Fresenius Medical Care - Q1 2024

Transcript

Operator (participant)

At this time, it's my pleasure to hand over to Dominik, Head of Investor Relations. Please go ahead.

Dominik Heger (Head of Investor Relations)

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 (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 will begin my prepared remarks on slide four. I'm pleased to report that we continue to make tangible progress on both our transformation and our turnaround efforts, and 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 first 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 first 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 2,000-3,000 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. 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 cost under management to grow to $8 billion for the full year, and 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 on 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 improvement, 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 operations 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 five. For the group, the first quarter is always 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 effect, 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 for the exit from less profitable acute care contracts, U.S. same market treatment growth came in at -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%-2% over the course of the year, and the changes in 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 a strong first quarter of 2023. This was supported by strong execution of our FME25 transformation program. As planned, FME25 contributed EUR 52 million in additional savings, and we are well on track to achieve the targeted EUR 100 million-EUR 150 million in additional savings by year-end.

As already mentioned, we continue to move at speed on our portfolio optimization plan. While we are 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 thirteenth 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 six. As I just referenced, we are moving at pace to exit non-core and dilutive assets. In the first quarter, we announced that we will divest our clinic networks in Brazil, Colombia, Chile, and Ecuador.

After further signing the divestment of our clinic networks in Guatemala, Peru, and Curaçao, 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 divestment of the Care Delivery businesses in Turkey and the Cura Day Hospitals Group in Australia during April. These collective transactions that I just described are expected to generate cash proceeds of around EUR 650 million upon closing, which we will use to continue to deliver. All transactions that are currently signed as part of our portfolio optimization plan are estimated to have a negative impact of around EUR 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 (CFO)

Thank you, Helen, and welcome to everyone on the call. I will recap our first quarter performance beginning on slide eight. 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 EUR 157 million in special items that you see on the chart comprise EUR 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 EUR 28 million, as well as EUR 1 million in costs associated with the legal form conversion. Additionally, Humacyte remeasurements contributed positively to special items with EUR 15 million. Turning to slide nine. 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 a 7.3% to a 8.6% group margin in the normally weaker first quarter is visible progress towards our 2025 group margin target range. 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 international 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 COVID-related one-time 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-based 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.

Although 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 compared to 2023, with clear progress towards our 2025 target margin then. Continuing on page 12. Our operating cash flow development was negatively impacted by EUR 58 million, resulting from a cyber incident 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 EUR 273 million. At the end of quarter one, EUR 311 million of the short-term financing instruments in the U.S. had been utilized.

On the back of strong crisis management and quick implementation of countermeasures, plus advanced payments received from different payers, which totaled EUR 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 3-3.5 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 (CEO and Chair of the Management Board)

Thank you, Martin. I will finish the presentation with our outlook on slide 14. While phasing for first quarter earnings was 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 off 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%-14% in 2025. That concludes my prepared remarks, and with that, I'll hand back to Dominik to start the Q&A.

Dominik Heger (Head of Investor Relations)

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. With that, I hand it over to Alice to open the Q&A, please.

Operator (participant)

We will now begin the question-and-answer session. Anyone who wishes to ask a question, may press star and one on the touch tone telephone. You will hear a tone to confirm that you have entered the queue. If you wish to remove yourself from the question queue, you may press star and two. Participants are requested to use only hands while asking a question. In the interest of time, please limit yourself to two questions. Anyone who has a question may press star and one at this time.

Dominik Heger (Head of Investor Relations)

Thank you. The first question comes from Richard, from Goldman Sachs. Richard?

Richard Felton (Equity Research Analyst)

Thank you very much. So two questions from me, please. The first one on Care Enablement margins. So obviously strong sequential improvement. But my question is, you know, how sustainable do you think that improvement is now? So obviously last year, you know, you had a strong start in Q1, and then margins faded slightly through the year. Is there anything that you can call out in terms of sort of phasing for CE margins this year? Or can we expect further improvements from the solid base in Q1? That's the first question. Then my second one is on the Q1 number for U.S. treatment volumes. Obviously, we're relatively subdued start to the year. Are you able to share any additional color or quantifications on the drivers of that between excess mortality, missed treatments, and new starts?

