DaVita HealthCare Partners Earnings Call Insights: Kidney Care Centers and Business Development

DaVita HealthCare Partners Inc (NYSE:DVA) recently reported its second quarter earnings and discussed the following topics in its earnings conference call.

Kidney Care Centers

Matt Weight – Feltl & Company: Kent, I was wondering if you could start with rebasing here, and clearly there were several discussions you guys had with CMS. 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?

Kent J. Thiry – Co-Chairman and CEO: Fair question. Let me sort of stumble for a moment and then you come back and see if I’ve added any value. 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. So how much of what drove their preliminary recommendation or idea or a proposal was driven by category A versus B, we can only speculate.

Matt Weight – Feltl & Company: 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?

Kent J. Thiry – Co-Chairman and CEO: No. What they need to do is absorb the comments which they are and we’re grateful for the fact that they are listening. They are hearing a lot from the kidney care community because there are a lot of people, big and small, that are worried about clothing 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. 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…

Matt Weight – Feltl & Company: In the past, you’ve discussed – at times, anywhere from a maybe a 150 to 200 of your centers do operate at a loss. So to the expense the proposed rule isn’t adjusted, would you say a majority of those clinics are at risk?

Kent J. Thiry – Co-Chairman and CEO: We’re not talking about an aggregate number because so much will be driven by what they ultimately decide. So suffice it to say it won’t be zero. I mean, we’re first and foremost a caregiving company and the notion of closing a center where we’re taking care of kidney care patients is pretty much anathema to us, which you can see by our track record. At the same time, at some point, the reimbursement has to be fair, encumbering the cost of those centers that don’t have enough private patients in order to subsidize the government, and 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 zero for us and won’t be zero 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.

Matt Weight – Feltl & Company: 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 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?

Kent J. Thiry – Co-Chairman and CEO: You words were exactly correct. It is much as we think; both HealthCare Partners and kidney care have done very nice job 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 if 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…

Matt Weight – Feltl & Company: One more and then I’ll jump back in queue. Switching just briefly over that HCP. 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 these are small acquisitions, but curious if 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 an acquisition versus an IPA would be helpful color.

Kent J. Thiry – Co-Chairman and CEO: 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 their three legacy markets; clinically, economically, patient service, patient satisfaction, physician satisfaction, HEDIS ratings, star rating et cetera. They focused on those three markets and did beautiful things on all those dimensions. They did not go about into new markets. They did not go about 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.

Dr. Robert J. Margolis – Co-Chairman, DaVita HealthCare Partners Inc.; and CEO, HealthCare Partners: 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 clinical results that we want of all of our systems. 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 we 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…

Kent J. Thiry – Co-Chairman and CEO: Matt, I think it’s time for us to go to someone else. We probably should try to stick to that normal convention of one to two questions each, and then back in the queue, if that’s okay.

Matt Weight – Feltl & Company: Thank you very much.

Business Development

Gary Lieberman – Wells Fargo Securities: I guess maybe just to drill back at the HCP muscle development or the business development, I guess can you 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? How would you characterize that?

Kent J. Thiry – Co-Chairman and CEO: It’s a fair question. And I don’t know if we asked everyone in the room, or in the rooms. That question; you 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 that 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 two 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 two 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 ex quarters of our time after the announcement, the operating performance was so much stronger than we expected.

Gary Lieberman – Wells Fargo Securities: 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?

Kent J. Thiry – Co-Chairman and CEO: It’s primary a resource question, and you can’t, of course, just go out and hire two people and have them be wonderful day one 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.

Gary Lieberman – Wells Fargo Securities: 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.

James K. Hilger – Interim CFO and Chief Accounting Officer: Sure. Actually you’ve got the numbers pretty much spot on, Gary. 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 – we initially value it in purchase accounting at roughly $125 million number. Our assessment at the end of the second quarter was it was more of a 50-50 matter. So the value of it is approximately 50% of the total earn-out, which is $137.5 million.

Gary Lieberman – Wells Fargo Securities: And is that, forgive me for not knowing this, so is that the earn-out for 2013? Or is that over a longer period of time?

James K. Hilger – Interim CFO and Chief Accounting Officer: 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 has been paid and then in 2013, the other 50% of the $275 million is the opportunity for HCP, and we’re handicapping the likelihood that they will achieve that at roughly 50%.

Gary Lieberman – Wells Fargo Securities: The goal there was – that was $600 million of EBITDA, is that the number that’s the target?

James K. Hilger – Interim CFO and Chief Accounting Officer: That is the target.

Gary Lieberman – Wells Fargo Securities: Then maybe if I can 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?

Kent J. Thiry – Co-Chairman and CEO: 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’ve planned on. Is that responsive?

Gary Lieberman – Wells Fargo Securities: Yeah, that’s helpful. Maybe just to 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?

Kent J. Thiry – Co-Chairman and CEO: It’s pretty much the same.