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Fresenius Medical Care AG & Co. (NYSE:FMS)

Q2 2010 Earnings Call

August 3, 2010 09:30 am ET

Executives

Oliver Maier - SVP, Head - IR

Ben Lipps - Chairman and CEO

Mike Brosnan - CFO

Analysts

Kevin Ellich - RBC Capital Markets

Andreas Dirnagl - Stevens Incorporated

Tom Jones - Berenberg Bank

Lisa Clive - Sanford Bernstein

Michael Jungling - Morgan Stanley

Ilan Chaitowitz - Redburn Partners

Stephan Gasteyger - Jefferies

Martin Wales - UBS

Ann Wireheim - Invesco

Justin Lake - UBS

Martin Whitbread - Credit Suisse

Rosanna Burcheri - FrontPoint Partners

Oliver Maier

Good afternoon and good morning everybody. I would like to welcome you to our second quarter and first-half year results conference call. I am joined today by Ben Lipps our Chairman and CEO. Ben would address our strategic priorities and give us a general business update and our Chief Financial Officer; Mike Brosnan who will then discusses our second quarter and first-half results in greater detail and addresses our growth outlook for the full-year.

We will use slides for the presentations today which has been posted on our website and link will sent to you separately by e-mail. I would like to remind you that our comments today will be gathering to our Safe Harbor statement. So the course of our presentation today we make certain forward-looking statements and actual results could vary materially. We will use non-GAAP financial measures to help you to understand our underlying business performance although the GAAP reconciliations are provided in our investor news.

So with that actually I would like to turn the call over to Ben. Ben, it’s yours.

Ben Lipps

Thank you, Oliver. Ladies and gentlemen let me extend a warm welcome to you, our board members and all of our employees and associates around the world who have joined us today on the internet. Oliver has pretty much covered the agenda, so let me start right in by turning to chart 4.

We are very pleased to report an excellent quarter. We are fully on track to meet our full year guidance. Now before I start I would like to thank all of the management board members and the employees who put much extra effort into our activities this quarter. We really had a very challenging quarter in a number of areas but we accomplished all of our objectives as you will see both strategically and in terms of short-term objectives. So again thank you very much for all that effort and at the same time now we turn in revenues of around $2.95 billion for the quarter, a growth of 7% in both actual and constant currency, Mike will talk about the revenue, the EBIT margin development it was excellent. Therefore, on the net income line we turned in a 12% growth or $248 million for the quarter.

Turning now to page five, let’s look a little bit as a revenue breakout by regions. We saw solid revenue growth in all the regions especially in North America and Latin America where the actual growth rates, constant currency in Latin America actually in North America was 8% very, very good job. North America turned end around a little over $2 billion in revenue, international had about $920 million revenue at a constant currency growth of 5%. And again, Latin America grew at 8% constant currency Asia Pacific five and Europe at 4% constant currency.

Turning now to page six, chart six let’s look at the half year it’s really pretty much, pretty similar to what we saw for the second quarter. North America turned in just short of $4 billion in revenue, actual growth of 9%, international turned in $1.8 billion in revenue, constant currency growth of 6%. Again we saw Latin America turn in a growth rate of 9%, Europe 5% constant currency in Asia Pacific 7%.

Our organic growth was a little bit lower in international again, for a couple three reasons and we expect as we go through the back half of the year, we expect to see a rebound in that area and I’ll talk a little more about that when we get into some of the other discussions of this service area and the product area. But buy and large are very strong first half of the year we turn in $5.8 billion a revenue growth of 9%, 8% in constant currency.

Turning now to page 7, let's look at the dialysis services on a global basis. We had very strong revenue growth globally our focus has been on growing the service business. We now treat over 200,000 patients on a world wide basis. North America turned in an 8% in the second quarter basically very strong continued the momentum from first quarter and I will talk a little bit more about the revenue treatment that was also quite reassuring. If you look at international we turned in a 9% constant currency growth in the year dialysis services business very strong and so at the end if you take a look at the entire picture then for dialysis services we had an 8% constant currency growth or the second quarter basically treating about 200 to 2,000 patients.

Now in this area we saw a 12% growth in Europe in constant currency in the dialysis services area again pretty much following the focus that we’ve had during the past quarter and the past year and so if you look at it from an overall basis then we are very strong revenue growth in the dialysis services in the second quarter. Turning now to chart eight we looked at it through the full half year and again for the whole half year North America continued an excellent pace at 10% growth the dialysis care group and a group in North America doing outstanding job of growing their revenue and you’ll also see when Mike talked about it we are also growing the EBIT margin so very, very strong growth in to the US over the first half and they turned in about $3.6 billion revenue. We had also equally strong growth in your international area with a 9% constant currency growth. And so again, we basically are staying in the range of the high single digit, low double digit growth which gave us then a 10% constant currency growth in the dialysis services for the first half year 2010.

Now, let me turn to chart 9. Clearly, I think you all recognized that we have a clear and absolute commitment to quality, both in the products and the services. And so, let me take a couple of minutes to talk about what we’re doing in the quality area. Then again, this is one of my standard chart and we have some areas that we think we’re essentially getting a very good job and some other areas that we’d like to do better as we get some of the regulatory constraints off the table. Now first of all, when it comes to the treatments we deliver, over 95% of the time, we deliver the prescription therapy that the doctor orders.

And that’s both in North America and Europe, Middle East and Africa or EMEA. Therefore, you can see on the top line, we’re between 95 and 96%. Looking now at the anemia management part of it, in North America, we’ve been able to tighten our distribution and we now have about 68% of our patients between 10 and 12 gram per desolater hemoglobin. We have not made the progress yet in the nutritional area that we’d like too although we do expect that we see some early signs of that on the month-to-month basis by, with our new program where we’re actually allowed to provide supplements to patients that are below 3.5.

So I think you’ll see that increase over the next year here in the nutritional area and of course in the binder area, we’re just rolling out our PKM program and we hope to able to improve that number. It is creeping up from the 50 to the 55. So all-in-all though, as you look at North America, we continue to improve our hospital days.

We’re now below 10 days per year, which is really getting probably at the low end of what we can hope to do and so now lets turn to EMEA and as you can see when it comes to albumin our nutritional status doing an outstanding job and we’re really pleased with that we’re also doing a better job in terms of bone mineral metabolism and I believe that probably relates to the more acceptance of hemodiafiltration which we’re the leader of here in the industry. Again the hospitalization days or in the 9-5 range balancing around, that’s probably the best we’re going to do around the world.

