Jim Gustafson - Vice President of Investor Relations Kent J. Thiry - Co-Chairman of the Board and Chief Executive Officer James K.

Hilger - Interim Chief Financial Officer, Chief Accounting Officer, Vice President and Controller Robert J. Margolis - Chairman and Chief Executive Officer LeAnne M.

Zumwalt - Group Vice President

Matthew J. Weight - Feltl and Company, Inc., Research Division Gary Lieberman - Wells Fargo Securities, LLC, Research Division Justin Lake - JP Morgan Chase & Co, Research Division Kevin M.

Fischbeck - BofA Merrill Lynch, Research Division Kevin K. Ellich - Piper Jaffray Companies, Research Division Matthew Borsch - Goldman Sachs Group Inc., Research Division Ben Andrew - William Blair & Company L.L.C., Research Division John W.

Ransom - Raymond James & Associates, Inc., Research Division Gary P. Taylor - Citigroup Inc, Research Division Frank G.

Morgan - RBC Capital Markets, LLC, Research Division

Thank you, Ian, and welcome everyone to our second quarter conference call. We appreciate your continued interest in our company.

I'm Jim Gustafson, Vice President of Investor Relations; and with me today are Kent Thiry, our CEO; Bob Margolis, the CEO of HealthCare Partners; Matthew Mazdyasni, HealthCare Partners Executive Vice President and CFO; Jim Hilger, our Chief Accounting Officer and Interim CFO; and LeAnne Zumwalt, Group Vice President. I'd like to start with our forward-looking disclosure statements.

During this call, we may make forward-looking statements within the meaning of the federal securities laws. All of these statements are subject to known and unknown risks and uncertainties that could cause the actual results to differ materially from those described in the forward-looking statements.

For further details concerning these risks and uncertainties, please refer to our SEC filings, including our most recent quarterly report on Form 10-Q and annual report on Form 10-K. Our forward-looking statements are based on information currently available to us, and we do not intend and undertake no duty to update these statements for any reason.

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

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

Okay. Thank you, Jim, and thanks to all of you out there for your interest in our enterprise.

This quarter, as maybe you've already noted by seeing the press release, we experienced mixed results with continued solid performance in our Kidney Care business but with results below your and our expectations at HealthCare Partners. I will cover 6 topics: number one, clinical performance; number two, HealthCare Partners performance; number three, Kidney Care performance; number four, a policy update; number five, a quick comment on investigations; and number six, our outlook going forward.

Category 1, clinical outcomes, which we always present first, because that is what comes first, you probably know, we serve about 1 out of every 3 dialysis patients in America at this point. Our adequacy at 98% of our patients with a Kt/V of greater than 1.2 is outstanding.

Our vascular access was 72% of our patients having fistulas is outstanding. We've talked about those metrics in the past.

We'd like to comment on an additional one this time and talk about our strides in reducing their peritonitis rates for our PD patients, which represent between 9% and 10% of our patients. The international guidelines for peritonitis is 1 episode per 18 months; our data, 1 episode for every 45 months, about 1/3 the rate of issue and is across a very substantial patient population.

Overall, as you've heard many times, our patient outcomes compare very favorably with national averages and that is both good for patients and saves taxpayers money. I'd also like to start talking more about the wonderful clinical outcomes at HealthCare Partners.

We can compare our 2012 performance in California, for example, to the national HEDIS data for Medicare HMO patients. We are still harmonizing the rest of the HealthCare Partners data across the 3 markets and so in the future, we'll be able to provide aggregate metrics.

But right now, California, which is the biggest market by far, our Medicare Advantage patients, once again, several years in a row, scored near the top across a wide variety of metrics, including above the 90th percentile with respect to colorectal cancer; above the 90th percentile with respect to female patients screened for breast cancer; and near the 90th percentile with respect to diabetic LDL less than 100. For these and many other clinical outcomes, HealthCare Partners compares very favorably to national averages.

In addition, we averaged 4 stars or better on the HEDIS clinical quality metrics in all 3 of our legacy HealthCare Partners partner markets. Next, turning to HealthCare Partners operating performance, which I'm sure is the subject of primary focus for many of you.

It was a weak quarter, no 2 ways around it. What's the right way to think about it and diagnose that weakness and its implications going forward.

First of all, if you take our guidance for the year, which was OI of $400 million to $450 million and take the midpoint, $425 million, you just divide that evenly and that would be about $106 million per quarter. Then you allow for, in general, the long-term trend being second half better than first half of each year, probably tweak that down to $103 million or so, which means we were $22 million off what someone might have expected.

Of course, I'm picking single-point numbers when one would normally use a range but I'm trying to simplify things. Well, about half of that, $10 million, was a normal seasonal decline that happens in Q2, about of that magnitude.

Last year, it was a little bit higher and you should expect a similar seasonal trend in future years, indexed to our MA growth, which is where you experienced a bunch of that seasonality. So about half of that number was, in fact, not an operating shortfall.

However, the other half was; first sub-point under that category is sequestration, which started April 1 and that explains about $7 million, so it's over half of the remaining $12 million, sequestration, which is might very well recur for some time. And then of that remaining 40% or so, 40% of the $12 million, Albuquerque was the single, biggest chunk, where our operating performance is under what we expected, and then there was this small basket of miscellaneous things that round out the variance.

We do expect to do slightly better in Q3 and Q4 than Q1 and Q2, hence, are lowering the full year HealthCare Partners expectations, which I'll talk about in a minute. Regarding growth, very important to us and to you.

Total member months did decline 2% sequentially in Q2 compared to Q1 due to our ending a relationship that had unfavorable rates. That one is actually good news for you.

