients are getting what now.

So you might know a number of what you’re spending but you don’t know exactly what percent patients it covers and how compliant they are. And so they are in a very tough spot because they can’t accept our number, although we have given them an honest one. They know their originally number is totally wrong. They want to move in this direction for very sound reasons. We’re not against orals in a bundle in theory, we just want it to be at the right number so patients get the right drugs in the right quantity which is why we advocate they spend a couple of years working with us so they can feel comfortable with calculating the number, testing all assumptions, seeing all the data and then put it in. So that’s the spread and that’s the quandary they find themselves in. We hope they work with us over a couple of years to figure out the right number and implement it in a very transparent way. Is that responsive?

Kevin Ellich – RBC Capital Markets

Yes. And then thinking about DaVita Rx, could you give us some information how many patients you have using your pharmacy and how the grassroots efforts have been going?

Kent Thiry

The answer to the second question is the grassroots efforts have been going well. 2009 was our best year for incremental penetration and the total number of patients on is between 18,000 and 20,000. Anybody know the exact number?

Rick Whitney

It’s very close.

Kent Thiry

It gives you the range. It is by far the largest focused kidney care pharmacy in the world and we got a growing database that’s unique for helping pharma companies, think about enhancing the penetration of their drugs, for remarkable influence, making sure the right people get the right drugs as well as data tying it to reduced hospitalizations when patients do comply. So it’s really a unique data set, it’s one of the assets separate from the incremental margin on delivering the script.

Kevin Ellich – RBC Capital Markets

And then my last question has to do with people and your thoughts on the new ESA tests were coming to the market soon like Hematide and also the upcoming government meeting for ESAs. I think there’s one at the end of March. What are your thoughts going into that meeting, what do you think it’s all about?

Kent Thiry

On the new ESAs coming to market, we are very excited. We think the world of Amgen as a company and their drug has been a great gift to thousands of patients. At the same time, we would love for there to be a competing great gift because there’s an awful lot of gross margin sitting there. And then the meetings coming up, I don’t know where they’re going to come out, you talk to 20 nephrologists, you get 20 different opinions about what some of the new studies suggest or don’t suggest, prove or don’t prove and they have not yet even published the exact questions they’re going to address in some of those meetings and so you end up doing hyper speculating, which isn’t time well spent. So I think that’s both questions.

Rick Whitney

Hey, Jeff, the gentleman, next to Schaff [ph] in the back has hand up for quite a while.

Unidentified Analyst

Thank you. Your profitability is in part derived from a pricing floor that set by the less efficient providers in the industry, by your own description; we can’t have them go out of business at a rapid rate. And I’m wondering therefore if you can describe a little bit what the size and shape of the industry cost curve is sort of with an eye to how many years is it until we have nothing but efficient providers in which case who knows what the profit structure would look like? Thanks.

Kent Thiry

We don’t know you can look right now at our current non-acquired growth 4.5% to 5%, what FMC is doing, what the MDOs are doing, the medium investor-owned enterprises and if you just extrapolate out a straight line it’s a long time before you have a critically material body of independence. And some of them will never sell. They may lose share. So maybe they’ve gone from 30 patients to 40 to 50 to 60 and they’re going to then go from 60 to 50 to 40 as they lose share to us and others but they’re still going to have their center, because if a doctor doesn’t want to sell or it’s a hospital doesn’t want to sell or it’s an investor doesn’t want to sell. Then further delays the curve. So absent some discontinuity like a really bad bundle at least a lot of people do want to sell quickly, it’s quiet sometime but I don’t have the model in my head.

Rick Whitney

I think the other interesting thing is that we’re about to go through industry transition here where several billion dollars the industry costs are going to move from cost plus into the bundle and so that has the potential to widen the gap between the floor and the efficient providers as scale advantages are likely to be more important in the bundle than they were previously.

Unidentified Analyst

A follow up again, how large is that more inefficient part of the market and at what rate is it departing today?

