Fresenius Medical Care AG (FME) Earnings Call Transcript

Great. Good morning, everybody. I'm David Adlington, Head of the European Medtech research team for JPMorgan. It's my pleasure to introduce Helen Giza, CEO of Fresenius Medical. There will be an opportunity for questions after the presentation. Thanks. Helen.

Thank you, David, and good morning, everyone. It's great to be back in person after 2 years of remote participation. And it's also my first conference as CEO of Fresenius Medical Care. I joined the company 3 years ago and have worn a number of hats over those past 3 years, initially as CFO, then Chief Transformation Officer. And during that time, I feel like I've really got to know this business really well. And I think whole-heartedly I can say this patient-centric mission-driven company is a great company with great people, great assets and truly a great future. Obviously, safe harbor statement, I won't read through that, you'll be glad to hear, but obviously, it does apply here. We're going to talk a little bit about our strategy and our FME25 transformation program and also give you an update on -- I know what feels old news now, but our Q3 business update. As a reminder, we are the leading vertically integrated dialysis provider. And as that leading provider, we are obviously focused on patients with kidney care, and we touch the lives of more than half of the world's dialysis patients with our products. And we do run the largest dialysis network with over 4,000 dialysis centers globally. We treat patients with the life-sustaining treatments, believe it or not, every 0.6 seconds. And this is the core and center of what Fresenius Medical Care is about. You can obviously see a lot of statistics on this page, I won't walk you through them all, but very impressive numbers and what our company stands for. As I turn to Slide 5, talking about the key growth drivers in our core dialysis business. And there's no question, we have experienced a temporary disruption in our growth due to the unfortunate impact of COVID-related excess mortality. To date, we've lost almost 25,000 patients since the pandemic started, and that's been further exacerbated by the unprecedented labor challenges, hindering our ability to grow patient volumes at the level we would like, particularly in the U.S. While I don't want to downplay the severity of these challenges, it is important to remember that these are temporary in nature. The underlying business fundamentals are intact and the business model is strong, and we do believe that we will get back to underlying patient volume growth of historical levels of around 2.5% and 3%, once these temporary challenges are behind us. But the key drivers of our -- kind of core dialysis business haven't changed. And I think what you can see here is that the global population continues to age. We continue to see increasing incidences of hypertension and diabetes. And with that, we do see growing incidents of end-stage kidney disease and the need for dialysis. And for a patient with kidney disease, we know that their journey takes them through different stages of the disease and different treatment modalities. Our strategic focus looks to extend our patient reach and treat patients more holistically as they move along the renal care continuum. And that includes patients with CKD and transplants as well as supporting acute home and incentive treatments and new payment models like value-based care. And at the heart of our strategy is our core dialysis business. And we are able to leverage our experience in both services and the medtech part of our products business as well as pharma to maximize the impact of vertical integration. And I'd like to move on with focusing on a couple of strategic priorities within our renal care continuum where we've been making some really important progress. We know that the reimbursement model for dialysis patients continues to shift towards value-based management -- value-based arrangements as both U.S. government and private payers, focus on ways to improve clinical outcomes, but obviously, whilst trying to reduce the overall healthcare cost. And we are continuing to play a leading role in this space. Our resources and know-how to treat the ESRD patients holistically is second to none, with our market-leading database and artificial intelligence capabilities. And with the closing of the 3-way InterWell merger that was finalized earlier in 2022, we've significantly stepped up our capabilities to manage CKD patients with the addition of Cricket Health and their CKD experience and proprietary databases. And another distinguishing factor for us in this space is we are already profitable. Our expectation for 2022 was to manage around $6 billion in medical costs under management and earn around 1% operating income margin on that amount. And by 2025, we are forecasting to manage roughly $11 billion of medical cost under management. Home dialysis represents another key strategic initiative for us and one that goes hand-in-hand with value-based care and the goal of improving patient outcomes while reducing healthcare costs. We are uniquely positioned to support our dialysis patient population being treated at home, and I'm proud of our leadership in this space. As a vertically integrated business, we already offer a fully integrated home product in the United States, and we have the leading technology on the market with NxStage and the supporting infrastructure and connectivity in place. Home dialysis is not only important for empowering patient choice, but it also serves as an antidote for some of the labor challenges we face as home dialysis, as you can appreciate, requires substantially less labor spend once a patient is trained and is doing their treatments at home. Given the level of interest that we have from both patients and the physician side, we have increased our target of home penetration from the 15% that we have today to 25% by 2025. And this is an ambitious target as it will require a steep ramp-up in training, which also requires further improvement in our clinic staffing and labor challenges across the country. Next, turning to our new operating model and FME25. This is our transformation program. And in 2022, we were preparing to transition