But more important, we had 20% year-on-year growth of Medicare Advantage patients in our 3 legacy markets, of which, 12 -- 60% or 12 of the 20 was organic and 8% through a series of small but important acquisitions at reasonable multiples. Please note that the year-on-year comparisons incorporate dates prior to the completion of our merger, which was in the middle of the fourth quarter last year.

We'll now move on to Kidney Care performance. I think I can handle that quite concisely from my point of view, although Jim Hilger will go into more detail, just by saying our Kidney Care business continued to operate solidly all across the board in the quarter and year-to-date.

Enough on that, I'll move on to public policy. Starting here with Kidney Care and the proposed 2014 Medicare reimbursement cuts.

This is exceptionally frustrating, given already dialysis providers lose money on Medicare patients and charge private patients significantly more in order to subsidize government patients. It is our understanding at this point that CMS felt compelled to focus on a very narrow sliver of the bundle having to do with pharmaceutical utilization and felt circumscribed from not being able to take into account other factors.

We actually disagree with that interpretation and are making that point vigorously and hoping this comment period that our protest with respect to that logic is taken seriously. Time will tell.

If they cut reimbursement, there will be changes to patient access to care. There's no 2 ways around it for the nationwide community.

I could provide a list of the potential consequences but the most significant one is that, almost inevitably, some centers will close -- actually, inevitably, some centers will close and they will tend to be those centers that served the most vulnerable patients. We have carried a lot of centers that lose money overall in aggregate, trying to be a good citizen of the system but if they cut reimbursement, at some point, it becomes impossible to do that everywhere.

Moving on to health care policy. The big policy issue, as you know, is around Medicare Advantage.

We have no material update on this to provide. It's nice to reflect on the facts, however, that Medicare Advantage remains a superior value proposition, both in terms of clinical outcomes and overall cost to taxpayers.

Let's go back to Kidney Care for a moment, another aspect of policy and that is the ESRD Seamless Care Organizations or ESCOs. First, we do want to publicly thank CMS for all the time that they have put into this whole process in the ESCO design.

Second, however, we are very, very disappointed that the small changes to the proposed ESCO design will not make it one that merits significant investment; and to implement the kind of spectacular success that we've had in integrated care, the proven success we've had in integrated care does take a bunch of upfront investments and we simply can't put a lot of your capital at risk in that way when we know we could generate a return through improving quality and reducing costs with the right architecture of the program and the right duration of the program. But we can't make all those formidable investments if, in fact, after we make all those improvements, there won't be any return because, of course, you would not allocate anymore capital to us to continue to grow what could be a beautiful program.

We will not give up hope for the future, and once again, we're grateful for the hard work that CMS put in. It's a complicated subject, no doubt.

But you can tell by our remarks and the consistency of our remarks over many years now that we believe strongly in coordinated care, that it is a win-win-win for the patient, for the taxpayer and for the enterprise and that we have proven that this is the case and it can be scaled. Next topic, quick update on investigations and lawsuits.

On the physician relationship side, we continue to have discussions with the government but have not reached any settlement or resolution yet; and then 2 pieces of really strong good news. We had 2 previously disclosed lawsuits against HealthCare Partners, the Zanre [ph] suit and the Slogan [ph] suit, both previously disclosed as I mentioned; and each of them, the judges ordered that the cases be dismissed with prejudice, meaning the plaintiffs cannot refile those claims.

In both cases, dismissed before they got very far at all because the claims were so meritless and our advocacy was so appropriately and justifiably strong. So 2 very nice pieces of good news on the legal front.

Last, our thoughts looking forward. As you probably read already, we have made changes to our 2013 guidance, decreasing HealthCare Partners OI guidance by $20 million, so there's now a range of $380 million to $430 million.

And on the other hand, increasing Kidney Care OI guidance by $50 million to the range of $1.45 billion to $1.50 billion and the net impact is, what you probably already calculated, is a net increase to the bottom and top end of our consolidated operating income guidance of $30 million, in other words, to somewhere between $1.83 billion to $1.93 billion. Of course, this guidance excludes the impact of any legal settlement related to the physician relationship matters or anything else, as well as any impact from any change in value of the 2013 earn-out associated with the HealthCare Partners marriage.

As always, all the guidance that I have mentioned and we've referred to in our documents capture a majority of the probabilistic outcomes based on our whole wide number of swing factors and it could happen that we end up outside the guidance above or beyond. Looking beyond 2013, we are unfortunately unable to provide any useful guidance on 2014 right now.

You all know of the significant reimbursement cuts. You all know we've all operated reasonably efficiently in the past.

So simply too many variables at this point to provide useful guidance to you, and we wish we could but to provide guidance that's too speculative doesn't do anyone any good. So we will not succumb to that temptation.

Looking longer, the good news is, we are well positioned. A, we have strong relative value propositions on both sides of the enterprise, that's both in absolute terms and relative to the competition.

B, a second piece of good news, we have strong business development opportunities at HealthCare Partners. C, the bad news is that muscle, the new market muscle, the business development muscle, still needs to be developed at HealthCare Partners.

But D, fourth and finally, the good news is we have a very robust and secure cash flows as we proceed down the path of building those capabilities and taking advantage of our strong relative value propositions. Thank you very much.

I look forward to the Q&A, and I'll now turn it over to Jim Hilger. Take it away.

Thanks, Kent. First, I'll cover a few more dialysis operating metrics.

Our non-acquired growth was 5%, when normalized for days of the week and our commercial mix improved slightly in the quarter. Our U.S.

dialysis revenue per treatment was down $1.58 from the prior quarter, reflecting the impact of the 2% Medicare sequestration cut, which went into effect in April, partially offset by improved commercial mix. Our dialysis G&A per treatment was down $1.28 from the first quarter due primarily to seasonal fluctuations, including compensation expense.

