FMS

Business Context and Reporting Period

Company: Fresenius Medical Care AG & Co. KGaA
Filing Type: Form 20-F (Annual Report)
Reporting Period: Fiscal year ended December 31, 2006
Business Overview: The Company is the world's largest kidney dialysis company, operating a vertically integrated business providing dialysis services and manufacturing dialysis products. Operations are conducted in over 25 countries for services and over 100 countries for products.
Key Corporate Event: In February 2006, the Company transformed its legal form from a German stock corporation (AG) to a partnership limited by shares (KGaA). Additionally, in March 2006, the Company completed the acquisition of Renal Care Group, Inc. (RCG) for approximately $4.2 billion, significantly expanding its North American footprint.

Key Financial Metrics

Note: 2006 results include the impact of the RCG acquisition from April 1, 2006. Interest expense increased significantly to $351 million (from $173 million in 2005) due to debt incurred for the RCG acquisition.

Material Changes vs. Prior Period

• Revenue Growth: Net revenues increased 26% (25% at constant currency). Growth was driven by the RCG acquisition (contributing 15%), organic growth (10%), and favorable currency effects. Dialysis care revenue grew 31% to $6.377 billion, while dialysis product revenue grew 11% to $2.122 billion.
• Profitability: Operating income increased 40% to $1.318 billion. Adjusted operating income (excluding one-time items like restructuring, legal form transformation costs, and FAS 123(R) stock option expenses) increased 38%. Gross margin improved to 33.9% due to higher treatment rates in North America and the acquisition of RCG, which has higher margins.
• Debt Levels: Total long-term debt more than doubled to $5.083 billion, primarily due to the $4.6 billion syndicated credit facility entered into to finance the RCG acquisition. The debt-to-equity ratio stood at 1.15.
• Divestitures: To comply with FTC requirements for the RCG acquisition, the Company divested 105 dialysis centers and a laboratory business, receiving net cash consideration of approximately $516 million. A gain of $40 million was recorded on the sale of legacy clinics.
• Segment Performance:
  • North America: Revenue increased 32% to $6.025 billion; Operating income increased 50% to $965 million.
  • International: Revenue increased 13% to $2.474 billion; Operating income increased 22% to $440 million.

Guidance, Outlook, and Risks

Outlook and Guidance

Management provided the following outlook for 2007 and 2008:

• 2007 Revenue Growth: 11% (Targeting $9.4 billion).
• 2008 Revenue Growth: 6% to 9%.
• Net Income Growth: 18-21% for 2007; >10% for 2008.
• Capital Expenditures & Acquisitions: Approximately $650 million annually for 2007 and 2008.
• Effective Tax Rate: Approximately 39%.
• Debt/EBITDA: Targeting under 3.0.
• Dividends: Proposed dividend for 2006 (payable 2007) is €1.41 per Ordinary share and €1.47 per Preference share.

Key Risks and Contingencies

• Government Reimbursement: Approximately 38% of consolidated revenue is derived from U.S. federal health care programs (Medicare/Medicaid). Changes in reimbursement rates or coverage could materially impact results. Specifically, new CMS policies regarding EPO (Erythropoietin) dosing and reimbursement limits implemented in 2006 have had a slightly negative impact.
• Regulatory and Legal Investigations: The Company is subject to ongoing civil and criminal investigations by the U.S. Department of Justice (Eastern District of New York and Eastern District of Missouri) regarding clinical quality, physician compensation, and anemia management programs. An adverse outcome could have a material adverse effect.
• Corporate Integrity Agreement: The Company's U.S. subsidiary is subject to a Corporate Integrity Agreement with the U.S. government. A material breach could result in exclusion from federal health care programs.
• Patent Litigation: Ongoing litigation with Baxter International regarding patent infringement. While a jury verdict was initially in the Company's favor, the court granted a motion to retry certain aspects of the case.
• Tax Audits: The Company is subject to ongoing tax audits in the U.S. and Germany. In 2006, the Company paid $99 million in U.S. tax assessments and $78 million in German tax assessments related to prior years. Additional payments may be required if appeals are unsuccessful.
• Supply Chain: The Company relies on a single source manufacturer (Amgen) for EPO in the U.S. Interruption of supply or price increases without corresponding reimbursement increases could reduce revenue.

Investor Verification Checklist

• RCG Integration: Verify the successful integration of Renal Care Group and the realization of anticipated synergies, given the significant debt load incurred.
• Regulatory Outcomes: Monitor the status and potential financial impact of the DOJ investigations and the Corporate Integrity Agreement compliance.
• Reimbursement Trends: Track changes in Medicare/Medicaid reimbursement rates, particularly regarding the EPO dosing policies and the composite rate adjustments.
• Tax Liabilities: Assess the final resolution of ongoing tax audits in the U.S. and Germany and the potential for additional cash outflows.
• Debt Covenants: Confirm continued compliance with financial covenants in the 2006 Senior Credit Agreement, specifically the leverage ratio and fixed charge coverage ratio.
• Patent Litigation: Follow the retrial proceedings in the Baxter patent infringement case.