Feb 12, 2009
Executives
Kent J. Thiry - Chairman of the Board, Chief Executive Officer Richard K.
Whitney - Chief Financial Officer LeAnne Zumwalt - Investor Relations
Analysts
Darren Lehrich – Deutsche Bank Securities Mark Arnold – Piper Jaffray Kevin Ellich – RBC Capital Markets Arthur Henderson – Jefferies & Co. (Mitch Campa – Mountain Lake) Gary Lieberman – Stanford Group Company Unidentified Analyst Valerie Brown – AllianceBernstein Unidentified Analyst Darren Lehrich – Deutsche Bank Securities Unidentified Analyst Justin Lake – UBS Bill Wolkstein – Centurion Capital Unidentified Analyst Andreas Dirnagl – Stephens Inc.
LeAnne Zumwalt
Welcome everyone to the DaVita fourth quarter earnings conference call. We appreciate your continued interest in our company.
I’m LeAnne Zumwalt, and with me today are Kent Thiry, our Chairman and CEO, and Rich Whitney, our CFO. We will start out with a really interesting part of the presentation, and I would ask that each of you take a look at the forward-looking statements.
I am not going to read that today. We are going to get started with Rich Whitney and an overview of the quarter.
Richard K. Whitney
The roadmap for this morning is first our comments on the fourth quarter performance, then DaVita overview, a discussion of the opportunities and risks that one should consider while investing with us, a deep dive into our business fundamentals, financial review, and then we will wrap up by taking your questions. Before we get into the fourth quarter results, the question that a lot of you probably have is what drove the sequential decline in revenue per treatment.
The answer is primarily, 80% of it, pharma utilization. I will come back to the details of that in just a moment.
Also, before we dive into the numbers, throughout the presentation, we will be referring to certain adjusted and non-GAAP numbers, and a reconciliation of these numbers to the most related GAAP number is included in the back of the presentation. Q4 revenue was $1.5 billion, up about 8% versus last year, and we ended the year at about a $6 billion revenue run rate.
Operating income of $212 million for the fourth quarter was in line with our guidance. Full year operating income of $822 million was in line with our guidance as well.
Q4 operating income margin was stable, and our EPS was $0.94 in Q4, and you should note that we benefited by about $0.02 from favorable tax rates driven by FIN-48 fluctuations, certain tax credits, and some state tax true-ups that we normally have at the end of the year. In 2009, we would expect our tax rate to return to a more normal level of 39.5 to 40.5.
Our treatments, $16.2 million, our non-acquired growth was 4%, our non-acquired growth for the full year averaged 4.3% which was right in the middle of our stated guidance range of 4% to 4.5%, and we are now treating a little more than 112,000 patients. What’s the story for the quarter?
First, pharma utilization impacted revenue per treatment. Revenue per treatment for the quarter was down about $3.80, which was 1.1% sequentially, and it was up $4.50 versus the prior year quarter, and that is up about 1.4%.
The sequential decline, a little more than $3, was driven by lower pharma utilization, and the balance, about one-third of it, was lower Medicaid rates, and the rest of it was normal quarter-to-quarter fluctuations in the mix of our various payers. Now, of the pharma utilization decline, the biggest part of it was EPO, and over the last four to six quarters, as you know, we have been experiencing some quarter-to-quarter volatility in EPO utilization in physician prescribing patterns, so this quarter utilization impacted us by a few dollars per treatment just like in Q2 of last year, it impacted us positively by a few dollars per treatment.
That said, in the near term, we expect we may have some more downside in this area. Also remember that pharma margins are not as high as they used to be and so therefore, of course, the impact on our profitability is not as high as it used to be.
Kent plans on covering more on pharma utilization, the trends in physician prescription patterns, and the related outcomes later in the presentation. Next cost trends, they have been stable.
For the full year, our patient care costs were up 1.2% per treatment which is consistent with our long-term trend, and full-year G&A per treatment was down 5.3% as we continued to achieve leverage on G&A in our core business. Next, we continue to experience certification delays with our De Novos.
We have 54 De Novos that have been built but are waiting to be certified. Our time to certification has more than doubled over the course of the past 18 months, and several states are particularly troublesome, including Texas, which has informed the public that they don’t intent to certify any more certain healthcare facilities including dialysis facilities.
We are, of course, pursuing several different potential solutions in the regulatory and legal front including proposing a fee-based system. However, it is our expectation that we will continue to experience certification delays as we go through 2009, and this fact could weigh on our non-acquired growth in 2009 a bit.
Next takeaway, solid operating income in the quarter. OI was up 8% in the quarter versus the prior year quarter as we anniversary off the end-of-year payer rate reductions in 2007.
OI was up 3% for the year in line with our guidance, and recall that Q1 is typically a seasonally weak quarter for us because of lower treatment days and higher payroll taxes, so it is quite possible that we could have a small sequential decline in Q1 operating income as we do in many years. Solid EPS.
EPS for the full year was up 11% year-over-year, and EPS for the quarter was up 19% versus the prior year quarter. That 19% EPS growth was driven by the higher OI as well as the lower interest expense which is primarily rate, as our net debt is about the same year over year, and it was also driven by about a 3% lower share count.
Cash flow was solid, a little bit above the high end of our guidance range and that was driven primarily by the timing of certain payments at the end of the year, basically working capital timing as well as lower cash tax payments driven by the stimulus package passed in the fall, so those things are one-time, and we would expect that to impact cash flow in the opposite direction as we move into 2009. Our 2009 guidance remains unchanged for operating income at 820 to 880, and we are now providing our cash flow and CapEx guidance.
Of note, the cash flow guidance range is somewhat lower than the full year 2008, and that is related to the timing of the payments we just discussed. Of course, acquisition and De Novo CapEx is subject to sufficient number of projects at reasonable returns, and finally, we will just point out that in the first quarter, we will be subjected to an accounting change, all companies will be subjected to an accounting change where minority interests will no longer be counting as part of operating income, so you should expect our operating income will go up as a result of that, and we will be sure to reconcile between the old numbers and the new numbers and the new guidance when that happens.
Now, I would like to turn it over to Kent to take us through the DaVita overview.
Kent J. Thiry
Good morning, and I will reiterate Rich’s and LeAnne’s welcome, especially to those of you who have been with us at these sessions for many years. It is actually really nice to be here now more than 12 months past the period where we self-inflicted some contracting wounds over a 4-month period.
It’s nice to start putting that behind us. The mission is important.
We do consider ourselves to be a caregiver first. It is in fact more important that you feel good if your wife or child needs dialysis than it is how you feel about us as a capitalistic entity.
Having said that, we work incredibly hard to meet whatever expectations we set in sessions like this, but we are a mission-driven organization. For those of you who have not been in a center, this is what it looks like when you are taking care of a human being, and we take care of 112,000, as Rich said, and I’d like to say this is what a center looks like, but that is what a really clean center looks like, not a normal one, but we have about 1500 of these across America, and this will give you some sense of what the operating unit feels like, how many people are in it, how many chairs, etc., just to give you a feel for the operating entity itself.
Most of these numbers you have seen. We have done what we said we would do in dramatically reducing the leverage that we took on in order to buy Gambro a few years ago, and we have done it slightly ahead of the schedule that we talked about back 3 years ago or so.
It is very nice, over the last 9 years to have moved from about 12% of the patients to 29% of the patients. We think that is incredibly relevant for the security and upside of your equity investment in us, and we have every anticipation that that trend is going to continue.
Onto investment highlights, so if you are going back to talk to your partners, what would be the right way to summarize reasons to invest or reasons to be scared of investing. From an industry point of view, there are just a lot of nice solid positives, and these are not hypothetical.
If you look back over the last 9 years, you see evidence of this showing up in the economic performance of this space. First, very stable demand growth, unique government accountability and I will elaborate on that, a steady cash flow, reasonable credibility in DC, that does not necessarily get you anything, but it is much better to have it than not, and we can elaborate on that in Q&A if you would like, and then continued consolidation we expect.
Let’s talk about each one in particular. On the demand side, it is still the case that there are not enough transplants available, not nearly enough, no one is predicting a big change in that area in the near term.
That means you either get dialysis or you die. There is very strong loyalty to the physicians and to the centers, and there is very strong loyalty between physicians and centers, and a whole bunch of other attributes that mean that demand is quite stable and quite sticky.
In many cases for us, we would actually prefer that it was not as sticky because we think we would actually, in a more fluent competitive environment, do even better. Nevertheless, from a downside elimination point of the view, that stickiness is a very big deal.
Because diabetes and hypertension are the primary causes of kidney failure, and because the Hispanic and African American elderly populations are those that are disproportionately inclined to end up with diabetes or hypertension, we are in the demographic jet-stream of America. There are going to be a lot more folks with kidneys failing in the next decade, and this is just the actual numbers through a consensus estimates going forward, and the actual empirical data going backward.
Then, you need government accountability. What do we mean by that?
It means in other areas, the government can make a mistake, hospitals have, whatever, 200 DRGs, I don’t know the number, 467, whatever the new name is for those groups. Surgery centers do all kind of procedures, nursing homes have all kinds of patients, and that allows the government to either make mistakes or make their own judgment calls as to what they want to achieve from a policy objective point of view; not in our space.
First of all, we are 87% government, about 82% Medicare, Medicaid 4% to 5%, and we already have universal coverage in the sense that, anybody, virtually anyone in America, if you’re private insurance, you opt not to be on it. When it runs out, you get to go on Medicare absolutely.
We’re a single DRG. You know that 90% of the centers in America are free standing, and they do this one thing, so the costs are the costs.
It is not complicated, and the debate between us and government as to what our costs are is quite a narrow band compared to any other part of healthcare. The bad news around that is they are not going to make some mistakes suddenly and add a huge amount of margin to our reimbursement.
In fact, we wanted a Medicare deficit, and they know it, although at times they like to deny it for political reasons, economically they know it, but it also means that they are not going to make some mistake that suddenly creates a significant negative margin. There are also about 1000 centers that are still independent, and because we have achieved certain efficiencies that they have not, which is good for the system, it continues to force other people to try to keep up with us.
At the same time, that creates a political safety net, because you cannot have dialysis centers start to shut down, and since 87% of the patient’s are government, if the government starts to create a deficit that is too large, and they start to have lots of independent centers close down, the political feedback loop is exceptionally tight, because these people must get dialysis 3 times a week or they die, and there are limits to how far they can drive or be driven, etc. So, in our case, there is this unique level of transparency and therefore accountability for the federal government by the federal government.
The bad news is it means that they are very much in the room with us all the time. The good news is that they are in the room with us all the time including if something would ever go wrong.
As far as steady cash flow, it’s basically a manifestation of everything that we have already talked about. I think the only new thing here to emphasize, for those of you who have not been here before, is very nice that we have low fixed costs.
Our typical center, which we should probably have a picture of that as well, is right next to an auto-parts store or a McDonalds or whatever in a shopping center, so it is not expensive real estate, not expensive leasehold improvements, so the good news is if volume moves, a lot of our costs move with it as opposed to many other healthcare facilities which have exactly the opposite situation, exceptionally high fixed costs, and therefore margins, cash flow, etc, are incredibly volume sensitive. That’s not the case with us as long as we do our job right.