And during the quarter, we experienced $6 million in international losses, in line with our prior expectations. Now next, a comment about HCP.

We've reduced the estimated fair value of the contingent liability with the HealthCare Partners earn-outs or 2013, creating a gain of $57 million, which is reflected in our operating income. We're adjusting the expected fair value of the earn-out based on the first half performance of HCP and the expected operating performance for the remainder of the year.

We'll continue to value this liability each quarter until the earn-out is finalized. So we may continue to see some swings in the value -- if the value changes.

As far as the overall enterprise goes, our debt expense was $108 million in the second quarter and this is consistent with what we've guided last quarter. This should be a good run rate for the remainder of the year.

Our effective tax rate attributable to DaVita HealthCare Partners was 39.5% in the quarter, excluding the accounting adjustment for the HCP earn-out. Note that we now expect a tax rate of between 39% to 40% for 2013, excluding the loss contingency reserve we recorded in Q1, as well as the HCP earn-out adjustment.

Now turning to cash flow. Our operating cash flow was $307 million in the second quarter.

We're raising the bottom end of our 2013 operating cash flow guidance and our current expectation is for operating cash flow to now be between $1.4 billion and $1.5 billion for the year. This guidance excludes the impact of any legal settlements we may reach in the physician relationship investigations.

And with that, operator, let's go ahead and open it up for Q&A.

Kent, I was wondering if you could just start with rebasing here. Clearly there were several discussions you guys have with CMS.

And so when I look at the disconnect here, is this a function of just poorly written legislation to begin with or did CMS, more or less, disagree with your analytical analysis, I guess?

Fair question. Let me sort of stumble for a moment and then you come back and see if I've added any value.

The -- right now, they are maintaining that they have a different interpretation of the legislation, and so that is a part of what is going on and we are asking for a more senior legal review based on the premise that, that hasn't happened yet and so that is potentially one variable. Based on what we've been told, it is one variable.

And then second is, of course, just their overall view of the sector in a world where they want to find Medicare savings. And there, it's impossible to say for sure what their real view of our economics are.

On the one hand, we know the facts are. We lose money on Medicare on average across America.

On the other hand, they see that we and other providers are, in aggregate, successful. And so how much of what drove their preliminary recommendation or idea or proposal was driven by category A versus B, we can only speculate.

Do you feel that -- so it sounds like you don't feel that there would necessarily need to be a new bill that would almost replace what was written in the fiscal cliff though?

No. What they need to do is absorb the comments, which they are, and we're grateful for the fact that they're listening.

They're hearing a lot from the kidney care community because there are a lot of people, big and small, that are worried about closing centers, restricting hours, et cetera, et cetera. So there's an awful lot of feedback being provided to them, which is exactly what they want in order to make their final decision, which they'll make in a couple of months after hearing from us and parts of Congress.

And then depending on what happens, of course, we always have the recourse of trying to go to Congress if we feel we've been unfairly harmed, but we all know what a tortuous path that is.

And in the past, you've discussed at times anywhere from a -- maybe 150 to 200 of your centers do operate at a loss. So to the extent the proposed rule isn't adjusted, would you say a majority of those clinics are at risk?

We're not talking about an aggregate number because so much will be driven by what they ultimately decide. Suffice it to say, it won't be 0.

I mean we are, first and foremost, a caregiving company, and a notion of closing a center where we're taking care of kidney care patients is pretty much an aftermath [ph] to us, which you can see by our track record. At the same time, at some point, the reimbursement has to be fair in covering the costs of those centers that don't have enough private patients in order to subsidize the government.

We wish there was some magic wand where they could just increase Medicare reimbursement, where there aren't enough private patients to subsidize because that at least would be a move towards a more rational system. But right now, while we know the number won't be 0 for us, it won't be 0 for the industry.

Nonetheless, we're not talking about an aggregate number because it would be totally speculative and it just hurts too much to even think about it.

Fair enough. I'm assuming, obviously, you guys are not just sitting on your hands here.

So what kind of levers can you look to pull? I know you're already run an efficient model there, but there's clearly going to be some pressure.

So can you help us think about some of the levers?

No. Your words are exactly correct.

As much as we think, both HealthCare Partners and Kidney Care have done very nice jobs in managing productivity and efficiency over time, you just can't stare at reimbursement cuts of this magnitude and do nothing. It just doesn't make sense just as you wouldn't do nothing in your family household and suddenly your income was dramatically impaired.

So we will be looking at every single expense and I'm confident we'll find some savings. Right now, we can't put a number on it.

And unfortunately, it’s not going to be big enough to change the fact that we're going to take quite a hit.

All right, I'll -- one more and then I'll jump back in queue. Switching just briefly over to HCP and I think, Kent, you made the comment in your prepared remarks that the new market muscle still needs to be developed there.

So I'm curious if you could expand on that, what's maybe taken a little bit longer. And then also, I know they are small acquisitions but curious that HCP acquired in Nevada in March a hospice operator and then a cancer center in June in Nevada, too.

So any color on what's the strategic thinking with that kind of acquisition versus an IPA would be a helpful color.

Well, I'll let Bob comment on the hospice and cancer center acquisitions. But before he does that, as to the new market muscle, it's pretty straightforward, which is HealthCare Partners had and has an amazing track record in the 3 legacy markets clinically, economically, patient service, patient satisfaction, physician satisfaction, HEDIS ratings, star rating, et cetera.

They focused on those 3 markets and did beautiful things on all those dimensions. They did not go out into new markets.

They did not go out and do different models and so it's a new thing. And I think we're making steady, not impressive, but steady progress in building that capability.

Cannot, at this point, translate that into numbers for you. The pipeline is very robust.

