FMS

Business Context and Reporting Period

Company: Fresenius Medical Care AG & Co. KGaA
Filing Type: Form 6-K (Interim Report)
Reporting Period: Three months ended March 31, 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). A significant portion of U.S. revenue is reimbursed by Medicare under the new End-Stage Renal Disease Prospective Payment System (ESRD PPS), which fully implemented on January 1, 2011.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Net revenue increased 5% year-over-year, driven by a 9% increase in the number of treatments (8.17 million vs. 7.51 million). Growth was fueled by same-market treatment growth (4.3%) and acquisitions (5%).
• Segment Performance:
  • North America: Revenue increased 1% to $1,977 million. Operating income rose 1% to $312 million. Revenue per treatment decreased due to the ESRD PPS implementation, offset by lower costs per treatment and reduced bad debt expense.
  • International: Revenue increased 14% to $1,055 million (13% at constant exchange rates). Operating income rose 13% to $171 million. Growth was driven by acquisitions (13% contribution) and same-market growth (6%).
• Costs and Expenses: SG&A expenses increased to $572 million (18.8% of revenue) from $518 million (18.0% of revenue), primarily due to higher freight costs, increased donations, and the impact of lower revenue rates in North America. R&D expenses increased to $26 million.
• Interest and Taxes: Interest expense increased 12% to $82 million due to higher debt levels. The effective tax rate decreased to 33.3% from 35.6% due to non-taxable noncontrolling interest and tax-free income from equity method investees.
• Cash Flow: Cash from operations decreased significantly to $175 million from $349 million, primarily due to unfavorable Days Sales Outstanding (DSO) development and increased inventory days.

Guidance, Outlook, and Risks

Outlook and Guidance

Management has increased its full-year 2011 guidance:

• Net Revenues: Increased to >$13,000 million (previously $12,800 - $13,000 million).
• Net Income Attributable to FMC-AG: Increased to $1,070 - $1,090 million (previously $1,035 - $1,055 million).
• Capital Expenditures: Expected to be ~5% of revenue.
• Acquisitions: Expected to be ~$1,200 million, including the pending acquisition of International Dialysis Centers (IDC) for approximately €485 million.
• Debt/EBITDA: Targeted at approximately 2.8x.

Management Commentary

The Company successfully transitioned nearly all U.S. facilities to the ESRD PPS on January 1, 2011. While the new system resulted in lower average reimbursement rates, the negative 3.1% transition adjuster was eliminated by CMS effective April 1, 2011. The Company is mitigating impacts through protocol changes, pharmaceutical cost savings, and efficiency initiatives.

Risks and Contingencies

• Reimbursement Risk: Ongoing pressure on healthcare costs and potential legislative changes affecting Medicare and Medicaid reimbursement rates.
• Legal Proceedings:
  • IRS Litigation: Ongoing dispute regarding disallowed deductions for civil settlement payments and intercompany preferred shares. An adverse determination could materially impact liquidity.
  • W.R. Grace Settlement: A $115 million payment obligation related to the W.R. Grace bankruptcy settlement is pending final court confirmation.
  • Patent Litigation: Ongoing disputes with Baxter International regarding hemodialysis machine patents, though recent rulings have invalidated several asserted patents.
• Regulatory: Compliance with the Affordable Care Act (ACA), which includes an industry fee on pharmaceutical sales and a future excise tax on medical devices.

Investor Verification Checklist

• DSO Trends: Verify the sustainability of the increase in Days Sales Outstanding (from 76 to 80 days) and its impact on future working capital.
• ESRD PPS Impact: Monitor the long-term effect of the new bundled payment system on North America revenue per treatment and margins.
• Acquisition Integration: Track the closing and integration of the International Dialysis Centers (IDC) acquisition and other planned M&A activity totaling ~$1.2 billion.
• Legal Resolutions: Monitor the status of the W.R. Grace settlement payment ($115 million) and the outcome of ongoing IRS tax litigation.
• Debt Structure: Review the utilization of the $1.062 billion senior notes issued in February 2011 and the company's ability to maintain the targeted Debt/EBITDA ratio of 2.8x.