As to DC, it is always important, and now over the next few years ever more important that we have a relative unique coalition. I don’t think any other segment can stand up in front of their shareholders and talk about a coalition which we put together about 5 years ago, but it took years to create, the Kidney Care Partners Coalition.
It has got the major patient groups as members, it has got the nursing group as members, it’s got the physician groups as numbers, it has providers large and small, for profit and not for profit, it has got pharma and device, and for the last several years, not only do we have that group together, I refer to it as our own little Kidney United Nations, but we have reached consensus on important positions, and they will be able to go to the Hill with those consensus positions. There are very few other segments that can do that, speak with a united voice.
That is why some of the legislation that has been good for us and good for you and good for our patients in the last few years has passed, but for segments, they have not gotten anything done or in some cases experienced negatives, so it is a very important investment fact. It’s a fact that still exits today, and we are making every effort to ensure that it continues to exist.
In addition, it is very good that our segment, as well as our company, have significantly improved quality over the last 5 to 10 years. We monitor the improved quality.
We do more actual clinical outcome reporting than virtually any other segment in American healthcare, which again, from an investment point of view creates an incredible security blanket, because you are not going to wake up someday with the finding that the segment has been grossly over-utilizing something or the segment is providing lousy care. With this provider or the entire space, you are not going to find that because we are already so transparent, we are already so accountable, and DaVita remains one of the most fervent advocates of an expansion of public accountability and public reporting to the extent that we are big advocates that they actually mandate standard methodologies for measuring clinical outcomes.
We believe the more they standardize those methodologies and require they be done in a certain way and in certain timeliness, the better we will look on a relative basis, and the better you will do on a relative basis, but just the fact that we are in there unlike some of the other segments as opposed to fighting accountability and public reporting, we are intent advocates for it and making it more rigorous and more intense and more timely, again creates both an investment security blanket and within Washington DC, it is a very different pitter patter than they are used to hearing, and reflects well on us in a way that then sometimes influences some of the reimbursement decisions they make, the notion that the dollars they spend with us, they will be able to track whether or not we are actually doing good or not. Continued consolidation.
There are two companies now that take care of a lot of patients in America, on average, those two big companies, us and FMC, do a much better job for the patients than that final third, which is not say there aren’t some outstanding, awesome, excellent providers in that third, but on average, the two large companies do much better. That is both good for our patients, it is also very good for society, because it means that our patients are in the hospital less often than others, and at this point, we don’t have an efficient market for getting paid for that value added, but of course, we are working very hard on that, and we think we are making some progress, probably not relevant within your investment timeframe, but a very big deal again for the way that we are viewed in DC in favor of accountability, in favor of reporting, trying to reduce total costs, and getting better and better at measuring when we do that.
That is just a line of bullet points that other segments cannot claim, or even if it’s true, could not point out in any kind of substantiated way, so the nature of our dialogue, because of the coalition we’ve created, and because of our attitude and philosophy, and because of the facts is different conversation. Now having said all that, they can make decisions that do terrible harm to us, and periodically, they do, so all that does not necessarily buy you success, but it buys you a very different conversation with folks over time.
There are several private equity owned MDOs. In the vernacular of kidney care today, there are LDOs, large dialysis organizations; two; MDOs, the medium dialysis organizations, there is a small handful; and then SDOs, the small folks.
There are a number of MDOs that are private equity backed. It is no surprise to anyone here that the world has changed quite a bit, and so virtually every one of those companies has approached us, both approached us last year asking us to submit a bid to purchase them and again this year already, virtually every one.
So, the world is different than it was a couple of years ago, and in addition for the MDOs, the payers are now starting to pay attention to them in a way that they didn’t a couple of years ago when they started at first, as anyone would, looking at these largest companies, now recognizing that some of the small players have reimbursement rates that are higher than ours and in fact, that does not make sense, and now they are starting to get, what we would call, appropriate attention.
The market position is strong and has gotten stronger. Operating competency hopefully has been reflected in what we have done with some exceptions over the last 9 years, and I will talk a little bit about our compliance record and then this notion of being a high-value provider.
In a way that matters for shareholders, not just for patients. I am not going to bore you with the clinical education, but the fact is on the core measures, we are relative to other providers very good at what we do.
We also have, and these are the exact same word that I use internally in talking to doctors, nurses, and others within DaVita, right now, we have the best portfolio of clinical improvement initiatives that we’ve had since the year before we bought Gambro. This is literally the most exciting time for us in terms of thinking about the kind of impact that we can have in making care better next year and the year after than it was this past year.
We have never had a portfolio like this. We haven’t had a portfolio like this as good, as robust, as tangible, as focused, with the right kind of teams on it since the year before we bought Gambro.
So, we are very excited about that, and that’s on the top of the fact that this year, for a ninth year in a row, we improved the quality of our care. We have something that is called the DaVita Quality Index.
Some of you are familiar with it, but for the last 9 years in a row, if you handed all of our clinical data to your favorite nephrologists and had him sit through it all, each of those years they would have said yes for these 50,000 patients, for these 60,000, now these 112,000 patients. They did better in ’09 than ’08; they did better in’08 than ’07.
It’s the ninth year in a row we got to say those words. This is without going into detail.
These are five of the programs that have already been rolled out or in the process of being rolled out that we think are going to deliver some very nice incremental benefits for our patients. This is what the picture looks like from a high level in terms of who has got what.
This gets to that operating competency going backwards. Just talking about our intense effort around delivering on the ranges that we set, and this is what EPS has done if you look a little bit, essentially going back to right before the acquisition of Gambro.
Then, on compliance, I have said this and no one has ever countermanded it, but maybe it is not 100% true, but I don’t know that, no one has pointed that out. We don’t know of any other major healthcare service provider with our compliance track record over the last 10 years, which is to say we’ve never paid any money despite being subjected to the same big mass of subpoenas that all the big hospital companies have been subjected to and big dialysis companies, etc.
Everyone else has had to pay very significant checks, not us. That’s not a coincidence.
We take our compliant incredibly seriously. We bring great intellectual, regular, and operating discipline to every single decision we make, and we’ve done that for years and we knew in the year 2000 that we’re going to get subpoenaed about EPO stuff every other year for our entire lives until such time that it’s not the most expensive drug in Medicare, and therefore every decision we ever made and every process we ever implemented was with the total knowledge and expectation that we would be subpoenaed.
So, you not only had to do right in terms of making ethical decisions, but you had to do it in the right way so you could document that you were doing it right in a provable way and that’s the attitude we brought to it. That’s why these results are not a coincidence.
Does that mean we are going to necessary the next 10 years have the same track record of paying zero? Of course, we can’t guarantee that to anyone, but if you look at the track record here, we had the big lab subpoena in 1998 that went on for 6 years, and they had to pay us over $90 million, and that’s not that we paid them.
We had the big Philadelphia subpoena, which went on for 6 years and then was closed. We had a smaller investigation in Nevada but intense that opened up in ’07 and was closed, and then you have a number that are in process but two of the older ones, one has been literally dormant for a long time, zero activity, and the other has had a very low activity level.
We now have been subjected to two more. So, the bad news is we have to spend millions of dollars for years defending these things, often defending the exact same issue we already defended successfully with another subpoena, and unfortunately it appears to us that as long as pharma is an important part of our cost and revenue structure that we will continue to have lots of subpoenas on that subject.
Every time they are able to find someone who does something wrong and get a penalty settlement from them, that creates tremendous incentive for them to subpoena everybody else because the incremental cost is quite low. It is just like rolling out a new product; you’ve done all the development work, and now you might as well see if there’s another place where you can get some payback.
Unfortunately, we can’t tell you that just because of the track record, these new ones are going to close down soon. That’s just not the way it works as you can tell from the data.
Lastly, this notion that being a high value-added provider is not just important to our patients. The world is changing slowly, spasmodically, but the kind of reform that people are talking about is the kind of reform that we can deliver in a way that few other segments can, and the will of the federal government, the intensity of their desire to do something about healthcare that actually involves reducing cost and improving quality, is going up and up and up out of necessity, of course.
It’s the only way that they often do things. While in years past this may have seemed like marginally important or window dressing or modestly annoying to you, we would submit that this is actually quite relevant for the long-term investment horizon.
We are getting better and better at preventing or delaying the onset of dialysis. No greater gift to the patient or the taxpayer as people move from costing a couple of thousand a month to seven thousand dollars a month.
Then, in dialysis, of course you see the outcome that we have in that area and our increasing ability which I’ll talk about later to reduce hospitalization, which is two-thirds of the cost of a kidney care patient is in the hospital not in the center. People picture the cost of dialysis as being the cost of kidney care, when in fact, we’re more the tail that can wag the dog if we would just get a chance and over time, we’ve accumulated quite an arsenal of capabilities.
The labs we’ve had for a while, integrated labs, totally focused on getting the right timely, accurate, and customized information for managing the portfolio of clinical attribute to the patient. We now also have our specialty pharmacy, 15,000 patients, where we coordinate all the pharmaceutical care, the oral pharmaceuticals as well as those infused in the treatment.
It’s both asserting management influence over a very significant chunk of revenue and in addition being able to add clinical value, the likes of which other people talk about but can’t do because you have a PBM that’s separate from the hospital. Not so in our space.
We are our own PBM, and we are tightly linked to the facility. Yet, in another way as well, which has to do with access.
When you need dialysis, you’ve got to have a point at which we can take our butt out, clean it, and put it back in. That’s called an access, and the fact is that that’s sort of rife with issues both clinical and economic when it’s done poorly versus well.
We are the leader in doing that well with a series of focused vascular access centers that offer spectacular economic benefits for society as well as clinical benefits for the patient and once again start to put all this together in a way that doesn’t exist elsewhere. Well, we are the facility.
We can do the focused surgical procedures, and we can manage all the pharmaceuticals, and lastly Falcon, which is our name for our electronic medical record, modules of which are starting to be rolled out right now, which then as opposed to just doing all this stuff and coordinating it in a manual way is in fact what other people talk about, an electronic medical record where a doctor, the doctor, the portfolio of doctors managing this patient can link all of this stuff together in real time and so can effect diagnostic decisions and be coordinated so you can actually get reporting which synthesizes for you if you have 100 patients which 10 have this kind of issue, which 3 have this kind of issue, the kind of artificial intelligence in a pragmatic way that just doesn’t exist elsewhere in healthcare and happens to be very leveraged in our population, and all of these things increasingly tightly linked to the practice itself. We think this becomes economically relevant as the next 5 years or so unfold.
Investment low-lights: In order to preempt your partners, when they talk about why you wouldn’t want to invest in us, the darn fact that 13% of our patients are private subsidized, 87% are public is a real structural negative because that means we have to charge the private a bunch more than the Medicare patients just to break even, so that’s a negative because you always have that double-edged sword. The near-term EPO volatility, and I’ll talk more about that in a little bit, so that’s not a fundamental issue for the long term, but right now, that’s sort of noise in the economic system.
