FMS

Business Context and Reporting Period

Company: Fresenius Medical Care AG & Co. KGaA
Filing Type: Form 6-K (Interim Report)
Reporting Period: Three and six months ended June 30, 2008
Business Overview: The Company is the world's largest kidney dialysis company, providing dialysis care 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 operates 2,318 clinics globally as of June 30, 2008.

Key Financial Metrics (Six Months Ended June 30, 2008)

Material Changes vs. Prior Period

• Revenue Growth: Driven by a 5% increase in treatment volume (4% same-market, 1% acquisitions) and a 20% increase in dialysis product revenue. International segment revenue grew 26% (12% at constant exchange rates), while North America grew 3%.
• Margin Pressure: Operating income margin decreased slightly to 15.8% due to increased Selling, General, and Administrative (SG&A) costs (driven by corporate expenses and stock compensation) and higher R&D spending. Gross margins were impacted by reduced EPO reimbursement rates and utilization, partially offset by improved commercial payer revenue in North America.
• Cash Flow: Operating cash flow decreased 21% primarily due to an increase in Days Sales Outstanding (DSO) to 77 days (from 73 days) and higher inventory levels.
• Cost Structure: Interest expense decreased 10% due to lower interest rates and repayment of trust preferred securities. R&D expenses increased 42% to $40 million due to new product field tests and home therapy projects.

Guidance, Outlook, and Risks

Outlook and Guidance

• 2008 Revenue: Projected to exceed $10.4 billion (>7% growth).
• 2008 Net Income: Projected range of $805 million to $825 million.
• Capital Allocation: Expected capital expenditures of $650–$750 million and acquisitions of $150–$250 million.
• Debt/EBITDA: Projected to decrease to below 2.8 by year-end 2008.
• 2010 Outlook: Revenue expected to exceed $11.5 billion with earnings growth in the low- to mid-teens annually.

Key Risks and Contingencies

• Regulatory Changes: The Medicare Improvements for Patients and Providers Act of 2008 mandates a bundled payment system starting in 2011, which could impact reimbursement rates. The Company expects stable reimbursements in the short term but faces long-term uncertainty.
• Supply Chain: Heparin recalls by Baxter Healthcare in early 2008 led to supply shortages and increased costs. The Company is acquiring APP Pharmaceuticals to secure supply.
• Legal Proceedings:
  • Baxter Litigation: A court ruling requires royalties on the 2008K hemodialysis machine ($2–$4 million/month) and an injunction on sales effective Jan 1, 2009. The Company is appealing and funding an escrow account.
  • W.R. Grace: A $115 million settlement payment is pending confirmation of a bankruptcy reorganization plan.
  • Tax Matters: Ongoing IRS audits and disputes regarding civil settlement payment deductions. A settlement for a $24 million refund is pending Congressional approval.

Investor Verification Checklist

• Reimbursement Impact: Verify the specific financial impact of the new Medicare bundled payment system implementation timeline (2011–2014) on North America margins.
• Heparin Supply: Confirm the closing status of the APP Pharmaceuticals acquisition and the stabilization of heparin costs.
• Legal Exposure: Monitor the outcome of the Baxter patent appeal and the finalization of the W.R. Grace bankruptcy plan to assess potential cash outflows.
• Working Capital: Investigate the drivers behind the increase in DSO (77 days) and inventory levels to ensure they do not signal collection issues or obsolescence.
• EBITDA Covenants: Confirm continued compliance with the 2006 Senior Credit Agreement covenants, specifically the leverage ratio and fixed charge coverage ratio.