away from the old regional model that you see on the left here, which is kind of the regional model with its own separate G&A functions. The former model served us well in previous years, but over time, it has become weighed down by inefficiencies and lack the necessary transparency of the both businesses to support sustainable, profitable growth. Since the beginning of January, just a few days old, we have been working in our new streamlined operating model with its new operating segments, care delivery, which is our services business and care enablement, which is our products medtech business. The new country organization is now in place with globalized G&A functions supporting both of those segments. And in addition to the opportunity to sustainably reduce costs, this new model is really allowing us increased transparency, both internally and externally to have an end-to-end view of both of these segments. My goal is to incorporate the new reporting with first quarter results and provide more transparency throughout the course of 2023 on the performance of both of these segments. We are convinced this is the best structure for us to provide an optimal basis to accomplish the next optimization steps and the future success of our company. 2023 will be a critical year as we fully implement and execute on the new operating model and our cost-saving initiatives. Through 2025, we anticipate that we will invest around $450 million to $500 million in FME25, but that, in turn, will create $500 million of savings by 2025. And we do expect to realize about half of those savings by the end of 2023. And we are making great progress through the first 9 months of 2022 with realizing around EUR 51 million in cost reductions. And since we designed the FME25 framework back in 2021, obviously, additional areas of our business have faced increased challenges that need to be addressed. We continue to explore additional opportunities and execute on those priorities, which does include things like clinic closures, looking hard and executing on international service markets, looking at our manufacturing footprint and a holistic review of our portfolio. Moving on to the Q3 business update. I recognize that the challenge with the January conferences is that we're already in the new year. The last results you got from me at the end of September. And I hope you all understand I'm not able to share the fourth quarter results yet or guidance for 2023. We will do more of that on February 22 when we give our update. Needless to say, the third quarter of 2022 remains a challenging environment for us at FMC. Our business development continued to be impacted by the unprecedented U.S. labor situation and slower organic growth on the U.S. services than anticipated. Additionally, the persistent and challenging macroeconomic environment with inflationary pressures on the global supply chain and material costs heavily impacted our product business and the margins, in particular. Following our second quarter results, we immediately initiated the necessary interventions that were needed in our North America service business. However, we are seeing that those initiatives are taking time -- taking longer than we perhaps had initially anticipated to realize, but we are now starting to see the benefit of those as we go through the fourth quarter. Obviously, our business has been impacted significantly by Covid over the past 3 years, and we continue to monitor the COVID-related excess mortality, but that was somewhat elevated during the third quarter, but still in line broadly with our expectations for 2022. We obviously don't have the latest data for the fourth quarter yet due to the 6- to 8-week lag, but we do anticipate that the overall COVID number will be in line with our expectations. On a reported basis, currency effects further extended our positive revenue development for both the services business and the products business. On a constant currency basis, you can see here that the healthcare services revenue grew at 2%. That was mainly driven by organic growth in the international markets. However, that was offset by negative organic growth in North America. The products business delivered revenue growth of 4% on a constant currency basis, mainly driven by higher sales of in-center disposables and renal pharmaceuticals, offset by some lower machine sales in the chronic treatment space. I think this has become our infamous slide as we've reported on all the many headwinds and tailwinds in FMC over 2022. Since the beginning of the year, we've shared our assumptions on how we see these developing. And as we look through the biggest headwinds for the first 9 months, there's no question that, that is the macroeconomic inflationary environment. Obviously, when we set guidance in early 2022, I was ahead of the inflationary challenges and ahead of the war in the Ukraine. So we -- that has been a very challenging environment for us through the year where we've seen elevated raw material prices, logistics and energy prices. And that ongoing war has also caused us to assess our manufacturing facilities, in particular, in Russia and kind of not really have a strategic value for those in the future. So we're looking hard at those implications. COVID-related excess mortality, and that is the mortality over and above what you'd normally expect to see in the dialysis patients. We expected that to impact us around $100 million for the year and through the first 9 months, we did see that impacting us around $84 million. And labor, which has been the other challenging topic for us to navigate, we had assumed that beyond the typical 3% merit inflation, another 100 million headwind net of the U.S. provider relief that we were fortunate to get in 2022. And we did receive that relief, and we did use that to offset the labor cost. We spent a total of EUR 270 million of those provider relief funds and only $9 million of that remains for the outlook of the year as we've applied that to the labor challenges that we've had. And while we did see that labor challenge through Q3, we are now starting to see some stabilization and the initiatives that we have in place really translating into improving trends in the fourth quarter. And at the end of -- sorry, at the end of the