Business Context and Reporting Period
Company: Fresenius Medical Care AG & Co. KGaA (FMC-AG)
Filing Type: Form 6-K (Interim Report of Financial Condition and Results of Operations)
Reporting Period: Three and six months ended June 30, 2011
Filing Date: August 2, 2011
Business Overview: The Company is the world's largest kidney dialysis company, providing dialysis services and manufacturing/distributing products for end-stage renal disease (ESRD). Operations are segmented into North America and International (aggregating International and Asia-Pacific). The Company is heavily reliant on government reimbursement, particularly Medicare in the U.S., which transitioned to a new bundled payment system (ESRD PPS) effective January 1, 2011.
Key Financial Metrics (Six Months Ended June 30, 2011)
| Metric | 2011 (in millions) | 2010 (in millions) | Change |
|---|---|---|---|
| Net Revenue | $6,230 | $5,828 | +7% |
| Gross Profit | $2,157 | $1,976 | +9% |
| Gross Margin | 34.6% | 33.9% | +0.7 pts |
| Operating Income | $955 | $892 | +7% |
| Operating Margin | 15.3% | 15.3% | 0.0 pts |
| Net Income (Attributable to FMC-AG) | $481 | $459 | +5% |
| EBITDA | $1,227 | $1,137 | +8% |
| Cash from Operations | $487 | $643 | -24% |
| Cash and Equivalents (End of Period) | $449 | $573 | -22% |
| Total Debt (Long-term + Current) | $6.19 billion | $4.57 billion | +35% |
Material Changes vs. Prior Period
- Revenue Growth: Consolidated revenue increased 7% (5% at constant exchange rates). North America revenue remained flat ($4,005M vs $3,986M) due to the implementation of the ESRD PPS lowering revenue per treatment, offset by volume growth. International revenue surged 20% (14% constant currency) driven by acquisitions (including Gambro peritoneal dialysis business) and organic growth.
- Profitability: Operating income increased to $955M. Gross margins improved primarily due to pharmaceutical cost savings (lower EPO usage) in North America, partially offset by lower reimbursement rates under ESRD PPS and higher SG&A expenses.
- Cost Structure: SG&A expenses rose to 18.7% of revenue (from 17.9%) due to higher personnel costs, freight expenses, and foreign exchange losses in the International segment. Interest expense increased 15% to $172M due to higher debt levels.
- Cash Flow: Operating cash flow decreased significantly to $487M (from $643M) primarily due to unfavorable Days Sales Outstanding (DSO) development (82 days vs 76 days) and increased inventory levels.
- Balance Sheet: Total assets grew to $19.1B from $17.1B. Debt increased significantly following the issuance of $1.062B in senior notes in February 2011 and the repayment of Trust Preferred Securities.
Guidance, Outlook, and Risks
Outlook and Guidance (Full Year 2011)
- Net Revenues: Greater than $13,000 million.
- Net Income (Attributable to FMC-AG): $1,070 million to $1,090 million.
- Debt/EBITDA Ratio: Less than 3.0x (increased from previous guidance of ≤2.8x).
- Acquisitions: Approximately $1.9 billion (increased from $1.2 billion).
- Capital Expenditures: Approximately 5% of revenue.
Management Commentary
Management is mitigating the impact of the ESRD PPS through protocol changes, pharmaceutical cost negotiations, and efficiency initiatives. The Company successfully eliminated the negative 3.1% transition adjuster for the remainder of 2011. The Company expects stable reimbursements going forward, balancing unfavorable changes in some countries with favorable ones in others.
Risks and Contingencies
- Reimbursement Risk: Continued pressure on healthcare costs and potential changes to Medicare reimbursement rates or scope of coverage.
- Legal Proceedings:
- IRS Litigation: Ongoing dispute regarding disallowed deductions for civil settlement payments and intercompany preferred shares; potential material adverse effect on liquidity if resolved unfavorably.
- W.R. Grace Settlement: $115 million payment obligation related to asbestos claims pending final court confirmation.
- False Claims Act: Various qui tam complaints and government investigations regarding billing practices and pharmaceutical reimbursement.
- Regulatory: FDA guidance on Erythropoietin-Stimulating Agents (ESAs) requiring lower hemoglobin targets, impacting drug utilization.
- Acquisition Integration: Risks associated with integrating large acquisitions (e.g., International Dialysis Centers, Liberty Dialysis).
Investor Verification Checklist
- DSO Trends: Verify the sustainability of the increase in Days Sales Outstanding (82 days) and its impact on future working capital requirements.
- ESRD PPS Impact: Monitor the long-term effect of the bundled payment system on North America revenue per treatment and margins beyond the initial transition period.
- Acquisition Financing: Confirm the funding sources for the announced $1.7 billion Liberty Dialysis acquisition and its impact on the Debt/EBITDA covenant compliance.
- Legal Reserves: Review the status of the IRS litigation and the W.R. Grace settlement to assess potential cash outflows in the second half of 2011.
- Pharmaceutical Costs: Validate the sustainability of cost savings from reduced EPO usage given new FDA labeling requirements.