Earnings Call Transcript - FMS Q2 2023

Operator, Operator

Ladies and gentlemen, thank you for standing by. My name is Emma, your Chorus Call operator. Welcome, and thank you for joining the Fresenius Medical Care report on the second quarter 2023 Earnings Results. Throughout today's recorded presentation, all participants will be in a listen-only mode. The presentation will be followed by a question-and-answer session. I would now like to turn the conference over to Dominik, Head of Investor Relations. Please go ahead, sir.

Dominik Heger, Head of Investor Relations

Thank you, Emma. As mentioned by Emma, we would like to welcome you to our earnings call for the second quarter 2023 from a cold and rainy Bad Homburg. We appreciate you joining us today to discuss the performance for the second 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 earlier today. For further details concerning risks and uncertainties, please refer to these documents as well as to our SEC filings. We will try to keep the presentation short and leave time for questions. As always, we would like to limit the number of questions again to two in order to give everyone the chance to ask questions. Should there be further questions and time left, we can go a second round. It would be great if you could make this work again. Unfortunately, we are limited to 60 minutes for the call. With us today is Helen Giza, our CEO and Chair of the Management Board and until the first of October, also our acting CFO. With that, Helen, the floor is yours.

Helen Giza, CEO and Chair of the Management Board

Thank you, Dominik. Welcome, everyone. Thank you for joining our presentation today and for your continued interest in Fresenius Medical Care. I'll begin my prepared remarks on Slide 4. Earlier this year, we laid out our strategic plan to unlock value as the leading kidney care company. We are actively executing against this plan and today, I am very pleased to be able to highlight several meaningful proof points that demonstrate tangible progress to date. At the beginning of the year, our new operating model was implemented. And last quarter, we rolled out the corresponding new financial reporting. This leaves the simplification of our governance structure as the one outstanding structural element and our extraordinary general meeting in July was an important step towards completing this aspect of the plan. Following the 99.88% approval by voting shareholders in support of our change in legal form, all necessary administrative compliance and regulatory steps are moving forward, and the entire process is still expected to be completed by the end of the year. At the same time, we continue to advance our operational efficiency and turnaround plans. Our FME25 transformation program is well on track to deliver €250 million to €300 million in sustainable savings by the end of the year. And in the second quarter, we realized an additional €75 million in sustained savings. This is positively impacted by the 53 net clinic closures in the U.S. that we have completed in the last three quarters, and we plan to close up to 100 clinics as part of this program. It's very encouraging to see the execution against our strategic turnaround plans has resulted in visible productivity improvements, most notably in care delivery. This contributed to achieving a second quarter margin of 10.4%, which is promising as it is already at the bottom end of our 2025 target margin band for the segment. Our strategic plan also includes a careful reassessment of our portfolio assets and R&D efforts as we focus on sustainable profitable growth assets and seek to divest non-core assets and dilutive assets. In the previous quarter, we decided to discontinue the development program for a PD cycler, and more recently, we announced the strategic divestments of clinics in Sub-Saharan Africa and Hungary. These exits demonstrate progress against our portfolio optimization strategy. It is also important to us that we have found reputable and well-established partners to ease the continuity of care to the patients who had entrusted us with their care. As a reminder, portfolio optimization effects are excluded from our 2025 target margin band since the timing of the execution is dependent to a large degree on various external factors. This played out differently to our expectations, for example, in the second quarter. Since our Capital Markets Day, we have received many requests to size the impact of our divestitures. Therefore, I would like to give you at least an idea of how it could impact our revenues, should we execute on everything under review through the end of 2025. In this case, we