Thank you.

Helen Giza (CEO and Chair of the Management Board)

Hi, Richard. This is Helen. I'll take those two. So on Care Enablement margins, as you could probably tell from my, you know, my tone here, we're really excited to see the inflection point. You know, we had said that we expected the Care Enablement margin to at least double from last year. And of course, what you see here is quite a decent step up. We do expect, you know, there will be a little bit of phasing as we go through the quarters. And as we know, value, so VBP, value-based pricing in, procurement, excuse me, in, in China, will come in at the back half of the year. But at the same time, we also expect to have, you know, further FME25 contributions and the impact from price.

So I think overall, you know, that 6% might be an aggressive proxy for the year, but definitely trending toward that direction, but with some, you know, some fluctuations probably through the quarters. On your second question, yes, look, we know, we all know. We are watching, I think the world is watching the U.S. treatment volume growth. And, you know, obviously, while Q1 came in in line with our expectations, it is obviously, you know, still hovering around that flat-ish. We did have, you know, a flu season that was a little bit stronger than we had thought. That did result in higher mortality and missed treatments in January.

I think also for us, with our regional footprint, bad weather in the first six weeks of the year also impacted those missed treatments. The positive sign that we're signaling here is referral trends are better Q4 to Q1. And then I think, you know, outside the, you know, the external factors, if you will, about, you know, kind of the flu season and weather, obviously, you know, the operational double down here and pulling apart our end-to-end processes to improve our operational capabilities is well underway. Of course, we know these things take some time, but confident in the overall plan here that we'll get this within the range that we have obviously guided to.

Richard Felton (Equity Research Analyst)

Great. Thank you, Helen.

Dominik Heger (Head of Investor Relations)

The next question comes from Victoria, from Berenberg. Victoria?

Victoria Lambert (Equity Research Analyst)

Thanks for taking my question. Just, the first one for me is, where was clinic utilization tracking in Q1? DaVita commented that they were tracking near, I think it was, 67% during the quarter. So it would just be good to, see what the comparison is between, both of you. And then, I saw that there was, a divestiture from your Turkish clinics business. Could you give some color, how big that divestment is and what other geographies you may be looking to exit, this year? Thank you.

Helen Giza (CEO and Chair of the Management Board)

Hi, Victoria. I'll take your first question and maybe Martin and I, sorry, will tag team the second question. In terms of our utilization, I think we're seeing it very similar to DaVita. I think DaVita said 58% on their call. We are seeing it very similar in that high 50s. Obviously not where we want it to be, but it is, you know, kind of a key focus area for us. And I think the work that we're doing, you know, kind of on the operational turnaround, will certainly help that, as well. Obviously, you know, that constrained clinic coming down by a third, you know, from quarter end last year is significant for us as well.

I mean, Martin, do you wanna take the numbers on the Turkey divestiture? And then I can speak to the overall Turkey divestiture, the rest of the divestiture for you.

Martin Fischer (CFO)

Yes. So we have divested Turkey just only recently. I think there is, it's a smaller, smaller-sized business, and we.

Helen Giza (CEO and Chair of the Management Board)

I think we closed it in April.

Martin Fischer (CFO)

In April, exactly. We closed it in April. It's a smaller-sized business. I think it's more in the low double digit volume range that is relevant for us. And we are in the process or we just closed and have in Q2, we expect the divestiture effects to materialize. And with that, I think we have also divested the remainder or signed the remainder of Latin America in April and in the first quarter as well. But for the first quarter, there is almost no effect that we have from divestitures. It will be shown in quarter two.

Helen Giza (CEO and Chair of the Management Board)

So on your broader question about what else is in scope, as you can see, we have—we've moved at quite some pace, you know, from, you know, with Argentina and NCP, quite the laundry list in Q1 with many of those also going into Q2 announcements and closing. You know, we have signed roughly around EUR 1 billion of revenues for those divestments. I think you can expect that, you know, the majority of what we had in scope is now, is now out there. There's a handful of things that we are still working through some other country footprint, but obviously we can't speak to that until it's public. And, you know, kind of maybe some other smaller assets in scope. I think we've been very consistent with our portfolio optimization plan here.

