Fresenius Medical Care AG & Co. KGaA (NYSE:FMS) Q3 2023 Earnings Call Transcript

Fresenius Medical Care AG & Co. KGaA (NYSE:FMS) Q3 2023 Earnings Call Transcript November 2, 2023

Fresenius Medical Care AG & Co. KGaA misses on earnings expectations. Reported EPS is $0.28 EPS, expectations were $0.37.

Operator: Ladies and gentlemen, thank you for standing by. I’m Andrea, your Chorus Call operator. Welcome, and thank you for joining the Fresenius Medical Care Q3 Results Conference Call. Throughout today’s recorded presentation, all participants will be in a listen-only mode. [Operator Instructions]. At this time, it’s my pleasure to hand over to Dominik, Head of Investor Relations. Please go ahead, sir.

Dominik Heger: Okay. So unfortunately, we had some technical issues, but I’ve heard the introduction has happened. Thank you, Andrea, for the introduction. As already mentioned, we would like to welcome you to our earnings call for the third quarter 2023. We appreciate you joining us today to discuss the performance of the third quarter. I will, as always, start out the call by mentioning our cautionary language that is in our safe harbor statement as well as in our presentation and in all the materials that we have distributed yesterday evening. For further details concerning risks and uncertainty, please refer to these documents as well as to our SEC filings that have already happened. As we have a hard stop at 4:30 CET, we have prepared only a short presentation to leave time for questions regarding the quarterly earnings and for our new CFO to introduce himself.

[Operator Instructions]. I’m aware that there is, with GLP-1, one dominant topic in health care research overall, which we fully understand, but we would appreciate if we could focus in this call on the quarterly business development. With us today is, of course, Helen Giza, our CEO and Chair of the Management Board and as just mentioned, for the first time, Martin Fischer, our CFO. Having joined the company on October 1 and after quarter end, Martin will share a bit about his background and focus areas in his new role, but he will not answer questions today, but for sure in our call in February. Helen will provide an update on the business development, financial performance and outlook and will then be available for Q&A. And with that, Helen, the floor is yours.

Helen Giza: Thank you, Dominik. Welcome, everyone. Thank you for joining our presentation today and for your continued interest in Fresenius Medical Care. I’m very excited to talk to you today about the meaningful progress we made in the third quarter as we executed against our strategic plan. However, before I begin the presentation, I wanted to update you on two changes to our Management Board. As announced earlier this week, will succeed as Care Delivery CEO as part of a planned transition following Bill’s plans to retire by the end of the year. Craig has many years of proven track record of operational management experience and successfully driving profitable business growth in different companies in the U.S. health care services industry.

He will be a very valuable member of our Management Board and will continue our turnaround and transformation while leading Care Delivery into its next chapter. The second change is our new CFO, Martin Fischer, started on the 1st of October. I would like to say how thrilled I am to be joined here today by Martin and I’d like to hand over to Martin to introduce himself.

Martin Fischer: Thank you, Helen. Good afternoon and good morning to everyone on the call. I’m honored to speak with you today as the new CFO, as I’ve just completed my first month in the company. I would like to share a bit about my background and why I’m so very excited to be part of Fresenius Medical Care. I spent most of my professional career with the technology company side, especially within its health care division. In my most recent role, I served as the Global Head of Finance for the diagnostics segment of Siemens Health — based in — New York. Prior to that, I held the — area of management roles, mostly in finance leadership with some positions in corporate as well as operational areas. I have extensive experience in the European and American health care markets and has the opportunity to be an active part of the IPO of Siemens Health — in 2018 and to shape the stand-alone organization of the newly listed company post-IPO.

Joining Fresenius Medical Care was a very conscious and deliberate decision on my part. FME is a global player with a great company purpose, with a great legacy and an even — price of future. In my role, I will work with Helen and the team to drive forward the successful turnaround of the company, particular attention will be paid to securing sustainable profitable growth. A prerequisite for this is the continuous implementation of the FME25 transformation program and a stringent financial approach. I will focus on driving performance with clearly defined value creation priorities, a targeted resource and capital allocation and rigorous special assessment of our investments and strategic treasures. At least doubling the return on capital by 2025 is one of my priorities as is a clear commitment to manage the leverage ratio.

To me, transparent capital market communication is a key element of my approach. As a pragmatic and optimistic person are highly value clarity, integrity and reliability. It is very encouraging to see the company’s turnover measures already beginning to translate into improving financial performance. I’m optimistic about our ability to drive further improvements to 2025 and beyond. I look forward to speaking with you in the future. And with that, I will hand back to Helen.