could see a negative impact from the overall portfolio optimization on 2025 revenues of up to €1.5 billion. Under the same assumptions, we expect a positive impact on margins. As you heard me say before, the resulting cash proceeds will be used towards deleveraging in line with our disciplined financial policy. I am also proud of the fact that as we execute against those strategic plans, we are simultaneously driving a winning culture focused on accountability, along with an ongoing commitment to sustainability. We remain a mission-focused company with our patients front and center in everything we do. Turning to Slide 5. To that extent, we are continuously monitoring our clinical performance to enhance care. An important KPI in this regard is our Global Quality Index. The quality index considers dialysis effectiveness, vascular access, and anemia management. Through the second quarter, we continue to see sequential stability at a high level. I will move to Slide 7 to review our second quarter business performance. In the second quarter, we saw an acceleration in organic revenue growth driven by both operating segments. This includes sequentially stable treatment volumes in Care Delivery U.S. I'm encouraged to see proof of strong underlying trends beginning to translate into improved financial performance. The execution progress I have mentioned in the beginning is also clearly visible when looking at the second quarter. First, the execution against our strategic turnaround plans has resulted in visible productivity improvements in Care Delivery. Secondly, our performance in the second quarter was also supported by savings resulting from our FME25 transformation program. Thirdly, we continue to execute on our portfolio optimization strategy with the announced divestments of two international markets and are actively working on divestments of other dilutive and non-core assets. Given our stronger than planned earnings development through the first six months, we are narrowing our full year 2023 operating income guidance range, which I will speak to later on. Turning to Slide 8. In the second quarter, we delivered revenue growth of 6% at constant currency and we continue to deliver accelerated organic growth with positive contributions from both segments. This development is driven by favorable pricing in both segments by positive volume development and growth in the value-based care business within Care Delivery. During the second quarter, operating income on a guided basis improved by 44%. This results in a group margin of 8.3%. Earnings development in the second quarter was bolstered by reduced personnel expenses resulting from improved productivity as well as from improved business performance supported by FME25 savings. Although we have seen a degree of stabilization, our business still faces the expected inflationary pressures that particularly impacts our Care Enablement segment. Next, on Slide 9. This slide shows the contributions to the operating income development by operating segments compared to the prior year second quarter. Starting from the left, you can see how we get to the starting point of our guidance basis. From the contribution of the two operating segments, Care Delivery represents 88% and Care Enablement 12%. The €44 million special items in the quarter relate to €25 million in FME25 costs and the remaining €19 million relates to charges associated with our legacy portfolio optimization, the humor site investment remeasurements, and costs associated with the conversion of legal form. Turning to Slide 10. Revenue growth for Care Delivery was driven by organic growth, which was supported by a positive impact from our value-based care book of business in the U.S. reimbursement rate increases in both the U.S. and international markets and a favorable payer mix in the U.S. In Care Delivery U.S., same-store treatment growth was virtually stable on a sequential basis and at the midpoint of our volume assumption of minus 1 plus 1 for the year. This reflects mortality trends effectively at pre-pandemic levels and still muted new starts as we move through the annualization of COVID-19-related excess mortality in the late-stage CKD and ESRD populations. Earnings were positively impacted by lower personnel expenses resulting from improved productivity with a meaningful contribution coming from the continued optimization of our clinic network. Also, savings from FME25 and business growth contributed in a significant way. In Care Delivery International, organic growth was supported by the effect of hyperinflation in various markets. As I highlighted earlier, we also executed on our portfolio