Kent Thiry

About 25% of the market. 1,000 centers more or less, again sort of defining the boundary is a quest somewhat subjective, but that gives you a sense, and the market is growing at 3.8% and you will see we’re at 6%, FMC is at right about the market, and the MDO is a little hard to quantify but they are so tiny so you are not moving much each year on a share basis. But we probably can give you an actual set of the numbers. So I can only give you the directional business answer and some of the mathematical components. I just can’t do it in my head and I don’t have the numbers memorized.

Unidentified Analyst

I’ll wait, is that okay?

Kent Thiry

Andreas.

Andreas Dirnagl – Stephens Inc.

Good morning. Andreas Dirnagl from Stephens.

Kent Thirty

You usually wait until closer to the evening

Andreas Dirnagl – Stephens Inc.

Well, I can always come back.

Rick Whitney

It’s been twelve years and you don’t age ever.

Andreas Dirnagl – Stephens Inc.

Kent, just to pick up on a term you used a couple times, now there are really bad bundle. Would you characterize the current proposal as a really bad bundle?

Kent Thiry

The interim rule? Oh yes. That would be an understatement.

Andreas Dirnagl – Stephens Inc.

The $14 versus $45 makes it a really bad bundle?

Kent Thiry

It’s an abomination.

Andreas Dirnagl – Stephens Inc.

Okay. On the same line when it comes to the current rule than as it’s proposed now assuming that there would be no changes, do you have an opinion as to whether DaVita would opt in immediately or would you take it in over the four years?

Kent Thiry

On the current rule you would head for the hills. You would opt to resign. Under a new rule you got to wait to see it to know what you would do.

Andreas Dirnagl – Stephens Inc.

And majority, you put out I think three or four different things that you and the industry were working on. Would you say that the oral drug is the number one key focus of your conversations now?

Kent Thiry

The math of a few of them. A few of them have striking math if they get them as wrong as what’s contemplated. But I want to go back and emphasize. They were very open in saying, hey, we had to get this out because the fastest way for us to get a better handle on it was to get it out and start the communication in a more intense and open and deadline kind of way. So, we know they are going to change some of that stuff, which is why you end up getting caught, how much you have to talk about it, because they said it’s not going to stay that way.

It doesn’t mean that we’re trying to tell anyone that you should be (inaudible) exactly what we think is right, although we try to be credibly open and honest in our analysis with them, because we’re just trying to get to the budget neutrality that the legislation mandated. We just wanted what the legislature wanted. We don’t want leakage. That’s really, that works for us. So it’s not a case of we’re trying to add stuff in. But they did the right thing by bringing it out the way they did to accelerate progress and learning and they listened with great intensity. There you go. That’s all we can say factually.

Andreas Dirnagl – Stephens Inc.

Okay. And another issue then you made a comment that what would be positive for both DaVita and the industry would be an expansion of coverage with no public option. Do you therefore see the Senate version of healthcare reform as a positive to the industry and to DaVita as being the most likely thing if we’re going to get reform to pass?

Kent Thiry

If the legislation that passes creates subsidies of any sort which make it easier for citizens to buy or retain private insurance, which parts of the Senate bill might do, that is an unambiguous good. And as probably you all know, state facts here that are very time sensitive, a fact that is true today, may not be true tomorrow, but the public option is quite severely politically damaged, yet the desire to have more people covered by insurance remains strong. And so ergo someone this year soon or later might try to do something in order to show their constituents that there is more insurance coverage without tackling the monster, the third rail of the public option. I’m not predicting that, but it wouldn’t surprise me if someone tries to do it. The big countervailing factor, of course, is just spending money is very difficult right now and then the countervailing fact is in our case, if you extend private pay you can pay for it providing coverage.

Andreas Dirnagl – Stephens Inc.

One or two relatively quick ones, can you remind us when your current Amgen contract is up and what you’ve done in terms of starting to renegotiate that?

Kent Thiry

I don’t think there is ever been a period in ten years we’re not negotiating with Amgen. And I don’t know, do we disclose when it ends? I don’t remember.

Rick Whitney

(inaudible) files Amgen this year.

Kent Thiry

Okay. So it’s the end of 2010, December 31, 2010, isn’t that right?

Rick Whitney

Yes.