Now the other good knowledge is not on the chart but I’ll tell you, as we keep track of our mortality and of course everybody measures it differently, so we look at it just in our own way and now, the way we calculate it, we continue to see an improvement of both Europe and North America are less than 15% mortality, which is excellent and so we’re very pleased that we’re now getting down into the 14 to 15% mortality, even with the 50% diabetic patients in North America and 30% diabetics in Europe.

So again, I think when it comes to quality, in the same with the products, that is our focus and I believe that our customers and our employees and our patients really appreciate the effort we put on in that area and we will continue to try to improve as we go forward.

Turning now to page 10, let’s talk a little bit about some of the key metrics in the service business. Our organic revenue growth globally was 7%. Again, this mirrors the 7% we saw in North America which is again quite outstanding and we saw same market growth, 4.3% and so both regions are growing between 4 and 4.5%, same market growth and we are quite pleased with that we do think that in certain areas there is a mix effect here in the international because as we buy into more established programs, country is ahead more established program so our rates will be lower and so it really depends on little of that and as we go forward next year, we will probably break out really slightly different metric here so you can see the organic growth on clinics that have been in our system for over a year.

But at this point of time that’s the average and its actually quite good, looking at revenue per treatment what we have seen our revenue per treatment, constant currency as Europe continues to accomplish the 2% growth in terms of the constant currency revenue per treatment which is really quite outstanding considering the environments that we are operating in around the world economically at the same time we are about 17 out of 35 of our countries over last 12 months has basically provided a revenue increase and so we are still very optimistic that we will accomplish our goals in international of the 2% constant currency increase and in North America we said between 2% and 4%, I will show you here in middle, in a minute right we are in middle of that range so essentially I think everything is pretty as we had targeted for the year.

Now that’s not without lot of effort but at the same time it's nice to see that that effort pays off, we have opened through the six months of the year 45 de novo 28 in the US, 17 international. The good new also is we only have 33 waiting for certification in North America. So that problem has pretty much I think anticipated and we are pretty much in real time where we always have somewhere in the range of 30 to 35 clinics waiting for certification.

Turning now to page 11, or chart 11, lets look at the revenue per treatment in the US, if you look at versus our revenue per treatment for Q2 of 09 to Q2 of 10 we had a 4% increase and that was about 85% what we call reimbursement or rate increases and about 15% utilization. Now the utilization was primarily IV iron as we trying to optimize some of our positions that are interested in optimizing linear management with potentially looking at iron product costs but essentially it’s been primarily rate increases Q1 2010 to Q2 2010 were pretty flat to upper dollar to a little less than a dollar.

Again as we mentioned this year because of our essentially our utilization stable it has been for a couple of years in terms of depot and most of the drugs we will see them essentially two to three, two to four percent increase over the average of 2009 and then we are pretty much on that track if you look at it being in a 355 to 356 range so that’s our target to be within 2 to 4% and if we stay flat in the 255 range we will be pretty much past 3% for the year achieving our target.

Turning now to page 12 lets talk about the products side of the business or segment of the business. If you look at the chart 12 you will see that our overall revenue growth was 5% in constant currency and that includes sales to ourselves and that’s an important number because as we continue to expand especially in the international area in terms of acquiring dialysis clinics you will find more and more of the sales internal and they don’t show up in your external sales. In your external sales numbers.

However our external sales were about 3% growth in terms of constant currency, we are really pleased that North America, bounced back to above market at 5%, we are seeing a little bit this quarter international was in the 2% range and really this comes from couple of activities that we think will work their way through this year and as we looked back after the year we expect to be in a normal gross range of products in the international we are a couple situations that essentially are on going as we mention because of the economic issues in international. There has been a tendency of some of our customers to continue to use our machines for a longer period of time so therefore the machine sales have been soft but that essentially works this way out after a while and we know that when they but they will buy our products.

We also had a pharmaceutical registration or basically restriction in Turkey where we there has been a change in terms of how we can essentially sell our pharmaceuticals too so that our patients can essentially use them and they define pharmacies that the patients have to go to and some of them we didn’t have contracts with so there is a regulation change there in Turkey on the pharmaceutical side which has impacted our pharma business again on a temporary basis we will work our way through this as we go through the year and so those were the two areas we probably took away any work from 200 to 300 basis points in the international sales and those are things that essentially the guys are on top of them and we expect this as we said the back half of the year will see an increase in the revenue for the product area.

Turning to page 13 this is basically a look at the year and not a whole lot to mention here on a 13 again we had a 4% extra revenue growth constant currency and again as I mentioned for the first quarter the US was focusing with the Liberty Cycler and with IV iron internally basically we have done a very good job of converting our clinics for the new patients coming in looking to use both our own benefit and also there have been great acceptance for the Liberty Cycler for new patients coming on.

So, that essentially basically average down the products growth in North America for the first half and you see its basically bouncing back the second quarter and the same thing I think we saw here on second quarter in international. So, as they look forward then, I think I have mentioned that we expect the products business to basically get back into the mid to high single digit.

Moving now to chart 14 and talking the bundle and again I'm certainly not an expert on the bundle, so I will always say few words but result that there was some progress and I guess what FMC would like to do is we certainly would like to applaud the agency hard work and diligence in creating a very thorough comprehensive final rule. And I think by and large they listen to the community with, good dialog with the community, a number of things that were basically listened to and changed such as the base treatment that you are delaying the Part D drugs and the lab test.

And again I think the full morbid case mix was good to shrink that down in terms of basically administrating. But there is one area that quite frankly we still don’t believe that we are particularly pleased about it and that of course is the transition adjustment and its not that we haven't had good dialog, we just don’t quite understand exactly how this is going to be how its calculated and how its essentially why its supplied the way it is, but we do have a good dialog with CMS and may be agree to look at this again in 2012, if not before but its really the one area that I think it's not what Congress intend the 2% tariff cut is in there but I don’t think any of us were looking at an additional haircut due to transition adjusted at least if we went internal to a 100%. So at that point in time really I think a very good dialogue everybody knows they are out roll amount basically working on how we move forward and I think to give you some idea again we will talk about this on our capital market day third quarter Rice Powel, CEO of North America will give you basically a much better tutorial on what he is going to do and he is teams going to do, yes but I want to say that there are sort of three areas that we are focusing on and have been all year, one of them is the basically the calling performance, we have been focusing like I said on tightening up our EPO distribution and we think we are better than national average in terms of sub ten and we are really pleased with that, we’ve also had programs that have been underway now for almost 2 years on the right and the right return where we essentially have improved the mortality significantly in first 120 days, we think that’s going to be beneficial to both the patients and to the reimbursement and finally the hypo responders we’ve been looking at that pretty intently and we find that really nutrition infections an optimum IV iron therapy had some benefits in essentially mitigating some of the hypo responders. Again we define hypo responders I know there is other deficits but that’s sort of what where we are at this point.