The De Novo certification delay is a new thing. There’s always been some delay in getting some de novos certified, once we’re done building them.
That’s gotten to be a more significant problem. So, we have right now 54 centers that are built, sitting there, and we can take care of patients in a more convenient way than they are currently being taken care of, but the government hasn’t been able to show up yet and certify that, and we’re getting some nice audiences with folks in the government both at federal and state level who don’t like that fact, because again, in our case, it’s not that anyone is going to get more dialysis than they would otherwise, so the system is not going to spend any more money, but the patients are going to have a more convenient care.
The more convenient care in dialysis is better care because if you are in the night shift somewhere and driving a long way, you tend to cut your treatment time short, you tend to miss more treatments, it tends to be a more tiring experience, all of which affects the quality of care, all of which affects the probability of being hospitalized as opposed to being able to be dialyzed during the day in the place that is convenient for you and your family. So, it actually has clinical significance.
It’s not just a nicety, and again, Medicare is not going to pay any more. Nobody is going to get more dialysis because of a center opening up, and then lastly of course, the economy.
We’re not immune to it over the long term in the sense that if people literally dropped private insurance, don’t get COBRA, then at some point, that affects that 13% for us, and of course, the government is doing an awful lot to try to make sure that there is continued insurance access including the provisions of the stimulus bill supply to extending COBRA or having premium subsidies and things like that. So, there’s an acute political sensitivity to that issue as you know, and it’s more likely that there’ll be more people insured in the future rather than less, although there are big questions as to exactly what form that insurance will take.
So, these are we think the four things that you should really ask us a lot of questions about in order that you can satisfy your partners that you’ve calibrated these risks appropriately. Here’s a summary again of the highlights, and we think a formidable array, and if you had to again put sort of a conceptual label on this, there is a level of coherence and transparency that doesn’t exist in most healthcare segments.
Business fundamentals: Let’s just talk about the holy trilogy of dialysis economics, which is the number of treatments times the revenue for treatment minus the expense for treatment in the same way that we’ve talk about it for a long time. Treatment growth is a function of buying things and getting growth through non-acquisition means, which is to say same store growth or building new greenfield centers.
Let’s talk about the non-acquired first. Here’s the empirical data on our non-acquired growth, and again our guidance for this year was between 4 and 4.5.
We finished here at 4.3, and in the latter part of the year, again because of the certification delays, you see some lower numbers at the end than you did in the beginning. The economics are similar to what you’ve seen in the past, but we are building bigger centers on average, and for a while, the construction costs were going up.
We’re still going to be building bigger centers on average, so the capital investment is a little higher than it used to be. On the other hand, some of our construction costs will go down a bit, not in a way that’s actually economically material for you.
The most economically material facts for you that are reflected in the slide are, number one, that most of the capital is re-capturable. In other words, if a center wouldn’t work, we get to take the machines out and put them elsewhere and we got to work down the receivables, so most of the capital is not irrevocably exposed.
That’s just a small amount for leasehold improvements and the issue if we can’t sublet. That’s it; the rest is capturable.
The second piece of good news is that that whole thing about what’s recoverable and what’s not hasn’t been that economically relevant because our track record is almost perfect in terms of these things ultimately making money. Now, of course that could change depending on what goes on with reimbursement, but that’s just looking backwards, and here are the actual numbers.
2008 was our best year ever. We got much more aggressive in terms of building centers, up to 87 certified, and as you’ve heard we have accumulated a fair number that are done but not certified.
Our de novo strategy, you’ve heard it before. It’s the same as before, only we have gotten even more aggressive and intense about it, which probably means for the first time, we will start to have some failures, but we decided strategically it was better for us to be right only 90% of the time and do a lot more than be right 100% of the time and do fewer from a competitive strategy and long-term return point of view.
I think there is really nothing new on this slide, although you may want to ask some questions in Q&A. On to acquisitions, here we talk about the fact just because of what’s going on in the world and because we have cash that the world is on average a better place for us now in terms of the prices at which people are offering properties.
Now, as always, you worry about that when prices are low that’s because returns are lower. Well, the fact is our economics haven’t changed, but there is greater fear that they could of course.
The good news for us is that smaller players have to think about that fear in a fundamentally different way than we do. So, we’re hoping there’ll be some nice opportunities for us to do more buying than we have been.
In addition, for the small players, bundling and a general increase in regulations, there was a new set of regulations issued for our industry this year called new conditions for coverage – the basic conditions that every provider must meet in order to take care of Medicare patients, which added a whole bunch of operating costs for people and a whole bunch of difficulty, a whole bunch of reporting difficulty and other challenges, which are much more difficult to deal with if you don’t have an integrated information system like we do and the standardized training programs for large numbers of people. So, you just put it all together.
Back when things were booming, your had a fair number of people who were willing to sell at very high prices. You have more people willing to sell today and their valuation outlook is quite different.
Does that mean anything is going to happen in the near term? Who knows, but it’s much better hunting grounds for us than it was a year ago.
As we look forward, we say the range of non-acquired growth is 3.5 to 4.5 as we work away with the government trying to solve our certification delay issue, and in acquisitions, the same things will stay, right around that 1% level that we have hovered around for the last few years unless we get to buy one or two of the MDOs. On revenue for treatment, where so much of the game is played, this is the same fact, the same terrible fact that we have disclosed for years, which is that we lose money on average on 87% of our patients and charge more for the other 13% in order to make up for that.
Certainly, if you were designing a healthcare system, it’s ridiculous, but that’s the way our world has worked for 20 years now. If you just had to summarize everything because we tend to get this question in a lot of different forms, but on the one hand, payers are more consolidated and more sophisticated and so are we, and so everybody has got better helmets and is faster and so the game is still very intense.
If you had to just summarize a whole bunch of stuff, that’s where you kind of end up. There’s a whole number of things that haven’t changed, however.
Number one, there is a trend of growing appreciation for who actually reduces total cost. That is good for us, painfully slow in emerging, but good for us.
Number two, if you don’t dialysis, you die, and there’s no controversy about people getting too much dialysis. We’ve had to go through a whole lot of EPO controversy, but as to the fundamental thing we do, there isn’t any controversy.
Many of the referrals that come to us are network independent. If you go to your doctor tomorrow and are told your kidney has failed and you’re going to start dialysis in a week, you do not run to the book to find out who is in the network.
You go to whatever person you think is best to keep you alive, and you’re going to blow through your co-pays and deductibles no matter what. That’s not on your mind at that point.
Living is on your mind. It’s very different from a lot of other healthcare decisions that could be made both by the patient and by the payer.
I talked about the loyalty before, and it is very important that any insurer have an adequate dialysis network. There’s increasing sensitivity when some insurers have tried to force patients to drive a very long way for the state legislatures or regulators to say you can’t do that to someone who needs treatment three times a week to stay alive.
It is your job to have a reasonably adequate network, meaning reasonable access, and it is still unambiguously true that they aren’t that many dialysis patients in America, and so a payer in any given city does not have that many compared to other types of patients. This is a slide we haven’t shown before because it wasn’t as relevant, but if you think about our economic reality, that 13% subsidize 87%, a good thing for shareholders and a good thing for patients is that pretty much everybody realizes this is how it works, so you don’t get someone who foolishly adopts a pricing approach which is suicide for them and their patients in the long term, and one metric is interesting.
About 76% of the centers in America are owned by some sort of equity type of investors, either a private equity or folks like you, and as to the contract reality, I have made most of these points. Because of the stickiness, because of the variable cost structure, because of the intense loyalty, and because you are dealing with patient’s lives, this is not the kind of thing where you just cut prices to gain share or try to force thousands of patients to move with any ease.
Onto mix, from the positive side, historically our mix has been relatively stable. The patient can stay in the private insurance for 30 months, and they drop off into Medicare, and good news that is more true today than it has been in the past is MSP which is code for Medicare Secondary Provision, that’s essentially the provision that says you stay in private insurance for 30 months and Medicare is secondary during that time and then it becomes primary.
There are more people in Congress that recognize that it would be good to extend this, good for the patient than ever before. It doesn’t mean they are going to extend it tomorrow, but there are more members who understand it is actually a good policy, not just because it saves Medicare money, which they often need in order to get Medicare money to take care of other patients, but also the way they do it right now is, number one, discriminatory, dialysis patients are the only patients in America that cannot stay on private insurance if they want.
You can get cancer, AIDS, or whatever, but no other families get forced off of private insurance other than dialysis patients, so there is increasing sensitivity to the fact that it is really not fair because a lot of those people would prefer to stay on it, and second, it creates tremendous disincentives for the private insurance companies to do good for these patients, whereas they have very aligned incentives to make AIDS patients healthier, oncology patients healthier, because they have reduced hospitalizations and saves them money, and they know they are going to be with them for a while. In our case, not only do they not have that incentive, but they actually have the incentive to add negative values so that may be the patient will drop private insurance sooner and go onto Medicare, so it is perverse, negative, nasty incentives, and there is a growing appreciation for that, so we think at some point, they are going to do what is right for their budget and what is right for patients and extend that.
On the other hand, in today’s economy, we have got the unemployment issue and when COBRA starts running out for folks, are we going to have fewer private patients? You can do our own macro-analysis of that, as to whether or not that will happen before the government steps in and does something to ensure that people can keep insurance, and there are product mix shifts.
When times are hard, more people will choose more restrictive plans than before, and on the margin, that will affect us, and the big elephant in the room in terms of economic questions for the long term is exactly how Obama’s insurance exchange will work, if in fact it gets implemented as opposed to them just providing more and more subsidies for people to continue to be able to afford private insurance, and anybody who makes a confident prediction of how that will turn out, you should distrust for the rest of your life. If you just look at private revenue, it is such an important thing for our wellbeing.
It is the same old battle. The economy is a big issue for us over the long term if the recession really is sustained and deepens for an extended period of time and this recognition that MSP is actually a good public policy even though, of course, large employers would prefer for it not to happen.
Onto the government side, here is what happened with MIPA. MIPA is the name for the Medicare legislation that passed mid last year.
Although we don’t love the numbers in it, it was a victory in the sense that the year before, there was legislation to take $4 billion out of kidney care over the 10-year time frame, and then in MIPA, in fact, $1.6 billion was put into this segment over the 10-year time frame, so on a relative basis, it was a very significant policy victory. The absolute numbers are not thrilling to us, but they are what they are, and for us, the holy grail of actually getting an annual market basket update which we have talked about for 10 years actually happened, and so starting in 2012, we have one, -1%, and of course we will be working hard to improve our reimbursement in the intervening years, but for those of you who have been around, you have known that we have talked about the need for a market basket update literally for 10 years and worked on it for 10 years, that’s how long it took.
Medicaid is not a big deal. On the other hand, it is not trivial either in that 4% is 4%, and if you take a 6% weighted average haircut, then you just do the math, and it is not trivial but it is not fundamental, and by far, California is our big issue, and California, which is where I live, has got its own budget issues to deal with, and the way that Medicaid can hurt you that you have to be sensitive to is not just rates, but also eligibility and other coverage issues, but it is more marginal than fundamental.