Helen Giza: Thank you, Martin. I’m really excited to have you on board and already see how great we are working together as a team. I will now begin my prepared remarks on Slide 4. You are all familiar with our strategic plan to unlock value as the leading kidney care company. And I would like to highlight some of the accomplishments of the quarter. The simplification of our governance structure with change of legal form is the only remaining structural element to finalize. And I’m pleased to report that we have cleared all relevant hurdles and expect the conversion to be completed by December 1 of this year. With that, we will have completed all of our major structural changes within less than 1 year. We continue to advance our operational efficiency and turnaround plans.

Our FME25 transformation program is well on track to deliver EUR 250 million to EUR 300 million in sustainable savings by the end of the year. In the third quarter, we realized an additional EUR 97 million in sustained savings, bringing year-to-date savings to EUR 232 million. This is positively supported by the now 70 net — in the U.S. We have realized accelerated productivity improvements in Care Delivery, which have helped to meaningfully mitigate the originally anticipated labor headwind of EUR 140 million to EUR 180 million for the year. As we focus on sustainable profitable growth and seek to divest noncore and dilutive assets, we have continued to execute against our portfolio optimization plan. We announced yesterday that we have entered into an agreement for the sale of National Cardiovascular Partners or NCP.

This business comprises 21 facilities, providing outpatient cardiac catheterization and — laboratory services in the U.S. In line with our disciplined financial policy and well ahead of maturity, we were successful in refinancing a EUR 650 million bond expiring at the end of November without accessing the bond market. Rather, we use a mix of long-term bank financing at very attractive conditions as well as cash and short-term debt. The term loans carry — interest rates, which gives us more flexibility to reduce debt. And of course, upcoming extraordinary cash inflows will enable us to further delever. I am not only proud of the fact that we are executing with speed and success against our strategic plan but also that we are driving an important cultural shift.

For the third consecutive year, we were named one of Newsweek’s top 100 most loved workplaces in the U.S. Turning to Slide 5. While it’s not a third quarter earnings topic, clearly, the GLP-1 medication headlines — acknowledging. We think it’s important to reinforce our assessment of the future population and volume development. As our Chief Medical Officer, Frank Maddux outlined at our Capital Markets Day in April and confirmed again more recently in an expert call, we expect the GLP-1 red class to have a balanced impact on the ESRD patient volumes in the long run. We treat a complex patient population with multiple comorbidities and it’s important to remember that roughly 46% of our dialysis patients crash into dialysis, meaning they have even not been diagnosed nor been receiving regular medical treatment for their kidney disease earlier.

So when we talk about the potential impact of these new medications, we talk about the other 54% that are more likely to have access to these medications. At a high level, when assessing the potential real-world impact of the drug, we consider three main features of the use of the medications: Medical effectiveness, prescription rates and patient adherence. Starting with medical effectiveness. Based on the limited information that is available to us today, GLP-1 help control type 2 — diabetes and have proven benefits for cardiovascular health that are a potential significant positive effect on people with diabetes. More CKD patients are likely to survive early SKD status and progress to ESRD. Additionally, we have also assumed that GLP-1s would have a positive impact on slowing the progression of kidney disease.

Based on what we know today, we expect these two competing effects to balance each other with respect to population impact. Looking at the prescription rates, there are unknowns here. Currently, calendar pricing of GLP-1 is prohibitive to broad adoption in the short term, as could availability or access, but we would assume these would normalize over time. The impact of known and developing side effects will impact prescribing choices as prescribers gain experience in managing patients on the drug. SGLT2 inhibitors, for example, have been widely available for a decade with proven medical effectiveness for both cardiovascular health and more recently, for slowing the progression of kidney disease, yet only 8% of our patients have ever been prescribed an SGLT2 inhibitor in the predialysis CKD stages unless have consistently taken them.

Finally, we have to consider expected patient adherence and compliance over long periods of time. We know that the adherence rate to medications that require permanent use has not been anywhere near 100%, and that will challenge the full effectiveness of this class of drugs in our patient population. When assessing all of these factors, and based on the limited information available today, we come to the conclusion that the effects would be rather balanced on our patient population development in the long run. Multiple independent experts in this field are of the opinion that it may take at least a decade before we could fully observe the effects and impact from GLP-1 on our patient population. Moving to Slide 6. Ensuring the highest quality of care for our patients is of the utmost importance.