optimization strategy with international market exits in Sub-Saharan Africa and Hungary and continue to progress further divestment decisions. Next, on Slide 11. On this slide, we show how these trends have translated into financial performance. Care Delivery revenue increased by 6% on a constant currency basis, driven by a 6% organic development for the reasons I just outlined on the previous slide. In addition to positive business growth and FME25 savings development, Care Delivery also experienced a net positive labor and inflation development in the quarter. The tailwind is mainly driven by a low prior year comparable in the second quarter and by improved productivity. While we experienced a labor tailwind in the first half of the year, we will face a different prior year comparable in the second half. Overall, while the market is stabilizing, we are still monitoring and managing key hotspot markets and implementing measures as needed. Therefore, for the full year, we still expect a labor cost headwind in line with our guidance assumptions. Turning to Slide 12. Care Enablement revenue was supported by higher sales of machines for chronic treatment, critical care products, and home hemodialysis products, as well as increased average sales prices driven by the first impact of our targeted pricing measures. On the earnings side, second quarter business growth is muted by the negative currency transaction effects. The inflationary pressures are developing as expected. In the second quarter, Care Enablement saw a positive benefit from FME25 savings driven by organizational as well as manufacturing and supply chain initiatives. Next, on Slide 13. Here, we look again at how these trends have translated into financial performance in this operating segment. Care Enablement revenue increased by 6% on a constant currency and organic basis. This was driven by the reasons I outlined on our previous slide. On a guided basis, operating income for Care Enablement increased to €19 million. The improved operating income was driven by FME25 savings as well as positive business growth, which already includes the negative currency transaction effects I mentioned earlier. Operating income was partially offset by inflation, which, as assumed in our guidance, continues to be the biggest headwind for this business. Year-over-year, the margin has improved as planned. As laid out at our Capital Markets Day, the measures we are taking in Care Enablement to get into the 2025 target margin band will take time. Turning to Slide 14. In the second quarter, we experienced a strong cash flow development compared to the prior year period. The increase in net cash provided by operating activities was driven by seasonality in invoicing and improved cash collection, as well as a weaker prior year comparable due to CMS' recruitment of advanced payments previously received under the Medicare accelerated and advanced payment program in 2020 in the second quarter of 2022. Supported by our disciplined capital allocation policy, the quarter delivered strong free cash flow conversion. Our leverage ratio was 3.4x and remained in our target corridor of 3x to 3.5x. As it is still at the upper end of this self-imposed range, deleveraging remains our top capital allocation priority, with any proceeds from divestments to be used for deleveraging. I'd like to finish with our update to the outlook on Slide 16. For 2023, we continue to expect revenue to grow at low to mid-single percentage rates. For our earnings outlook, we initially guided for a flat to high single-digit operating income decline for 2023. Based on those stronger than assumed earnings development in the first quarter and again in the second quarter, we are confident to narrow our operating income guidance range from a flat to high single-digit decline by around 600 basis points. We now expect operating income to remain flat or decline by up to a low single-digit percentage range. It's important to me that we provide a realistic but careful guidance that we have a clear path to achieve. Operating income improved sequentially and year-over-year, due to stronger-than-expected operational performance. But we carefully need to take into consideration the many moving pieces, like labor headwinds, continued impact from inflation and potential currency transaction impacts in the second half of the year as well as a higher comparable in the prior year. Even after considering all these moving parts, I feel confident with our new considerably narrowed operating income guidance range. And of course, we are fully 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. I'll now hand it back to Dominik.