Andreas Dirnagl – Stephens Inc.

You mentioned going, switching to acquisitions for a moment you’ve been talking for, I think a year or a little bit more than a year about your desire for potential MDO acquisition. You mentioned today that you haven’t been able to get there in price which has been a good thing. Can you talk about not for any specific transaction, but just in general, what you are willing to pay for acquisitions in terms of say on a per patient basis the way we always looked at them in the past?

Kent Thiry

I don’t think it’s in your best interest for me to talk about that publicly. But maybe the generic answer might be useful. Want to give you a good internal capital.

Andreas Dirnagl – Stephens Inc.

Looking back at the Gambrel acquisition if I recall correctly you paid about $75,000 a patient or $80,000 a patient. Looking back on that, is that sort of, yes, we think that’s a good pricing level in general, or no, we got a bargain, you shouldn’t be expecting that going forward?

Kent Thiry

I don’t even know our per patient numbers for '09. We just simply don’t look at it that way. We look at it in two ways, an IRR and a year three after tax cash return on the actual net capital invested to do the deal. So, one very, very hard core intermediate term, pragmatic cash, cash, cash, cash, cash, and the other, the more normal conventional financial IRR with the terminal value and all that stuff. That’s what we use. In evaluating an MDO one also takes into account that it could be by buying, having two more centers in Milwaukee, you actually help strategically the performance of the four others that you already own, which then adds a return and that’s not has anything to do with the multiple you’re paying on their profit. And so, all I can say is, we want to be very comfortable that we are going to get a sustainable after-tax return on capital. That’s what it’s got to be.

Andreas Dirnagl – Stephens Inc.

Okay. And then the finally one for me for now and you’ve hated this one in the past but it’s been a while so I will ask again. Your own commitment to the Company, can you remind us what your length of your employment contract is and what the options for renewal are?

Kent Thiry

You are still trying to get rid of me. There’s no date set by me as to when I will go and I’m totally committed and loving what we do and are trying to do. Of course, when at the board wants to fire me any time soon it’s not something I can control, but I have no personal date set and I’m very, very, very excited about some of the stuff we are doing. We will go here and then there’s a gentleman in the middle.

Andreas Dirnagl – Stephens Inc.

One quick question, you talked about village health and then coordinated care both you present has been pretty vocal about the opportunity. Understanding MSP has some political opponents in Washington, who could be the gaining factor in getting accord any care pilot large or more on track?

Kent Thiry

Who could be an obstacle or gaining factor?

Andreas Dirnagl – Stephens Inc.

Why hasn’t it been more?

Kent Thiry

It was frustrating this last year because we were told, we were advised by the right people not to pursue a large globally capitated pilot because they just were sick of dealing with us after the whole HIPAA legislation for the bundle. They spent a lot of time on dialysis they wanted a break. And they knew they were going to tackle the healthcare reform. They got to deal hospitals, doctors, insurance companies, pharma, so they had to deal with the aircraft carriers and they don’t want to, were going to have time.

Against odds, we refused to listen and moved forward anyway and created a significant body of support to the point where they were working with us and crafting language. So all the legislation, the language was drafted. And it got sent to the CVO. So we climbed a tall, tall mountain and got people excited, even in the context of, my gosh, we’re already working 18 hour days and why would we add to this thing which is not the political main event.

And then we tried very hard to make clear to the CVO that we will do anything to avoid a concern that we would cherry pick which is a concern when losing global capitation will people cherry pick and somehow pick patients where they are going to make money just because they were superior underwriters. And visual, we will put whatever language you want, but they don’t craft language for you. They still had a concern so they didn’t give us a neutral or a saving score. They gave us a slight costing score which then knocked us out in this go around. So we overcame all the obstacles and got into the legislative red zone and were stopped by a relatively small costing score, but it was a costing score and so the optics of that were not acceptable. But it does put us in a very good position going forward because there’s a lot of familiarity with the concept.

And everything they talk about those of you are familiar ACO is with a big concept in the Senate bill, other people talk about integrated care, we can be a poster child for the kind of thing they want to deal with all chronic care in America and that’s what we were offering up, a substantive political victory and so we will be back at it, but that’s what happened this past year. Is that responsive?