To that extent, we are continuously monitoring our clinical performance to enhance care. Our Global Quality Index is an important KPI in this regard. The quality index considers dialysis effectiveness, vascular access and anemia management. Through the third quarter, we continue to see sequential stability at a high level. I’ll now move to Slide 8 to review our third quarter business performance. In the third quarter, we continue to deliver solid organic revenue growth, both in Care Delivery and Care Enablement. This was supported by sequentially stable same-market treatment growth in the U.S. The successful execution of our turnaround plans continue to translate into improved financial performance. Most notably, this included productivity improvements in Care Delivery and higher pricing in Care Enablement.

Savings from our FME25 transformation program also contributed meaningfully to the improved performance in the third quarter. And we continue to execute our portfolio optimization strategy. And as I mentioned earlier, we have entered into an agreement to divest NCP in the U.S. Based on the earnings development for the first 9 months of the year and solid business expectations for the remainder of the year, we are raising our full year 2023 operating income guidance, which I will speak to later on. You will have seen on the 27th of October that CMS announced the final ESRD PPS rate for 2024. Final ruling increased from 1.6% to 2.0%. The market basket has not been adjusted to reflect the higher labor costs nor the inflation forecasting error has been addressed.

While a 2% increase are a little improvement, it is still disappointing. However, in our 2025 margin targets, we have only assumed a moderate increase. So this is in line with our assumptions. On a very positive note, last week, the CMS Star ratings for clinics were published, and I’m delighted to report that we outpaced the industry for 3-, 4- and most importantly, 5-star clinics. This shows our strong and clear commitment to deliver high-quality care to our patients. Turning to Slide 9. In the third quarter, we delivered revenue growth of 7% at constant currency, and we continue to deliver organic growth with positive contribution from both segments. This development was driven by favorable pricing, including hyperinflation in Care Delivery.

And in Care Enablement, it was supported by both volume and price. During the third quarter, operating income on a guided basis improved by 20%. This resulted in another sequential improvement of our group margin to 8.7%. Earnings development in the third quarter was driven by business performance supported by FME25 savings and reduced personnel expenses — accelerated productivity improvements. Although we have seen a degree of stabilization, our business — excuse me, our business still faces inflationary pressures that particularly impact Care Enablement. In the third quarter, we also had a negative impact from the absence of a nonrecurring percent payment on certain pharmaceuticals and experienced a further increased transactional exchange rate headwinds in Care Enablement.

Next, on Slide 10. Starting from the left, you can see how we get at the starting point of our guidance basis. The EUR 107 million special items in the third quarter specifically comprised EUR 53 million in legacy portfolio optimization costs, primarily relating to the NCP — costs. FME25 costs were EUR 49 million, which has us well below our planned run rate for this year. We will likely stay below the lower end of our planned FME25 onetime costs this year but should see a shift into the next year. EUR 6 million in costs were associated with the legal form conversion and the human site investment remeasurement contributed positively with EUR 1 million. Turning to Slide 11. In Care Delivery, in the third quarter, organic revenue growth was supported by a positive impact from our U.S. value-based care business, InterWell Health, along with reimbursement rate increases and a favorable payer mix.

In light of our commitment to drive sustainable profitable growth, we continue to exit less profitable acute care contracts in the U.S. And the negative 60 basis point impact was particularly pronounced in the third quarter. When adjusted for acute contract impact, same market treatment growth in the U.S. improved from negative 0.4% to positive 0.2% compared to positive growth of around 0.1% in the first half of this year. In Care Delivery International, revenue growth was supported by the effect of hyperinflation in various markets but was negatively impacted by exchange rate effects. Care Delivery earnings overall were positively impacted by business growth, lower personnel expenses resulting from the already mentioned improved productivity and FME25 savings.

We had planned to show a bigger contribution to earnings from InterWell Health in the third quarter. And while we are continuing to generate positive savings from CMS’ CKCC programs within the late-stage CKD and ESK segments, we realized lower-than-expected contributions from our CKCC models for the 2022 program year. This translated into a higher-than-assumed margin dilution in the quarter. As I highlighted earlier, we also continued to execute on our portfolio optimization strategy with the signing of the agreement to divest NCP in the third quarter. Next, on Slide 12. Care Delivery revenue increased by 6% on a constant currency basis, driven by a 7% organic development for the reasons I just outlined on the previous slide. Operating income development for Care Delivery faced a meaningful headwind from currency translation effects in the quarter.

And although we realized positive business growth, this lagged our own expectations due to the already mentioned lower-than-anticipated contribution from InterWell Health on CKCC. FME25 savings were a strong tailwind in the quarter as we continue to drive clinical operational efficiencies with 17 additional net clinic closures in the U.S., bringing the total now to net 70 closures. Although initially expected to be a sizable headwind for the year, we were able to compensate the higher wages and other labor cost increases by the accelerated productivity efficiencies which yielded strong savings. Turning to Page 13. Care Enablement revenue in the third quarter was impacted by negative exchange rate effects but supported by higher sales of in-center disposables and machines as well as home hemodialysis products.

It also benefited from increased average sales prices driven by our targeted pricing measures. The third quarter earnings were supported by increased volumes, pricing as well as FME25 savings. These positive developments offset inflationary cost pressures, which developed broadly in line with expectations and a further increased transactional exchange rate headwind. Care Enablement continued to execute on the FME25 and turnaround measures. We have made progress with organizational as well as manufacturing and supply chain initiatives. Next, on Slide 14. In the third quarter Care Enablement revenue increased by 5% on a constant currency and organic basis. This was driven by the reasons I outlined on the previous slide. On our guided basis, operating income for Care Enablement increased to EUR 22 million.

The improved operating income was driven by positive business growth, which already includes meaningful currency transaction losses as well as FME25 savings. Operating income was partially offset by inflation, which, as assumed in our guidance, continues to be a headwind for this business. We have also seen a smaller currency translation impact. Turning to Slide 15. A clear focus for us is our cash flow management. In the third quarter, we — a strong cash flow development compared to the prior year period. The increase in net cash provided by operating activities was the result of a change in working capital items. This was mainly driven by the weaker prior year comparable resulting from the CMS recruitment of advanced payments previously received under the Medicare Accelerated and Advanced Payment program in 2020.

Supported by our disciplined capital allocation policy, free cash flow conversion accelerated in line with operating cash flow. Our leverage ratio of 3.4x remained in our target corridor of 3 to 3.5x. As it is still at the upper end of this self-imposed range, delevering remains a top priority for capital allocation with any proceeds from divestments to be used for further delevering. As I mentioned earlier, we were successful in refinancing the EUR 650 million bond expiring at the end of November. We used the mix of long-term bank financing at very attractive conditions as well as cash and short-term debt. This better positions us for further delevering. And by diversifying away from the bond market, we support further balancing of our financing mix and utilize our ability to access various funding sources.

I’d like to finish with an update to the outlook on Slide 17. For 2023, we continue to expect revenue to grow at a low to mid-single percentage weight, but are likely to land in the upper half of this range. For our earnings outlook, we previously guided for a flat to low single-digit operating income decline for 2023. Our assumptions around installation and volume have broadly developed in line with expectations. FME25 savings are likely to be at the upper half of the EUR 250 million to EUR 300 million range. While labor costs developed as assumed, the accelerated labor productivity we are realizing provides a compensating tailwind, which has additionally helped offset the emerging transactional exchange rate headwind in Care Enablement. Based on the resulting stronger-than-assumed earnings development in the first 9 months and our solid outlook for the remainder of the year, we now expect operating income not to decline but to grow at a low single-digit percentage rate.

Already in the third quarter, our group margin improved 130 basis points to 8.7%. And in Care Delivery, we are with a 10.3% margin, already at the lower end of our target margin band. Year-over-year, the Care Enablement margin of 1.7% while low has improved. And as laid out at our Capital Markets Day, the complexity and scale of the initiatives in Care Enablement to get into the 8% to 12% band result in a more back-end loaded improvement. We are confident in our path to unlock value as the leading kidney care company and to achieve an improved operating profit margin of 10% to 14% in 2025. This concludes my prepared remarks, and I’ll now turn it back to Dominik.

Dominik Heger: Thank you, Helen. Thank you, Martin. [Operator Instructions]. And with that, I hand over to Andrea to open the Q&A, please.

Operator: [Operator Instructions]. The first question comes from the line of Victoria Lambert with Berenberg.

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Q&A Session

Victoria Lambert: The first one is just on home treatments. Could you provide an update on how this is progressing? I think when we last spoke, it was like 16%. And then second question is just on the labor market. How many open positions are you at? And where is wage growth trending?

Helen Giza: Thank you for your questions. On home, it’s still stable at around that 16% that we saw last quarter. And then on your labor question, we have seen some improvements since last quarter, and we’re sitting at around 4,300 open positions, which is improving. Clearly, where our focus is on labor is kind of on the hotspot areas that some metro areas are still experiencing. But obviously, the labor situation is much more stable and controllable than it was a year ago or even quarters ago. So we feel good with the development that we have there.

Dominik Heger: We will take the next question then.

Operator: The next question comes from the line of Hassan Al-Wakeel with Barclays.

Hassan Al-Wakeel: I have two. So firstly, sorry to start with GLP-1. But as it relates to operational performance, to what extent do you think you are already seeing some impact from GLP-1s or SGLT2s amongst diabetes patients? Or could we indeed see an impact sooner than in weight loss? You noted that only 8% of your patients have been prescribed SGLT2 and CKD. Do you know what the number is in GLP-1s for diabetes? And related to this, are you seeing any increased uptake in transplantation on the back of improved eligibility around GLP-1s? And then secondly, you talked about margin dilution from CKCC models in the quarter, could you quantify the full year contribution and help us understand why this is different to ESCOs given the challenging experience you’ve had in the past here? And to what extent this is a worthwhile business for you?

Operator: [Technical Difficulty]. They are connected back.

Dominik Heger: Hassan, could you please repeat your question because we were dropping off.

Hassan Al-Wakeel: Apologies. Yes. So let me do that again. So firstly, I was saying sorry to start with GLP-1, but as it relates to operational performance, to what extent do you think you are already seeing some impact from GLP-1s or SGLT2s amongst diabetes patients? Or could we see an impact sooner than in weight loss. You noted that only 8% of your patients have been prescribed SGLT2s and CKD. Do you know what the number is for GLP-1s in diabetes? And related to this, are you seeing any increased uptake in transplantation on the back of improved eligibility with respect to GLP-1s? And then secondly, you talked about the margin dilution from CKCC models in the quarter. Could you quantify the full year contribution and help us understand why this is different to ESCOs given the challenging experience you’ve had in the past? And to what extent this is a worthwhile business for you?

Dominik Heger: Thank you, Hassan. I’m sorry for making you repeat that.

Helen Giza: Thanks, Hassan. Yes, look, as far as we can tell, we’re not seeing any impact or tiny impact on GLP-1s at this time and nothing that we could quantify. In terms of your SGLT2 question, yes, it’s pretty small, as you say, at 8% at CKD. I don’t have that number to hand of what that could be in diabetes. I’d have to follow-up with Frank on that question. But I do know with regard to transplantation piece of your question, the rates are very stable at the normal — at the moment. So we’re not seeing any kind of really change there. In terms of the number of patients who have any exposure to weight loss, I think we would see that as small, maybe kind of a couple of kilograms and the only improvement was with a slightly lower blood pressure.

So in terms of the diabetes piece, I’ll follow back up. But overall, so far, we’re not seeing really any other impact. In terms of your margin dilution question on CKCC, what I would say, it came in, and we had the 3 quarter true-up for plan year 2 come in, in the third quarter. While it was positive, it was lower than what we had anticipated. And clearly, it’s immediately asked the same question of is this ESCOs goes all over again because we’ve definitely kind of learned the hard way on some of these government programs. We’re definitely seeing less transparency and more variability in the government reporting in terms of their data and methodologies around trend adjustment factors and patient alignment, which is making it more difficult and challenging actually for us to be able to predict that — those results with the lumpiness that we’re seeing.

What I would say is we, and the coalition of CKCC participants, are very much providing that feedback to the government to improve the collaboration between CMS and participants to drive the intended results. And I think for us, we will continue to do that work and ensure that we are getting the expected results. And if we’re not or something changes, then clearly, we would exit where and when or if it makes sense.

Operator: The next question comes from the line of Lisa Clive with Bernstein.

Lisa Clive: Helen, I’ll ping you, although if the same Frank isn’t on for giving the interest in GLP-1 today. But I guess, per your comments around SGLT2s and GLP-1s, I mean, they’re not very widely used today, but they — SGLT2s are going generic in 2 years. So that will change quite quickly. What I really would love to know is where we’ve seen sort of similar experiences historically? I mean, the — and look at the CKD population in the U.S., it’s actually been remarkably stable over the last sort of 15-plus years. Yes, over that time, the ESKD population has grown 3% to 4% per annum. So I know that the ACE and ARB class adoption have really helped control hypertension and improve mortality. And so I take your point that there could be a sort of tailwind of sorts from these drugs to some extent.

But it would just really love to understand what the sort of historic experience has been within the dialysis population? And then secondly, on that, one of the issues around this delay in progression, you may well get these patients in the end, especially if the mortality goes down, but at what age? Because the proportion of patients in the broader ESKD population, 20 years ago, 2/3 of those patients were under 65. Now it’s more like 57%. So a lot of these patients may age into Medicare before they end up with ESKD. So just would love to get your thoughts on the delay in progression and how that could affect your economics longer term?