Dominik Heger, Head of Investor Relations

Thank you, Helen, for your presentation and the insights. Before I hand over for the Q&A, I would like to remind everyone to limit your questions to two, please, so that everyone has a chance to ask questions. And with that, I'll hand it back to Emma to open the Q&A, please.

Operator, Operator

Thank you. Ladies and gentlemen, at this time, we will begin the question-and-answer session. One moment for the first question please.

Victoria Lambert, Analyst

Thanks for taking my question. First one is just on geographies as medical care now want to stand. So you guys are out of Hungary, you're out of Sub-Saharan Africa. What would you consider your core geographies in the U.S., obviously? And then my second question is just on the outlook for the business how we can expect margins to develop in H2, given the margin performance between Q1 and Q2 was pretty volatile. I would just like to get a steer on how we should think about that.

Helen Giza, CEO and Chair of the Management Board

Thank you for your questions, Victoria. Regarding the geography aspect, rather than specifying individual countries, I’d like to summarize how we categorize the markets in CVI. As I mentioned earlier, I categorize them into three groups. The first includes core markets where we see favorable reimbursement conditions and profitability, and where we believe we can continue to expand. The second group consists of markets that are profitable but where we think we can enhance performance with more focused efforts. We may consider running these markets for a while, adjusting as necessary if profitability does not improve. The third group comprises markets that are either unprofitable, smaller in scale, or ones we feel we cannot effectively manage, suggesting that there might be better owners for these markets. Africa and Hungary fall into this third category, and we will continue to advance those endeavors promptly. As you understand, we can only share information once we have finalized agreements, which makes timing challenging to predict. We are aware of what we have in progress, and that’s how we plan to evaluate it. Moving on to your second question about the outlook for the second half, I can't provide specific margin guidance for CE and CD, although we have issued guidance for the company as a whole. There will be fluctuations in margins, especially considering the year-over-year comparisons in the respective quarters. However, we do have a full-year guidance in place. As we mentioned at the Capital Markets Day, CE will take time to improve, but we expect to exceed our 2022 figure of 1.9%.

Veronika Dubajova, Analyst

Hi, good afternoon. And hello Helen and Dominik. Thank you for taking my questions. I will keep it to two, please. First, I want to just go back to the guidance for the full-year, and I appreciate your comments about conservatism, but just maybe to push you a little bit. I think historically, the seasonality in new business is the second half EBIT was always higher than the first half. Are there any reasons whatsoever for that not to be the case this year, because obviously, the guidance seems to imply that. I'm just trying to understand why that would happen? And then my second question is just to drill down a little bit, in particular, on the North America care delivery growth range. Clearly, some very notable benefit from revenue per treatment. Just if you can quantify to what extent that's mix versus underlying rate increases? And how durable you think that is into the back half of the year? Thank you.

Helen Giza, CEO and Chair of the Management Board

Thank you for your questions, Veronika. Regarding your first question on guidance, there's a lot to consider. I want to ensure we're providing consistent results quarter by quarter, which we've managed to do for the last three quarters. If you analyze our guidance for the first half of 2023 compared to the implied guidance, it may initially suggest that we will have a weaker second half of 2023 than we did in 2022. However, we anticipate that our EBIT for the second half will be higher than in the first half, though there are some factors to consider. In the second half of 2022, we experienced certain factors, which I wouldn't term one-time events, but rather special circumstances, including operational improvements that could be seen as one-time occurrences. We also benefited from NCP deconsolidation gains and received an additional consent payment in the second half of 2022. As we approach the second half of 2023, we also need to factor in the increase in stock price affecting stock incentive compensation. We are mindful of this adjustment for our second-half outlook. Additionally, while we had a strong performance in the first half, we don’t expect all of those factors to persist. We are particularly monitoring the transactional impacts in some more volatile countries. I am confident about our underlying operational performance when comparing the second half of 2022 to that of 2023, although there are some nuances to consider. Overall, I believe we can achieve growth in the second half over the first half. As for your second question on North America care delivery growth, I'm very pleased with the progress we're seeing. This growth is driven by both improved rates and changes in mix, particularly from Medicare Advantage, which now constitutes around 40% of our business. It's encouraging to see these metrics moving in the right direction.

Richard Felton, Analyst

Thanks. Good afternoon, Helen. Good afternoon, Dominik. Just a follow-up on what you're seeing in terms of labor costs in the U.S. market. In particular, I'd be interested to hear an update on your reliance on sort of contract labor and general levels of wage inflation in that market? I mean it looks like from your numbers that H1 was pretty good, but your comments into H2 sound a little bit more cautious. So an update on what you're seeing would be very helpful. And then my second question, just a follow-up on Veronika's question on the payer mix in U.S. care delivery. Is there any reason why that sort of tailwind or mix that you saw this quarter, is this sort of a one quarter anomaly? Or are some of those shifts kind of a little bit more durable and maybe duration more than just one quarter? Thank you.