third quarter, kind of a metric that we've been tracking quite closely is the number of open positions, and we had still around 5,000 open critical positions at the end of Q3. Turning to the tailwinds. I think another challenge for us is where we had anticipated that we would return to business growth, that was muted versus our expectations. And we only received about EUR 15 million for the first 9 months. And for the full year 2022, we had assumed a EUR 20 million tailwind. And as I mentioned earlier, we do continue to make important and good progress on FME25. And through the first 9 months, we realized the EUR 51 million that I mentioned earlier of savings from the transformation program. We've not given 2023 guidance, and we won't until February 22, but we know it's important for you all to have insight into all the tailwinds and headwinds that we are tracking. Within that business growth contribution bucket, we are evaluating the continued cumulative annualization effect from COVID and its impact on organic growth in 2023. We do know from the final ruling, we will receive 3% PPS rate increase from the government and also assuming a smaller, but incremental increase in our Medicare Advantage book of business, which continues to grow quite nicely. And as I mentioned earlier, we continue to see the benefits of our further expansion on our strategic priorities of value-based care and home. The contributions of the interventions to address the North America dialysis service business should also have a greater impact of the business growth in 2023. But of course, that business growth will also be muted by the full reduction of the nonrepeating sequestration relief that we also benefited from in 2022. FME25 is well on track to achieve 50% of the savings by the end of 2023. And on top of that, there will be the additional savings from the measures I referenced earlier, although some of those savings may have a longer payback because of the nature of the initiatives. Although we haven't reduced our overall PPO protocol, given the vulnerable nature of our patient population, we do expect the overall cost to further decrease next year. And we're not anticipating costs related to the California ballot initiative that we incurred in 2022 as well. However, for headwinds, the absence of provider relief funding will likely be the biggest. We had EUR 279 million of relief, and there's no indication that any of this will repeat in 2023. And the same applies to some of the other positive one-timers that we have in 2022. Many, many moving parts to the labor component that are expected to result in overall headwind. While we do expect some of the 2022 onetime measures to not repeat, we do anticipate annualization of the measures, temporary adjustments that we made in 2022. And obviously, ongoing, we have higher merit increases in our base for 2023. And also, since we are still carrying a larger than we would like number of open positions, we are also seeing that mix change in the labor construct between permanent and temporary labor due to the ongoing labor shortages that we're seeing. And although we're seeing some stabilization, I would say the pressure on the macroeconomic environment persists, and we are weighing up how that is going to kind of affect us in 2023, the impact of the annualization plus the stabilization. And I think overall, what we would say here is for 2023, we expect more headwinds than tailwinds despite the opportunities for driving improvement. On this slide, we thought it was important for me to share with you my initial thoughts and focus for myself taking on the CEO role and my leadership team to bring the company back on track to its historical sustainable, profitable growth path. It's clear we will not compromise our unwavering patient-centric mission. And with the go-live of the new operating model, we have truly implemented now 2 global divisions within FMC. The medtech products business and our care enablement and our global services business and care delivery and they are supported now by global G&A functions and the Global Medical Office. We're already seeing that the new operating model is giving us a higher degree of transparency into the performance of each segment. For the first time, we can now see end-to-end the profitability of these segments. And I think that's really going to help us focus and concentrate our efforts on where we can look for further margin expansion and also give us direct benchmarking to our competitive peer set. Which probably brings me to the most important topic, we have to focus on this core business and fix the foundation. We are working on the path to turn this business around, and we have challenges in each of those divisions that we have to overcome. We have great assets. We know how to run this business, and we just really need to get this back on track. We know we need to improve our profitability. We also need to review and optimize our portfolio to make sure that we have really good running businesses, and we're investing in the right sustainable profitable growth. We will trim our clinic footprint in the U.S. We haven't touched operating leverage in 3 years, and it's time to do that with the decline in the patient population that we've seen. And we're also taking a hard look, as I mentioned, at the international markets, and we'll exit those markets that are not performing to the benchmarks that we would expect. Clearly then such a transformation approach within culture is key for me and my leadership team. The approach that we've taken on FME25 will stand as well, and we will build a culture of continuous improvement to drive the mindset of becoming a leaner and more efficient and agile in many respects. So I think it's clear on our priorities. And I just want to emphasize that my goal here is clear that we need to bring FMC back on track -- onto a profitable growth track and ensure that we're seeing the valuable improvements in our cash management and our return on invested capital and reducing our leverage ratio, which is sitting a little higher than I would like to see right now. So with that, David, I look forward to our fireside chat and taking questions from you and the audience. Thank you all for your continued support and interest in FMC.

