Business Context and Reporting Period
Company: Fresenius Medical Care AG & Co. KGaA (formerly Fresenius Medical Care AG)
Reporting Period: Fiscal year ended December 31, 2005
Business Overview: The Company is the world's largest kidney dialysis company, operating a vertically integrated business providing dialysis services and manufacturing dialysis products. As of December 31, 2005, it operated approximately 1,680 clinics in 27 countries, treating approximately 131,450 patients. The Company provides 19.7 million dialysis treatments annually.
Legal Transformation: On February 10, 2006, the Company completed a transformation of its legal form from a German stock corporation (AG) to a partnership limited by shares (KGaA). This change did not alter the Company's assets, liabilities, or contractual relationships.
Key Financial Metrics (2005)
| Metric | 2005 (in millions) | 2004 (in millions) |
|---|---|---|
| Net Revenues | $6,772 | $6,228 |
| Gross Profit | $2,333 | $2,086 |
| Operating Income | $939 | $852 |
| Net Income | $455 | $402 |
| EBITDA | $1,190 | $1,085 |
| Operating Cash Flow | $670 | $828 |
| Total Assets | $7,983 | $7,962 |
| Total Long-Term Debt | $1,895 | $1,824 |
| Shareholders' Equity | $3,974 | $3,635 |
| Working Capital | $883 | $508 |
Margins: Gross profit margin improved to 34.4% in 2005 from 33.5% in 2004. Operating income margin increased to 13.9% (calculated) from 13.7%.
Dividends: The Management Board proposed dividends for 2005 (payable in 2006) of €1.23 per Ordinary share and €1.29 per Preference share.
Material Changes vs. Prior Period
- Revenue Growth: Net revenues increased 9% (8% at constant exchange rates) driven by 7% organic growth, 1% from acquisitions, and 1% from currency effects. Dialysis care revenue grew 8% and dialysis products revenue grew 10%.
- Profitability: Net income increased 13% to $455 million. Operating income increased 10% to $939 million.
- Cash Flow Decline: Cash flow from operations decreased by approximately $158 million (19%) compared to 2004. This was primarily due to $119 million in income tax payments for prior periods (€78 million in Germany and $41 million in the U.S.) and a smaller reduction in Days Sales Outstanding (DSO) compared to the prior year.
- Segment Performance:
- North America: Revenue increased 8% to $4,577 million; Operating income increased 10% to $644 million.
- International: Revenue increased 11% to $2,195 million; Operating income increased 21% to $362 million.
- One-Time Costs: Selling, general, and administrative (SG&A) costs increased partly due to $22 million in one-time costs related to the legal form transformation and a shareholder suit settlement.
Guidance, Outlook, and Risks
Proposed Acquisition: The Company entered into a definitive agreement to acquire Renal Care Group, Inc. (RCG) for approximately $3.5 billion in cash. The acquisition is subject to regulatory approvals (including FTC review) and is expected to close in the first quarter of 2006. To facilitate this, the Company secured a $5 billion credit facility. The acquisition is expected to be earnings neutral to slightly accretive in 2006 and accretive from 2007 onward.
2006 Outlook:
- Capital Expenditures: Budgeted at approximately $450 million.
- Acquisitions: Planned at approximately $100 million (excluding RCG).
- Net Income: Expected to be in the 10%-15% range on a pro forma basis, excluding one-time RCG transaction costs and FAS 123(R) impacts.
Key Risks and Contingencies:
- Government Reimbursement: Approximately 36% of consolidated revenue is derived from U.S. federal health care programs (Medicare/Medicaid). Changes in reimbursement rates or policies (e.g., EPO dosage limits) could materially impact revenue.
- Legal Proceedings:
- W.R. Grace Merger: The Company has a $115 million settlement obligation related to the 1996 merger with W.R. Grace & Co. regarding asbestos and tax claims. This amount is accrued.
- Government Investigations: The Company is cooperating with U.S. Department of Justice investigations regarding laboratory testing (PTH levels, Vitamin D) and physician compensation. An adverse outcome could have a material adverse effect.
- Patent Litigation: Ongoing litigation with Baxter International Inc. regarding hemodialysis machine patents.
- Competition: The acquisition of Gambro Healthcare by DaVita Inc. may reduce DaVita's purchases of Fresenius products.
- Debt Covenants: The Company must maintain specific financial ratios (leverage, interest coverage) under its credit agreements. The RCG acquisition will significantly increase leverage (pro forma debt-to-equity ratio of 1.61).
Investor Verification Checklist
- RCG Acquisition Status: Verify the final closing date of the Renal Care Group acquisition and any required divestitures (e.g., the sale of ~100 centers to National Renal Institutes) to satisfy FTC conditions.
- Reimbursement Policy Changes: Monitor CMS implementation of the new EPO monitoring policy (effective April 1, 2006) and its actual impact on revenue per treatment.
- Legal Settlements: Confirm the final confirmation of the W.R. Grace bankruptcy reorganization plan to trigger the $115 million payment and assess any remaining exposure from the Grace Chapter 11 proceedings.
- Government Investigations: Track the status of the DOJ investigations into PTH testing and physician compensation to assess potential fines or operational restrictions.
- Debt Servicing: Review the Company's ability to service the increased debt load post-RCG acquisition and compliance with leverage covenants under the new $5 billion credit facility.
- Share Conversion Impact: Verify the accounting treatment and EPS impact of the conversion of preference shares to ordinary shares completed in early 2006.