If you wanted a step back from the government, separate from looking at specifically what they decide and specifically what the levers are and specifically what data sets they evaluate, the good news is we have got some long-term clarity, there is an automatic increase going forward. We are less exposed than most.
There is this issue of 1000 centers that do not have on average the efficiencies that we have achieved. They chase us to keep up, that is good for the system, but you cannot have them closed, and bundling could turn out to be a very good thing for us.
On the negative side, you got the fact that budgets are really tight, and they will be looking for Medicare money, so the free lunch period that we are in right now will go away, and when it goes away, it will go away with a vengeance. I mean that pendulum will swing back with great intensity.
When that happens, I don’t know, but it will be just like the capital markets in terms of a pervasive move swing that will happen quickly and in both directions out of proportion to reality, and then at the same time, there is an upside. There is an equal amount and equal probability of bundling risk because the government could make some mistakes in their numbers, and that would be bad, so bundling is very much the double-edged sword.
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The pharma spend is very large and 80% of it or so is EPO. In bundling, of course, the obvious statement is that there as opposed to being paid fee-for-service for drugs, we’re paid a capped amount, and if we could figure out a way to hold clinical outcomes constant and use less drugs, then we would get to keep the difference.
Obviously, if the difference gets too big and it is pervasive, the government would reduce reimbursement accordingly, but there is an awful lot of upside between now and then, and of course, the mother of all upsides for us in bundling is the cheaper way to take care of anemia, because that is an awful expensive service that we provide now. We will more about that in a little bit.
Amgen’s patent starts to expire in 2012, and then expires over a couple of years. There are people far more thoughtful than us who can tell you exactly the significance of each patent, and there are people far more thoughtful than us who can talk about the drugs in the pipeline.
Our only point is that those companies are looking at a couple of billion dollars of market that they want to penetrate, and they’ve got customers in that market who are eager for a lower cost alternative and have the ability to implement that with rare alacrity, the nature of which is rarely seen elsewhere in healthcare, and so a couple of billion dollars is a lot particularly again in an environment that has the architecture that we do in terms of implementation ability. This is what has gone on with EPO.
The bad news is that is the percent of patients that are sub 10. You don’t want to be sub 10.
You don’t want to have a hemoglobin or hematocrit sub 10. That is generally defined as being anemic, and that number is going up.
It’s going up for a number of reasons. This is our data.
It’s going up all the way across America the last couple of years, and in particular, what happened with us is that our physicians designed modifications to the protocol that we’ve put out there doctors to use or not use in part or in full and the revisions to the protocol were response to some of the new science and all the controversy over the last couple of years in this subject, and lots and lots and lots of our docs worked lots and lots of hours to say can develop a new protocol that narrows the distribution, that has more people between 11 and 12 and fewer people under 10 or over 13. That’s a simple way to think about it, and so that protocol was recently implemented in a lot of our centers.
It was exposed to a lot of physicians, and a number of physicians adjusted their practices according to the new protocol in part or in full, of course their own decision in each case, and that’s what led to the drop in utilization and that’s what’s leading to this increase in sub 10. What happens next is difficult to say.
We anticipate that in Q1, there will be less EPO prescribed than in Q4 still; however, the fact that this number was already up to 7.4 in Q4 and it looks like it’s going to be up in Q1 has got a lot of our physicians concerned that maybe they’ve gone too far the other way, that they’ve been trying to narrow the distribution. We now have an unacceptable percentage of people that are sub 10.
Exactly what’s going to happen, we do not know. Our goal is to help them try to get as many people between 11 and 12 or between 10 and 13 as is possible.
If my mother was on dialysis, I’d much rather have her at 13 than 9.5, and that is true for many patients and is true in the minds of many doctors. G&A, here’s what we’ve done over time.
This excludes the whole stock expense accrual, but we have picked up 1.1 points of leverage, so it’s about $62 million of cost structure that’s gone versus a few years ago, and we hope to do a little better in ’09 than we’ve done in ’08, continue the directional trend at least. Onto our related services outside the mother ship, all that stuff I said about high valued added provider, one of the reasons it’s important and has the potential to be relevant for you is that about 0.6% or 0.7% of the Medicare beneficiaries are dialysis patients, and if you add in those that are close to dialysis, it makes it about 1% of the patients, and they consume about 10% of the Medicare budget, so it’s a material line item and increasingly recognized as such, and most of it is outside the dialysis center, so we’re the very visible tail, but your ability to manage the dog is driven by the tail, and so we’re doing and have been doing four things in order to add more value for society and our patients and ultimately hopefully get reimbursed in an attractive way for doing that, and it really starts with dialysis care of course and then moves into preventing kidney failure and then managing the comorbid conditions.
About half our patients, for example, have diabetes. A majority have some type of cardiovascular issue.
A third of them are hypertensive, and so there’s just an awful lot of leverage which in general in healthcare is very awkward to get at, but since we’re with these patients already 12 hours a week, the incremental cost of adding high-value integrated care in kidney care is a fraction of what the incremental cost of trying to provide coordinated care to any other population because we’re with them all the time in a supervisory environment with an integrated information system. That operating reality doesn’t exist, so these are the three big levers – delaying onset, avoid crashes in dialysis, and then reducing hospitalizations.
There are some real world examples. This is something we’re doing, nobody else’s.
It’s a very large demo with CMS where we’re actually working to delay kidney failure, and you can see we’ve approached a very large control group. It’s relatively unusual in CMS history to have a very substantial legitimate control group versus the population we’re working with, and even though this data includes a whole period where we’re just ramping up, we’re already showing a 1% drop in the percentage of patients who are entering into dialysis within a certain period of time.
So the patients we’re taking care of, fewer of them are having their kidneys actually fail and going to dialysis in the control group which has similar characteristics, and we’re getting better at this all the time. As I said, this data includes the startup time, and when you start thinking about a program, this can look like a tiny number when you think about other people talking about 20% disease management or 30%, that’s very nice when you’re dealing with 6 patients and assign three nurses and a doc who is a zealot.
It’s a whole another thing to implement this in a real world normal community with thousands of patients doing normal things, and we’re doing that and doing it successfully, and we’re one of the few chronic care special programs that were renewed by Medicare recently. Similarly, we’re got one of the world’s longest and largest ever capitated pilots going.
It could be the largest and longest ever. It’s now up to over 400 patients in Southern California where we’re paid the full capitation and we take care of the patient in a very holistic way – hospitalizations, SNF care, surgery center care, the whole ball of wax.
We’re gotten better and better at it every year. This is just one of the steps that has to do with catheter rate.
Very significant improvement, down to 14%, that’s a very big deal for America if we can do that everywhere. Huge savings to the taxpayer, huge benefits to the patient, very important metric, and you can see the actuarial forecast at this point.
This is the one with private payer. It’s accurate, but it’s misleading.
This is one of those classic disease management stuff people show, but this actually did happen in one payer although I always question the starting data to see if we actually had this much impact, but directionally we did reduce hospitalization significantly in a private population. That’s the message.
So for Village Help which is what we call our disease management team, if you will, the positives are that we’re getting better and we’re improving outcomes, and there is this reform opportunity in America. It’s really too bad that Senator Daschle withdrew, because he would have been a very nicely receptive audience for our very aggressive reform proposal.
The negatives are you can just never be confident of anything in DC, and there would be challenges to scale and some of the regulations that they apply generically are bad for providing these new types of care. DaVita Rx is our specialty pharmacy, and this is another beautiful thing which we started from scratch.
Our typical patient separate from what we’ve infused during the treatment is on about 8 drugs. My mom is on some of the similar things, and I know others of you have relatives where they’ve got the blue ones, the black ones, the white ones, and some are two a day and some are one every other day.
It’s a real nightmare, and so our patients see their endocrinologist for diabetes, they see their cardiologist for their congestive heart failure, they see their internist for general stuff, they see their nephrologists, they might see a diabetic podiatrist for the ulcers in their foot. It’s a real nightmare.
They go to multiple pharmacies. No one knows, and no doctor actually knows what all they’re taking.
Reflect on the fact that that statement is literally true, and it’s horrifying that a human being is getting 9 drugs, and no doctor knows all of them, but that the dominant reality. This data is misleadingly positive.
It’s again accurate, so we couldn’t change it, but the message you get here is we’re very good at helping patients adhere to taking their drugs, meaning they take the drugs they should when they should. It’s a radical increase in the percentage of adherence.
Assuming that prescriptions are right, that’s very good for American healthcare. It keeps them healthy, and if you’re a pharmaceutical company, it’s really good for you because they’re consuming a lot more of your drug, so it’s tremendous value in both directions, and then here you have hospitalization rates.
This is in part withheld because it overlapped with some Village Health patients, so again don’t lock and load on that number, but we are beginning to see what we expected to see which is healthier people, and it’s grown nicely. It’s a scale business.
It’s grown 100% a year, and at the end of the year about $125 million revenue run rate, up from 0 a few years ago, and just going awesomely glorious things for human beings. We expect having better outcomes.
The goal is to break even by the time we’re next together in this room or some functional equivalent, and the good thing about this is that no one else can go into a dialysis center, we don’t have to let anybody into a dialysis center, so nobody else can go in and market to these patients, and we are incredibly linked to these doctors for all reasons you already saw. We do the access.
We do the labs. They’re medical directors of our centers, and so this isn’t a space into which other people would lightly tread.
There are tremendous barriers to entry that would get in the way of them having a return. Lastly, access – this again shows the point of access for an individual patient.
This is one of our centers. We’re by far the biggest and the best in this space.
There’s glorious value to the patient. If you go in and your access is clotted, you can immediately go to one of these centers and get the procedure done that day and still get your dialysis on a timely basis, much more convenient than having to go to a hospital and potentially not getting taken care of till the next day or having to be admitted.
The doctor loves it because of that quick response time, and the centers are in partnership with them. They’re a part of their practice, and so they actually get some enhanced income at the same time with more quality control over the patient.
The payers save a lot of money because these centers charge much less than what you’d pay in a hospital. Society benefits from all of the above, and for us, it’s a profitable business, so it’s quite a virtuous circle.
The clinical outcomes are outstanding compared to what happens in general in this space from focusing on doing one type of procedure on a timely basis with good data feedback. We’re at 57 centers, and there’s just a lot of growth versus a year ago, and the negative on this while it’s still profitable is that we took a big reimbursement cut a couple of months ago.
That hurt the numbers, but we’re still in the black. If you think about the 4 items, there’s the Village Health disease management, the specialty pharmacy, the access centers, each of them attacking these big piles of clinical and economic waste, to attack them in a way that’s coherent in the end you have to glue them together with information, and that’s Falcon – our electronic medical record linking the access center to the lab, to the practice, to the dialysis center, and ultimately to the doctor at the practice’s web site and perhaps the patient home page.
So this stuff is good. It loses money now, less this year than last year.
We basically did right about what we said we would do this year. We’re looking for a significant decline again next year, and the value proposition to payers is becoming quite coherent.
Our home infusion acquisition, the obvious statement about home infusion at the top and then perhaps one or two not so obvious at the bottom. Very fragmented, kind of like dialysis was 15 years ago, fits with out competencies in terms of running as a centralized service business, negotiating with payers, working with physicians, etc.
Two other things is that over the next decade, there will be more dialysis done at home perhaps, and looking at the home through the glasses of a home infusion company, it’s been very healthy. This sort of forced us to rethink some of our conventional wisdoms around that, and then lastly and over the long term the most exciting, over the short term probably a waste of time for most of you to contemplate, in America there are these pipelines of increasingly complex biologicals that require some value added distribution.
You can’t have people slip in to the hospital to get them, and you don’t just send the drug out to 12,000 physician offices across America and then provide it, so what do you do? Well, what you do is perhaps use a network of 1500 low-cost facilities that have nurses, dietitians, social workers, text and integrated electronic medical systems that are incredibly convenient with patient parking and all the rest, and a home service capability attached to it as appropriate in order to do value-added delivery of a lot of these complex biologicals, so hopefully, in the years to come, all that rhetoric will actually mean something.
Right now, it’s just a hope. Here’s the actual math.
We had estimated the ’08 number before, and we came in I think within $1 million of what said. Our estimate for ’09 is roughly the same as what we said it would be a year ago, and once again, we are looking out another year to 2010, so you get a feel for the drop here.
How would I rate the efficiency with which we’ve spent the money here? I’d give us a very poor grade.
We’ve gotten to a good spot, but we’ve been unimpressive in the amount of money we’ve spent to get there, so I think that’s the right to characterize it. Financial review, Mr.
Whitney.
Richard K. Whitney
Just a few more minutes on some financial information, and then we will move on to take your questions. Revenue has grown from a little bit more than $2 billion in 2004 to a run rate at the end of 2008 of around $6 billion.
Of course, a big part of this was the Gambro acquisition, a revenue CAGR of 25%. It’s important to note that we’ve done without using any additional equity capital.
Revenue per treatment 5-year CAGR 1% per treatment. Current year, flat for the reasons that we mentioned, the payer hits in late 2007, the pharma intensities.
If you adjust for those things, revenue per treatment grew in line with the historical trends in spite of having no Medicare increase affecting us in 2008. On the private side, we continue to get modest increases overall, consistent with the levels of prior years.
Patient care cost trends, 5-year CAGR of 1%, very consistent trend. Operating income, last couple of years, from around $700 million to $822 million.
Current year, as we mentioned 3% growth in spite of some pretty significant headwinds, so the payer hits, once again, fourfold increase in heparin prices, de novo certification delays, no Medicare increase. Margins decreased in 2008 back to around the 2006 levels for those very same reasons.
You’ve seen this, earnings per share growth, 14% over the five years, 11% in the current year. Our cash flow is strong and growing, and if you step back and say what about your earnings growth over that time period and how does that compare to your cash flow, 2004 cash flow to 2008 cash flow up about $150 million.
If you say, well, what about the earnings, look at the incremental operating income growth, look at the incremental interest expense, tax affected, and you get about $140 million. So the point is $140 million in earnings growth compared to $150 million of cash flow growth for turning our earnings into cash.
Debt, we have $3.3 billion approximately of debt, 70% of which is fixed, 30% variable. If you count our cash, which is a natural hedge, about 80% of our debt is economically fixed, and we exited the year at a blended weighted average interest rate of about 5.1%.
A little less than $800 million of our fixed rate debt is subject to swaps. Over the next year or so, more than half of those swaps will roll off, so absent any additional hedging activity, we would expect our fixed rate debt as a percentage of the total to go from 70% down to closer to 55%.
Debt maturities, the good news is that our big maturities are still 4 years off. We have a little more than $200 million in maturities over the next three years which we expect to fund out of our cash flow, and our term B matures in 2012, which will of course have to be refinanced, and obviously we continue to monitor capital markets to find opportunities to refinance those maturities ahead of 2012.
Unfortunately, there haven’t been a lot of those opportunities in the last 9 to 12 months. Leverage, as Kent mentioned before, increased to about 4.5 times when we purchased Gambro.
At the time, we said we’d reduce it to three times. We did, and it’s at 2.88 times.
We still believe that 3 to 3.5 times is the approximate optimal leverage for this business, given the stability of the cash flows that I can talk extensively about, and as we have said and in fact as we have done, from time to time we expect that we maybe have periods of time that would be below 3 times, periods of time when we’d be above 3.5 times. It’s really depending upon the particular circumstances.
What about profit growth over the next few years. That’s what everybody wants to know.
Let’s look at a very reasonable scenario and step through it. Revenue growth – same-store growth, de novos, small acquisitions that we do every year, a little bit of treatment growth consistent with historical trends - revenue growth of 5 to 6%.
Care business has a little bit of fixed cost leverage – not a lot, little bit, yielding operating income growth of 5 to 7%. Our balance sheet typically has a modest amount of financial leverage yielding net income growth in the 7 to 9% range, and to the extent that we use our excess cash flow to buy back shares and return capital to the shareholders or acquire additional centers beyond the normal levels, net income growth of 9 to 11%.
So this is a very reasonable scenario. So you ask what are the big things that can cause you to be to do a little better than this scenario.
Two things – private revenue trends and bundling transition, which as you know begins in 2011. Okay, what are the two things that can you to be below this scenario?
Coincidentally, two biggest things are the same things – private revenue trends and bundling transition. Now, I’d like to turn it back to Kent to wrap up.
Kent Thiry
I’d just like to emphasize that if bad stuff happens in private revenue or bundling, then those numbers can’t happen. Summarizing the whole package before Q&A, what is the bad news as you talk with your partners back at the office.
Short-term EPO noise, the private risk, despite the track record you can’t like the fact that we get investigated, the bundling risk which is nontrivial given how many things the government has to get right, and then the economy stuff if it stays bad for a long time. That would be relevant for us.
On the other hand, we’ve got this wonderfully stable demand, we’ve got a cost structure and operating approach yields a nice cash flow where we get to make a lot of decisions along the way about debt versus repurchases versus de novos, versus acquisitions, versus holding it, as opposed to other places that have to place big bets at one given time for most of our stuff. We really get to make a lot of discretionary cash flow decisions quarter by quarter.
We have a wonderful market position, and we’re poised to be buyer at a time when it’s nice to buy things if you’re disciplined. Bundling, we might be able to do some good stuff in reducing pharma expense to benefit the taxpayer and ourselves, and this whole notion of the high-value provider being relevant both from a branding point of view, a responsible citizen.
It’s really fun to show these slides to someone in Congress that there’s a return in that alone, and it’s not been trivial over the last couple of years, as well as the fact that we may be able to start monetizing more and more of that value-added capability which nobody has and in particularly the smaller players don’t have. Onto questions, I think there are some people that have mikes, so fire away.
Kent Thiry
It’ll be good if you introduce. Maybe we know each other, but go ahead and introduce.
Unidentified Analyst
I guess I just wanted to ask a few question relative to the economy. You talked about the downside, and I did want you to talk a little bit more about the downside of mix shift relative to unemployment, whether you’re in fact seeing any of that in markets that have high unemployment and what your sense is for that, and then on the upside, which you didn’t talk about, but I would think there are some possible upsides relative to the cost structure, and if you could just share with us your thoughts around labor turnover, labor cost in this economy, rent, and perhaps the supply cost side if there is anything that you see in the business that could be of help.
Exec
Kent Thiry
On the first one, the downside, the answer to the question are we seeing any dropoff in our number of privately insured, the answer to that precise question is no, but we’re watching it with even more intensity than we have watched it in the past, which was pretty intense, so we will see. When people are no longer employed, many of them COBRA, and the government of course is contemplating all bunch of ways of supporting that, and in addition, about a half of our patients qualify for an additional 11 months of COBRA beyond the normal 18 because of the way the laws work around disability, and so we have sort of a double safety net, if you will, runway period for that person to become re-employed or for any other government program to kick in.
So, we are scared, but the answer to the question is what I said. On the upside in the cost structure, we do think that wage increases will be less in ’09 than they were in ’08, and we had one of our lowest nursing vacancy rates in a long time in the fourth quarter.
That actually was we think too soon to be an effect of the meltdown. It was a product of a whole bunch of other stuff that we had been doing, but maybe was given a little nudge, and we think it is directionally representative of what’s going to happen, that in general with the unemployment situation the market is going to say that you don’t have to increase and can’t in fact increase wages as much as in the past.
As to other parts of the cost structure, on the supply side, we’re doing all the normal battles. I have no systemic comments to make there, and on rents, they are going down, but because we already have this installed base of 1500 places for long-term leases and we only add 80 to 100 a year, it’s a small part of the cost structure that it’s not material.
Mark Arnold – Piper Jaffray
Can you give, Kent, in some general terms how far the gap is between the expectations of some of these medium-sized dialysis organizations that have approached you guys versus the levels that you guys would find it accretive enough to make a deal? That’s the first question, and the second question is you brought up HomeChoice and you talked about the adjacencies, is that a business that you intend to grow and would you make further acquisitions in the home infusion space?
Kent Thiry
On the first one, can we usefully quantify the gap between our bid and their ask, the MDOs, possibly. We’re in conversations, and who knows.
To try to put in terms of gap of multiple, it’s too deal specific. I don’t think I can give you a useful number.
In the end, we’ll see if we get something done or not. We’re very glad we said no.
We didn’t agree. We didn’t meet the gap last year, and everybody has reduced expectations this year.
Virtually all of them have initiated conversations in the last year and a number of them recently, and then on the second one, HomeChoice, it’s unlikely we’ll do any acquisitions in the near term. We’re going to first see if we can demonstrate the right kind of de novo and same-store growth, and if we demonstrate that capability, then we would look at acquisitions, but not until we’ve got a track record of nice profit growth without it.
Kevin Ellich – RBC Capital Markets
I was wondering if you could talk about how much the certification delays could weigh on your non-acquired growth, and also the pharma utilization how much impact you expect going forward?
Richard K. Whitney
It’s difficult to say on the certifications because it’s difficult to predict how this will change throughout the course of 2009. We are literally with 54 centers sitting waiting to be certified and without a plan in most of those cases as to exactly when they’ll be certified.
It’s tough to say. We did 80 something de novos this year, so you can imagine that’s a pretty big chunk de novo sitting there relative to a year’s worth of de novos, so difficult I think to quantify, but certainly half a point somewhere in there would be my guess, but I wouldn’t even want you to lock and load on that because it really is so difficult to predict.
So I’d just say sort of a negative headwind is the way to think about it.
Kent Thiry
On pharma utilization, I don’t know that we can go any further in quantifying. We think Q1 will be lower than Q4.
We think we are approaching the world of stability, that all doctors will have made their decisions based on all new information, and so whatever it will be, it will be that for a while, but it’s very difficult to predict what these thousands of folks are going to decide, and as I mentioned earlier we do know a lot of them are very uncomfortable with the growth in sub 10’s, but when that’s going to manifest itself in any change back to the way things were in Q4 or Q3, I don’t know.
Kevin Ellich – RBC Capital Markets
What type of visibility do you have on how long you’ll see that headwind?
Kent Thiry
Absent any new studies, I’d be surprised if we didn’t reach EPO stability in the next five months, because again people process new information, they process new government policies, they process through the new protocol that a whole bunch of them developed, and make widely varied decisions, so if there’re a couple of thousand doctors, each makes different decisions, not that everybody does the same thing. Just like with all drugs, you have some people who go to one doctor, he’ll say take four Advil every 4 hours and others would say, no, only every eight, and someone else will say take two.
You get that same natural variability in what a doctor thinks is right on the margin, but I’d be very surprised if we didn’t achieve stability in the next five months, and I’d be surprised if there was anything that would qualify as dramatic, which is not to say it’ll be trivial, but I don’t think it’ll move into the dramatic category in either direction.
Arthur Henderson – Jefferies & Co.
Kent, could you remind us are there any structural impediments to rolling out home dialysis from a reimbursement perspective, and the second question for Rich, and you may have discussed this, but uses the free cash flow, I know you’ve got a range of leverage ratio there, but could you discuss what your priorities are for that?
Kent Thiry
What’s your first question on home dialysis again?
Arthur Henderson – Jefferies & Co.
Are there any impediments to rolling that out quickly just from a reimbursement perspective or a structural perspective that needs to change before that really becomes embraced?
Kent Thiry
The short answer is yes and that many payers resist paying. We think that’s sort of logically indefensible.
Home dialysis and dialysis more than three times a week has been done for 30 years. It’s not an experiment, and it is intuitively natural to assume that doing something less acute more often is easier and in many ways healthier for your body.
Having said that, my answer to the question is it’s still what it is, that you get lot of payers who resist because they just don’t want to have to pay more.
Richard Whitney
Art, on the uses of free cash flow, really nothing has changed in terms of the way we think about it. First priority is spending cash on growth investments where we can get good returns.
After that, any excess cash, we constantly evaluate between our two basic choices which are debt reduction and returning capital to all of you here in the room, and those decisions are really just very situation dependent. I’d say given the current situation, we decide between holding cash and returning cash to shareholders because paying down debt is really not a particularly attractive alternative right now because we can’t re-borrow it under the same terms as we have borrowed it, and so we just make those decisions year by year, quarter by quarter, and this year we felt comfortable enough to return a little over $153 million of cash to shareholders, but we make those decisions with that excess cash quarter by quarter.
Kent Thiry
I want to go back on the home dialysis for just a moment. We are so far winning the overwhelming majority of cases because in those cases where doctors are prescribing more frequent dialysis, it is good for the patient.
We do a great job of it. We do more of it than anybody in America, so it’s a tussle, but we are winning, and at this point the primary thing getting in the way of growth is while we haven’t been able to develop the right relationship with NextStage as opposed to not having the right relationship with payers because when we do more frequent dialysis right, we think we can reduce pharma use and hospitalizations, and so the aggregate mass for the payer could be quite attractive, so we are winning most of the time.
The primary obstacle is much more. We just can’t seem to get as good a working relationship with NextStage as we have with people like FMC and Baxter.
You know that FMC is a competitor.
(Mitch Campa – Mountain Lake)
When over the next several years, people goes off patents, do you think of your margins as staying similar in gross margin dollars or in gross margin percentage terms? How will the government look at the dramatic fall in the cost of your key items?
Kent Thiry
The way it will work is some companies are going to have other drugs and biologicals to treat anemia. That’s going to happen, and they will offer them to us at an attractive price, but you don’t just flip a switch because there are loyalties, there are data differences, so in healthcare and in the kidney care space, you don’t typically see a massive immediate conversion; however, you do sometimes see a pretty rapid shift.
You can go back to the days of when Venofer came out, and in a very short period of time, a substantial percentage of our doctors switched to Venofer from the predecessor drug, and so there is always some mess, and different providers decide different things. Different providers have varying levels of ability to communicate with the physician community to actually implement a protocol.
When you have a new drug, doctors are appropriately tentative because with any given patient you’re making a dosing decision every month, maybe twice a month, and you’re doing it for 80 patients, and so you actually want to get familiar with how exactly your patients interact, and this is where we can be so helpful to the doctor by providing easily digestible mass data about what’s going on every month with a new agent as well as patient population specific data, what’s going on with his or her patient. Therefore, our ability to implement something that’s new and better or the same and cheaper radically exceeds that of many other organizations.
Ergo, what you have happen when new things come out is even if they reduce the cost dramatically, if we do our job right, they’ll reduce our cost more and faster, and therefore, there will be a period of time when others are trailing us, but we get the benefit of that new spread. Clearly, the government over time is going to be adjusting our reimbursement up and down as a community, but within that we think the odds are very healthy that we’ll have a dramatically superior capability in implementing something that’s better or cheaper.
(Mitch Campa – Mountain Lake)
Although ultimately what you are saying is that if a big chunk of cost comes out of the system, the government will pick that up?
Kent Thiry
Correct.
(Mitch Campa – Mountain Lake)
It seems like in theory eventually we are going to get to the point where there’s one person left on private insurance. He’s going to be paying $100 million, and the government will still be paying at a negative 10% margin, and when that person dies or loses his job, at some point we are going to have a new system, and your profit structure will be determined by something other than the happenstance mix of private pay and Medicare patients.
How do you think about what your margin opportunity will be at that moment and why will it be greater or lesser than where it is today?
Kent Thiry
I actually think in the next 5 or 6 years, the odds are higher that there will be more private patients than fewer because the private payer timetable will be extended, and what we always have said is that when that happens, it’s a very good chance our rates will be lower, but our aggregate economics will be better and more secure, and so everybody can win in the sense that we’ll actually be able to or be forced to bring private rates down, we’ll actually have healthier mix between private and public, and it’ll go on that way forever. The only way the number of private insurance patients goes down is if the new administration actually changes the structure of insurance or there is a dramatic change in care that way disproportionately benefits people on private insurance versus people in government programs, so if diabetic care is going to get a lot better for people who are in general better off on private insurance, then that part of the new patient pipeline would be reduced relative to the government population which maybe isn’t getting that high quality of preventive care or doesn’t have the same ability in their lives to implement some of the new insights about taking care of their condition.
Those are the two scenarios in which you would have fewer and one can attach a probability to insurance reform. There is X amount of probability to improve care on the private side disproportionate to the public.
That probability is lower than the probability that private pay will be extended, and unfortunately in all cases it is a probability thing, none of those three is definite.
(Mitch Campa – Mountain Lake)
In the scenario where we went to some kind of new structure for national health insurance, the nature of your profit structure would be the difference between your cost and the 1000 centers that today are barely breaking even. Is that the right way to think of it?
Kent Thiry
Yes. It’s a reasonable way, and also for FMC that’s a more complicated role since FMC does pharma now.
They have a different calculation for making decisions just like for buying new products. They would have a calculation because they have their home brand, and so sometimes that means they might adopt something new more slowly.
They also have a global relationship with Amgen, so that changes it a bit. They have a different calculation, so there might be differences in our penetration rate versus also.
Who knows?
Richard Whitney
Mitch, the other development that is relevant to this issue of Medicare losses, which is what you were referring to, is the implementation of automatic market basket increase in 2011 as part of the bundling reform, and so while it is still market basket minus, it is much better situation than where we have been historically, where we’ve had to fight every year for a rate increase. Some years we get them and some years don’t.
The years we don’t get them, we’re clearly taking a big step back in terms of our Medicare losses, so I think that’s a structural change that will not solve the problem but will help.
Gary Lieberman – Stanford Group Company
Kent, just going back to the COBRA issue, can you talk about to what extent the industry does or can help patients subsidize COBRA if they can’t afford it?
Kent Thiry
Yes. The question is to what extent can the community help patients pay for COBRA, take advantage of COBRA, and I’ll answer and then other people correct me if don’t get the words exactly right.
There is a group called the American Kidney Fund which exists to provide premium assistance for dialysis patients, kidney care patients. It’s been around for a long time.
It’s blessed by the OIG because if there weren’t that assistance, there’d be a lot of patients in serious trouble, and so that safety net does exist.
Gary Lieberman – Stanford Group Company
Is there any idea what percent of commercial patients actually get some sort of subsidy?
Kent Thiry
I do not know. People will check to see if we can give you that answer.
Gary Lieberman – Stanford Group Company
You mentioned being a little bit more aggressive on the acquisition front. Can you talk about what you are seeing on the competitive front?
You mentioned private equity. Are you seeing more new entrants into the market, fewer, or the same as you have seen over the past couple of years?
Kent Thiry
We were seeing more and more until five months ago. We’ve seen none since then.
Now more people are heading for the exits than the entrances.
Gary Lieberman – Stanford Group Company
Rich, on your patient care cost per treatment, it looks like you took about $10 out of that number if you look at the last number. Last quarter, you reported at 242, and then you are reporting it at 232 this quarter, so is there is some change that you guys made to how you are actually reporting that?
Richard Whitney
Yes, there is. Let me just do a fact check for you.
Gary, what we did actually in response to feedback from a number of you is that we’ve put in the financial metrics, the segment information, and then when we show our patient care costs, we’re only showing in these metrics the dialysis and lab segment patient care cost. Of course, the other segment has a number of costs that don’t relate to dialysis treatment, and so the segments were beginning to get large enough that they were creating distortions in the quarter by quarter trends in the cost per treatment, so we pulled those out, so the actual if you look in the supplemental information, the sequential trend was still improved from Q3 to Q4, but it was 232.50, down to 228.29, so the improvement was about 1.8% sequentially.
Gary Lieberman – Stanford Group Company
That $10, is that in G&A or where are you putting that?
Richard Whitney
On the face of the P&L, it’ll show up in the same spot that it always has because the P&L has consolidated both segments, but in the supplemental information, what we have done is showing the dialysis segment separately the numbers and metrics, and then the non-dialysis segment separate, just the numbers. We haven’t started putting metrics in there really because we got kind of a hodgepodge and it’s hard to come up with any metrics that you’ll find meaningful, and again it’s still 5% of our revenue, so it’s relatively small.
Gary, we don’t have the answer to your question about what percent gets subsidy, but I think what we can say is relatively a few number of patients who are eligible for COBRA are not able to elect COBRA because of financial reasons, so they can either afford it on their own or they get assistance.
Valerie Brown – AllianceBernstein
Do you see any evidence that better management of chronic kidney disease is actually slowing the rate of growth in terms of demand for kidney dialysis services, and secondly, could you talk a bit more specifically about the ways in which you are preparing for bundling? Are there technological advances that you plan to implement that would allow you to optimize care while also minimizing the amount of EPO that you use or other significant elements of expense?
Kent Thiry
The short answer is no. It appears right now that any improvements in the way diabetics and hypertensives and people with other types of kidney disease issues, any improvements to how they are being treated is being offset by the fact that there is just more of them because of the growth in the diabetic and hypertensive population period because of the growth of the Hispanic, African-American, and elderly populations.
The qualifier to that and maybe may answer is actually directionally false. If you look at the historical data and say it’s been running at 2.6 to 3.8 and over the 5 to 6 years, it’s pegged at 3.1 as a consensus estimate, then the answer I guess is the opposite, and maybe there is a net slight change, so maybe that’s the best quantification of it, but it is those two titanic forces sort of pushing against each other.