Now turning to chart 15 lets talk about some of the international expansion, I wont spend too much time on that but I want to mention at the same time we’ve seen some real nice opportunities to expand our service business and our products business and we closed at the to beginning of Q3, the acquisition of Asia Renal Care. It adds about a 100 clinics to our operation and about 6,000 patients and the annual revenue is in the 80 million range. So we’re very pleased but more than that it gives us an a stronger position in about seven different countries in Asia Pacific where we would like to build up our presence to where we are true partners with the government payers, so that we can essentially support their programs and do the best we can basically for the patients and also reimbursement.

We’ve also essentially expanded our products business in Korea by taking over the Nikkiso hemodialysis business in Korea. At the same time, we formed a partnership with Nikkiso in Japan because they have a very strong machine base in Japan. We have a very good disposable base and as Japan is now going to open up with respect to service, we really need to have a strong partner in Japan and this makes more sense for us to work with Nikkiso than anyone else. So we’re pleased and I think that was announced right at the end of the year and finally, we’ve expanded our business in Russia. We see that certain regions of Russia are quite attractive with respect with respect to their commitment to dialysis and so we’ve essentially expanded our business in certain regions of Russia.

Moving now to my last chart which is 16, again I think we’ve talked about the quality of and I be it a little bit on the service quality but again it’s something we live by everyday and I think everybody knows that. We continue to see good quality in terms of products and service. We have increased our R&D budget this year essentially in the chronics area and we got a number of new products that will be introduced in the back half of the year. Again a new machine in North America and also the new machine in international and will borrow you with all the products that this time we do expect to see those prices into the market that GAAP year. Michael talked about the basically operating performance, so let me finish by saying we’re really pleased with the second quarter and the first quarter, we do reiterate our guidance for the year it's certainly not going to be easy but at the same time we’re very comfortable where we are this year. I take this point Oliver and let me turn it over to mike, and go into the details.

Mike Brosnan

Alright thank you Ben and let extend my welcome to them for all the participants on the call today. I’m going to page 18 or chart 18 in the materials that we distributed. Ben reviewed the details of the top line performance with you and I won’t repeat that again this year, other than to simply say you can see $2.9 billion very strong performance on the top line. New 7 % constant currency growth and 6% organic growth. That top line was transformed by our employees around the world, to an even stronger operating performance for the quarter. With earnings before interests and taxes growing 11% to $165 million, our margin improved for the quarter from 15.1% last year 15.8% currently. This represents about a 70 base point improvement. I will add little bit more color to the operating margins in a few minutes on a separate chart.

Continuing to move through the P&L you can see that our net interest expense continues to run favorably year-over-year and this largely due to the low levels of LIBOR and EURIBOR rates that we continue to enjoy. Our interest expense is essentially flat with first quarter of 2010. Moving to the tax expense line for the quarter you can see that the reported effective tax rates shows some variability and this is due to two specific valuation decisions we have taken in each of the quarters. Now I will take a minute to explain that so that you get a better sense of what our underlying effective tax rate is on our operations.

First, you may recall last year we had a tax claim on litigation and we have reported in the second quarter that we after a careful review of the facts in the second quarter of 2009, made the determination that we could improve the overall valuation of that tax case.

If you separate that favorable impact in our second quarter of 2009, you would see that the underlying effective tax rate was about 35% last year. In 2010, we were able to look at some additional tax assets and put some structures in place in the second quarter that will allow us to realize those benefits over the next several years. Consequently we were able to recognize the full value of those benefits in the second quarter.

Separating that valuation determination from our underlying operations would also indicate that the guidance that we provided you for 2010 of an effective tax rate between 31.5 and 35.5 is still the appropriate range with regard to tax on our operations for the year. Our performance in the quarter lead to net income of $248 million or 12% double-digit increase over the comparable period for the prior year.

Moving to chart 19, to just spend a few minutes on our first-half results; again you can see very strong top line performance at $5.8 billion that represents 8% growth on our constant currency basis and 7% growth organically. Again this was transformed by our employees to 9% growth in earnings before interest and taxes or just under $900 million, $888 million to be precise.

Our EBIT margins for the first half of 2010 are 15.2% and on the surface that shows about a 10 basis point reduction over the prior year, I would just like to remind you that in the first quarter we recognized the effects of the devaluation of the Venezuelan Bolivar and the one time affects of this event reduces our reported margin for the first half by about 20 basis points, we also indicated in our guidance for the year that our reported EBIT margins would be around 15.6% or roughly flat with 2009. Finishing the first half we continue to believe that this will be the case for fiscal 2010 EBIT margin around 15.6%.

Our tax expense in the underlying effective rate is consistent with the discussion that I just went through for the second quarter and all of this produced an overall results for the first half of the year of net income $459 million or about a 10% improvement on a year-over-year basis.

Moving to page 20, and our operating margin development, you can see for the second quarter end the 15.8% margin and the 70 basis point improvement in our global business. In addition, both of our operating segments delivered margin improvements the North America growing 40 basis points and international including 150 basis points. The North America the expansion is the result of the 4% improvement in revenue per treatment that Ben already commented on. Along with the increases in our operating expenses and our consistence with the guidance that we provided you at the beginning of the year of operating expense increase of roughly 2 to 3% for fiscal 2010. On the international side of our business our top line improvements were coupled with additional leverage in our operating expenses and some favorable foreign exchange to produce a 150 basis point improvement.