Helen Giza, CEO and Chair of the Management Board

Thank you, Richard. Labor continues to have many variables, but I believe the assumptions we made at the beginning of the year are still valid. We have discussed labor stabilizing, and the availability is improving. The decline in temporary labor volume and rates has returned to more normal levels. What we experienced in Q1 has carried into Q2, and it's significantly less than last year. A key factor with labor is that not only are costs and wages meeting expectations, but the U.S. operations team is doing a fantastic job driving productivity. This improvement is evident, particularly in Q2. I feel confident that we have a good handle on labor. However, as I approach the second half of the year, I recall the challenges we faced last July with rising labor costs and availability that impacted our operations. Unfortunately, we expect some of those labor costs to carry over into the second half of 2022, resulting in a tough comparison for 2023. Overall, we're positive about the full-year outlook, although we do have to be mindful of certain high-pressure areas. Most parts of the country are under control, but we still face challenges in some states, metro areas, and hotspots. As we see ongoing improvements in labor productivity, we anticipate needing to invest a bit more in these specific areas, though it remains within our guidance range. It's crucial that we keep investing to support future growth. We're managing each clinic and location very carefully now and taking a targeted approach rather than a broad one. Wage inflation is still around 4%, and as we enter the holiday period, we will likely need additional temporary labor to handle the seasonal increases, which may temporarily increase open positions. Overall, I think we've managed the situation quite well, and the team has performed excellently. Regarding your second question about the payer mix in the U.S., there are no anomalies. We are managing the mix rates effectively, and we anticipate that trend to continue in the second half as it did in the first half.

Hassan Al-Wakeel, Analyst

Hi, good afternoon. And thank you for taking my questions. I have two, please. Firstly, on rate, what is your take on the preliminary ESRD PPS for 2024, which looked to be a more modest increase than many expected. Do you expect the final rule to land here? And could this present a challenge at all to your 2025 margin targets, and do you still think the 2025 PPS rate should accelerate meaningfully from here? And then secondly, could you update us on the portfolio side and your progress on divestitures. You highlighted the €1.5 billion of revenues that are addressable if you do all you set out to, which is helpful, thank you. But could you help quantify the rough margin differential or indeed tailwind, all else being equal? Thank you.

Helen Giza, CEO and Chair of the Management Board

Thanks, Hassan. Clearly, we're disappointed with the 1.6% proposed rate. We obviously don't know what that is going to look like in the final weight. I don't have that crystal ball, unfortunately. Obviously, we continue to put our case forward for an improved rate, but we'll see where the final weight comes in. As I've said previously, we have forecast and guided for moderate rate increases. And I think that is consistent with how we have thought through the 2025 targets, but obviously, we will continue to advocate for a higher rate for the cost increases that we've experienced. We have no reason to believe that the reimbursement model shouldn't hold true. But clearly, we've seen a disappointing reaction to the current inflationary environment in that rate. And clearly, it's not just an issue for us; it's for all service providers. Look, On the portfolio, and we do listen, we do take note of the many questions we got about that. So we thought it was helpful to try and size it. Obviously, we're not trying to get an unpacked 2025 detailed guidance because we're trying to be moderate with how we roll that out, and that's why we're kind of focusing on the margin bands. But as I said, if we execute everything, it could be up to €1.5 billion of lower revenue. Clearly, we are, and if you go back to my Capital Markets Day slide, that was quite deliberate. If you go back to there, and you can kind of look at the things that are either lower growth or lower strategic value, you can assume that they're all in scope. And what we are seeing, if we execute on everything and there are some that we would lose absolute EBIT, but there are others that are loss-making. Our current assumption is that it would be margin accretive, and it wouldn't take us out of the margin band.