Great. Thanks, Helen. So I'll just kick off with a couple of questions here, maybe before we open up to the floor. You mentioned in the presentation, your volume growth last year, particularly in the U.S., was below where you anticipated. Maybe just touch on the key drivers of that, you expand on what you've missed in the presentation?

Yes. Yes look, I think for all of us, we had all hoped that COVID was going to be behind us sooner than it was. And as we started 2022 outside this inflationary environment, the labor challenges and so on, and we really thought that we would get through that last wave of COVID, and we would start to return to organic growth over the course of 2022. And we didn't. And not just the fact that the excess mortality continued to accumulate, but we were also hindered quite badly, particularly in the Q2 and early parts of Q3 by the labor shortages that probably for the first time, impacted our ability to take on new patients, which obviously did catch us flat-footed and not something that we wanted to see. Look, I think the obvious question, I know we've asked ourselves as a management board and my supervisory board asked me is, where did this volume go? And we obviously were forecasting a lower patient projection in Q2. Our competitor didn't until Q3. But I think now all the industry is seeing that there is this lower volume growth and lower number of patients, but none of us can speak to where did those patients go at this point. The obvious question is, did they go to a competitor? That doesn't appear to be the case. Was there some pent-up demand? Is it being seen in the hospital setting? A little bit, yes. So then the natural question is, has something fundamentally changed with the CKD population, which is the funnel that is feeding our patient population. And everything that we're seeing so far would suggest that the CKD population was affected by COVID in line with the general population. So there's nothing that we can point to at this stage that says it's something -- it's something different than we would be expecting. So it's a bit of a head scratcher. We continue to -- we know that the patient volumes are there. We know the patient growth is there and it will come back. I think the hardest thing for us to forecast is exactly when does it come back. And as you rightly said, I know we had expected growth in 2022 and at the end of Q3, we were still sitting with negative organic growth. And it will be one of the harder numbers to forecast for 2023, and we'll put strong assumptions around that in our guidance when we give it later in February.

Perfect. And then maybe on the cost side, you've had a good revisit of slides -- in the slides there of how you've been tracking so far, the various buckets. Obviously, wage inflation has been a big one, but also raw materials, freight. How do you think -- how you feel about those as we go into -- each of those buckets as we go into '23?

Yes and many moving parts, let me take -- maybe take labor first. Obviously, as you just heard me mention, we have invested significantly hundreds of millions of dollars in the labor situation in the U.S. in 2022. And that was broken down with what I'd call temporary measures like kind of retention bonuses, sign-on bonuses, maybe critical pay, emergency pay, things like that. But then some permanent measures, which were off-cycle wage adjustments kind of an increasing wage rate more kind of this mix of temporary and permanent labor really added to the cost base in 2020. We had -- we do expect some of the temporary measures, obviously, to not repeat in 2023. And obviously, trying to call -- talk about the 2 numbers I say the hard just to call the volume number and the labor merit increase number. So obviously, for 2023, we have the annualization of what we've already had in 2022, plus the higher merit increase that we'll give more light on in February. But I think the key is here, back in the summer, we were seeing how kind of this outrageous agency costs. I mean everybody was competing for the same labor and rates went through the roof. Also, there wasn't the availability that we needed. So we -- I do feel confident now we've got our agency spend under control, and we've got our agency usage under control. And I think with the increasing recession, we are seeing some stabilization of labor, and we are making inroads into our hiring as well. So I'm hoping that, that does stabilize and it's not the maybe 8%, 10% that we were seeing in the summer, and it's definitely starting to come down. So labor is something we continue to track and the availability of it and making sure we don't impact our operations, of course. On the -- so we've had excess mortality and the big labor issues impacting the services business. I mean on the products business, we've really had the broader macroeconomic inflationary measures, supply chain disruption, the war in the Ukraine, shortages, fuel, et cetera, impacting our projects business. So I think we've seen our supply chain challenges subside. That seems to be stable. Thankfully, on energy, we were hedged through 2023. So in our manufacturing plants, particularly in Germany, we didn't get a significant impact for the big energy prices that were happening in Europe. But of course, a lot of our raw materials are pegged to some of those kind of broad commodity prices. But I think we're seeing it stabilize. Well, I think we have good insight into how that's going to impact us in 2023. But of course, I mean, like many of my tails here today, we do have an annualization effect of these higher material prices now going into 2023, which are obviously further impacting our projects margin, and we have to work harder to drive those efficiencies and truthfully take a hard look at how we can pass price on. We have not had a lot of opportunity to pass price on those contracts, and we're really opening up the whole -- the kind of whole contract space in the projects business to make sure that we are maybe more aggressive than we've been historically on pricing.

Perfect. I'll just check there if any questions in the room. Microphone, please.

How are you looking at your expansion into the U.S. market?

In terms of?

In terms of acquisition or leveraging sort of becoming more competitive with whether it's DaVita or other, as you are in Europe. You have an incredible position in Europe, and you have a foothold in U.S., but there's an opportunity to expand that, and I'm wondering if that's part of your plan.

I mean I'd say we are the market leader already in the U.S. kind of sharing the market completely with DaVita, particularly on the services side. I think as we look to see where we can expand further in the U.S. business, particularly in the U.S. dialysis business, I think that's where we have the competitive advantage in our home offering as well as how we're further expanding into value-based care, which will take those renal patients kind of up the chain into CKD. I think, on our product side, as you just heard me mention, we have the leading home products with NxStage and kind of a formidable pharma position as well in those renal patients. So look, I think for me, it's not about market share in the U.S., it's more about making sure we are driving the right focus and level of profitability and execution on our operation. But I don't think from an FTC perspective, we could get more competitive in the U.S. on the existing assets.

There is a lot of innovation going on. I was sort of more going in that direction. That home care you're driving that which is really innovative, so that's important.

Yes. No, I think that's right. And the whole kind of connected care, the digitalization, when you think about the amount of data that we are capturing on our patients every given day, we have a wealthy database that is attractive to many players. So -- and look, and I think our value-based care, 3-way merger by pulling Cricket Health, our own healthcare plan business as well as our InterWell physician practice, putting those together really speaks to how innovative we can be in this space and how we can drive the future. And as I also said, we are the only profitable company in value-based care today.

I'll just ask an additional question. You got a decent chunk of EUR 279 million, I think, of provided relief funding. Obviously very helpful, but it disappeared for going to this year, do you see any opportunity for some sort of offset additional funding coming through?

No. I mean, look, the funding is depleted. We got -- I think we got our fair share of it, it was incredibly helpful in 2022 to really offset the labor challenges and issues that we've had from continued excess mortality, but no signal on anything and any kind of relief. I mean I will give you one bone, David, which will be an assumption for 2023 is that we will not expect to have government relief. And of course, I think this is the challenge with our reimbursement model, as you well know, the lag on getting the reimbursement increase when we have high times of inflation, 3% for 2023 certainly doesn't cut it when you're sitting in a 10% inflationary environment. It will catch up. So I think, for me, we can't just sit back and wait for relief, we have to get really focused on the operational excellence and drive margin expansion through efficiencies and passing on what we can through the top line.