Moving to page 21, and the start of our discussion of cash flows we always like to start with our receivables management around the world and again we had an excellent quarter for cash collections for the one day improvement in our bubble business to 71 basis you can on the chart. North America continues to demonstrate the results of hard work and good process control by reducing DSO an additional day for a record 51 days for that we reach in the world. And international has crept up a little bit in the very difficult environment to a 113 days we continue to collect the amounts due in these markets. It’s a little bit slower than our recent history would indicate. Moving to page 22, selling the cash flow performance for the second quarter again we had very strong cash flows and you can see that our cash flow from operations came in at about 10% of revenues this is consistent with our guidance and represents more of our ongoing historical trend. We have had some periods of time in the past where because of the dramatic reduction of our DSO we were showing 11 and in fact 12% but the 10% you are seeing here is consistent with what we indicated our performance would be for 2010.

Our capital expenditures are a little on the lighter side coming in at about 4% of revenue and traditionally, we’ve lent about 5%. And our mix is at 60-40 in terms of maintenance and expansion capital. As a result of this, our free cash flow is coming in at about 6% revenue and a 23% increase year-over-year. Acquisition spending at $68 million is a little lighter than the first quarters $82 million but we continue to be opportunistic in this area and the spending for the quarter and half as Ben indicated is a little bit more heavily weighted towards the international side of the business this fiscal year.

Moving to page 23, the first half results in terms of cash flows, operating cash flows are at 11%, CapEx is consistent with Q2, a little bit lighter than the norm, just under 4%. Free cash flow shows a $127 million improvement, and a very strong 7% of revenues. Our acquisition on a year-to-date basis at a $150 million are consistent in terms of mix with the second quarter.

Turning to page 24 and just spending a few minutes on our debt and the overall health of our balance sheet, our debts did increase slightly in the quarter to $5.8 billion. This is not unusual for us as seasonally, we typically pair dividend with shareholders in the second quarter and that usually results in a slight up tick to overall debt. Our leverage ratio was flat with year end at 2.46 times and that’s consistent with our guidance for the year of less than 2.5 times. We did have our annual review with ratings agencies and as you may know, Standard & Poor’s and Fitch upgraded us from BB stable to BB with a positive outlook and Moody’s maintained our BA 1 rating for the stable outlook.

Lastly we indicated in our prior calls with you that we planned to extent the credit agreement. We will do that extension of our term loan A and our revolver in the third quarter. We anticipated closing in late September. We also indicated previously that we would address our remaining 2011 maturities in late 2010 or very early in the first quarter of 2011.

We continue to believe that that’s the right timing for the company and we anticipate no problem in achieving these capital markets objectives. Turning to my last slide on page 25 with regard to our outlook for 2010, I provided you with some comments during the presentation with regard to the details, but we would like to reaffirm our guidance for the year with revenues greater than $12 billion, net income in the range of 950 to 980 million. Leverage ratio of less than 2.5 times, capital expenditures in the range of 550 to 650, frankly with the results I just reported, we’d probably be on the lower end of that range and we are increasing our guidance with regard to acquisitions. We had previously told you that we would spend up to $400 million. We now believe that it's appropriate to increase that to an amount of up to $500 million or increase the envelope by approximately $100 million.

I’ve stated before that our EBIT margin guidance was flat in 2009. I would expect our guidance on interest rates would be less than 5.5% inclusive of the transactions we anticipate in the back half of the year.

With that, thank you for your attention and I’ll turn the call back to Oliver to open it up for questions.

Oliver Maier

Great, thank you Mike, thank you, Ben for the update and the presentation. Think we can now open up the lines for the questions Brian.

Question-and-Answer Session

Operator

(Operator Instructions) We will take our first question from Mr. Kevin Ellich of RBC Capital Markets.

Kevin Ellich - RBC Capital Markets

I was wondering if you could provide us a quick update on your thoughts on bundling and have you guys started to change your pharma utilization trends yet?

Ben Lipps

Kevin, no we have certainly been looking at some alternatives not knowing exactly where the quality incentives or disincentives would land and so we have started some programs and now we will probably accelerated and during the back half of the year in terms of trying to essentially look at optimization here.

Kevin Ellich - RBC Capital Markets

Just wondering on the acquisition front, you guys update at the guidance trend to up to 100 million, I thought I saw something this morning about Gambro’s peritoneal dialysis business. Any sense did you guys buy them?

Ben Lipps

No comment at this point. Send us the note.

Kevin Ellich - RBC Capital Markets

Going back to bundling, I think I saw some head quotes and from earlier as Ben talked about how you think it's going to be a positive. You know what was better than expected in the final reg, first is we know that 3.1 was disappointing. Where do you think you can really optimize treatment modalities and then drive cost savings?

Ben Lipps

Kevin I think it’s just a little early to just actually give you some clarity on that. But I think as we step back and they estimate our orders from the dialysis industry standpoint the real positive growth is we get an automatic update starting in 12 and that’s been something that we have been basically remiss and not having.

Secondly if you look at some of the quality incentives now and some of the latitudes that will have to actually provide better care and the situation where we can innovate and do some of these things. We think it is going to be good for the patient and for ourselves. So long term this looks like and I still believe it is going to be positive for all three of us. The payers and the patients and ourselves.

Clearly the transition deduct is a, is sort of a negative at this point. But I am assuming based on the good working relationship between the industry and CMS by 2012 we will get that behind us. So when I talk long term I am really looking at 12 and beyond. I had no more clarity than that at this point we just it’s only been out a week and we are busy. I haven’t even got through all 900 pages so. I am in 400 so I still have 500 to go, give more in the next couple of months we should be able to look at this pretty carefully.

Kevin Ellich - RBC Capital Markets

Okay, that’s helpful, and you know thinking about the acquisition activities you guys have done this looking at Asia and Russia. Should we assume that’s where you want to continue to focus here your attention or other geographies that you want to extend into?

Ben Lipps

We are little bit, I don’t mean to, we are little bit opportunistic and that is that outside the US we basically operate in about 30, 35, 36 countries. And within those countries we tried to operate in a payer region and so in each of those regions whatever becomes available that is attractively priced, the good programs, good provisions. We will expand and purchase it because we like to build up our presence in each of those areas to enough that we are clearly a partner with Payer. So, we basically just have our radar screen and our map and whatever comes up in those areas, will pick up. With the economic crisis being what it is around the world, we would expect more activities in the back half of the year. And I think you will probably see that. But it is not major acquisitions. These are basically kind of like five to seven clinics at a time.