Gary Lieberman – Wells Fargo

Thanks. Gary Lieberman from Wells Fargo. You talk a lot about the cost opportunity from bundling, are there any revenue opportunities from bundling, does it make more sense to do more hemo or do PV?

Kent Thiry

Excellent question. We have to wait for the final rule.

Gary Lieberman – Wells Fargo

Okay. I guess under the proposed rule, is there anything that stands out might be an opportunity?

Kent Thiry

I don’t know. We know this we thought a moving target. We spend more times just focusing on trying to get the problems fixed so I don’t honestly know the answer to the question. Rick?

Rick Whitney

I would say, no, I think the dominant focus is really on the cost side.

Gary Lieberman – Wells Fargo

And then with regards to EPO you talked about there being an opportunity and the contract with Amgen ends in 2010, I guess is there any opportunity to potentially get some significant cost savings prior to the expiration of the patents?

Kent Thiry

Don’t know. We would like that.

Gary Lieberman – Wells Fargo

So I guess the other piece of that is it sort of in your mind if you could share with us what do you think the potential size for the savings is on $800 million piece it is EPO?

Kent Thiry

It’s going to be fascinating. They have what they have. You know the facts. How this place out is, who knows. It’s going to be quite exciting.

Gary Lieberman – Wells Fargo

Alright, I’ll hope for too. I will go for my third one. Is there anything different that you’re doing in terms of the contracts, the long-term contracts that you have with your directors, is there anything you are doing different because, I guess, some of the competition from some of the new entrants or some of the other guys doing JVs? Is there anything that you are doing different in your contracts to keep those physicians either longer or to get physicians the first time?

Kent Thiry

Short answer is no. Our medical director agreements are quite similar to what they’ve been in the past. What we’ve demonstrated in the last few years back when we talked about some of the headwinds is that we had a lot of physicians who’s contracts were expiring, who didn’t have tails, who didn’t have non-compete tails. And what we’ve demonstrated is very, very, very high percentage capability of renewing even with that, which is why we don’t even talk about it anymore because our hit rate is so strikingly high. And so that was the one watch that throughout there a couple of years ago but the end for all, going forward contracts noncompete tails are a part of doing the business and virtually always achieved. So that would be the only difference. But it’s only a difference for those contracts. It was always the standard, but we inherited a bunch of contracts that didn’t have that provision. Everything else is pretty much the same.

Rick Whitney

We generally are it’s a matter of course entering into a discussion about renewals far in advance of expirations. That’s something it’s not different over the last couple of years, but it’s one of the reasons why we had pretty good success. I guess the last thing is people don’t take the impression that it’s all about contracts is the other thing is all the work we’ve done to improve our position as a high value provider, high value partner is really critical for a lot of docs, particularly, as we go into a time of significant industry changes with the bundle.

Gary Lieberman – Wells Fargo

Okay, thanks a lot.

Kent Thiry

Thank you.

Justin Lake – UBS

Thanks. Justin Lake with UBS. Just a few questions on your commercial mix. The number was 13% last year; it looks like it went down to 12%. Any more color you can give us on that? You can get from 13% to 12% a lot of different ways, was that 30 basis point move or was it a 120 basis points decline?

Kent Thiry

I don’t know the answer to that.

Rick Whitney

Less than 100.

Justin Lake – UBS

Less than 100?

Kent Thiry

I remember the first time I was told the rounding has moved. I know it was less than 100 but I don’t know the exact.

Justin Lake – UBS

Right. Was it materially different, it’s probably a full year average, was it materially different coming out of the year than the 12% or the decline?

Rick Whitney

No, if I’m answering the question correctly or incorrectly, let me know. It did continue to deteriorate in Q4, so the number we’re giving you is where it’s declined to.

Justin Lake – UBS

That’s the Q4 spot number?

Rick Whitney

Yes. And again sort of half, the reason half the retaining patients longer, half tied to the economy, and then the other thing for a little bit more color that we’ve been saying for the last several quarters is that it seems to be disproportionately in the lower rate segment of our business. That was a little bit different in Q4. Still disproportionate to the low rate but not as “favorable” as it had been in previous quarters.