And as you saw in our press release, we expect to get around EUR 650 million of proceeds from what we had signed in, in 2024, which adds to roughly the EUR 135 million that we got last year. So I think all, all on track, proceeding well, a lot of activity this, these last few months.

Victoria Lambert (Equity Research Analyst)

Thank you.

Dominik Heger (Head of Investor Relations)

The next call comes from James, from Jefferies. James, the line is yours.

James Vane-Tempest (Managing Director and Senior Equity Analyst)

Hi, thanks for taking my questions. Two, if I can, please. If I can just come back to the same store number you mentioned. I think it was -0.7 or -0.3, adjusting to the acute clinics. This seems to be on a different trajectory to DaVita, who I imagine also had to deal with, you know, weather and flu and things. So I guess, what are the key differences between them and your business? And did I hear correctly, you're also reiterating the 0.5%-2% volume growth target for 2024? As I didn't see that in the slides. And then my second question is just on the intersegment business. I mean, the margins were positive here, so I was just kind of curious, does this contribute to the Care Enablement margins?

Should we expect a positive margin for the eliminations in full year 2024? Thank you.

Helen Giza (CEO and Chair of the Management Board)

Hi, James. I'll take that first question. Yeah, look, there's. Clinic footprint does vary. You know, I think, you know, there is definitely a distinction between our competitors' performance on same-market treatment growth and ours. But the footprint does, you know, does vary. You know, we were hit pretty hard on East Coast. So, you know, flu season should be roughly the same. Weather can vary. And clearly, you know, we've got some operational work to do, and that is well underway here, particularly on some of our processes, as well as unconstraining clinics and still some labor challenging markets for us. So, you know, we do reconfirm our growth. It wasn't on the slide, but I think I spoke to it of 0.5%-2%.

But obviously, you know, we, we know that that is expected to, to step up over the course of the year. And I think, you know, what we're looking at in terms of the, the patient funnel and referral trends, admissions, new patient starts, obviously, they're all important metrics for the incoming funnel. And then for us, operationally, we need to, you know, kind of make sure that we can, we can get them into our clinics and service them, and that's kind of the, the ongoing process work that we're doing. In terms of the, the intersegment business, nothing has changed there in terms of the intercompany pricing or, or anything like that. So I, I wanna be very clear that that's not, you know, transfer pricing or, you know, intercompany, gains.

This is really the progress in Care Enablement is really underlying the operational FME25 transformation program that I've been telling you all, it's coming. We just they take longer, you know, we just gotta be patient and well, now we're starting to see that inflection, particularly on the manufacturing side, and that was evident in the first quarter, as well as the continued pricing.

Martin Fischer (CFO)

Also perhaps to add on the intersegment, it does not roll up into Care Enablement. It rolls up together on the corporate piece. So what you see in the Care Enablement numbers is a true Care Enablement operational performance improvement.

James Vane-Tempest (Managing Director and Senior Equity Analyst)

That's very clear. Thanks very much.

Dominik Heger (Head of Investor Relations)

Thank you, James. The next question comes from Veronika, from Citi. Veronika, the line is yours.

Veronika Dubajova (Managing Director and Senior Equity Analyst)

Hello, everyone. Good afternoon, and thank you for taking my questions. I will also stick to two on two very predictable topics. I apologize. The first one is just to circle back to the same market treatment growth. And Helen, I don't know if you can maybe articulate a little bit better your expectation of the cadence of growth as we move through Q2, Q3, and Q4. I guess, would you already expect to be in the 0.5%-2% range in the second quarter, or do we need to wait for that until Q3 or Q4? And then apologies for being nitpicky, but any impact from number of days in Q1? And if you can just remind us if that's included or excluded in the -0.7.

Apologies, I should have asked that of Dominik first thing this morning, but I forgot. My second question is just a bigger question on your revenue per treatment expectations. I know you don't comment on this, but obviously backing out the same market, it does look like revenue per treatment in Q1 was very healthy. Anything unusual here? And if you can give us an update on Medicare Advantage and how that's trending, and if that was a meaningful driver. Thank you, guys.