Because of our capabilities on that side of the house, lots of folks are interested in working with us, and so that's wonderful news. Exactly how long it will take us to develop all the right capabilities of transferring those capabilities and implementing them with partners, right now, we just can't put the kind of number on that, that you would legitimately want.

But let me go ahead and turn to Bob for the hospice and oncology, and then you can come back at me if you'd like.

It's an interesting question. Certainly, there are acquisitions related to new doctors, new IPAs, medical groups, new markets and that's, perhaps, what you think of when you think of acquisitions.

But first and foremost, we're a caregiving company and the opportunity to manage and coordinate the full continuum of care is an important driver in the clinical results that we want of all of our systems. And so a hospice acquisition made a lot of sense because of the opportunity in Las Vegas to coordinate the very difficult time of life, the end-of-life care in a fully seamless and compassionate way relative to the continuum of care.

And likewise, cancer care or an earlier cardiology acquisition that you may have mentioned, or similarly, so that we could have the full integrated services delivered to our patient, the populations we serve in that market. We may do similar things in other markets where a buy-versus-build decision pushes us in that direction.

And Matt, I think it's time for us to go to someone else. You probably should try to stick to that normal convention of 1 to 2 questions each and then back in the queue, if that's okay.

I guess maybe just to go back at the HCP muscle development or the business development. I guess, can you maybe share with us what your expectations were and if they fell short or that you sort of didn't know what to expect and it's maybe going slower?

Or how would you characterize that?

Okay. It's a fair question and I don't know that we -- if we ask everyone in the room or in the rooms that question, you'd get the same answer because I think different people had different expectations.

Overall, if you look at the expectations we talked about when we made the announcement of the combination, we still have a shot of being on track with that here in the first couple of years, which we always said were years that had some headwinds, both because of the integration of the 2 companies and because of what was going to go on in the reimbursement environment. So I think, in that sense, there is no surprise.

But then if you ask, have we performed superbly, excellently, medium, average or terribly? Unfortunately, we're not yet operating at the excellent level just because it is a new muscle.

So I think how you net those 2 facts together, we're probably a little bit behind in capability and still okay in the game with respect to the numbers themselves because for the first x quarters of our time after the announcement, the operating performance was so much stronger than we expected.

Okay. So is there -- I mean, can you lay out any details on kind of the plan going forward or timing?

Is it a manpower issue? Is it finding sort of the right integration or the right structure for the organization?

It's primarily a resource question and you can't, of course, just go out and hire 2 people and have them be wonderful at day 1 or 20 people and you can't suddenly take 10 people and shift them from one job to another. So it's all the normal nitty-gritty operating stuff.

But at the core of it is just having enough of the right bodies in order to deliver that which we know how to deliver with partners who want us to deliver it. So lots of good news if we can drive ourselves to a new level of capability quickly.

Okay. Jim, could you explain the earn-out contingent fair value in a little bit more detail?

If I'm doing the math correctly, it looks like it declined from $126 million to $57 million, which would seem like a relatively big change in the fair value of something, so maybe walk us through the math there.

Sure. Actually, you got to the numbers pretty much spot on, Gary.

The -- when we acquired HCP in our purchase accounting, we had to estimate the fair value at that time. We had thought the likelihood that they would achieve their 2013 earn-out being quite high and we had initially valued it in purchase accounting at roughly the $125 million number.

Our assessment at the end of the second quarter was it was more of a 50-50 matter and so the value of it is approximately 50% of the total earn-out, which is $137.5 million.

Okay. And is that -- forgive me for not knowing this but -- so is that the earn-out for 2013 or is that over a longer period of time?

It's for 2013. If you recall in the original architecture of the transaction, there was a $275 million potential earn-out related to the achievement of EBITDA in 2012 and 2013.

HCP achieved the earn-out in 2012 and that's been paid. And then in 2013, the other 50% of the $275 million is the opportunity for HCP and we are handicapping the likelihood that they'll achieve that at roughly 50%.

Okay. And the goal there was -- that was $600 million of EBITDA, is -- was -- is that the number that's the target?

That is the target.

Okay. And then maybe if I could get one more question in on HCP and I'll jump in -- back in the queue.

Could we maybe get a little bit more detail on the update in New Mexico?

Sure. We continue to -- what are the right words?

We have not yet nailed down a sustainable partnership there. That's the bad news.

It'd be good if that was done. The good news is there are multiple people who want us to be their long-term partner, and we're making good progress in figuring out who is going to be the right one.

But in the meantime, we're taking some hits in the context of the overall enterprise. Not huge, but nonetheless, versus what we expected when we were developing the guidance for 2013, they're higher than what we had planned on.

Is that responsive?

Yes, that's helpful and then maybe just a follow-up. It's essentially the same issue that's been fairly well documented in the press or has there been any change in that dynamic?

It's pretty much the same.

First, let's start on HCP. You mentioned on your last call that approximately half of the rate pressure in Medicare Advantage next year could be mitigated by whole-plan bidding.

Given those bids were filed in June, I'm hoping you can give us an update here on how we should think about HCP going into next year in this regard.

Justin, Bob Margolis here. We won't know that, unfortunately, until the plans officially are approved by CMS and that's not until the October timeframe.

So as you may know, the plans hold, fairly close to the vest, their decisions on benefits for competitive reasons, give us some indications that they may or may not be moving to greater beneficiary responsibility and we continue to estimate, as we said before, that perhaps, half of that allowable portion of the MA cuts could be mitigated through benefit changes but we do not have new information at this point.

So this isn't a two-way discussion between you and the plans in terms of how they're going to accept benefits. At the end of the day, they are going to set them where they feel like they need to and you'll respond in terms of either accepting them or not, how do -- is that the way to think about it?