Kevin Ellich - RBC Capital Markets

Got you. I appreciate that. Thank you.

Operator

Thank you. We will now move to our next question from Andreas Dirnagl of Stevens Incorporated. Please go ahead, sir.

Andreas Dirnagl - Stevens Incorporated

Just a sort of follow-up on what Kevin was asking. You commented that pharma utilization is up, especially year-over-year, but I guess within that increase in pharma utilization, you are seeing a decrease in EPO utilization, due to a tighter control of iron. Is that correct?

Ben Lipps

No, basically I went back and looked at that. We are basically seeing a tighter control which means that we have got more in the 10 to 12 and our EPO utilization has really been pretty flat from 2007 through 2010. So, this is just, what are the influences below 10. I’m calling those non-responders or IPO responders. So we are just, we are just trying to optimize our distribution and have as below there’s a few below 10 and this is few above as well. That’s really all we are doing at this point.

Andreas Dirnagl - Stevens Incorporated

And then, sort of, maybe a little bit of a premier to the sort of the Analyst and Investor Day that’s coming up, but in terms of why you were talking about with Kevin, I guess that would be kind of the goal here, wouldn’t it though, I mean as we move into the bundle as to find ways to reduce utilization of EPO, probably through tighter controls of other areas in order to not have an impact on quality.

Ben Lipps

That’s certainly what I think everybody has been discussing and the quality standards out now so we clearly know what we are dealing with. So the question is how do you tighten the distribution and basically there is number of things you can do to do that. But again we'll give you more flavor in a couple of months, but that’s down the path that we are on right now.

Andreas Dirnagl - Stevens Incorporated

Okay, great. And then finally on the transition adjustment that 3% or 3.1%, both you and DaVita have been pretty vocal over the past few days. That’s still something that you have sort of a fundamental disagreement perhaps with CMS. Is it correct in thinking that one of the ways that you guys see this as being incorrect is that their estimate of the percentage of clinics that are going to opt into the bundle is too low because that is the generator of that 3%, if that number were higher, then the transition adjustment would obviously have to be lower. So, am I thinking about that in the correct way?

Ben Lipps

You are very much, so and I think the issue for myself and I think for anyone is that we all have to declare when we go in and what are we going to do by November 1st, I believe it is. And so, I feel like the real penalty to a group that declares to go in a 100%. They’ll have the transitional gesture applied to them. So, I'm just having a hard time understanding the logic of why we would have a transition gesture if we basically agree to go in 100%, okay. And that should all be known in time for somebody to calculate it for ’11. But I'm sure there is more behind it than just my simple analysis, okay.

Andreas Dirnagl - Stevens Incorporated

And I really didn’t mean to sort of state this as what could potentially be seen this kind of a (inaudible) question, but if that’s the case then, I mean basically isn’t what you and DaVita are saying that you expect to see a higher percentage of the clinics opt in and given that you two control two-thirds of the US market, we have to make the assumption that a large majority of both of your clinics are very likely to opt in then as of January 1st.

Ben Lipps

That would be the math and I think people have calculated it and looking at anywhere from 37% to 75%. So, that’s exactly right and again my position and really we haven’t discussed this too much with anyone but it because I felt that the end of the day they will still come to a fair assessment which means once you know what's going to happen if there is a honest transitional gesture, then it should be applied, but it should not be applied in a fashion were you are penalized twice.

Andreas Dirnagl - Stevens Incorporated

Sure. And then I guess final on the topic would be, would you have an expectation that if CMS were to sort of the review this in 2012, is there an expectation that the industry could get some money back from that or is it just the expectation that they would reduce the 3% to some lower level or eliminate it all together?

Ben Lipps

Well, you are way ahead of me on that I guess was really encouraged by the fact that they said they would review it, because our relationship with them is such that is very good working relationship. So we appreciated their comments that they would review it. Now what they do have to review honestly I would be only speculating but I am pleased that they said they would review it.

Operator

Thank you. Our next question will come from Mr. Tom Jones of Berenberg. Please go ahead, sir.

Tom Jones - Berenberg Bank

Good afternoon I just got a couple of question, one for Ben, one for Mike and one for I am not sure who. Ben just in terms of your comment you made on Japan. You made it very briefly talking about a potentially opening up from a service standpoint. As a company with lots of capital and fewer places than you might like to put it, I wondered if you could give us some more color on what your plans from the service side are for Japan. The second question probably from Mike on payer swaps, you’ve got quite a sizable amount of payer swaps to that [landing] is what I understand. I just wondered how much do those, if and when you come down to refinance your term loans, whether you need to do something with those as well or whether they will continue to be a bit of a drag on your interest charge. And the third question, CMS produced a fairly detailed impact file after they produced the proposed bundle rule. Do you know either if they have or if they intend to publish a similar excel for with the impact facility for the final rule? I can’t get a straight answer to CMS at the moment.

Ben Lipps

Okay. I probably can give you an update to the last one, Tom. I certainly have heard that, that is there intention but honestly that’s really just talking with our guys. So, the feeling is that, that probably will be done, but we don’t have any assurance that it will at this point or when. So that’s kind of I think we are giving the same answer you have, it’s a little early to get the right answer there.

Tom Jones - Berenberg Bank

It would seem divested to that after the 1st of November, but you said you think that that should be the sort of the line in the [sand bar] when some point this all that, they should at least get it done so the providers can work to CMS’ math from a clinic crisis.

Ben Lipps

I believe they will do that. It’s a very extensive rule, they’ve been working pretty hard at it and we’ve all had a lot of dialogues. I think it’s probably their goal, but I have no inside information that would say that’s the case. But they’ve been pretty upfront with this I think through this whole process. To Japan, basically (inaudible) has a very machine position in Japan. And we’ve got a pretty good dialyzer position with production. So, we just decided to rather than spend a lot of money and try to bring our machines to Japan, that it may be in the best interest of our company to find someone to work with there, and we believe that service area is going to open up and therefore we would like to have a partner in Japan that we’re working with on the products area, so they will have distributions system, expensive distribution systems so we can essentially effectively move into the service business over that five years. So that surely the decision we made is to focus on the service business in Japan rather than trying to insert our machine into Japan. Okay.

Tom Jones - Berenberg Bank

Is it kind of a medium and long term thing, the service business I think Japan, there’s nothing changed on that front in terms of any expected

Ben Lipps

I don’t know we just did, it makes more sense for us to essentially find a partner now and be working with them and essentially get prepared for the service side in Japan.

