Fresenius Medical Care AG & Co. KGaA (NYSE:FMS) Q1 2024 Earnings Call Transcript

Fresenius Medical Care AG & Co. KGaA (NYSE:FMS) Q1 2024 Earnings Call Transcript May 7, 2024

Fresenius Medical Care AG & Co. KGaA beats earnings expectations. Reported EPS is $0.36, expectations were $0.26. Fresenius Medical Care AG & Co. KGaA isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Dominik Heger: Thank you, Alice. Good afternoon or good morning, depending on where you are. I would like to welcome you to our Earnings Call for the First Quarter of this year. We appreciate you joining us today. 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. As we have only 60 minutes for the call, we have prepared a short presentation to leave time for questions. As always, we would like to limit the number of questions to two in order to give everyone the chance to ask.

Should there be further questions and time left, we are more than happy to do a second round. With us today is Helen Giza, our CEO and Chair of the Management Board; and Martin Fischer, our CFO. Helen will start with an update on the major developments and Martin will provide a review of the financial performance in the first quarter. Then we are happy to take your questions. 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 will begin my prepared remarks on Slide 4. I’m pleased to report that we continue to make tangible progress on both our transformation and our turnaround efforts. We are meaningfully advancing toward our 2025 group margin target band. The progress is visible in both of our operating segments. Care Delivery, the first quarter was marked by important leadership changes and organizational improvements. As you know, Craig Cordola, our new Head of Care Delivery, officially started on the 1st of January. A key priority for his first 100 days was to implement a new organizational structure and leadership team for his business and focus on holistic end-to-end process improvements.

With the streamlined Care Delivery organizational changes now in place since the 1st of April, I’m very encouraged by the focus, professionalism, and speed of implementation that Craig and his new leadership team are bringing to the business and their priorities centered around driving patient growth are very clear. In the U.S., a major focus for the Care Delivery team is on improving clinic utilization, optimizing processes, as well as unconstraining clinics, and optimizing the clinic footprint, especially in growth markets. We were able to decrease the number of constrained clinics by about one-third by the end of the first quarter. We have very good visibility on the capacity constrained markets and specific clinics, and the challenges are not uniform.

For example, in several constrained markets, staffing shortages remain a factor. Therefore, hiring and reducing turnover remains a priority. By the end of the first quarter, our open positions for nurses and technicians across the U.S. were reduced by around 500 to approximately 3,500, which is now very close to a normalized level of 2,000 to 3,000 open positions. This will position us better to take on more patients in the coming quarters. In other markets, for example, we are seeing strong demand and do not have sufficient capacity to capture all the patients. For growth markets, it is not just about more hires, but we also need to consider how to make more dialysis chairs available if the expansion drives profitable growth. Expanding our strategic growth areas within Care Delivery remains a priority.

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Q&A Session

The main driver of the mentioned favorable phasing in the first quarter comes from our value-based care business. We had a strong first quarter with patient lives increasing to 125,000 lives and positive revenue and earnings contributions. We know that value-based care revenues and returns can be lumpy and therefore, focus more on annual performance. We have planned for our medical costs under management to grow to $8 billion for the full year. We expect our value-based care business to be a positive contributor for full year 2024, and the positive EBIT contribution in the first quarter puts us in a good position to achieve that. As you have seen, we continue to move at speed in our portfolio optimization plan with several additional market exits announced and others closed since our last earnings call.

I will review those in more detail later on. Turning to Care Enablement. I’m very excited about our progress with further proof points demonstrated the continued momentum of our FME25 transformation efforts. This resulted in an inflection point in our Care Enablement margin expansion from 1.3% in the fourth quarter of 2023 to 6% in the first quarter of 2024. Driving this positive margin development is a further improvement in pricing as we both renegotiate and sign new contracts on more favorable terms. With an eye toward cost reduction and margin improvements, several initiatives are underway to optimize our manufacturing footprint and supply chain, which will further benefit the margin development in 2025 and beyond. For example, we are in the process of moving production from our plant in Concord, California to Mexico with production set to wind down in California later this year.

We continue to optimize the production of a lower-cost fluid line in Knoxville, along with additional cost reductions across initiatives across the manufacturing network. In January, we launched further supply chain initiatives in North America to improve operational effectiveness of our distribution network. Pricing as well as margin expansion continue to be a key focus of the CE commercial and operation teams globally. At the same time in Care Enablement, we are preparing for the rollout of high-volume hemodiafiltration in the U.S. and the opportunity to bring much needed innovation and set a new standard of care for patients and at the same time, maximize the benefits of our vertically integrated strategy. While all of these developments in Care Delivery and Care Enablement are essential for the future success of our business, it is terrific to see our turnaround and transformation efforts, driving improved financial performance already, and we are on track to achieve our 2025 margin targets.