That is generally a true statement. I wouldn't say we did not have significant conversations and input with our plan partners, more with the ones where we have our large penetration in their membership and less when we have a smaller penetration.

But ultimately, for competitive reasons, they make decisions about margin versus market share that are broader than their relationship just with us.

Got it. And then my follow up question, I just wanted to go back to the interactions with DC and CMS.

If we -- clearly, I think, Kent, you gave a lot of color on how these rate cuts have iterated and -- in and of themselves, it's clear that dialysis isn't the only industry going through this in terms of CMS looking for dollars. And when you add it on top of the oral meds being delayed by Congress, the integrated care demo been disappointing, curious if you can expand a little bit in terms of how you feel with the relationship with DC is currently versus what I call, at least on my 10-plus years following the company, the partnership that the industry has kind of enjoyed with DC over time.

It's a fair question, Justin, and I guess, when you cite the facts as you just did and as we have, it's clear that they made some decisions that we really wish they hadn't and in particular, in a couple of cases, really affecting our ability to take the quality of care and the effectiveness of each taxpayer dollar to a whole nother new level so it's profoundly frustrating. I don't think there's been any big change in our effectiveness as a community or how we're viewed as a community.

Maybe some change because sometimes when a couple of companies are successful then they become more tempting targets. But that -- also, we don't want to throw out at some sort of convenient excuse if we're not doing the right job of advocacy and doing it the right number of years ahead of time.

So I -- as you know, it's kind of unanswerable question because there's so many different people in CMS. There's so many different people in Congress.

There's so many different people in MedPAC. I -- I'm kind of stumbling here.

So I think it's a fair question and certainly, we haven't done as well the last couple of years as we did the prior 10. But I don't think it's because of a dramatic shift in either of those 2 areas.

But if someone asserted there had been some shift, I certainly couldn't prove them wrong.

I think that there's not many providers would feel like CMS is treating them terribly well nowadays. But maybe we'll go back to Justin's first question around how the bidding process actually works.

And I guess I understand the concept of not being able to see the plan's full benefits, understanding how that flows through but I guess I'm just trying to understand to -- the way I interpreted your response to that question was that you would not really know what rate you're going to get paid until October from the health plans. And I would think that would make it very difficult for the health plans to bid appropriately, not knowing if a major provider's are going to be in their network or out of network and [indiscernible] -- they didn't vote [ph] for you to run your business for the following year without the kind of visibility until October.

So I just want to make sure that I understood that dynamic correctly and to the extent that I did, in periods of rate volatility in the past, I guess, how outside of the expectations did the rate come? How often do you end up terminating in October when you finally see the rates?

So let me take a shot at that and perhaps Matthew will chime in as well. We do not generally need to renegotiate the contracts based on benefit changes because we prenegotiated that material benefit changes that have financial impact will be re-adjudicated and the benefit change is often just member responsibility or beneficiary responsibility versus plan.

So we have the opportunity if there is a shift of copayments, et cetera, to the beneficiary to collect that directly, which has a bit of a neutral offset. So significant benefit changes that were detrimental to us would in almost all of our contracts require a negotiation, which, since we are major providers to the health plan and they have been traditionally excellent partners, I would say has low probability of the terminations that you suggested.

Okay. But do you have preliminary indications at this point?

Or is that really still an October time period when you get that visibility?

We will not know the final benefit design of the plans until October.

Okay. Until then, you won't know your final rate until October.

Okay. And then I guess you kind of alluded to the problems at EBQ [ph] , I guess, but is it purely an issue of volume shortfall that's creating the problem?

Is -- or is there something on the medical management side that's falling short? I guess I am still not clear about what exactly is the shortfall there.

Yes, I don't think we want to go into too much detail on one market and some of the competitive dynamics. It's just not in your best interest.

But suffice it to say, when a leading physician group and a leading hospital get into a battle, it's expensive. And it's because of what happens with volume, what happens to the rates, what happens with referral patterns, what happens with also administrative expenses, legal expenses, PR expenses, lobbying expenses, so you put all those together and it means that everybody is distracted and not doing as well financially.

Okay. And then I guess going back to the commentary before about centers that aren't profitable and closing or potentially at risk for closing if the rate cut was to go through as proposed.

Is there any way to get a ballpark number as to how much money is actually being lost in those centers? Is it $50 million?

Or is it bigger than that? Or I mean, how do we think about the relative size of that?

Yes. And I think I know we've not disclosed that and, at least for now, won't disclose it.

In some cases, it's a tricky analysis because a center that loses money is part of a broader network of centers where we're strongly affiliated with a particular physician group or hospital and so talking about the losses of a particular center in the form of an exact number is kind of tricky in exactly what would happen if you closed it. And then many other centers are just much more pure-play, independent centers that lose money.

So for right now, we've not gone through the exercise of trying to segment them into the different categories. We're just focused on looking at which ones we would very sadly have to close if reimbursement made that a necessity.

Okay. And then maybe last question on a very different topic, one that we haven't talked about this couple of quarters but I just want to make sure I'm not going to be surprised by this next year.

Any thoughts on exchanges now that we've gone through exchange contracting? How has that been going for you?

Are you getting rates close to commercial? Is there any reason to expect any kind of disruptions as far as whether dialysis is or is not covered under the, like I said earlier, the payer part on the exchange or that the rates are substantially different than in commercial at this point?

Yes, in general, our position is that our commercial rates are commercial rates and exchanges are commercial patients and commercial enterprises. And as to the impact of exchanges, overall, of course, you know that nobody -- anybody who forecast that with uncertainty should not be trusted.