Helen Giza (CEO and Chair of the Management Board)

Hey, Veronica. Thank you. Same market treatment growth, not a surprise. Look, I think the cadence of growth, you know, our expectation is that this is going to ramp up over the quarters, and we're expecting it to be stronger in half two. I think the—you know, obviously I have a range out there, and you know, kind of, you know, we're obviously managing, you know, the guidance within that range. You know, the work that we're doing, some of that's taking, you know, kind of weeks and months to take hold. So I think that's also why, you know, we're kind of saying, you know, it'll ramp up.

I don't think it'll be, you know, the significant step up like, like, you know, the numbers you threw out there, Veronika, for, for Q2, but, you know, ramping up over the, over the course of the year. The impact of dialysis days, there is actually one more day in the quarter, but we actually adjust for that in our same market treatment growth calculations in our company anyway. So that has been, that has been adjusted out already. So obviously that, you know, kind of, it's a negative, negative adjustment. Moving to your, you know, your RPT question. You know, look, this is something, you know, we. You know, you see the revenue growth, and obviously, as you say, you back out the volume.

Really, really pleased with the progress that we're seeing on that line from, you know, reimbursement, from pricing, and from mix. MA mix continues to grow. There was a time when I said: "My gosh, if we can get this to 35%, that would be great." And now we're, you know, north of 40 and, you know, kind of going toward that mid-40 number. So I think, you know, the, the mix, the commercial mix is strong, slight improvement there. And then, you know, kind of obviously the contracting that comes with it. So really pleased with the progression on the RPT.

Veronika Dubajova (Managing Director and Senior Equity Analyst)

Excellent. Thanks so much.

Dominik Heger (Head of Investor Relations)

Thank you, Veronika. Next question comes from Graham, from UBS. Graham, the line is yours.

Graham Doyle (Executive Director of Equity Research)

Hi, guys. Thanks for taking my questions. Just first, one on GLP-1, which hasn't been asked in a while, but we're obviously still waiting to get more information from the FLOW data. But I was wondering, in terms of what you have internally, do you have any data that indicates when you're treating a patient who's currently taking GLP-1, that it actually does translate into longer times on dialysis, i.e., lower mortality overall, therefore a benefit to you guys? So that'll be question number one. And question two is, as you continue this great delivery and you're seeing the balance sheet deleverage, what are your thoughts in terms of what you might do with that extra balance sheet room?

Maybe not the next sort of 6-12 months, but beyond that, particularly as you've obviously retrenched from some international markets, that leaves flex for things like, say, buybacks, as one of your peers clearly does. Thank you very much.

Dominik Heger (Head of Investor Relations)

Thank you.

Helen Giza (CEO and Chair of the Management Board)

We're fighting over the mute button. Sorry about that. Hi, Graham. The, yeah, GLP-1, we do have good data on, you know, the patients, our patient population that is, is taking GLP-1s. Two things I would say. For those that are on it, they're not on it long enough yet for us to have any experience to kind of see what that, what that translates into in terms of extended time on dialysis. I think, you know, maybe we have about a year's worth of experience there. I think the other comment I would add on, you know, on GLPs in our patient population is that we have a very, very high dropout, thus far of those patients that are, you know, on a GLP-1, and then kind of dropping off it pretty quickly.

So I think that there is a study that will read out on GLP-1 drug in on dialysis, and I think that's not expected to read out until 2027. So, you know, we obviously we're later this month, we will have the expected readout of the double click, if you will, of the data from FLOW. But everything that we're seeing so far continues to confirm our expectations. Let me have Martin speak to the current capital allocation and delever plan, and then I'll speak to maybe how I'm thinking about the strategy for the broader capital allocation plan.

Martin Fischer (CFO)

Yeah. So Graham, we have a well-articulated 2025 plan, so until then, it is all about execution. It is about making sure that we continue to execute on our divestment plans. And we will continue to deploy capital to deleverage, also, kind of to make sure that we do what we can do from our side to keep the investment grade. There is a 3.3%-3.5% on implied, on applied range that we have, and I think with the 3.2, we are well positioned therein, and there's still some room for us to optimize. Having said that, capital allocation follows strategy, and with that, I think I hand the strategy part of the question to Helen.