Moving to Slide 5. For the group, the first quarter result was relatively weaker compared with the full year, which usually ends with a strong quarter. Please keep this in mind when we guide you through our first quarter developments although we have benefited this quarter from a favorable phasing effects, which I’ll come back to later. In the first quarter, we delivered solid revenue growth of 4% with positive contributions from both Care Delivery and Care Enablement. For Care Delivery U.S., we knew that the first quarter was not going to be easy from a volume perspective and it broadly developed in line with our expectations for a broadly flat quarter. Adjusted exit from less profitable acute care contracts, U.S. same-market treatment growth came in at minus 0.3%.

This reflected some more significant weather events within our clinic footprint and an increased impact from the flu season this year. Both led to a higher level of missed treatments, and while improving at the end of the quarter, we continue to have some capacity-constrained clinics, but at the same time, we are encouraged by the increase in referrals sequentially. Therefore, in line with our planning, we expect to see growth of 0.5% to 2% over the course of the year, and the changes and focus of the new Care Delivery leadership are ensuring that we are well-positioned to better capture the growth. In the first quarter from an earnings perspective, both segments realized an improved operating income margin on a year-over-year basis. In particular, strong momentum in Care Enablement led to an accelerated margin improvement on a sequential basis and solid development against the strong first quarter of 2023.

This was supported by strong execution of our FME25 transformation program. As planned, FME25 contributed €52 million in additional savings and we are well on track to achieve the targeted €100 million to €150 million in additional savings by year-end. As already mentioned, we continue to move at speed on our portfolio optimization plan. While we were executing against our turnaround and transformation plans, it is paramount that we do not lose focus on our patients. In the first quarter, we remained on a high level of clinical quality, which is not only the core of all we do, but integral to our sustainability agenda. To this extent, we will host a Sustainability Expert Call on the 13th of June to highlight our initiatives and achievements in this area.

Information on the call is available on our Investor Relations website. Turning to Slide 6. As I just referenced, we are moving at pace to exit noncore and dilutive assets. In the first quarter, we announced that we will divest our clinic networks in Brazil, Colombia, Chile and Ecuador. And after further signing the divestments of our clinic networks in Guatemala, Peru, and Curacao, we have now signed or closed the exit from all of our clinic operations in Latin America. Additionally, in April, we closed the previously announced divestments of the Care Delivery businesses in Turkey and the Cura Day Hospital Group in Australia during April. These collective transactions that I just described are expected to generate cash proceeds of around €650 million upon closing, which we will use to continue to delever.

And all transactions that are currently signed as part of our portfolio optimization plan are estimated to have a negative impact of around €250 million in the full year 2024, mainly from goodwill write-off and book value adjustments, which will be treated as special items in operating income. With that, I’ll hand over to Martin to walk you through the first quarter financial performance.

Martin Fischer: Thank you, Helen and welcome to everyone on the call. I will recap our first quarter performance beginning on Slide 8. In the first quarter, we delivered strong revenue growth of 4% on an outlook basis. Organic growth of 5% was mainly driven by our growing value-based care business and the favorable rate and mix development in Care Delivery. In Care Enablement, growth was supported by positive pricing development. During the first quarter, operating income on an outlook basis improved by 23%, supported by higher prices, higher value-based care contribution and strong but expected FME25 savings resulting in a meaningful margin improvement of 130 basis points. As Helen mentioned, our value-based care business not only improved year-over-year, but was a positive earnings contributor in the quarter.

This led to an earnings development that was somewhat better than expected from a phasing perspective. The €157 million in special items that you see on the chart comprise €143 million in portfolio optimization costs. This is primarily related to the impairment of tangible and intangible assets resulting from the classification as assets held for sale. It also includes FME25 costs of €28 million as well as €1 million in costs associated with the legal form conversion. Additionally, Humacyte remeasurement contributed positively to special items with €15 million. Turning to Slide 9. This slide provides an overview of the 130 basis points improvement for our operating income margin compared to the first quarter of 2023 on an outlook base.

Starting from the left, as a reminder, the special items in 2023, mainly were related to our portfolio optimization efforts in Care Enablement. This brings us to the starting point of our outlook base and then the quarterly margin contribution by segment. The positive margin contributions from both Care Delivery and Care Enablement are important proof points that we are successfully executing against our turnaround and our transformation plans. While there is more work ahead of us, the step up from 7.3% to a 8.6% group margin in the normally weaker first quarter is visible progress towards our 2025 group margin target. Next, on Slide 10. Care Delivery revenue increased by 5% on an outlook base, supported by 6% organic growth. In the U.S., growth of 6% was driven by a growing value-based care business, assumed moderate reimbursement rate increases, and a favorable payer mix development as we continue to see incremental increases in our Medicare Advantage population.