Justin Lake – UBS

Is there anything figure out as to why that’s been the case?

Rick Whitney

Honestly, no.

Justin Lake – UBS

And then you’ve been pretty clear that the existence of COBRA, your ability to get people covered there, has buffered the economic impact to some extent. I know you track this pretty closely so as you go through the year, as you see people ticking off in that cobra coverage expiring, do you have an idea of where you think that number, nothing else change in the economy, we came out at the same unemployment rate we came in. At the end of the year where do you expect that 12% number to be just because of cobra expirations?

Rick Whitney

Yes, I don’t have a number for you because we haven’t isolated it in that way. As we think about mix going forward we’re hoping that it’s not going to continue to deteriorate, but planning for it to. And we don’t have a handle on is the lag time between sort of the impact of unemployment and the related decline in commercial membership. And the impact on our business, we are working furiously to get a better view on it, but we, at this point in time don’t have a forecast that we have a lot of confidence in, in terms of what our mix will be as the year progresses. So, as I said hoping that it doesn’t decline, planning that it will.

Kent Thiry

And just on COBRA, LeAnne, you correct me if it’s wrong, the Congress passed a temporary COBRA extension provision. That did not apply to our patients. And so when that expires, it doesn’t affect us. So the only thing that would change our COBRA reality is nothing tied to all that legislative, the stuff that got the legislative attention, but just that a fewer people in the normal course of life sign up for COBRA.

Justin Lake – UBS

And then just lastly on from a commercial contracting standpoint, it’s pretty clear that you have an understanding with commercial payors that they are the subsidy for Medicare, more people are on Medicare, is there anything you can do from a rate perspective in 2010 or have done from a rate perspective to try to increase that subsidy to offset this mix change?

Rick Whitney

2009 was a solid year in terms of our rate trend and we hope 2010 will be solid as well.

Justin Lake – UBS

You think it will be better or worse? I would assume most of that’s already contracted?

Rick Whitney

No, because I think as you know most of our business is up for renegotiation early every year because they are not long-term contracts. So, it’s not a situation where you go into the year with the rates locked and loaded. In some cases that is the case, but predominantly there’s a lot of discussion that have to take place between January and December. I don’t think we’re in a position to predict.

Justin Lake – UBS

And then just last question…

Kent Thiry

And, Justin, we’re doing a better job now of analytically establishing the credibility the fact that the rates are higher to subsidize the government. However, having said that when we go to them and say, well, our Medicare deficit is going to grow this year, they beg to differ when we suggest that, that means they should do something to incrementally make up for that.

Justin Lake – UBS

And just last question….

Rick Whitney

The problem is the quote, yes.

Justin Lake – UBS

Commercial bundling, can you give us an idea of where you are right now as far as the percentage of your contracts that are bundled and where you expect to go into bundling on at the end of the year?

Kent Thiry

We never reveal the exact number but it’s substantial and continues to grow and it’s going to continue to grow probably this year more than the normal year and 2011 more than the normal year.

Justin Lake – UBS

Great. Thanks.

Kent Thiry

He’s back.

Unidentified Analyst

You mentioned more frequent dialysis a few times and so I’m just wondering if you could comment a little bit more about, what clinical data do you think is important and maybe important overtime and I guess how you view this as a public policy item for your industry and how you lobby it? Just kind of where do we stand as far as more frequent dialysis goes, how should we think about that?

Kent Thiry

I’ll make a couple of statements and then you come back to fill the gaps. The policy makers are horrified at the prospect of doing anything that would lead to lots of people getting lots more treatments. And therefore, will set a high bar for data and/or physician frequency. That’s the policy side of it. On the data side of it, the people who are critical say the data is or I guess technically are not clear about sustained comparable adequacy and reduction in total healthcare cost. The supporters argue vehemently that the data are clear although there’s no massive control study that in fact outcomes are better. We are neutral because the fact is there’re not the kind of controlled studies that you might have for a new drug.

We do more home hemodialysis than anybody in the world, so there isn’t anybody with as much data as we have. We are continuing to learn very objectively every month or more about it and look forward to helping shape policy in whatever direction it should go. What is clear to me as a relatively ignorant lay person in the conversation, but as an observer, is that for some percentage of people it is better. I am quite persuaded of that. But as to what percentage that is, it’s just too wide a possible range right now. So that’s our answer. Did I cover all of it?

Unidentified Analyst

I think so. I guess my other part of the question just relates to a recent announcement you made regarding a hire, who is in charge of your home therapies. And my understanding is that person came from an organization with a much hire home hemodialysis and home-based therapy penetration. So maybe just talk about that hire in context around your strategy?

Kent Thiry

Yes, we just successfully recruited a gentleman named Dr. John Moran. He is one of the best known physicians in the world when it comes to home therapies and particularly PD with both PD and frequent dialysis. He came to us from a competitor who has placed lots and lots of emphasis on the home. And so we’re very excited that he wanted to come and join us. And what that reflects is the fact that it is our stated intent to be, and we have not only more home hemopatients than anyone in the world, we have more home patients than anyone in America. I don’t know FMCs global numbers.

And so our agreeing to get together with him is a reflection of our stated intent to be the most thoughtful, the most informed, the best equipped organization in terms of data on clinical outcomes and operational realities in home therapies in the world. That’s what that hiring reflects. And then exactly where that’s going to go in terms of policy advocacy we don’t know yet. But it further positions us to be what we’ve said we wanted to be for a few years, which is when Congress or CMS is looking to change anything, they want us in the room, because all along we’ve been ruthlessly objective players in this debate.

Unidentified Analyst

I guess my other question here just relates to some of the strategic initiatives that you talked about in these forums in the past. You highlighted really three in your slide presentation. I’m just wondering if you could maybe talk a little bit more about some of the other that make up that 5% of your revenue, in the last year comprise about $15 million or $20 million of investment for your shareholders?

Kent Thiry

Sure. We’re developing a fourth one, that’s consuming dollars is we’re developing an electronic health record, electronic medical record for physician practices, nephrology practices. It’s called Falcon. It an exciting piece of work. What are the once are sort of material? I hit the big once in terms of the math.

Unidentified Analyst

Fusion, you talked about in the (inaudible).

Kent Thiry

Oh just focused on kidney care, the home infusion company we bought a couple years ago at a very strong year in 2009 after we almost killed it in 2008 after we bought it and smothered it with value-added, had a very strong year, and we just hired a new Chief Operating Officer and are hoping to ramp up the growth significantly relative to '09 in 2010, primarily on a de novo basis in order to continue to test whether or not this is an area where we can throw substantial chunks of your capital to grow.

It’s a highly fragmented industry. It’s a very good fit with our core competencies. It could be that significant portions of it are susceptible to dialysis being dialysized in terms of a more clinical focus with more standard outcomes and a more coherent deal with payors. So we’re still learning and trying to decide and as we explained when we bought it, this could be another big growth pillar. We’re going to take some time and see if it’s a place where we want to place some significant bets and the best way to do that is place a small bet rather than consultants do PowerPoints in your conference room or with all due respect just reading your reports. We felt by owning it and running it for a couple of years we’re learning a lot and hoping that it ends up being something that we want to place some big bets.

Unidentified Analyst

And just financial part of it I guess I want to ask is the 30 basis points or 40 basis points of margin that you’ve been absorbing on a consolidated basis, how does that look in 2010? Do you think you can get to break even in all these businesses that you segment report now separately or do you think you still have start-up losses that you will be investing in, in 2010?

Kent Thiry

I will take it, Rick. What I said in the presentation is that we would expect the investment, the operating losses to be comparable in 2010 to 2009, not significantly higher or lower. And that number is 0.3% of revenue. There’s Andreas Dirnagl.

Andreas Dirnagl – Stephens Inc.

Just a couple more. Kent, we don’t talk about it a lot for obvious reasons, because there’s really not a lot to talk about, but you did put up a list of the investigations that you successfully completed. There are still three outstanding anywhere from two years old to five years old at this point. Is there any color you can give in terms of would you consider any of those active investigations still, are you still getting requests, etc.,?

Kent Thiry

One of them has been dormant for some time. And there’s been activity in the other two. In one case, positive activity in our mind, in another case, negative activity. It probably doesn’t make sense to go further but that gives you a some sense of how that portfolio is evolving.

Andreas Dirnagl – Stephens Inc.

That’s great. And, Rick, maybe just a question on the slide that you put up in terms of growth going forward, bottom-line was 9% to 11%. That’s clearly below what you’ve been doing on a CAGR basis for the past couple of years a good 300 basis points to 400 basis points. And I was wondering maybe one or two quick ones. You put in further share repurchases as one of the drivers for the leverage down there. Any assumptions that’s in there of how much or that you are going to do them or it could possibly add to that?

Rick Whitney

The assumption is built into that that basic financial model is that we reinvest our free cash flow in either acquisitions or share repurchases.

Andreas Dirnagl – Stephens Inc.

Okay. And you’ve done a good job in the past, always sort of talking about the levers and the probabilistic outcomes and things like that, what sort of a lever do you think particularly in 2010, 2011 that you can sort of push and pull against so that’s going to cause that number to potentially be versus the 9% to 11% more in line with your historic range of 14% to 15%?

Rick Whitney

The things that could cause us to be above that range or below that range I would say are outcomes on private rates, we’re able to get consistent increases overall on the portfolio, similar to what we’ve done historically or not. And bundling transition, I think, would be part of that answer as well that could put us out on either end. Those are the two that I would say. And they are both the same answer for the high end and the low end. I don’t know would you add anything to those?

Kent Thiry

What happens in that portfolio of the quieter government programs, VA Medicaid and Medicare Advantage is up there in the pantheon of big factors and then whether or not we get a private pay extension or private insurance subsidy would be a fourth one in the pantheon.

Andreas Dirnagl – Stephens Inc.

Of the three other programs that you mentioned and I think you said in general that they have higher than Medicare rates, do all three of them actually have higher than Medicare rates or is it them as a bundle?

Kent Thiry

Definitely as a bundle and I know two of three do, I can’t state definitively on the third.

Andreas Dirnagl – Stephens Inc.

I’m assuming its Medicaid.

Kent Thiry

I think it’s in your best interests that I not respond.

Andreas Dirnagl – Stephens Inc.

Okay, finally, and then one final question on just de novos or actually two on de novos, I’m assuming are we pass sort of the big certification issue now, has the log jam cleared or are there still some waiting and then finally are we still in a situation you’ve said in the past where clearly your development people bring you many more projects than you actually do on a de novo basis? Kent, you mentioned that you brought down your IRR hurdles. Are we still in a situation though where you probably have more capacity to do de novos than you are actually doing?

Rick Whitney

The actual number of centers delayed right now is 62 I believe. It’s down a little bit from its peak, not, what that? Still quite a few. Although just to make sure that everybody knows what we’re talking about, it’s not that we have a bunch of centers out there that are getting older and older and older where you have to say, oh my gosh, are they ever going to open those centers. Instead it’s taking longer to get from completion to certification. So you kind of build up a little backlog there.

So that is predominantly the nature of that pipeline. So a little better. We’ve also done a little bit better in controlling our costs for those de novos while they situating and so that’s helped a little bit, but there is still a drag on our costs right now. Now that number will never go to zero and it never has been at zero, it’s just about two times what it would typically be if you look back in history.

Kent Thiry

There’s another part to your question about capacity for growth. I might ask you to ask that again to make sure we hit that part, too. But we had a significant public policy victory on the survey and certification front which is there’s an appropriations bill that allocates money to the agencies for doing that sort of stuff and the related stuff. And this year we worked very hard again to be in the lead by far and the provision, the funding for dialysis survey certification went up by 65% or so. An increase, a dedicated allocation changed the likes of which had never been seen. And so that will overtime begin to help us, holding all other things constant reduce that number further. But you asked another question about sort of capacity to grow?

Andreas Dirnagl – Stephens Inc.

(inaudible).

Kent Thiry

The answer is, yes, we probably have 200 projects being evaluated right now and you saw the prediction for this year was comparable to the last two. And then many of the decisions we’ll make in the next few months actually affect what happens in 2011, but if I had to guess right now, I’d say '11 will be comparable to '10 absent again any discontinuity there. Our objective is always to see if we can stay here until no one has another question.

Andrea Bici – Schroeder

Andrea Bici, Schroeder. You talk about maybe transitioning to other ESA products, can you maybe give us the time line of, I know you run your clinical protocols very carefully, just how you run your pilot programs and if you were to be considering a new therapy how long a decision process is and then how long it would be to roll it out to all the centers?

Rick Whitney

Specific to ESA?

Andrea Bici – Schroeder

Yes.

Rick Whitney

There isn’t another ESA on the market yet. The one that appears to be closest is Affymax’s Hematide, which they’re saying late 2011. If you’re betting you probably bet that it flips from there. So we think about 2012 as possibly being the year that there could be a real alternative and then two years later is when the patents fall away and we anticipate several other alternatives which are already in the pipeline. So we don’t actually have an alternative right now. However, the spector of competition hopefully will be relevant today even before products are on the market.

Kent Thiry

She’s asking about the timing of penetration. LeAnne and Jim, are we doing clinical trials? Are we involved in the trials with AFFE? That’s what I was 99% sure, but. So as is often the case, if you want to bring a new drug to the kidney care market you want to come, work with the DaVita clinical research to do it because that way we’re developing mutual familiarity organizationally with the drug with all the subtleties of the results. Our leading physicians are getting familiar with it because they’re going to be using it in a highly controlled manner.

So that’s all done on a advanced basis, with us unlike virtually anyone else in our space. It gives us a tremendous leg up for the stage that you’re asking questions about, which is that when is it like to make a final go-decision and then implement the go-decision. I can’t answer using a number of months, but because of our involvement with them all along the way and between now and then, any more expansive testing or pilot phase can be relatively short and then if our physician leaders communicate to the rest of the community that this is equivalent or differentiated in some way, the take-up can be quite quick, very quick, as we’ve demonstrated.

LeAnne, how many years ago was it when we made the conversion to? It’s been for it was a fair number of years ago now, but, as there’s been in the last ten years there’ve been a couple of instances, where a new drug has either been clinically equivalent and economically superior or clinically superior or operationally superior, for example, by changing vial size between ampul [ph] and vial. And if you look at our track record even back then and we’d be better now at our ability to marshall communication across physicians and drive rapid implementation of something that is superior along one of those dimensions is fast. It’s fast. And I wouldn’t expect this to be any different.

Andrea Bici – Schroeder

Are you in any clinical trials for generic EPO? I heard there’s a few on the market in Europe.

Kent Thiry

(inaudible).

Andrea Bici – Schroeder

Okay, thanks.

Unidentified Analyst

Do you have any interest in licensing is something like Micera or generic EPOs when EPO goes fully generic to FAS 14?

Rick Whitney

Yes, we have a huge interest in any and all alternatives. And we love, we’d be very clearly to love to keep using EPO also if it’s clinically equivalent to everything else and we can strike a good business deal. We worked exceptionally well with Amgen for a long time other than the normal tussle on rates.

Unidentified Analyst

Would that mean it’d be a slight change in strategy instead of buying drugs, you would start to distribute and license them?

Kent Thiry

Oh, okay, I understood, I didn’t catch all honestly the question. That is unlikely, but it’s not off the table.

Rick Whitney

We would be very up for anybody’s advice on that score.

Kent Thiry

I guess, certainly, people have come to us with offers in that regard.

Rick Whitney

We typically conclude in those situations that it’s better to have complete flexibility and freedom to pursue all different alternatives than to be tied to one house drug.

Kent Thiry

We’re better at choosing and using than we’re at licensing and distributing. Well, thank you all very, very much for your endurance and interest and we’ll work hard for you until this time next year. Thanks.

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Source: DaVita Inc. Q4 2009 Earnings Call Transcript
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