But what we said, in general, is that if you look at the number of additional insured patients we might have but weren't insured before and the rates that they will be reimbursed at versus patients that are currently reimbursed high and move to an exchange where, for some reason, because of a change in plan or something else or plan design, have a lower reimbursement rates, that the net of those 4 different vectors, we think, for us is more likely to be a negative than a positive. But that's just repeating the same thing we've said for 2 years now.

And beyond that, like everyone else, we're watching what's going on in every state and don't know what's going to happen. I do think -- I appreciate the questions and we can come back to you again a little bit later in the queue, if that's okay.

No, he had it right, it was Piper Jaffray. I guess just going back to HealthCare Partners, Kent, did you say in your prepared remarks that you had exited a contract?

And if so, I was just wondering, is that why the membership is down sequentially? How much of an impact did that have?

Yes, that's exactly right. The sequential decline from Q1 was because we had bad rates in one arrangement and it wasn't going to change.

In fact, it was going the wrong direction and so we exited. It just didn't make sense and it's so important, as you know, to maintain rate discipline.

Will you say -- can you tell us which market that was in?

Don't think that's a good idea for you, for us to get into too many individual market competitive dynamics. More often than that, that can actually impair our ability to execute on our strategy and do the arrangements that you want us to as much more likely than helping us.

Got it, okay. And then I was just wondering if you'd maybe talk about the utilization trends that you saw during the quarter and kind of the puts and takes and how that impacted the HCP business.

Before Bob or Matthew answer that, let me just go back because I was being a little tentative in one of my answers and I now know I don't need to be that, with respect to rates and exchanges, up to this point, for health plans that want access to our network where we've agreed on them having access to our network, we've been successful in getting commercial rates. That is the dominant reality in that sphere.

And then I'll go back to one thing that Justin brought up too before they answer the question, which is, parts of that -- what was a little puzzling and surprising about the ESCO announcement is that very senior people at CMS, and I mean very senior, expressed a real desire to have integrated care happen for a lot more Medicare patients in the Kidney Care program. And to get a proposal back that's so inconsistent with that was -- is a little bit puzzling, although we've got our hypotheses.

But now, as to the answer to your question, I'll turn to Bob or Matthew.

Nothing specific to add on utilization. There is volatility as Kent described in quarter-to-quarter numbers in HealthCare Partners.

In the second quarter, we had higher-than-anticipated utilization. There's a variety of reasons why that happens but I don't think it's useful to go into great detail on that.

And so long-term trend, we were higher than expected with our great expectation that our coordinated care services and attention to detail will get us back on trend.

Bob, I just kind of want to follow up on that. It seems like everyplace else where -- all the other providers are really talking about lower utilization and is it really just the patient population in the markets that you guys are in, which is why you're seeing higher-than-expected utilization trends?

I think this was a one -- a quarterly issue. And I think, overall, our utilization trends compare very favorably with what you're seeing in the market.

We did have, which ultimately we believe will be good news, significant new member growth, which Kent described in those new members often come in with deferred health care needs, which, of course, we take care of as quickly as we can. So I think that may play a part of it.

I'm not going to -- as you saw, a 20% year-over-year growth in MA in our legacy markets is very substantial and hopeful signs for future margins on that patient volume.

Got it. And then just one more on dialysis, if I could.

Lot's been talked about with rebasing in the proposal. But I think Jim said LeAnne is on the call and I'm just curious what the conversations are like on The Hill and DC and how the efforts are going.

LeAnne, take it away.

Yes, we have been working late in the last 3 weeks with the House. And we did get a letter in support of looking fairly at reimbursement from 205 signatories, so that was very good.

We're also working with the Senate Finance Committee as we did before the rule was out to take a next step in pursuing appropriate reimbursement. We're also working with some non-Senate Finance Senate members until like we are getting good education and good response to help us work appropriately with the agency.

Is that responsive?

Yes, that's helpful.

And LeAnne, is it -- can you go ahead and disclose -- I know the entire community is scared and communicating proportionate to that fear. Can you -- is it fair to let the group know how many emails and letters have come from the DaVita community alone to people on The Hill?

Sure. We have topped the 80,000 mark.

And as Kent said, a number of the other organizations and coalitions have letter-writing campaigns and advocacy campaigns and those numbers are getting quite significant as well. So very good, uniform effort through the community.

Yes. There's never been such pervasive fear.

Maybe if you can talk about how are you working with private payers on reimbursement in that front? Are you -- I guess the question I'm asking is, are you seeing any pushback there on their effective subsidization of the dialysis program?

Or is the fact that they can also see this Medicare rate update scaring them away from even trying to impact the reimbursement on the commercial side?

The answer is they will push back on rates as aggressively as they always have and as we would if we were in their chairs. Now having said that, the laws of gravity can't be disputed.

And if we take a reimbursement cut, that means we and all sorts of dialysis providers will have to draw a different line in the sand in trading off price versus volume because you can't survive otherwise. So they will push as vigorously as they always have.

However, a cut does mean that everybody has to be even stronger in their resistance to that because it's so important.

And if I could ask a question on the pipeline for HealthCare Partners. As you think about those opportunities relative to opportunities that have come up since you closed or even before you closed, and in instances where hospitals and health plans have been willing maybe to offer higher amounts than you thought was prudent for some of these physician groups where they've come up for sale, is that dynamic something that you expect to change?

Do you think that there are groups that are willing to think longer term than just the immediate price that they might get and think longer term about which model will work best?

Well, we certainly believe so and hope so. The attractiveness, we believe, of a patient- and physician-centric clinical model is very attractive to physicians everywhere.

And as you referenced, the robustness of our pipeline is not just physician groups that we are talking to but payers that would like our model to be translated into markets that they have significant market share, shared participation arrangements with hospitals that are trying to learn how to take on and manage risk. And so I think there's a much broader universe than just the relative number of physician groups up for sale, some of whom will gravitate towards highest price and some of them towards sort of cultural alignment.