Mike Brosnan

Tom just coming back to your question for me, the payer swaps, you’re talking about the interest rates swap. That’s what I thought, those swaps essentially come due in 2011 and at the time that we put those in place we did not hedge the entire variable rate portfolio. So we will be able extend the term loan A and the revolver without having any effect or an overhang in term of those swaps, because we do have the term loan B that will continue to the outstanding through 2012 and early 2013, and the swaps that we do have on the books will apply to those once we refinance.

Operator

Thank you. Our next question comes from Lisa Clive from Sanford Bernstein. Please go a head.

Lisa Clive - Sanford Bernstein

A question on private payers. Yesterday evening DaVita mentioned they had recently signed two long-term contracts with large payers, those of which were on a bundle basis. What sort of progress can you made on this fund and are you happy with the proportion of your private payers that are bundled and how do you expect that to change over the next 12 months or so. I guess I will start with that question.

Ben Lipps

Yes, I think we mentioned last year as DaVita has also mentioned that there has been a movement towards the payers requesting the bundles in the commercial side, and we think it’s good for them, it’s certainly good for us because they are longer term contracts with certain escalators and so I think this is continuing and probably gaining momentum but I can’t tell you exactly what percent it is and I can’t tell you that we will apply to every commercial payer over the next couple of years. But it’s definitely increasing and we’ll probably continue to increase throughout most of ‘10 and into ‘11.

Lisa Clive - Sanford Bernstein

And then another question, given the increase in your expected acquisitions, you obviously have some opportunities outside of the US. So do you think we could potentially see a small wave of consolidations over the next maybe six to 12 months given the sort of challenges and uncertainties that bundled pricing may bring up for the smaller clinics?

Ben Lipps

Well, I think I have commented on this in the past. We really think that the US has a very stable ownership situation and that is where you have two companies DaVita and ourselves I believe are quite respectful in this field and we are certainly always driving for quality and we have to size them when we can afford to spend some money but do things for quality, and then we like to provide those to other smaller providers. So I think at this point in time FMC is probably not going to be too active in purchasing other clinics, because we think it’s healthy for the industries that have independent clinics. But we will do everything we can to make sure that they are financially sound by selling them whatever services they need as we analyze the bundle. As I am sure DaVita will too. So, at this point in time I think that FMCs program as far as acquisitions and most of our acquisition money is focused outside the US.

Lisa Clive - Sanford Bernstein

And then one last question, given the focus on bundled pricing topics such is disease management have really sort of slipped into the background for obvious reasons, with the accountable care framework and the (inaudible) health reform. What would Medicare really have to do to enable you to meaningfully expand your disease management offering and do you have any idea as a sort of longer term timeline?

Ben Lipps

Well, I think maybe as far as the analyst are concerned, it might have slipped into the background, honestly, within both DaVita and ourselves, this is in very much an FD project because I think both companies, as well as CMS have been quite pleased with results of our demonstration projects. So, we have been actively working with the industry to try to get a accountable care pilot under this new innovation pilot program. That hasn’t happened yet, but I think in terms of a lot activity going on we are all very pleased with the results and we think the patients will too. So yes, we are still trying to move it to the next step which would be a large pilot, but is FD supported by the industry, it will all be an industry type project.

Operator

Thank you. We will now move to Morgan Stanley and Michael Jungling for your next question. Please go ahead.

Michael Jungling - Morgan Stanley

I have three, first on the bundle, then as you progress to the bundle form 1 January, 2011, did I understand correctly that the drug paradigms you will adjust for the second half meaning that we may site reduction in the revenue per treatment in the US but for the benefit of 2011. Question number two is on your international dialysis care business. Can you comment as to why we are seeing that the constant currency revenue treatment continues to decline if you look at 2008 revenue per treatment constant currency was up 8% in 2009, up 4% in the second quarter, we are down now to 0.5%, what is causing that trend? And then the last question is, can u grow that product line in the US in 2011 in light of a positive impact from the bundle but also a competitive threat and pressures from Fareham? Thank you.

Ben Lipps

Let me go to the international one first Venofer and then we will talk I think about the revenue treatment. Basically remember we moved into the bundle in Portugal where we have a significant market share of the provider business and that escalated the revenue per treatment into I think 6% to 8% range which was really a 12 to 18 month type of situation. So, that’s not the rate that you would look at, on an ongoing basis. Our target is 2% and in terms of constant currency growth, and basically we are little light of the first half. We are about 1% but Europe is running at about 2% and again what works for us is that we don’t quite get the 2%, that means that the inflation is not as high, so our costs are not as high as inflationary cost. So, it’s really sort of balance situation where you still have the profitability as you can see from second quarter. So, it really depends on the inflationary drivers in the international. Except for when we can roll in the country bundle by bundle, rolling in a bundle. So, I think you are going to be looking at somewhere around 2% as the ongoing number.

In terms of Venofer, again we’ve got a number of programs going. It’s a very safe drug. We think there are certainly ways in which you can optimize its use, and yes, get performance increases in terms of anemia output or anemia outcomes. And so, we have a number of programs that we will be talking about during the back half of the year, and essentially one of them has already been approved by FDA and this is a Venofer pump that has a particular algorithm because we believe that you should be giving smaller doses or consistent dose, maintenance dose and essentially move the TSATs and space things around.

So, we’ve got a lot of programs now that are coming into play back half of the year, with them for because we think it’s safe to do this (inaudible) record. And I think on the flip side of that, the fact that we will be offering different doses and different algorithms and so on and so forth, that is something that we believe is better than having a large dose once a month. Okay. So that’s why we’ve got into this, two or three years ago. The third question you talked about the revenue per treatment in the back half. I don’t know right now from where I sit that we, anything we do during the back half of the year would necessarily reduce the revenue per treatment. We said it would be pretty flat for the year.

Most of the things that we’re doing now, we’re getting our algorithms together, we’re looking at points of the medical advisory boards, but I don’t think anything there is going to essentially a small value utilization that we’re talking about is going to influence the revenue per treatment. It’s driven pretty much by the contract. So at this point, don’t know that we plan to see that drop significantly in the back half but I’ll have to look at that a little more carefully in terms of how fast we accelerate some of these programs.

Operator

We now have our next question from Ilan Chaitowitz of Redburn Partners. Please go ahead sir.

Ilan Chaitowitz - Redburn Partners

Just on the private payer side, can you please give us any insight into any changes you've been having in your patient mix of private payers over the last six months and any changes you might anticipate over the next six months, particularly in the light of DaVita's comments last night? And on a similar vein, can you talk to how your ability to drive through price increases with your private payers is proceeding, if you're finding that tougher or if the situation is unchanged?

And the final question relates to a comment that you made in your Q2 report about being vertically integrated. I was just wondering if the new product launches that you're talking about later in this year, if that is on the machine side or the dialyzer side or both and if those are being specifically geared towards helping extract efficiencies on the services side 2011 and onwards.

Ben Lipps

Let me take the last one first. Absolutely, we were looking forward to basically introducing some capability in the machines and our team machines in the US essentially has complete computer interface for algorithm downloads and things like this because essentially we have to find ways to provide the same output and the same outcomes with less costs and so one of the areas is have the machine basically do more. So you will see that at ASN as we go through. Now as far as private pay, I think I get my arm broken if I said anything other than that. It’s always difficult in the private pay field and our group, as well as the DaVita group I think is probably working everyday, but when you get to a bundle contract you have a much tighter relationship with the payer and that is you have a multi-year contract and you have some sort of escalator. So everybody is sort of a little bit closer in terms of or at least there’s less worry, I’ll be back at the table next year. So, I think from that standpoint the more bundling we have, the better the industry is in terms of private pay.

Now as far as the commercial mix, the discussion, quite frankly we have continued to see depends on you can look at it as true commercial or you can look at it as commercial plus VA plus Medicare Advantage. We have seen that continue to creep up over the last couple three years and we believe that we are probably as an industry have gotten through where we expect to see unemployment come down. So probably we are at a point where this is going to less of a problem a year from now than it is today, but we have been able to manage it. Now with a lot of effort just like everybody else to make sure they don’t lose their insurance if they have it. So, that point this is kind of where we are.

Operator

Thank you. Our next question comes from Stephan Gasteyger of Jefferies. Please go ahead, sir.

Stephan Gasteyger - Jefferies

I have a quick one, please, on bad debt trends. You mentioned the improvement in that in the international field, and I was wondering if you could give us some more color on geographies. I was wondering if -- how this looks like in Europe and southern Europe in particular, considering the ongoing tough economic situation, if you see an improvement there as well or if you would rather see deterioration. Thank you very much.

Ben Lipps

Yes. I think that we are seeing, the improvement that we mentioned is largely coming from Europe, we appreciate that there is a lot of stress in Europe right now with the sovereigns, but frankly because we are in the healthcare field and in particular providing a service in the healthcare field we see that the bills are being paid and we are not experiencing some of the cuts that other parts of the healthcare food chain are seeing today. So overall, we are seeing bad debt improvements in, improvement in bad debt ratios in Europe. I think the situation in the US is still and as it gets stable in the Asian markets at this point in time.

Operator

Thank you. We have the next question from Mr. Martin Wales of UBS. Please go ahead, sir.

Martin Wales - UBS

Thank you. Firstly, could you talk a bit about what you saw in terms of revenues from your drug sales in the first half of the year and what trends you're seeing there? And secondly, I note that in the bundling documents are suggesting there are smaller players that should look to form some form of group, personally organizations. Is there any business opportunity for you there to take advantage of what you're already doing?

Ben Lipps

Let me try to take the first one and second one, I got to tell you we haven’t been that much thinking about how we approach the question of volume groups. The pharma sales are primarily in the US driven by essentially Venofer. We continue to see that grow. The utilization has increased per patient, and we are about 75% market share of Venofer in the US and externally as I mentioned earlier we had set back in Turkey because the pharmacy regulations changed where we couldn’t really provide pharmaceutical products to our patients. We have a very large patient base in Turkey. And so we are in process of adjusting to that. So, internationally they are down a little bit and in the US they continue to grow both internally and externally. As far the planning groups, I don’t think they’ll really review that close enough with Reece and the group in the US, but that’s certainly something that we’ll probably look at a number of our options that we are looking at here over the next two to four months.

Operator

Thank you. Our next question comes from Invesco, Miss Ann Wireheim. Please go ahead.

Ann Wireheim - Invesco

Most of my questions have been answered. First I guess just one clarification on what you were saying with a commercial patient mix. You said that you were seeing it increase over the past three years. Is that correct?

Ben Lipps

I think it was over the last couple of years, we’ve seen slight increases. I don’t know that we shared data back in forth, I don’t really know where the other groups are so it depends on kind of what they should coming from, just point in time that we’ve not seen a decline, that’s all.

Ann Wireheim - Invesco

And when you talk about commercial, you said that you do include VA in there?

Ben Lipps

Well, it’s kind of like definition of mortality. I always consider commercial anything, I know its not, Medicare, it’s Medicaid and clearly we do consider the VA as a commercial payer, we negotiate with them. So right now there are sort of two groups of commercial, one on this, what you called quote on quote or pure commercial, then the other would be Medicare Advantage VA and essentially the two commercial. So, we look at both of those.

Ann Wireheim - Invesco

And then just on the VA front, I know DaVita had mentioned that they had reached kind of a compromise with them as far as rates decreases going forward. Have you reached a similar agreement or are you still in negotiations with them?

Ben Lipps

Well, again on that preview to the discussion, I didn’t get a chance late last night to listen to it, but I think that basically the VA and their drive towards reducing the Medicare rates is probably not feasible when you look at we taking on that particular pricing as an industry, okay. So I think everybody has stepped back from it and yes we were negotiating with them. And I guess if that's the case that we just said that, that’s the case. So, yes, we're all working with them but other than that I don't know, I can't tell anymore than that.

Ann Wireheim - Invesco

Okay. And then one last housekeeping item. What was your revolver availability at the end of the period?

Ben Lipps

Okay. Mike.

Mike Brosnan

We'll look it up for you.

Ann Wireheim - Invesco

Okay, great.

Mike Brosnan

I'll come back and answer that question.

Operator

Thank you. We now have a follow-up question from the Lisa Clive from Sanford Bernstein. Please go ahead.