On the second one, right now, we don’t have any insight sitting on the shelf that we’re going off on January 1, 2011, and change our cost, but we’re be working on it, but right now we don’t have any powerful implementable idea on the shelf ready to be unleashed. The good news is we have some time to work on that, and we will, but so far, no luck.
Unidentified Analyst
How long in your view could the MSP be extended before it became so significant for the private payers that it began to be negative for you instead of positive, number one? Number two, will there be any issues in 2012 if Amgen decided to inactivate all such business?
Could they buy the dialysis chain? Would there be regulatory issues with that?
Third, with respect to de novos, I assume you always have things that are waiting certifications, so how many could you have in the pipeline awaiting certification that were already built a year ago and what would your de novos plans be for the next two or three years?
Kent J. Thiry
How much of an MSP would be so long that it will turn out to be negative because of how private service would react? I think in no way would it ever be a negative for two reasons.
One, I think we would fully anticipate and be very open to having lower rates on average in exchange for having the increased mix. That will probably happen, and that’ll be fine with us on that basis.
It’s still a positive. It would also be much better again because then these patients would get the investment in wellness and prevention that doesn’t currently happen, but that’s sort of an editorial aside.
So I see no scenario in which an extension would be negative for us. Could Amgen buy a dialysis company?
The answer is yes to the best of my knowledge, but I think they will stick to the strategic decision making pattern they’ve had for 15 years which is they don’t buy the distributions systems, so to speak. That’s fraught with complexity and unintended consequences and all that kind of stuff, and in fact would create a stunning regulatory scrutiny even beyond which already exists as well as competitive dynamics because they couldn’t buy everybody, and then you get that classic thing of people that they haven’t bought would be competitors as well as customers, and that’s always delicate, although we’ve gotten to a point with FMC where we work very well together, but it took a while to get there.
Richard K. Whitney
On the de novo certification question, in rough numbers, it’s about double; however, what I would note is that the de novo certification issues will go back more than a year and really just have been intensifying as more and more become an issues, and states remain at issue for longer periods of time, so significant.
Kent J. Thiry
I want to go back to an earlier question quickly because I got the hard data I was searching for. With respect to home dialysis and payers, we have never had a situation where we couldn’t get paid for additional treatments, so we have always won in the end because the clinical evidence is what it is, but your question was is there a tussle and all that kind of stuff, and the answer is yes, there’s a tussle, but I wanted to make sure I didn’t say something that wasn’t exactly accurate.
So if we’ve lost them somewhere, we don’t know about it, and we track it relatively carefully. We’ve always won in the end because the darn evidence is the darn evidence.
Unidentified Analyst
The percentage of treatment revenue, how much is that patient pay out of pocket? I guess that probably is very tiny.
Given the economic environment, do you see any change in that in terms of ability to pay out of pocket, and the second question is regarding the MSP extension, obviously next year the Congress has to work out a way to fix the physician fee problem because 20% cut. Do you think that will give them more incentive to maybe find money from other places and MSP extension may happen in 2010?
The third question is regarding the CKD demo with CMS. I’m wondering do you have any idea when that instead of demo maybe implemented.
Do you have any timeline for that?
Kent J. Thiry
On the first one what percent of our revenue is self-pay, virtually zero. That’s because we have universal Medicare safety net, and all plans cover dialysis because it’s not a discretionary thing, so that answer is very clean.
On MSP and the fact that Congress has a huge gap to fill, if there’s no change in legislation, as many of you know, the doctor’s reimbursement plummets, and so historically Congress has needed to fill that, and to fill that you have to find pay force in the normal world, which we’ll probably get back to by the time this comes around, and yet MSP some people would think about as one of the pay force for that. The other big thing lurking about is the whole thing about specialty hospitals scored savings and then you have Medicare Advantage scored savings, so there are a number of things on the short list.
The demo, when could that become a broader reality, I’d say the earliest would be three years from now.
Darren Lehrich – Deutsche Bank Securities
Going back to my notes, I think a year ago you said that around 15,000 patients was the breakeven point, and you’re saying you’re still losing money at this point, so at $125 million revenue rate, the question is what is the level of revenue and what is the patient count, or what is it structurally about the business that can get you to the profitability? I think a lot of your shareholders want to know why you’re still investing in losses in that business at this point.
Kent J. Thiry
We used to think that breakeven was going to be about 22,000, I thought, so we have to go check the transcript to see if I said something different, but it has moved around as we’ve learned more about the business. I’m just saying the number that I remember from the past, and it is lower now.
I actually don’t know the answer to the question. I know it’s lower than 22 because we’re getting very close as it is which is why we’re forecasting breakeven by the end of the year, and the CBM business especially pharmacy business is a high fixed cost, scale intensive business.
It just is, and the cost of selling into this many centers, building out the three pharmacies, building the software to deal with our customized population, and dealing with the classic pioneer thing, we had to get Medicaid legislation changed and Medicaid regulations changed in 4 to 5 or 6 states, so there’s been our learning curve. There’s been changing regulation.
There’s been educating doctors, payers, etc. It’s quite a slog.
It’s a classic pioneer thing where you get the arrows, and so we know that the cost structure will continue to get better over time, absent some discontinuity. Why are we continuing to do it?
For three reasons – one, we think we are going to hit profitability and we think we can get to where the return on capital is very nice. Second, it is tremendous value added to pharma which is sort of a good spot to be in, and third, it’s part of having that aggregate control over the total patient and the economics and care around it which is where some of the big opportunity could be.
Is there a chance that it will turn out to be a failure, that it will not get to being profitable, and we will shut it down? Yes, there is that chance, but something will have to change.
For the first time I can say that unless something in the world changes, it is highly likely that we are going to get to the point where it is profitable. Now, something could change in the world if they dramatically change the way reimbursement works or do something to change the cost structure, but now it’s just a matter of taking our growth to the next level.
Darren Lehrich – Deutsche Bank Securities
The loss estimate for ’09 was built into the guidance?
Kent J. Thiry
I think what we probably said is just deal with the aggregate because there are lots of shared costs across these units, so it gets kind of arbitrary. As we said, last year was 34 in aggregate.
This year is about 22, and next year about 14, and so they are subset of the 14, so in the grand scheme of things, it’s not something that allows you to put a pretty small box around it.
Darren Lehrich – Deutsche Bank Securities
As it relates to consolidation, you commented a lot about the MDOs in the West. I’m wondering if you can just spend a moment or two talking about international and how you view international as a priority over the next three to five years as a new element of growth for the company.
Kent J. Thiry
Regarding international, looking backwards, no one has ever done a good job for their shareholders by exporting healthcare service, but that’s looking backwards. The world is different, and so in the next 5 years, we may do some small joint venture with the right kind of local player in some other major country as a way of seeing if we can constructively with reasonable returns start to move down the path of becoming a significant player outside of America.
We’ve had some conversations, very casual. The brand of DaVita American Kidney Care is actually very attractive to people who are significant healthcare players in some other countries, so I wouldn’t contemplate just sort of bopping into a country and setting up dialysis centers, but there are major healthcare players in countries who look at us as a very attractive partner, and that could make economic sense in a way that doing nothing is not prudent, and going in alone and thinking you’re going to learn a lot of stuff and grow a lot is not prudent.
I think it’s going to be economically material in your investment timeframe, but as I said there’s a solid chance that we’ll try something with a partner that could work out very nicely.
Darren Lehrich – Deutsche Bank Securities
As it relates to bundling, we heard the response that you’ve got off the shelf that you’re going to implement, but perhaps if you could just talk a little bit about the delivery of care and specifically PD and what DaVita is doing right now with that particular initiative and how important do you think PD will be with bundling.
Kent J. Thiry
First of all, the current trajectory of PD is flat, basically for us and for American. It’s actually been a slight decline both for us and for the country over the past couple of years, and we think in the new world of bundling and in the new world of improvements that have happened in PD in terms of clinical outcomes, there will be more PD in the future than there is now, but we’re not seeing it yet, but we think that that will happen.
PD is peritoneal dialysis, and it is when as opposed to getting hooked up to a classic machine and coming to a center, you have a fluid exchange. In PD, you don’t have to come into a center and you’re far more mobile in your life.
Those are the reasons for it. The reasons against is that the patient has to be more self-sufficient, and if you make mistakes, you can get an infection that’s bad for you, and about 8% of our patients are on PD now.
Unidentified Analyst
Can you discuss about what’s driving the delay in certification and what percentage of the 54 which are currently delayed are in Texas?
Kent J. Thiry
Texas is one of the worst states in this. I don’t know about percentage, but it’s disproportionate.
Part of that is just because Texas is disproportionate in terms of population, and part of it is they are also disproportionately behind. What drives it is typically state budgets.
Their surveyors say we’re going to certify these other types of facilities first because they’re higher priority, and it’s like being number four to the buffet when there’s only food for three. We just sit there, and while at times in the past we’ve had delays, they’ve never been like this, which is taking up our solution game to the next level both at the federal and state level because it is not a sensible position since, again, this doesn’t cost the system any more money, so that’s not part of the motivation, and in fact, sometimes the states charge some fees so they actually get money.
What we’re willing to do as a community is literally user fees. We’ll pay enough to cover the cost so that they can add people, so in the end, that could be the way that this gets solved because the expense of an actual survey is miniscule, so we’ll see if that’s there we end up.
We already do that in one state where we had this problem existed, and now that community pays the state enough that they can hire enough surveyors and therefore it’s better for everybody.
Unidentified Analyst
Any sort of estimates of when the pipeline of delay should shrink?
Kent J. Thiry
No, because we’re dealing with these different decision makers in different states, and we don’t know how long it will take us.
Unidentified Analyst
A followon question to that would be the implications of these delays on your CapEx for ’09 and ’10.
Kent J. Thiry
In some states, it will mean we are less likely to build de novos or we won’t. In some other case, we still may because it’s the right strategic decision because if we build in a timely basis, it could mean someone else will never build and we want to be there even if we have to wait 9 months, but in some case, it’s already changing our calculations, and in some areas, we are not building stuff that we’d otherwise have built.
Unidentified Analyst
What kind of capacity do you have in Texas and what’s your ability to add capacity in Texas, and what’s the regulatory environment to adding capacity to existing center?
Kent J. Thiry
I do not know. I know it’s not going to solve our problem.
It’s not that by adding more stations to our existing centers, we make up for the fact that these other ones are not open, so it’s not a solution to our problem, I can tell you that, and I don’t know what the exact number is.
Unidentified Analyst
What’s taking so long for certifications and what other states you’re having getting certification, and isn’t there a standard to which these sites are to be built and work with the people as you’re building them?
Kent J. Thiry
That would be rational. We’ve proposed that.
We have had no takers. What the state says is our surveyors are busy surveying other stuff and call us when you’re done building.
There is one other segment that actually gets to self-certify. The logic is if it was applied to us, so you’re built 1449 of these successfully, maybe you can do another one, and so we would attest that we’re ready, and if we are ever found to have attested incorrectly when they ultimately get there, there’d be big penalties, which we would absolutely welcome that.