And is the challenge for the company now to have the -- to build up the business development assets to be able to simultaneously go at different complicated opportunities in many different geographic markets?

I think that's a fair statement and why Kent referenced the significant work we're doing to build the, as he puts it, the muscles of our business development team, using a lot of the growth and knowledge and experience of our DaVita teammates, who have done these for years successfully, and the HealthCare Partner capabilities translated into coordinated and accountable care in many, many more markets where, we believe, the country is moving inexorably away from fee-for-volume to fee-for-value.

And let me just, if I could, ask a question on the integrated care pilot. And you got this question before but have you considered where you could be maybe an MA-plan sponsor yourself, not in competition with payers generally, but just for the purposes of the dialysis patients and take it on that way?

We would love to. There's a whole bunch of structural obstacles to our being able to do that.

However, we think about it every year because we know we have such a powerful value proposition to bring to bear. It's just that there's not a clear rifle shot, nothing close to it, in terms of an ability to have that manifest itself in a commercially, reasonable and sustainable way.

Maybe a question about the dual eligibles opportunity. With some of the states delaying implementation of their programs, it does seem like California might still be moving forward.

Is there any update there, plans or how that may shake out for you guys over the next year or so?

You're absolutely right. The states are all in a state of negotiation and discussion.

California does seem committed to rolling out a modified dual eligible program, meaning -- modified, meaning smaller than everybody in the counties that were approved. There is still intense discussion that we're told about but not participating in between the states and CMS over how this will be reimbursed and where the responsibility will lie for certain risks.

We believe we are well positioned if the revenue meets the risk to be a very active participant in the dual program in the 2 largest counties, Los Angeles and Orange County, that are going to have approximately 200,000 dually eligible patients in the program.

Interesting, okay. And so can you talk a little bit about how they may affect the 2 different sides of the business?

And so specifically, in dialysis, what -- that is -- is that what you're referring to there? Or is that a separate opportunity?

I'm sorry, could you repeat the question?

The question is how that affects the different parts of the business because if I was talking about the 200,000 patients, is -- was this specifically referring to your overall HCP business and then how would that affect, perhaps, the dialysis side?

So let me speak to the 200,000. That 200,000 currently fee-for-service dually eligible patients, that will be eligible and will be assigned to a managed Medicaid and presumably, a managed Medicare program.

So that's where the population helps the health care partner piece potentially in the future.

And then on the dual side for Kidney Care, about half of our patients are duals. And so to the extent any of them become a part of other programs that are risk programs, we become a very attractive subcontractor to whoever has the global risk.

Having said that, there's been a lot of talk about duals for a while and the pace at which stuff is happening is pretty slow.

Okay. So we shouldn't expect a meaningful update there; probably some time next year, perhaps?

Well, we hope. They're only a couple of decisions away but you never know when they're going to be made.

I think that the net for you guys is -- the good news is the long-term potential is immense and quite sustainable because there's so much waste. But predicting when they're going to actually make final decisions and implement and how much the architecture will really reflect the need to create rational incentives for people to make the big investments, predicting those 2 things is sort of a level of speculation we're not comfortable with.

Okay. And then maybe a quick question for Jim on the expense side and on the international side.

It looks like you lost a fair bit less money in international this quarter even as you are investing. How should we think about that, quarterly, over the next year in terms of the losses versus what you had projected before?

Well, we still expect our international losses to be in the range of $30 million for the year, and that's assuming that we don't do any large -- start up any large programs late in the year. If we do, then those numbers may change.

But that's -- we were happy to see those losses trim down to $6 million in the quarter.

Okay. And then another thing on the P&L we noticed was obviously the gross margin came down but SG&A kind of came down but in a commensurate amount.

Do you feel like you have a fair bit more leverage to absorb some of the volatility in HCP to the extent that, that materializes? Or how should we think about those -- that margin opportunity as things shake out?

I'm not clear on the question whether it's HCP or Kidney Care or consolidated.

It's really consolidated, Kent. I mean, it's thinking through kind of the moving pieces and you missed on gross margin but you also exceeded in terms of performance on controlling costs on the SG&A side.

And how controllable that is versus things that are sort of, if you will, done to you each quarter?

Boy, I don't know how to answer. We certainly can't move G&A down quarter-by-quarter based on a retroactive recognition of what happened on the reimbursement side and utilization side.

And so first, with respect to whatever happened coincidentally this quarter, I don't think want to draw any broad conclusions from that as to our ability to juggle these things. Second, are we going to look for SG&A savings in 2014 versus '13?

On both sides of the house, the answer is yes. So the -- we will not come back to you with a 0 answer on that.

Just on the HCP side, it's not going to be enough to offset all the cuts. In the Kidney Care side, we don't know yet if we have a cut to offset.

But certainly, the one proposed would be impossible to come anywhere close to offsetting it.

Yes, I think we're all in discovery mode with HealthCare Partners. I know you're not going to have great information as you said until the fall.

But maybe if you look back in history, what has happened historically when your major partners, let's say, Humana and United, people like that, end up getting 5% to 7% cuts sequentially. Have you ever seen anything of that magnitude in your history?

And historically, how have they acted with their downstream partners versus their benefit design? That might be helpful.

John, Bob and Matthew will answer. But before they do, let me just announce that I've got a conversation booked with a former government official.

It's important I go do that. The rest of the team will be here to continue to take questions.

And if in any instance there's a question where someone feels that my perspective is important beyond that which the team offered, we can take care of that over the next week or 2. So thank you all for your consideration and interest in us, and we will do our best here in the quarters and years to come.

But now, Bob and Matthew, the question.