As expected, our U.S. volume development was down by 0.3% when adjusted for the impact of acute contract exits. This is broadly in line with our expectation for the first quarter, and we expected this to improve over the course of the year. Revenue in the internal markets increased by 2%, driven by organic growth and the benefit of increased dialysis days year-over-year. In the first quarter, we observed operating income growth of 25% year-over-year. Positive business growth was driven by improved pricing, payer mix effects, and higher contributions from value-based care. Additionally, FME25 savings also contributed to improved earnings. This was partially offset by higher labor and inflation costs, largely related to the annualization of merit increases in the prior year and fully in line with our assumptions for the current year.

Turning to Page 11. In the first quarter, Care Enablement revenue increased by 2% on an outlook basis supported by 2% in organic growth. This growth largely reflects our continued pricing momentum. We need to compare this to a very strong first quarter in 2023 that benefited from higher sales in critical care products in China as part of a corporate-related onetime government initiative. On an outlook basis, operating income for Care Enablement grew by 23%. Business growth remained stable with continued improved pricing being offset by the negative volume base effect from the mentioned prior year China critical care sales as well as unfavorable foreign exchange transaction effects. The positive development was driven by strong FME25 savings, but partially offset by inflationary cost increases.

This is well in line with our outlook assumptions for the year. Despite the absence of the China Critical Care sales, our first quarter development not only increased, but also better reflects more sustainable improvements in performance. This is, in particular, visible when compared sequentially to the fourth quarter of 2023 with 1.3%. We see a clear inflection point in margin improvement. Also the extent of development might vary quarter-by-quarter. We also expect for the full year, a very visible step-up of the Care Enablement margin compares to 2023 with clear progress towards our 2025 target margin day. Continuing on Page 12. Our operating cash flow development was negatively impacted by €58 million, resulting from a cyber incident on February — in February at Change Healthcare, who is a U.S. clearinghouse provider.

This more than offset the otherwise positive operating cash flow development. As a consequence of the cyber incident, we had a ramp-up of open claims during the quarter. which were moderated at the end of the quarter to €273 million. At the end of quarter one, €311 million of the short-term financing instruments in the U.S. have been utilized. On the back of strong crisis management and quick implementation of countermeasures, plus advanced payments received from different payers, which totaled €250 million. The impact was mitigated and our gross debt for the group was flat compared to year-end last year. Cash collection has continued to pick up in April and with claim management normalizing, debt levels have also reduced to a normal level in the U.S. We continue to enforce our strict financial policy that includes a disciplined approach to capital expenditures.

As a result, we realized free cash flow conversion consistent with prior year level. Our net leverage ratio of 3.2% was stable sequentially. Remaining at the lower end of our self-imposed target corridor of 3 to 3.5 times net EBITDA — net debt to EBITDA. In line with our 2025 strategic ambitions and current capital allocation priorities, deleveraging remains a top priority. We continue to execute against our portfolio optimization plan and proceeds will be used to further reduce debt. I will now hand over to Helen to finish with our outlook.

Helen Giza: Thank you, Martin. I will finish the presentation with our outlook on Slide 14. While phasing for first quarter earnings were somewhat better than expected, driven by our value-based care business, overall, our performance and outlook assumptions developed broadly in line with our expectations. Therefore, we are confirming our 2024 outlook of low to mid-single-digit revenue growth and mid to high teens operating income growth for the full year. This quarter once again demonstrated that we are not only focused on executing against our transformation and turnaround initiatives but also serves as another proof point that we can deliver. I’m very encouraged by the progress we are making at a group level as we take the necessary steps to strengthen and transform our business and lay the foundation to capture profitable growth.

We started 2024 up strong with continued momentum with our FME25 savings and portfolio optimization plan as well as an inflection point in our Care Enablement margin. There is clearly more work to be done, and of course, but we do remain confident in our path to achieve a group operating income margin of 10% to 14% in 2025. That concludes my prepared remarks. And with that, I’ll hand back to Dominik to start the Q&A.

Dominik Heger: Thank you, Helen and Martin for your presentation. Before I hand over for the Q&A, I would like to remind everyone to limit your questions to two. If we have remaining time, we can go another round. And with that, I hand it over to Alice to open the Q&A, please.

Operator: We will now begin the question-and-answer session. [Operator Instructions]

Dominik Heger: Thank you. The first question comes from Richard from Goldman Sachs. Richard?