Oliver Metzger, Analyst

Good afternoon. Thank you for answering my questions. First, you mentioned that value-based care is a positive factor for Care Delivery. Can you provide some quantifiable details about its positive contribution? Should we expect similar results in the upcoming quarters? For my second question, regarding your guidance, I appreciate the refined guidance figure. However, there seems to be some confusion, particularly around labor costs. Initially, you estimated labor costs to be between €140 million and €180 million, but now in the first half, you have a positive €49 million. You're maintaining your guidance despite this, but it seems like the lower end of the range may no longer be realistic. Could you clarify what other factors influenced your guidance update? Thank you.

Helen Giza, CEO and Chair of the Management Board

Thank you, Oliver, for your questions. We won't be disclosing the specific contribution from the BBC segment. We're currently discussing how to provide additional metrics and key performance indicators for this area as it continues to grow, especially regarding our ESRD and CKD populations. We have 125,000 lives covered, with the majority being CKD patients. We're working on how to share some supplementary KPIs and will follow up on this in Q3. Regarding guidance, you are correct that our labor cost assumption remains a headwind of €140 million to €180 million, though we have managed to stay favorable through the first half of the year with some added productivity. However, we anticipate more changes in the second half, especially with merit increases starting in July. While I’m optimistic about the positive developments we’ve seen, I'm also cautious about the second half of the year. As I mentioned earlier, there are several factors affecting our guidance that were not apparent when we initially provided it, such as incentives tied to stock compensation and fluctuations in exchange rates. Despite these challenges, I'm hopeful about our ability to improve our guidance and will monitor how things unfold in Q3. I’m confident in our current direction while remaining aware of the various factors at play.

James Vane-Tempest, Analyst

Hi, good afternoon. Thanks for taking my questions. Two, if I can, please. And firstly, just to follow-up on the divestments of up to €1.5 billion. Just wondering, Helen, you've given some scope in terms of the different buckets and where they could possibly get to. But I'm sort of wondering, looking at those in aggregate, it's possibly around 7%, I think, of 2025 revenues. But if this is just the international care delivery sort of ex-U.S. is potentially up to 40% of that business. So I was just wondering, is that focusing on the right area where those divestments could be? Or are there in other areas? And I think related to that, I guess there's a question on the potential margin impact, but these are below group margin, I'm not asking for a point estimate, but just in terms of how to think about it potentially, those are essentially breakeven, and that would add around 70 basis points to a margin roughly or around 5% margin, it could be around 30 bps. So I was just wondering whether that's a good quantum to think about where those could be and what the impact could be to 2025 targets, which exclude those. And then my second question is, I'm just curious what it would take for you to raise the upper end of the EBIT guidance range to above zero? And what is the impact to EBIT growth from divestments closed or that could happen this year? Thank you.

Helen Giza, CEO and Chair of the Management Board

Thank you, James. I took some time to explain the CDI buckets for Victoria, especially in relation to geographies. There are additional assets to consider, so you should think more broadly than just CDI. I recommend reviewing the Capital Markets Day Chart, which illustrates those assets and their positions. Regarding the margin impact, what we’re observing overall suggests it could be margin accretive. The total effect is likely to result in a flat or slightly positive EBIT number. That might be the best way to conceptualize it since we’ll focus on some noncore assets while also addressing others that could negatively impact EBIT. When all factors are considered, it is probably a very low single-digit EBIT percentage impact, which is the clearest estimate I can provide at this time. It's challenging to specify further, especially since I haven’t provided guidance for '24 and '25 yet.

Dominik Heger, Head of Investor Relations

Thank you, Helen. I think we have covered a lot of interesting topics today, and with our discussion coming to a close, I want to remind everyone once again about limiting your follow-up questions. We appreciate your engagement. If we don't have any further questions, I would like to wrap this up and thank you all for joining us today.

Helen Giza, CEO and Chair of the Management Board

Thank you, everybody. Have a good summer. Take care.

Operator, Operator

Ladies and gentlemen, the conference has now concluded, and you may disconnect your telephone. Thank you very much for joining, and have a pleasant day. Goodbye.