I think the quick and easy answer is that the health plans have not been faced with this type of cut in the last many years, and so they're all reacting as well. And not being a health plan executive, I can't pretend to say what they're doing in their -- inside of their offices, but I think reflecting the past comments, they are trying to assess the market position relative to their competitors and whether they're going to lose market share if they trim benefits too much versus gain market share and have lower margins if they don't.

And the fact is CMS puts some limits on how much they could push these benefit changes down to the beneficiary. The good news is that in the markets we serve, there remains a considerable difference between the value proposition for MA and Medicare fee-for-service and that none of our markets even have a MA premium, for instance, where that is prevalent in some of the lower-paid markets that you might be aware of.

So there is a fair amount of room to maintain growth and continue at being a good product, even if some benefit changes to the beneficiaries are in the direction that the beneficiaries would rather not see.

And my other question, Humana has said they want to have much more of their book sub-capitated than they have today. Do you see any evidence of that downstream to you?

Or if so, when might you see and what would that look like exactly, do you think?

Well, as -- I think it's a great question and a business opportunity. As you may now, in all of our markets, we are capitated with our major health plans.

So when they make that kind of comment, it's not relative to the more sophisticated organizations such as HealthCare Partners, but to other parts of the country where they've not been able to find capable risk-bearing physician organizations. And of course, that is the formula that we plan to use to offer up to accountable organizations elsewhere.

So when Humana or others talk to us about new market entry, it's very specifically because of the problem that they're trying to address, which is they would like to go to capitated relationships. To align the incentives, we're recognizing in capitated relationships the incentives are to keep the patients well, healthy, delay or prevent chronic disease, avoidable admissions, readmissions and the like, whereas fee-for-service, those incentives do not exist and it's one of the main drivers of the health care cost conundrum the country faces.

Just a couple of questions. The first, I was probably hoping to get Kent's perspective but I'm sure someone else can tackle it.

I guess I was hoping you can maybe reconcile the thought that negative dialysis margins are an important part of the lobbying position of the industry with respect to the proposed rebasing cuts and I think this is an important part, so I just want to understand the reconciliation. If we go -- if we look at the MedPAC report based on the last analysis they did of 2010, they showed 2.3% positive margins for the whole industry.

I'd presume, because of DaVita's scale, your margins might be a little better than that and then certainly, margins improved once the bundle was implemented in 2011. So how do we get back to negative overall Medicare margins?

Is the MedPAC analysis just completely flawed in your opinion?

Yes, this is LeAnne. Yes, let me take that.

Hey, no, the MedPAC analysis is based on the cost reports that we file. As Kent mentioned, one of the most significant drivers of our difference is the, let's call it, uncompensated care bucket, the unreimbursed coinsurance, which is therefore also not reimbursed through the bad debt policies.

And so our biggest concern about any analysis that's done by the government, whether that be MedPAC or CMS itself, is that they're presumption is that primarily that the co-pay is 100% collected and it's not.

Okay. So even net of Medicaid contribution on dual eligible, that would net out to, overall negative, including that, that's the case?

Correct, that's a fair point. There's some other costs in the cost report, which are not recognized as we take exception for.

But as a vehicle of how they do analysis, they strictly maintain the cost report filing data and don't consider these other factors.

Got it. And my second question is a little bit of a cleanup from last quarter when you booked the legal reserve for the issues with respect to the physician relationships.

And I've had a few clients ask the question, so I thought I might pose it here. And the question is, is it contemplated once that settlement is reached, if it's reached, that there's any material change to physician ownership percentage in the JVs?

Any material change to operating practices or if this really is, perhaps, paperwork-type changes, for lack of a better characterization?

Yes. Gary, this is Jim.

And those conversations are ongoing right now on the settlement. Our goal, as we said last quarter is to ensure that we have clarification and that is a level-playing field going forward.

But to talk about the nature of those discussions doesn't make sense until we have clarity on that.

Two quick questions, maybe not answering this specifically, but maybe just a comment about directionally, can you talk about what your commercial mix of business is? How -- which way it's trending on the dialysis side, is it increasing, decreasing or flat?

Yes, I mentioned this earlier in my prepared remarks. This is Jim Hilger, Frank.

Our commercial mix in the quarter improved slightly.

Okay. Secondly, on -- in terms of -- if there is a need to close centers as a result, let's just say, worst-case scenario, this proposed rule stands, is there anything, any type of -- what would be the characteristics of the centers you'd be more likely to close?

I mean, are these that are presumably losing more money? Are they -- is it smaller markets, larger markets?

Is there anything that we could look for in terms of those centers that might be closed?

Yes, this is LeAnne. The commonality of those facilities are that they are high Medicare, Medicaid share.

So that could be a very inner city units and it can be the very rural units. Both of those frequently do not have sufficient private pay patients to cross-subsidize the Medicare shortfall.

Okay. So will there be a priority of one over the other in terms of the magnitude of wealth, albeit versus inner city versus rural?

No. I think they're both on the list and each center will be evaluated independently.

Just wanted to clarify something from earlier, was the earn-out adjustment from the original HCP deal or were there any other subsequent deals in there?

No, that earn-out adjustment that we called out in our earnings release in our call today was related to the HCP acquisition, which closed in November of 2012, and just to make sure I got my numbers right, because I may have just supposed a number in there, we had initially recorded a fair value of approximately $125 million through our purchase accounting of HCP in that transaction. And that -- we have adjusted that by $57 million and are now -- the fair value that we are placing on that earn-out obligation is approximately $69 million.

And I believe --

Yes, I'm going to say, I believe that's the last of the questions in the queue. So again, I want to thank everybody for your interest in the company.

And as Kent always says, we will strive to continue to do well with your money over the next quarter and look forward to talking to you in the future. Thanks.