Lisa Clive - Sanford Bernstein

One last question. In reading the bundled pricing final rule, there seemed to be a lot of concern that some patients may end up bearing higher out-of-pocket expenses under bundled pricing. Do you see this as an issue and will you be taking any particular steps to further manage bad debt expenses in the US?

Ben Lipps

We briefly touched on that and I think it just depends on basically how the Medicaid providers, how we get reimburse through that system. So, at this point in time it’s certainly something everyone is aware of but I don’t have any more insight in that.

Operator

We now have our next question from Mr. Justin Lake of UBS. Please go ahead, sir.

Justin Lake - UBS

Just one question here and I wanted to follow-up. I know a lot of questions have been asked about payer mix, but just wanted to drill down. You talked about true commercial, which I think is what we're all trying to get an apples-to-apples number on. Are you saying specifically that that true commercial payer mix, the ex-VA and Medicare Advantage, has been flat over the last, let's say, four to six quarters as the economy's declined?

Ben Lipps

Actually, it has been flat to slightly up. So, without saying any more than that, I have also been informed here that we do have agreement with the VA. So, we have that one covered also and again slightly up.

Justin Lake - UBS

And when you think about that versus what your largest peer in the United States, DaVita, is saying about their payer mix, is there anything that you can tell us that might help us reconcile between those two?

Ben Lipps

I think it depends a little bit on where you are coming from and that is quite frankly maybe DaVita was a little higher than we were. So at the end of the day, my guesses were all in about in the same range and I just wouldn’t read the whole lot into it, at least I don’t so I think all of us who worked very hard to try to during this downturn in the economy to make sure that our patients have the right to commercial coverage, we help them keep it okay. And so basically, that’s kind of the way I look at it.

Justin Lake - UBS

And DaVita's put that number specifically at 11%. Can you give us your comparable number they are on true commercial as a percentage of the total?

Ben Lipps

I’d prefer not to and if someone puts out that number, I'm sorry I don’t know that today so. Let me just say that we’re in the same range but I don’t think we ought to put out a number.

Operator

(Operators Instructions) We move to the question now from Mr. Martin Whitbread of Credit Suisse. Please go ahead.

Martin Whitbread - Credit Suisse

Just one actually own on your comments on the increasing adoption of the Liberty Cycler in PD and Ben, I don't know if you can share your view on where PD may be heading in the coming years. Do you look to materially grow your share of PD patients? Thank you.

Ben Lipps

I think the one thing that a bad delivery cycler is we are very pleased with the recent proceedings that happened with respect to the patent dispute with Baxter, but we see PD as a viable alternative to hemo for certain patients and we want to make sure that that’s always available to them. And so, we are not sure when you look at all of the bundle payment issues whether it will drive more or less PD but we feel that, that we want to have available and we do have the right start and the tops program where we inform the patience for the options. So, it very well means that PD will grow a couple of percent under this new situation. But at this point of time the matter of pushing PD is much as it is to having the capability if they elect to go to PD that we have it.

Martin Whitbread - Credit Suisse

Actually, one more question, if I can. Your acquisition of XCorporeal that happened I think at the end of last year. How is that being integrated into your own wearable kidney activities and prototypes? And do you expect to continue developments of both products?

Ben Lipps

Yes, we have, I’m glad you asked, actually there were two products that we were interested, one was a portable machines using sorbent. So I think their pack machine and were developing that pretty rapidly. And the hemo side of the wearable, that’s pretty much staying with Dr. Gura and the Group. We believe that there are some real advantages to the PD wearable, but we’ll show that as we bring the sorbents out and basically show what you can do with regenerating fluid right on the cycler as it sits today, and so you will see that over the next 18 months.

Oliver Maier

I think Mike, we have the answer for Anne from (inaudible) she consigned the availability on the revolver.

Mike Brosnan

I may extend the answer a little bit if you getting it general levels of liquidity of the available to the company, but under the revolver we had about $364 million available of we also have a receivable securitization program in the US with a drop of balance of $340 million and we have cash on hand some of which is restricted, but upwards of $700 million all of which would be available to address any financial needs we might have in the back half of this year.

Operator

And our final question today will come from Rosanna Burcheri of FrontPoint Partners. Please go head.

Rosanna Burcheri - FrontPoint Partners

A few questions. First of all, sorry, I lost myself during the presentation. In terms of the international sales, you said that they were weak for three reasons. I got the machine sales that looks soft and that looks like there is extension in the sales cycle. I got to the pharmaceutical problem that you had in Turkey in terms of registration. I didn't go to the third reason.

Ben Lipps

There were no surgeries in south, you did miss it, I was talking about the product sales and there were only two reasons that machines and the pharmaceutical the actual service side of business grew very strongly.

Rosanna Burcheri - FrontPoint Partners

Okay, the second thing season, the revenue was frequent in the US, DaVita has been explaining that they had this drop of $9 and $5 top of this $9 because the position either changed their prescription and I suppose it’s because of the EPO, you are sort of saying that the EPO usage has been stable. Could you just help me understand why there is this difference between you guys?

Ben Lipps

I don’t know that I have an answer on that one. Again it’s as we look at it, I guess it depends on sort of both does operate by what our medical group essentially decides to do and so if the medical group has some ideas on some diseases that are slightly different than what all physicians would feel, you may find the difference essentially in utilization. But I honestly, it depends on where you are coming from rather than where you are today, so I see a comment in any change in the reimbursement I can only comment about sort of where we are coming from. But I think we are pretty much on the same page today.

Rosanna Burcheri - FrontPoint Partners

And the third question and last that I have is in terms of the cost and in terms of CapEx and G&A that we should expect for the implementation of the bundling, is everything inside your guidance of plus 2% for the year or we have to expect something more backend loaded?

Mike Brosnan

Yes. Just to confirm because I think we indicated before that our guidance of our overall spending level of 2% to 3% for fiscal ‘11 is inclusive of what we believe we would need to spend on the bundle implementation.

Operator

That will conclude today’s question-and-answer session. I would now like to turn the call back to our host Mr. Oliver Maier for any additional or closing remarks. Thank you.

Oliver Maier

Thank you so much everybody for the presentations and for the questions, and we wish you all the best and see you actually at the calendar market (inaudible). Thank you, so much, take care, bye.

Operator

Ladies and gentlemen, that will conclude today’s conference call. Thank you for your participation. You may now disconnect.

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Source: Fresenius Medical Care AG & Co.Q2 2010 Earnings Call Transcript
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