Helen Giza (CEO and Chair of the Management Board)

Yeah. Thank you. Graham, I think, you know, we feel really good about the capital allocation plans we have in place, and obviously, you know, the combination of the divestment, the improving cash flow, improved operating performance is getting us, you know, to a natural delever. We've been asked the question a lot, is 3-3.5 times, you know, where you're gonna stick, or are you gonna change it? I think, you know, that answer depends on, you know, kind of our outlook. Obviously, you know, I'm working, you know, with the leadership team pretty hard now, on the strategy beyond 2025 and what those capital needs are. Obviously, we have HDF launch, clearly sitting in our strategy wheelhouse, as well as, you know, continued home and value-based care.

So I think, you know, we'll be continuing to work that internally, and when we can deliver the strategy, we'll also deliver the capital allocation plan with that. So, you know, we're probably thinking, you know, next year for a capital markets day on most of this. But for now, the focus is on strong cashflow generation, improving the profitability, delevering with the cash that we have, and building headroom, particularly in this kind of volatile, you know, financial market that we're in. So I think we all feel good about, you know, the current plan.

Speaker 15

Awesome. That's great. Thank you very much, guys.

Helen Giza (CEO and Chair of the Management Board)

You bet.

Dominik Heger (Head of Investor Relations)

Thank you, Graham. The next question comes from Lisa from Bernstein.

Lisa Clive (Senior Healthcare Research Analyst)

Hi, there. Can you just comment on the VBP in dialysis products in China? Is that going to be consumables and machines? And also, if you could just give us a rough estimate of what your Care Enablement sales in China are, and assuming that that, you know, gets cut in half, perhaps, what the profit impact would be as well. Thank you.

Helen Giza (CEO and Chair of the Management Board)

Hi, Lisa. Yeah, it's. For that business in China, it's consumables. I don't think we've disclosed our separate revenue on the China business, per se. We have built in an expected impact for VBP into our guidance outlook, and, you know, kind of with what we're seeing on tenders, and so on, expect that to be a back half impact, which also, obviously, with the Care Enablement margin in Q1, obviously we have. You know, that's why I'm saying that might be a little phasing through the quarters. So, I think, you know, what we've seen and what we've been successful on in the work there on VBP in China seems to be, you know, holding its own.

You know, yeah, we're on good track there, I feel.

Lisa Clive (Senior Healthcare Research Analyst)

Just a follow-up question. Could you give us a rough idea of what your market share is in China consumables? I mean, I think globally you're, like, in the 40%-50% range in most markets, if I'm, if I'm correct on that. Just wondering if China is different.

Helen Giza (CEO and Chair of the Management Board)

Lisa, I don't have that market share number to hand. Why don't I have Dominik follow back up with you there? I mean, you're right in terms of being the clear leader in the HD products, but let me see if we can snag that market share and get back to you.

Lisa Clive (Senior Healthcare Research Analyst)

Okay, perfect. Thanks.

Helen Giza (CEO and Chair of the Management Board)

Thanks.

Dominik Heger (Head of Investor Relations)

Thank you, Lisa. Next question comes from Robert from Morgan Stanley.

Robert Davies (Executive Director)

Morning, yes. Thanks for taking my questions. I had a few. One was just, could you give us an update, because I might have missed it earlier, just in terms of where you're seeing sort of labor inflation trends, so far this year? Are those still coming down, in the way you'd originally expected coming into 2024? The second one was on, just your sort of outlook. I know you set a medium to margin target. Just in terms of where you're at in normalized growth rates, given the sort of trends of excess mortality and, I guess, kind of exiting COVID comps, there's a lot of sort of moving parts.

So just be curious for a little bit more color around what your expectations of, of what the kind of mid-term growth potential for this business is, likely to be. And then the final one, perhaps you could just give us an update on how things are trending around home dialysis, where that is a percentage of overall, kind of activity at the moment. