Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)

DaVita, Inc. (NYSE:DVA)

Q1 2010 Earnings Call

January 27, 2010 05:00 pm ET

Executives

Jim Gustafson - VP, IR

Rick Whitney - CFO

Kent Thiry - Chairman and CEO

LeAnne Zumwalt - VP

Luis Borgen - CFO

Analysts

Kevin Fischbeck - Banc of America

Kevin Ellich - RBC Capital Markets

Gary Lieberman - Wells Fargo

Justin Lake - UBS

Brian Zimmerman - Deutsche Bank

Mark Afrasiabi - PIMCO

Mark Arnold - Piper Jaffray

Gary Taylor - Citigroup

John Ransom - Raymond James

Andreas Dirnagl - Stephens

Chuck Ruff - Insight Investments

Operator

Good afternoon. I’ll be your conference operator today. At this time, I would like to welcome everyone to the DaVita first quarter 2010 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks there will be a question-and-answer session. (Operator Instructions).

Thank you. Mr. Jim Gustafson, you may begin your conference.

Jim Gustafson

Thank you and welcome everyone to our first quarter conference call. We appreciate your continued interest in company. I’m Jim Gustafson, Vice President of Investor Relations and with me today is Kent Thiry, our CEO, Rich Whitney our CFO and LeAnne Zumwal, Vice President and Luis Borgen who will be our CFO starting next month.

I’d like start with our forward looking disclosure statements. During this call, we may make forward looking statements within the meaning of the Federal Securities Laws. All of these statements are subject to known and unknown risk and uncertainties that could cause actual results to differ materially from those described in the forward looking statements. For further details concerning these risks and uncertainties, please refer to our SEC filings including our most recent annual report on form 10-K.

Our forward looking statements are based on information currently available to us and we do not intend and undertake no duty to update these statements for any reason. Additionally, we’d like to remind you that during this call, we will discuss on a non GAAP financial measures, a reconciliation of these non-GAAP measures to the comparable GAAP financial measures is included in our form 8-K, submitted to the SEC and are available on our website.

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

Kent Thiry

Thank you and thank all of you for your interest in DaVita. We had another solid quarter. I'll cover five quick topics. Number one, clinical outcomes, number two bundling, number three government investigations, number four industry dynamics, excuse me number four outlook and number five, industry dynamics.

First clinical outcome is which we always cover first because we are first and foremost, a care giving company serving above 119,000 patients now. Referred to this spec of adequacy which is essentially how well you’re doing at, removing toxins from our patients blood, this quarter, 96% of our hemodialysis patients had a Kt/V greater than 1.2. Second with respect to divesture access, 66% our patients have fistulas which is a preferred form of vascular abscess. Third, in management, positions that managed 65% of our patients to hemoglobin levels it tends between 10 and 12 over the last three months.

For these inversely all other clinical measures are patient outcomes compared very favorably to the national averages. Our high quality, our high quality clinical care and that is only results in healthier patience. But it also drives reductions and hospitalization and surgical procedures and therefore significant savings to the American Tax payer.

Topic number 2 the bundle is simply nominal information to report. We are waiting for the final rule just as you are CMS is still likely to release it in late May or June while we hope the rule will be much better than the interim rule and in fact we expected it. I want to remind everyone that a bad bundling rule would mean that centers will close which would hurt both access to care and the quality of care.

Topic number 3 government investigations, we were recently notified by the department of justice that it is conducting a similar investigation into the company financial relationships with positions. We have not received any more detail in that but are expecting subpoena sometime in the near future. As most of you know investigations in this nature generally take years to conclude also as most of you know our comments at this stage must necessarily be quite generic.

Namely with 34,000 team-mates in more 1800 locations across the country it would be naïve to assert that we are sure that we are perfect everywhere and everyday. And we whole heartedly respect the government’s responsibility to ensure the appropriateness of our and other provider practices. However for any perspective share holders out there listening or doing due diligence on DaVita. You will find that our 10 year track record with respect to these types of investigations is almost uniquely positive in the world of American Health Care.

Topic number 4, outlook. Very simply we are maintaining our 2010 operating income guidance of $950 million to $1.02 billion looking into 2011 everyone know we faced challenges and opportunities of adapting to the new bundle and that could mean and probably will mean two to four quarters of transitional activities.

The fifth and final topic, just stepping back for a moment and looking at fundamental industry dynamics and the fundamental risk to avoid characteristics of your investments or potential investment in us. On the risk side there is no understating the fact that there is an unusual government rate pressure these days in all of American healthcare and there is normal private rate pressure, that there is simply no getting away from those risks on the upside side however point, A, the bundle does create $1.1 billion of innovation potential and in that sphere scale helps. Point B, if government funding becomes more inadequate centers will close and given CMS shares accountability for 88% of American dialyses patients center closings are appropriately highly visible and highly sensitive.

Point C, the structure of our industry and of course our own business model therefore is still marked by one stable demand, number two, distinctively transparent economics and clinical performance with 85% of the centers being stand alone and all during essentially 1 DRG 0.3 of that 75% of the centers in America being owned by rational shareholders who recognize the sad fact that the government does not cover the expenses in taking care of the patients for whom they have assumed responsibility and therefore the private sector must unfortunately subsidize that deficit and points soar. The proximity and continuity of care for these patients is incredibly important. And then the final point to be made on the upside side is recently three of the MDOs the Medium Dialysis Organization the small chains if you were have received private equity funding which appears to reflect compatible lead on risk reward characteristics that I just walked us through.

And now on to Rich Whitney our CFO.

Rich Whitney

Overall the first quarter came in as expected and was characterized by very strong cash flow, a continued product mix decline and solid commercial rate improvement. Compared to Q1 of last year, revenue was up nearly 8%, operating income up 10% and EPS up 13%, non-acquired growth was 4.2% in the quarter, this is somewhat lower than recent quarters and growth in quarter was adversely impacted by heavy snowstorms in the first quarter as well as a slowdown in a few key markets.

Taking the storm impact into account, we are around the middle of our recent non-acquired growth rate of 4 to 5%. Dialysis revenue per treatment increased $4.27 sequentially, the main contributors were an improvement in commercial rates, the 1% Medicare composite rate update and seasonally higher lab revenues, these positives were partially offset by decline in physician prescribed pharmaceuticals. Lower EPO ASP reimbursement and the deterioration in product mix that I mentioned.

Dialysis operating expenses per treatment increased $2.82 sequentially. About 80% of this increase was labor including seasonably higher payroll taxes and lower teammate productivity. The balance of the increase in cost was primarily the impact of spreading 6 to operating expenses over fewer treatment days in the quarter and an EPO price increase and those items offset somewhat by the lower physician prescribed pharmaceuticals mentioned above.

Onto cash flow, Q1 was a strong cash flow quarter operating cash flow $263 million, free cash flow $22 million and net cash flow $216 million. A 2 day reduction in DSO to 66 days, timing of working capital items and the timing of cash taxes all contributed to the strong operating cash flow. At this time we are maintaining our 2010 operating cash flow guidance of $675 to $725 million as we expect some of these timing items may turn around as the year progresses.

Finally regarding cash flow, both capital spending and acquisitions were low in Q1 about $70 million less than Q1 by comparison. So this also contributed to the strong net cash flow and the growth in our cash balances in the quarter. Our quarter end cash balance was a little over $750 million. As you know over the least year or so we have been conservative in our net leverage levels and in the use of our cash given the financial market disruption, uncertainty around health care reform and M&A discussions and of course the impending bundling rule.

While most of that uncertainty is now cleared, we still do not expect to take any dramatic actions ahead of the bundling rule. Once we have clarity around the rule, we would expect to make some more significant decisions regarding the allocation of our cash amongst growth buyback and debt repayment. In the meantime, as you saw in the release, we have recalled $200 million of our senior notes. Given our ample liquidity and the recent step down in the call premium on these notes as well as the fact that these notes ultimately need to be repaid in connection with any re-financing of our senior credit facilities, we knew this was a prudent use of our excess cash that will reduce our ongoing interest expense by approximately $1 million per month. That’s a pre-tax number.

Okay. Next, a few words about the better end administration. The average rates we receive from the VA are currently above Medicare rates but well below commercial rates. In late February, the VA announced a proposed rule that would unilaterally and significantly cut our rates if implemented. So if they go forward with this rule, number one, it may not look hold up to legal scrutiny. Number two; many better is access to care will be severely compromised. Number three, some setters will undoubtedly close and number 4, they will likely have a big operating mess on their hands as they try to implement a Medicare payment systems which is in transition and yet to be fully defined. The industry opposes this dramatic and unilateral rate cut and is working with the VA and Congress to find hopefully a more reasonable alternative.

So we do not know if or how or when the VA will implement any rate changes. But if they do it would be a meaningful headwind as we move into 2011. As per our financial outlook as Kent mentioned we remained comfortable with our full year guidance. With that said our current view is that certain timing issues will probably cause Q2 to be flat to Q1 in terms of operating income with more improvement coming in quarters 3 and 4.

There are 5 primary drivers of that reality, number 1, acquisition timing, while the pipeline and the full year looks solid. We got of to a slower start on acquisitions this year. Point number 2, our nation wide leadership meeting, this meeting of more than 2000 center level and other leaders of our company takes place in Q2 causing seasonally high expenses. Point number 3, Q2 typically has between 1 and 2 more treatment days than Q1.

This year it happens to have, Q2 happens to have only one additional treatment day. Point number 4, Q2 has another sequential reduction in the ASP for EPO reimbursement and then point number 5; we do anticipate somewhat higher labor costs in Q2. In part due to the transition to mandatory, mandatory patient care technician certification which is effective April 15, of this year. So I want to surely emphasize that this is no change in our outlook for the year. But it is likely that OI growth will be more back loaded this year then as typical. Similarly as we look at Q2, given that we haven’t bought back any shares year-to-date straight share count estimates are high. Also as you would expect, we are not likely to do anything dramatic head of the bundling rules and so we may buyback some stock, any Q2 buybacks would only impact weighted average share counts for a partial quarter.

And then finally as previously announced in the coming days Luis Borgen will step into the role of Chief Financial Officer, Luis comes to DaVita with a breadth finance experience having served in a number of senior finance roles in his 13 years at Staples. We are excited to welcome Luis to our team.

As for my part, I enjoyed serving our team and our shareholders as CFO for the last two years and I look forward to staying on to help Luis with his transition. And someone just handed me a note and indicated that I misspoke that we are saying the share count estimates are too low, not too high. Thank you very much. Okay, can you please open it up for Q&A please?

Question-And-Answer Session.

Operator

Yes, sir. (Operators Instruction). Your first question comes from the line of Kevin Fischbeck with Banc of America.

Kevin Fischbeck - Banc of America

Okay. Great. Thank you. Question for you, Kent. You mentioned earlier that there's been a few regional deals at pretty good multiples, multiples which I assume are above the range that you were hoping to pay for some of these transactions. Does that in any way change your outlook about your hope to essentially use your cash to do a large transaction? And if so, what then moves up the priority list?

Kent Thiry

Fair question and you are correct in your premise given the multiples that some of these transactions were done at the odds that we would offer a premium to that in time in the near future and do a transaction are necessarily lower than they were had we done the deal itself and so your premise is correct. There are still other potential acquisition in this space and then there are of course are the options which outlined of buying back stock or paying down debt and then we have the final option of investing in accelerating growth in our home infusion business or elsewhere. So those are things that start to move up the priority list given a number of the small change might be temporarily off the table at a reasonable price.

Kevin Fischbeck - Banc of America

Is there a view that you guys obviously have been doing a number of tuck-in acquisitions anyway? Is there a view that, that might accelerate or logistically it's very difficult to make up a small regional chain with a large number of small one-off type transactions?

Kent Thiry

Once again your premise is correct, higher to do enough tiny ones to equal doing a medium one, although the bundle may lead to an increase in the number of small properties on the market, we really can't predict that with any certainty at this time.

Kevin Fischbeck - Banc of America

Okay. Just obviously it makes sense to wait on the bundle reg before you figure out the best use of capital, if you deploy capital, but is there a view that, within a few months you guys would know what the best use of capital is or is this still something that could take some time to evolve the decision process?

Kent Thiry

A fair question We've historically been incredibly reticent to put some kind of time frame on making a decision like that because who knows what will change not between now, today when we say that and the day of whatever timeline that we would offer up so I guess we prefer rather than commenting on the short term future, instead look back at our history and it’s clear that we never go too long without making a definitive decision and acting on it in a relatively clear way and so I think the past is the most useful guide in this case and for decisions like this unless you think you are a superb predictor of the future in a way that no one else is plus or minus a month or two is just not relevant to long term shareholder value.

Kevin Fischbeck - Banc of America

That's helpful. Last question I know that historically you haven't given this number out, but would love to see if you can answer it this time or at least the very least as we head into the bundling. What percent of your commercial contracts are bundled? I know in the past, at your investor day in particular, you mentioned that the commercial contract bundling is one of the factors that might go into whether you would move all in into the bundled rate or whether you might phase in and given the importance of the decision process, we would like more color on that breakout on the commercial contract side?

Rich Whitney

We are not going to change our position so it doesn’t makes sense for us to disclose that number but I think what I would say is that we have fair amount of our business bundled and we expect to bundle more in the current year and I think that we’re comfortable with where we stand at this point in time. That’s probably the only color that I think we can offer.

Operator

Your next question comes from the line of Kevin Ellich with RBC Capital Markets.

Kevin Ellich - RBC Capital Markets

Good afternoon. Just a couple of questions. Kent, I was wondering if you can talk about the competitive landscape especially with some of the mid-sized deals that we've been seeing and capital infusion. And then with could you also talk about the pricing environment, pricing has been pretty good for you guys, obviously there are some moving parts. Just wondering what we should expect for the rest of the year?

Kent Thiry

I wish we knew what pricing was going to look like on deals for the balance of the year. Whenever there’s new capital infused into segments and we don’t know at this point exactly what the net amount of new capital but its appropriate how they are concerned that might drive up some pricing. On the other hand, most of the companies we’re talking about having a history of being quite disciplined in their deployment of capital and that’s a good thing. And then, in addition, the uncertainty around bundling makes a lot of folks a little more hesitant, not necessarily more hesitant to invest in the space generally but in deciding which centers are most attractive.

So at this point, if you asked everybody in this side of their speaker phone, whether prices would likely to be higher or lower the same, you probably get a mixture of opinions with a slight bias towards being higher, but it is really slight.

Kevin Ellich - RBC Capital Markets

Okay. That's helpful. And then I guess the other pricing aspect I was looking for was the average revenue per treatment. Rich gave some detail in his prepared remarks. I was just wondering should we expect the 2% type of pricing growth to continue.

Rich Whitney

Kevin there on revenue for treatment there is number of components of course one is the pricing and the other is at least until we are bundled the fluctuations that we see quarter to quarter in our position prescribed pharmaceutical intensities. And then off course we have the mix our care mix and so currently our commercial pricing is solid and pretty consistent with our recent experience so hasn’t been much of a change there.

As it relates to intensities the, what we seen over the last couple of quarters it is really fluctuation within the normal band of how it moved historically. But obviously it is important not mention as the driver of revenue for treatment. And then finally we have experienced discontinued deterioration and mix and its been seven quarters now as we said in the past its roughly half patients staying with us longer meaning lower mortality primarily and have the mix of new patients which really is tracking that the changes we’ve seen in the economy and unemployment and more directly the lower number of insurance lives that all insurance companies are reporting.

So it’s been very difficult for us to predict with any accuracy revenue per treatment direction right now. Those are the underlined components that we are looking for a signal on mix in terms if taught we haven’t seen that yet. And not much changing right now we are doing fine on commercial pricing and not much changing right now we are doing fine on commercial pricing and intensities we would expect the same kind of quarter-to-quarter fluctuation within reasonable bands that we have seen for the last four or six quarters.

Kevin Ellich - RBC Capital Markets

Excellent. And then last question, back to Kent. I wonder if we can get an update on DaVita Rx and to the disease management programs.

Kent Thiry

Sure, the DaVita Rx continues to be profitable, continues to grow, continues to do wonderful things for patients and taxpayer and so absent any structural changes out there and of course there could be some, we are feeling very good about having traded that capability for all the different reasons we were interested in doing so and then the disease management front that continues to be R&D which is closer code word their saying it looses money and we continue to get better at managing down total cost of Kidney care which we think for our shareholders is an asset and a capability that some day we are going to be able to monetize in a very healthy manner but not yet, because at this point there aren’t enough buyers for that integrated care to support the scale of the cost associated with delivering it.

But, we are getting better every year both in terms of adding value and adding it more efficiently and as you know from everything you read about healthcare reform, the market is getting more and more interested. The markets defined are both the government and the private sector in purchasing the kind of integrated care that we are prepared to deliver. Did I answer the question?

Kevin Ellich - RBC Capital Markets

Yes, thank you.

Kent Thiry

Thanks Kevin.

Operator

Your next question comes from the line of Gary Lieberman with Wells Fargo.

Gary Lieberman - Wells Fargo

Thanks. I was hoping maybe you could talk a little bit more about how you are thinking in terms of the bundle and transitioning, whether your thoughts are towards transitioning all at once or transitioning over time and maybe you can give us a little bit of color in terms of what would make you more likely to transition over time versus what would make you more likely to go in all at once?

Kent Thiry

To the basic question which we will do, we have no idea until we see the rule and as to the variable right Gary the list gets pretty long given everything that was in the proposed rule that will probably be different but we don't know how different and so it's I think too longer list to be useful because the rules going to affect so many part of our cost and revenue structure so I think it's better to just say at this point we are totally open minded.

Gary Lieberman - Wells Fargo

Okay. And then maybe just ask a question on the VA. Is there some event you can point to that made the VA focus more on their rates this year than in past years? Did someone increase the rates significantly on the VA that caused them to focus on it? Or is there some other event that you're aware of?

Kent Thiry

What caused them to focus on it which is their general budget situation the VA particularly and the government more generally and then it’s important to point out that the rule applies to all aspects of the health care they provide not just dialysis.

Gary Lieberman - Wells Fargo

Okay. And then I guess maybe ultimately do you think it gets negotiated out with the VA or do you think they take a hard line and you guys will have to do what you have to do?

Kent Thiry

It's too early in I guess calling in a conversation might not be the right label. It is too early in the process to handicap the outcome. There are a number of people on the VA who are still very resolved to do exactly what they set out to do ‘X’ months ago. There are number of other people who are now very worried that if they do that for dialysis patients they may cause harm to a lot of veterans and significantly increase total health care costs and so what’s the point. Its our responsibility as a community and as a leading provided to go to them with responsible coherent, implementable proposals which get them hard dollar savings and at the same time preserved gets access to the kind of care that we provided that they cant get otherwise so it simply too early to handicap and we are making a little bit of targets every month but to express any optimism would be unfair to you.

Operator

Your next question comes the line of Justin Lake with UBS.

Justin Lake - UBS

A few questions here. First, Kent, you mentioned this new investigation. I might have only heard half of it, I apologize but if you can flush out specifically, it sounds like you said they were looking at physician partnerships. Is that right? Is there anything else you can tell us?

Kent Thiry

Financial relationships with physicians and we don’t have any details beyond that, what that typically means of course is joint ventures and medical director arrangements and things like that but that’s just speculating. We just know the label of financial relationships for the physicians.

Justin Lake - UBS

Right. There's been investigations of this sort in the industry before, right?

Kent Thiry

Quite a few.

Justin Lake - UBS

And you've been looked at in this manner at both your medical directors and any agreement you have there, as well as the partnerships you have on the facility side, is that correct?

Kent Thiry

Well, the short answer is yes. Based on our guess on what they are going to look at and so, totally, know more about what they’re going to look at. We can't say definitively that someone else is already looked at it but a lot of our position related stuff has been looked at a couple of times over the last 10 years. That does not mean that this new process might not focus on something that has not been locked at before and so I want to be very careful in my word choice.

Justin Lake - UBS

Got it. I guess just one last question on this piece of the call. Like you said, you said we have seen this before, ten years you have a pretty good track record or very good track record. Is there anything new that you might be able to point in the industry as far as practices here? You've had medical directorships have been out there. You've had the same language in the case for a while and then on physician partnerships you've also had these facility agreements for a long time. Is there anything new there that they might be looking at that they hadn’t had a chance to look at the last time?

Kent Thiry

Not that we know of but it’s pretty impossible to answer given we don’t have any thing from them. So probably be best answer to the question you asked is we don’t know because we don’t know anything beyond that which we’ve said.

Justin Lake - UBS

That's very helpful, Kent. I just have a couple of questions on the business and then I'll jump back out of the queue. One, Rich, you mentioned the continued private mix decline, I think, was the way you put it. Can you give us any color here when you say it's continuing, is that I would assume that means it’s deteriorated further from where the mix was coming out of the year?

Rich Whitney

Yes deteriorated further as it has for past seven quarters and in Q1 the deterioration was not as significant as it was in Q4.

Justin Lake - UBS

Okay, so the second derivative has improved a little bit?

Rich Whitney

Don’t know whether to call that a trend or not for it’s effects.

Justin Lake - UBS

Okay. That is helpful. It just becomes a little bit more curious and I'm sure you have seen your largest competitor out there the last few quarters as you've been reporting this has been saying the exact opposite. Is there any way you can reconcile that given the place in the industry you two sit at?

Rich Whitney

Yeah well I think we should probably start by saying there is some confusion on our side as whether, whether they are talking about revenue mix or volume mix. We are talking volume mix so I wanted start by saying that and then as it relates to our own trends as we often said it is half improve mortality in half the climbed mix newer patients which to us given everything that’s going on around us broadly in health care and the economy this pretty expected. We would think that both of those factors would be impacting I can see in the same kind of way.

And in fact we have look at the mix changes to our markets where we share our presence with FMC and the decline of those markets has been consistent with the overall decline in the rest of our business so we don’t really see any difference in the markets where we are sharing market or competing head to head with FMC. So of course we don’t have any of this data we only have our own which we monitor incredibly closely but the difference could be in this definition of what does one mean by commercial mix, its possible there could be a geographic differences although again we only see it in the market that we look at and then finally we sort of have to be open to the possibility that they may just be up performing us. So, we are taking it pretty seriously.

Justin Lake - UBS

That's helpful. And then just one last question on the VA. So in the preliminary announcement they said the dialysis cut was 40% on average, I'm sure that varies. Can you tell us whether that is a reasonable number to think about for DaVita?

Rich Whitney

Well, I think what we could say is that there is at least one highly respected analyst that’s offered us a number of $50 million as being a potential estimate of the impact and I think what we would say is the fact that, that’s a fair and reasonable estimate of what the exposure could be here.

Justin Lake - UBS

When does that typically, if it just happens, when would it happen? If that goes through, would it be calendar year, government fiscal year?

Rich Whitney

Well as proposed, October 1, of 2010 and whether that actually can happen on that time table is another question. But that’s as proposed.

Operator

Your next question comes from the line of Darren Lehrich with Deutsche Bank.

Brian Zimmerman - Deutsche Bank

Thanks and good afternoon, this is Brian Zimmerman filling in for Darren. I was wondering if you can talk a little bit about de novos and how 2010 is shaping up on that front.

Rich Whitney

Sure, Brian. Really no change from what we said at capital markets day which is your expectation in the current year we are open around the same number of de novos that we opened last year and so you can think about it as around 80, the maybe the only other thing to report is that while we are still experiencing de novos certification delays we have been successful on working down that backlog of uncertified de novos and the number that we have right now is about 44 so it's down quite a bit from the I think the peak levels were around almost 60 if I am not mistaken, that give you a sense we probably won't continue to report on the exact number because the issue is moderating from a shareholder perspective but of course we are still dealing with the day to day and some states are worse than others etcetera.

Brian Zimmerman - Deutsche Bank

Okay thanks and then also, can you discuss a little bit about your JV strategy and whether it is becoming more important in your development plans?

Kent Thiry

We have done more JVs with nephrologists than any other company ever and we continue to be very comfortable with that model and therefore our position today is the same it has been when they are done correctly. They are very good for all stakeholders and we will continue to do them with great regularity.

Brian Zimmerman - Deutsche Bank

Okay. And then I guess one final question. I notice that your strategic initiatives business was better sequentially from an income perspective; do you think that this segment could turn break-even by the end of the year?

Rich Whitney

That's really just a timing issue; our guidance really remains the same on what we expect from strategic initiatives. That are first quarter than they were tracking at but no change in outlook for the year.

Operator

Your next question comes from the line of Mark Afrasiabi with PIMCO

Mark Afrasiabi - PIMCO

Hi, there. You answered a couple of my questions already, but on the bond buyback, the call, $200 million of that $900 million senior note tranche is there any I guess a small percentage of the bond, I was wondering if you can explain your rationale there in terms of taking out $200 million of that and why you won't look at the higher coupon subordinated bond, the 7 in the quarter of 15, and also just can you touch on your plans to refinance the capital structure given the bank debt maturity?

Rich Whitney

Okay so I think there are a few questions in there I think, I believe that the first question was why only 200 why not more?

Mark Afrasiabi - PIMCO

Yeah that’s right.

Rich Whitney

And that really is just a function of continuing to keep our options open in terms of relative mix of the allocation of our free cash. Again we are on the EPO of reimbursement rule change and so we kind of want to keep our options open, with that said we have ample of liquidity and generate a lot of cash this quarter and felt that it was time now to use some of that cash relief a bit of interest burden so that’s why 200 and not more.

I believe that your second question was why not take off the higher coupon sub notes and the reason is because they have longer dated maturities. They have substantially higher call premiums as a result and third the senior notes for all practical purposes will likely have to be re-financed that the time that we do re-financing of the senior credit facilities. And so, I call in an hour essentially just accelerating something that we would ultimately do inevitability. No longer dated sub notes, that’s not the case. We don’t have to take them out to re-finance our senior credit facilities. So did that answer the second question?

Mark Afrasiabi - PIMCO

Yeah, I mean thank you. And it made some sense that when you re-finance the credit facilities and give them the longer data but not by much I guess sort of 2015 and here we are mid 2010 etcetera. I mean as you re-financed that bank facility, sometimes people have, you might just re-finance the whole capital structure in terms of all the debt. Sounds like you are saying you probably just do the seniors?

Rich Whitney

TBD but we know the seniors would have to come out most likely, have to come out to facilitate a re-financing. And then I think your third question was what are you thinking about in terms of during the re-financing and I don’t have a concrete answer for you at the moment. Again, we’re kind of waiting that you get through this bundling rule here. However, given the maturities, it would be certainly are expectation that by the time we got into, first or second quarter of 2011 that we would have expected that re-financed by that.

Operator

Your next question comes from the line of Mark Arnold with Piper Jaffrey.

Mark Arnold - Piper Jaffrey

Good afternoon. I think that last question answered a few of mine. So, I'll just skip over here but one question that came up earlier and I was interested in your comments Kent in response to this but discussing your acquisition plans and how that may have changed given the new private equity investment in the dialysis space, and you mentioned beyond the debt paybacks and stock buybacks, the possibility of potentially expanding your home infusion business. Can you just talk a little bit more about your home infusion business? Have you looked at any home infusion opportunities over the past year? And just what you are thinking about with that business and has that changed at all given the changing landscape on the dialysis side?

Kent Thiry

First a moments history which will be helpful to anyone who is new to the DaVita. The first year after we bought the home infusion company we almost killed it, we smothered it with mothership love and the second year the team which was fortunately still there. And a new group of DaVita partners did a wonderful job of turning it around and giving it back not only to where it had been but beyond where it had been. And so we are only about 9 months 12 months into Phase 3, post hurting it, post turning it around and coming of a very nice 12 months of growth and a whole bunch of dimensions and improved capability. So with that as a factual backdrop we do want that business to grow much more in 10 and 11 than they did in 08 and 09. At this point we are focused significantly on de novo growth versus acquisition growth because we are not quite comfortable yet with paying the multiples and exposing near capital in that fashion. However we have looked at a couple of opportunities and we are not totally closed to it but I repeat our primary growth of this is on a dramatic expansion of our de novo’s in that space.

Mark Arnold - Piper Jaffray

Just one follow-up question to that. When you guys think about your home infusion business, do you think about potential synergies or in the future with your DaVita Rx business?

Kent Thiry

I think it’s very possible that what we have and this is in response to your question, so it’s not a point of view that we are pushing but in response to your question, everyone knows that over the next years coming down the biological pipeline the pharma pipeline there are a number of more complex drugs in biologicals that scream out for more coherence distribution, value added distribution if you will. In order to get to the right patients under the right clinical protocols with the right data collected etcetera.

And with our network of 1600, 1700 dialysis centers with caregivers and integrated electronic medical system with the some infusion companies experience in taking care of lots of different pharmaceutical delivery both at home and in infusion suits and the DaVita Rx’s capability to deliver either to a center or to the home all the drugs that a patient needs that don’t require being handed over and infused or injected by a nurse, it is possible that we could become a highly differentiated value added distributor and partner to a lot of those pharma and biotech companies. We will see, but we've put together the ingredient’s how long it might take to cook that into something that attractive to you guys is not clear but we certainly do think about it.

Mark Arnold - Piper Jaffray

And one more follow-up to that and I recognize that your answer will just be answering my question again, but when you guys think about what described or that possibility, how does that play into how you look at home hemodialysis as well?

Kent Thiry

Short answer is not very much. On the one hand it has been useful as we were hoping to use the home infusion company as way of getting a whole other lens of looking at home hemodialysis because you necessarily end up of having a whole bunch of conventional wisdom embedded and you are thinking that you don't even realize and by having another successful business that does a lot of stuff at home and helped us calling the question certain operating assumptions that we didn't even know we are making with respect to home hemodialysis whether hemo or PD so that is useful, having said that at this point still most of the investment dynamics around home hemodialysis are not affected by anything going on in the home IV.

Mark Arnold - Piper Jaffray

Okay. Just one last question and it just relates to the investigation you announced. I think you mentioned it's a civil investigation by the DOJ? Is that correct?

Kent Thiry

Yes

Mark Arnold - Piper Jaffray

And so the question was just, with the separate from that investigation, what's the status of the Missouri, the 2005 Missouri U.S. Attorney's investigation?

Kent Thiry

I cannot do a good job of responding so people understand we will scurry about while we are taking other questions and see if we can get you something useful for everyone else to hear and if not you can follow up with a phone call and we will give you that update.

Mark Arnold - Piper Jaffray

Great thank you.

Rich Whitney

I think the bottom-line if it has not been active in some time we will get you a couple of more factoids.

Kent Thiry

Well in fact now there is another 10 seconds to reflect and being a little slow here today when you sit in Missouri, I didn’t quickly align that with St. Louis. St Louis has been very quite for a couple of years now that’s the answer to that question; I apologize for my inability to do any geographic matching in my head.

Rich Whitney

I can add on to that. We were in document production all the way through the end of 2009 but in terms of having any kind of substantive contact with the government, it’s been since 2008 that we have had any.

Kent Thiry

So not a lot going on right now.

Operator

Your next question comes from the line of Gary Taylor with Citigroup

Gary Taylor - Citigroup

Hi. Good afternoon. Incidentally, calling from St. Louis, so, Kent, I'm appalled at your geography. A few questions, but I think very quick answers. Just going through the investigation again, your sense is this would be a national look at your practices? Are your physician relationships on a national basis?

Kent Thiry

Yes.

Gary Taylor - Citigroup

Any sense that others might be receiving the same inquiries as we have seen sometimes historically?

Kent Thiry

We have no insight into that.

Gary Taylor - Citigroup

And do you have an idea which U.S. attorney this come out of? Would this be one of culprits Missouri, Pennsylvania, New York that we’ve seen before?

Kent Thiry

I think all we can say now is what we’ve said.

Gary Taylor - Citigroup

Okay. Rich on the call premium, on the notes, did you say what that was down this side?

Rich Whitney

I did not say what it was. I believe it is 101.5 but I will check with you.

Gary Taylor - Citigroup

And that would just be a non recurring item in the 2Q I guess?

Rich Whitney

Correct.

Gary Taylor - Citigroup

Also I noted the new disclosure or I guess I think a little bit different disclosure of the equity investment income being called out on its own line item. Am I right if that’s new?

Rich Whitney

That’s not new. So I'm not sure what you might be looking at.

Gary Taylor - Citigroup

The fact that’s growing. That reflective of JV’s is that what that is primarily?

Rich Whitney

No. JV’s would show up in the minority interest.

Gary Taylor - Citigroup

So what is this line item?

Rich Whitney

We have some doubt this business that we don’t own, would be owned less than 50% that’s affected best. And there are few other things in there. Let me get back to you on that.

Gary Taylor - Citigroup

Okay. A quick question just on AR strength is about 50 million better. You called it out but it was about 50 million better than our model, both on the balance sheet and the cash flow statement. Any color at all just pure timing of nothing really to look at there? Obviously, good result. You’ll take it but anything else beyond that?

Rich Whitney

I'm sorry did you say AR?

Gary Taylor - Citigroup

Yes.

Rich Whitney

Yes just two day improvement sequentially and it is really a function of a strong cash collection quarter. You know some improvements they made, over time and we hope it’s sustainable but not ready to predict that at the moment.

Gary Taylor - Citigroup

And then finally just going to the VA issue, this isn't kind of, I guess, a federal or CMS rulemaking process that we are all kind of used to, seeing the proposed rule, whatever. If they were to proceed attempting to implement this on 10/1, is there some public notice that you think we might see or would you know that before the public would know that?

Kent Thiry

Well let make a step at the answering and then LeAnne you can correct me if I get it wrong. The fact is there was a common period and the industry did submit a number of written comments for their reflection and they are now in a reflecting stage. And LeAnne is bowing her head up and down saying that all those words are accurate.

Gary Taylor - Citigroup

But not a definitive idea on when, I guess, a final decision? Just sometime between now and October?

Kent Thiry

No, okay that is correct we do not know when they will make their decision.

Gary Taylor - Citigroup

Okay. That's all I had. Thank you.

Richard Whitney

Gary let me circle back and give you the answers to some of the things that we didn’t have at our finger tips. So the call premium is 101.656 and our estimate is that we would have a one time pre-tax charge of about $4 million to accounts for that in Q2. And your question about equity income I hope it is there and am not sure if there was something else in there, but here’s what it is in centers that we don’t a own a 100% but are consolidated in our financial statements the owner share of that income shows up in minority interest so what you use to get all minority interest.

What shows up in the equity income is our centers where we have the minority interest and we don’t consolidate those centers that we only pickup our share of their income. So, that’s the difference and what I wanted to check is whether that was everything and in fact that is everything you see that runs through that line item.

Gary Taylor - Citigroup

Is there a business reason why that type of non-consolidated investment would be increasing?

Rich Whitney

No.

Gary Taylor - Citigroup

Do you do more of those types of?

Rich Whitney

No, we had one larger one in the not too distant past; I think it’s really of more function of the changing profitability in some of those investments. We only have a handful of them just not really part of our core part of our strategy.

Operator

Your next question comes from the line of John Ransom with Raymond James.

John Ransom - Raymond James

Hi. Just a quick one here at the end. As you move into bundling have you noticed any change of behavior on behalf of your vendors? Are they coming to you with proactive solutions or is this going to be kind of a typical sort of interaction?

Kent Thiry

I’d say that, the conversations are spirited and.

John Ransom - Raymond James

You have a lot of good euphemisms today. That's a good one.

Kent Thiry

And they know that we are pretty intense in this subject, the entire provider community and so there will be some major league opportunities for some of them to dramatically improve or secure their strategic position but the details around that will require some thrashing.

John Ransom - Raymond James

Okay. And my other question is, and this goes back to the disease management business, but would you have expected it by this point in time that maybe some forward-thinking payers might be willing to talk about some kind of global capitation for their dialysis patients or is this progressing like you thought it would?

Kent Thiry

I think honest answer to the question is if you ask me four years ago I would have predicted that more would have happened by then and so that's the answer to your question. If you would ask me two years ago I would have said we will be right about where we are because the private payers have so many other larger segments that got some serious data issues and they have this issue understandably around their need to subsidize the government and when the X percent that are private subsidizing in deficit traded by the 85 to 88% that are government that leads to higher rates which don’t exactly put you in the mood to want to do all sorts of other things. So I think that some of why it is moved slowly and I wouldn't anticipate any dramatic change in the next year or two either.

John Ransom - Raymond James

Okay. And then lastly, looking at healthcare reform, one of the things that will happen is fairly large expansion of the Medicaid population, I think 15 million is the number. Have you guys done any analysis to try to predict what percent of your patients which you are currently privately insured might get moved to Medicaid?

Rich Whitney

We don’t have a belief of that is will be a significant trend, what we expect the impact will likely be as it will see a shifting from Medicare covered patients to Medicaid covered patients. Unlike other provider segments, we don’t have the uninsured issue because virtually all patients can qualify for Medicare. So I think that would be the primary, the other factor that plays into this is secondary coverage. A lot of patients are covered by Medicare in the primary position and don’t have secondary coverage for the co-pay because they don’t need to income test to qualify for the secondary coverage, to qualify for Medicare. So that also would be where we would expect to see the trends on Medicaid. That’s all independent from funding changes and Medicaid which are a whole different story.

Operator

Your next question comes from the line of Andreas Dirnagl with Stephens.

Andreas Dirnagl - Stephens

Good evening, guys. A couple of quick this and that’s here. Kent, I just always want to make sure that I'm hearing correctly what you are saying. Going back to your discussion in your prepared remarks on bundling, did you say that you, obviously, you are highlighting the risk that it might not happen, but at this point you are expecting the final rule to be better than the proposed rule?

Kent Thiry

Yes.

Andreas Dirnagl - Stephens

Looking at your outlook for 2011 you talked about two to four quarters of transitional activity. I'm wondering do you think that bundling is going to require any sort of increase in spending on your part or is that more sort of a way of saying that it might take two or three quarters, two or four quarters for you to institute some clinical and other operating changes to mitigate some of the impact at the bundles.

Kent Thiry

Primarily the latter but I would not want to claim that former is zero.

Andreas Dirnagl - Stephens

Sure. But primarily, the latter then. Just quickly on the department of justice announcement, having been through this a couple of times you guys have realized that there are no commentary really is necessary on what you think is going to happen but maybe just to clarify, you touched on. In terms of financial relationships that you do have with physicians, they are primarily medical directorships in terms of the salaries there and then in terms of joint ventures. Are there any other significant financial relationships that you have with physicians?

Kent Thiry

We have a small number of physicians who are employed full time or part time if that’s a tiny number. We off course do acquisitions and joint ventures, acquisitions and divestures separate from joint ventures. So those are a couple of the other categories that I can think of but the categories you mentioned are the ones that are numerically most prominent.

Andreas Dirnagl - Stephens

Okay, great. And then finally, Rich just a couple of questions. Again on the VA, what percentage of the revenue is VA?

Rich Whitney

Around two?

Andreas Dirnagl - Stephens

Around two percent. Okay, great. And is there any, I'm just trying to figure out how those it works literally on a day-to-day dialysis basis. Are there any centers that you have concentrations of VA patients or are they spread geographically?

Rich Whitney

They aren’t spread geographically but as Kent mentioned earlier, maybe they were in my remarks if the cut goes through undoubtedly, some centers will have enough VA patients but to make a difference relative to have a tough go and may have to close

Kent Thiry

Let me step in and a little closer to this one, the primary answer to your question is that they are quite spread. However it is definitely true when Rich had prophesized about it and asked for his answer that, there are a small number of centers for the high number of debts and it would be very difficult to keep them open.

Andreas Dirnagl - Stephens

And I just want to be clear talking about the small number of DaVita centers.

Kent Thiry

Correct and so you assume reasonable proportionality in thinking about the impact overall.

Andreas Dirnagl - Stephens

Overall.

Rich Whitney

Andreas just to be complete, the other thing that we would add to Kent’s answer about the financial relationships with the physicians that we do from time to time have leases with physicians where we think offices from them or in fact sometimes there maybe a leasing officers from us. And that’s an area where we have a whole seven procedures to make sure that those leases are done at an arm’s length to fair market value basis.

Andreas Dirnagl - Stephens

And I guess its just fair asking the question while I got you I would assume that the answer is yes in terms of that you consider your medical directorship agreement to be arms length in the market?

Kent Thiry

Fair market value is the mantra.

Operator

(Operator Instructions) Your next question comes from the line of Chuck Ruff with Insight Investments

Chuck Ruff - Insight Investments

Regarding the VA can you give us any feel for the percentage cuts that they are proposing?

Rich Whitney

You know its really the VA, it pays us in different ways in different parts of the country, so I think that the best we could do for you right now is really point to the estimates that are out there which are in the neighborhood of 50 million, I think we don’t want to cut it any finer than that and that’s a reasonable characterization of the risk.

Chuck Ruff - Insight Investments

Okay. Well, let me think about at it this way then. If your revenues this year are about $6.6 billion and their 2%, that's $132 million. If we are talking about 50 out of 132, that's about a 38% cut?

Rich Whitney

As you have all the pieces, you can do the math and kind of get close I just don’t want to close your number.

Chuck Ruff - Insight Investments

So I'm thinking about that right. Secondly, you talked about the uncertainty with bundling and obviously now there's the uncertainty here with the VA. Is that also part of why your, at least for now, a little hesitant on acquisitions and de novo, are you slowing those a little bit too until at least the bundling is clear?

Kent Thiry

Short answer is no, we are not hesitant on conventional acquisitions nowhere on de novos.

Chuck Ruff - Insight Investments

Why would you not be hesitant there at all, but obviously be hesitant on share repurchase?

Kent Thiry

Because when we are doing acquisitions we can allow for arrange of potential bundling outcomes and had a satisfactory price, we feel very comfortable that risk adjusted our shareholders equity getting good return and there are same ways de novos, those decisions tend to come in much smaller chunks than some other decisions. If we think about batching acquisitions together into a single $300 million acquisition then as opposed to sort of buying all, is the same as to buy stock all in one day or do you buy overtime does necessarily for both different thinking as we evaluate it and if you are doing 100 smaller transactions spread over a year.

Chuck Ruff - Insight Investments

So the share repurchase you would think of the same way, in other words, if the price was such that you felt like it was a good return under any reasonable scenario, you'd be willing to do it. It just hasn't been that recently because of the uncertainty?

Kent Thiry

I don't know if I’ve used those exact words so I probably just repeat the words I said, the good news about buying back our own stock, if we don't do it today we know we can do it tomorrow. The tough thing about acquisition is if you don't buy today somebody else maybe will and you can't come back and say 60 days, see I change my mind. So it's pretty hard to compare those two decisions given as such a radical difference in the context and in which you are making them.

Richard Whitney

I think the other thing in this sort that they were done in my prepared remarks is that you got to stop talking about the context that there were a series of reasons why we were being conservative with our cash for the last 12 months and none of those really had anything to do with what the price of our stock was. They had to do with preserving financial flexibility and liquidity for potential opportunities and because of uncertainty in the market place, financial markets and otherwise.

So I think that, sort of tempting as somebody’s things to start to clear to forget that it hasn’t been that long since the bunch of these uncertainties began to fall away and including literally in the last several weeks when a number of the mid sized balance, this organization did transactions that would lead us to believe that maybe the argument in near term transaction might be lower. So these things are evolving. We still have the bundling rule ahead of us and that would keep us from doing anything dramatic but I don’t think you should read too much into what our views are on the stock price by the fact that we have build up this amount of cash because its really the other factors that you have mentioned. Hopefully that helps.

Operator

Your next question is a follow-up from the line of Kevin Ellich with RBC Capital Markets.

Kevin Ellich - RBC Capital Markets

Just two quick follow-ups: one, the VA or a proposed VA cut, is that in your guidance order or not?

Rich Whitney

It is not.

Kevin Ellich - RBC Capital Markets

And then, two, I was wondering, Rich, if you could provide any more detailed coloring on the five items that you said would impact Q2 operating income, how much will the nationwide meeting add to, I assume that G&A, any of those details would be helpful?

Richard Whitney

Yeah I think the way I look at it is we give you a five of the primary reasons and each one of these reasons individually is only really a couple of million dollars. The collection of them that leads us to a different kind of sequential trend in operating income, this year that maybe you are used to. And again, still feel fine about the year; it’s really just how this develops quarter-by-quarter.

Operator

(Operator Instructions) And there are no further questions at this time.

Unidentified Company Speaker

Okay. Thank you, operator and thanks to everyone else for your interest between now and the next time, we will do our best.

Operator

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

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: DaVita, Inc.Q1 2010 Earnings Call Transcript
This Transcript
All Transcripts