That’s another alternative that’s being discussed, but they’re not geared up to start coordinating with us during construction or anything. We can give them all the heads-up in the world.
If they have a backlog, they don’t put you on the list until you’re done, and then you are where you on the list and if they continually put stuff that they think is higher priority above you, you sit and sit and sit. That’s how it works or doesn’t work as the case may be, and that’s why we have go in now and propose some structural solutions.
The good news is in 87 cases it worked, and then unlike history, in 54 cases it hasn’t worked well enough, although some of those opened quite recently, so they’re not really late, but again if you’d give us a call, we’d be happy to take all the advice possible on this, but in many we work very well with the local governments and in some cases not so well, and we need to get better a that.
Unidentified Analyst
What kind of growth rate are you looking for? You said about 70 to 80 de novos a year is what you’re looking for.
How many are you looking for in a year? What kind of volumes do they have to do and does it vary per state?
Richard K. Whitney
In 2009, we haven’t provided a particular number of de novos, but we would hope to be able to do a similar number this year, but again we have the uncertainty of the certification issues. We provided a CapEx for de novos and acquisitions, and as we usually say where we end up at the end of the year depends upon our ability to identify projects that we want to do, and so we have a pretty good sense at the beginning of the year.
Obviously, a lot of things are in the pipeline, but on the margin, it really does depend on what things we end up deciding to move forward on in the first and second quarter of the year.
Unidentified Analyst
How do you look for locations? What do you look for in a location?
Richard K. Whitney
Very situation dependent. It often depends upon where the doctors’ practices are located, depends upon where the hospitals are, where our physician partners round on patients, depends where the patients that we expect to be serviced by center live.
We do the normal real estate site searches with the normal help and identify sites.
Justin Lake – UBS
Specifically on the gross margin, it was interesting to see that the actual gross profit dollars for treatment increased in the quarter despite revenue per treatment being down. Given that you’ve talked about that being specifically pharma related and everyone is focused on pharma volumes quarter to quarter, is the read through there that does this speak volumes to how potentially little profitability is left in the drug reimbursement?
Do you see that as less of an issue going forward? Any volatility there as far as the bottomline impact?
Anything you can tell us about that would be helpful.
Richard K. Whitney
When you say gross margin, I assume you mean operating margin?
Justin Lake – UBS
The patient costs per day actually went down more than the revenue per treatment. Is there anything else that happened in the quarter that we should look at?
Richard K. Whitney
We did have some sequential improvement in other costs including labor costs, if you recall labor costs were high in Q3, higher than the trend line in Q3, so we did have a return back to trend line on labor costs, so that would be one of the big items, but your point is, as we’ve said the margins are a lot lower than they used to be pharma and part of the reason why you’d see a $3.80 sequential decline in revenue per treatment and not see as big of an impact on the bottomline is you would expect, if for instance it was a range of change.
Justin Lake – UBS
Can you give us a breakdown? Was it 50-50 on the labor versus the pharmacological?
Richard K. Whitney
I don’t have the ability to do that off the top of my head, and I’d also say it wasn’t just labor. There were a number of other cost items that we improved on in the fourth quarter, and part of that is the little bit of spike we had in patient care costs in Q3, and part of it sort of this tightening down a bunch more than we normally do just given the environment.
Justin Lake – UBS
Is this a good run rate for Q1?
Richard K. Whitney
Q1 is always a tough comp sequentially with lower treatment days and payroll costs, and other things that are specifically to the first quarter. People have co-pays and deductibles that are different in the first quarter, etc., so first quarter is always a tough comp, and you know we are not going to give particular guidance, but in many years we have a small decline sequentially in the first quarter.
Andreas Dirnagl – Stephens Inc.
Can we get a more precise number as to what percentage of the delayed facilities are in Texas because clearly if its 50% of the facilities and you can solve that one Texas issue, it has a much bigger impact than if it were spread across 50 different states?
Kent Thiry
It’s 13.
Andreas Dirnagl – Stephens Inc.
13 out of the 52?
Kent Thiry
It’s 54.
Andreas Dirnagl – Stephens Inc.
When you talk about the MDO, can you may be sort of give us an idea as to what patient count characterizes an MDO?
Kent Thiry
It’s never been technically defined, but I guess we would define an MDO as anybody with at least 25 to 30 centers and then they go up to 100 or so. There are a bunch of them in that pocket, and I do want to be clear in my language.
I said virtually all. It’s very important that that the one who hasn’t retains the right to say that they haven’t and one of them can make that claim therefore, and that’s healthy.
Andreas Dirnagl – Stephens Inc.
Given the size of what we are talking about here. Is it sort of a safe assumption that were you to start acquiring these as long as it was one or two of these groups that it’s probably something you could finance currently with existing cash/existing liquidity rather having to do a credit transaction.
In another words, is the biggest hurdle right now getting there on price or is it getting there in terms of financing?
Richard Whitney
It’s the former, getting there on price. Our existing arrangements do not restrict us from doing the acquisitions we would otherwise want to do.
Presumably we have the adequate liquidity to do it. We have about $400 million of cash.
We have $200 million roughly available under the revolver or a little bit less, and we generate cash, so it’s more of the former.
Andreas Dirnagl – Stephens Inc.
Kent, given your first comment about wanting to get the self-inflicted wounds behind you of a couple of quarters a go, can you give us a characterization as to maybe over the past couple of quarters how you’ve been working internally to make sure (a) that doesn’t happen again and (b) can you characterize the general level of the relationship between you and the private payers when it comes to these annual rate discussions you have?
Kent Thiry
As to what we have done differently so that while we can’t guarantee positive results, we can guarantee more thoughtful work that we did for a stretch there back in 2007, one of the keys was just brining Mr. Whitney back, and the second was just making it a bigger part of mine and some other people’s lives again, and so we learned a painful lesson, and again it doesn’t guarantee good results, but guarantees we’re putting the A team on the field every time.
The second part, they are not the same because there is more conversation going on which we said a year and a half ago, and with some, the relationships are starting to move a little bit in that collaborative direction where we say we can help you reduce total cost, we can help you deal with people who are really charging you atrocious rates, and so with some, there is the beginnings of actual collaboration, baby steps, and with others, it more still just the conventional fight over the rate, and neither side wanting to go into the capitalistic equivalent of nuclear war because everybody has sustained some casualties in that, so it’s a mix, but different from a year and a half ago or two years ago. Over the last two years, there has been a lot more thoughtful data driven quality conversations than there was in the two or three years prior to the last two years.
Andreas Dirnagl – Stephens, Inc.
This is not a question as to whether it was the right thing to do at the time, but given where we are today, looking back at the Gambro transaction and the guidance you gave at the time of the transaction being dilutive in year one, neutral in year two, and accretive in year three, would you agree that that was probably overly conservative?
Kent Thiry
Well, it turned out to be incorrect. I’ll leave it at that.
I use the metaphor often internally. If an NBA championship series goes to seven games, and one team wins by two points in the seventh game, if you read the paper for the next year, it’ll seem like that championship team is just way better than the number two team, and number two team has got a lot of problems and weakness, but the pros know that it was this close and could have gone the other way, and so just because something works, doesn’t mean it was a great decision, and just because something doesn’t work, it doesn’t mean it’s a bad decision.
I’m not trying to be too cute. There was a lot of stuff we were scared of, but it has worked out as well as we hoped and better than we expected, but I was wrong.
I’ll repeat that.
Bill Wolkstein – Centurion Capital
I have a question about the lifeline vascular access centers and your attempt to vertical integrate this whole process. Are the vascular surgeons and the interventional radiologists independent contractors or are they DaVita employees?
That’s my first question. The second is are you able to recoup facility fees for either the surgeries or the interventions?
The last question is approximately what percent of patients in the dialysis pool have either de novo AV fistulas done at those centers or maintenance of the shunts and grafts done at the centers?
Kent Thiry
We have about 60 to 70 centers depending on how you calibrate the pipeline, and I’d say on average they take care of patients from three, four, five centers, so maybe 25, 30% of our patient base has the benefit of a focused vascular access center. I’d like you to follow up by sending an e-mail to LeAnne, Rich, or someone because I never calculated that number, so I don’t know how far off it could be.
It’s just spontaneous. The second, most of the procedures are done by interventional nephrologists.
We have trained more nephrologists to be interventionalists than anyone else in the history of the world, and so it’s typically a nephrologist who decides they want to be an interventionalists, and they are part of the nephrology group, sometimes still doing some regular nephrology, often focusing entirely on the procedure, so it’s a glorious thing because they have all the contextual knowledge as well as the procedure expertise. That’s part of the reason why the outcomes are so superior to what happens when someone goes into a hospital and goes to a classical vanilla vascular surgeon to do an access that’s put at the end of the afternoon shift because it’s a low margin thing for the hospital.
It’s just one of the reasons it’s glorious, and then the center is actually owned by practice. It’s an extension of the practice, and we are the manager and get paid a management fee.
That’s how it works.
Unidentified Analyst
I just want to revisit a topic that you spent some time on last year relative to payer contracting and out-of-network conversion that you mentioned as a risk factor. That was an important topic last year.
I want to revisit and see where we are, how you think you are in that conversion process, and then one other element that I think is interesting is your competitors talking about as it relates to structural changes with managed care contracting and doing more bundling, and how you as an organization are thinking about that?
Kent Thiry
The percent of our private business that’s bundled has gone up every year, and we expect that will continue, and we are totally agnostic bundle versus fee-for-service in the private side. We are totally happy to do either, but the percent of the book that’s bundled has gone up every year, and we expect that will continue, and then second, on out-of-network, out of network people are at higher rates than in network.
Our dream is a world where we don’t have any out of network patients. We much rather not have one patient at $10 and one patient at $25.
We much rather have both of them at $17.50, and that’s where we would like to get with all payers. It’s a better system for everybody.
We can’t unilaterally disarm and walk away from out-of- network rates unless we have our contracted rates that are adequate to subsidize the Medicare/Medicaid group, and so hopefully in not too many years, we will be out of the out-of-network business, and go to healthy contracts at a stable midpoint with all the major payers.
Unidentified Analyst
In that process, are you able to able to preserve your economics as you migrate to that over time?
Kent Thiry
Yes. As Rich said if you take out the self-inflicted wounds of 2007 and look at 2008, that was a year in which there was an increase in bundling.
There was an increase in some resolutions on this out of network versus in-network issue with some payers, and we had net-net some modest rate increases, so the empirical answer to the question is that it has gone towards a more stable healthy footing, and we have come out fine. We didn’t come out with big whopping increases, but we didn’t come out with decreases.
We came out with modest increases, and what we want to deliver back to the payer is quality that reduces total cost and certainty in a part of their medical loss ratio where they don’t have to worry about the variability that we can lock into some mutual stability for the long term, and we are getting more of that kind of thing done each year, but it’s still not enough or fast enough or broad or deep enough for us to get bold about predicting because you just never know when you are going to be put back into some nasty battle, but so far so good. We do want to thank you all for your perseverance and resilience, and we will do our best job between now and a year from now when we get together again.
Thank you very much.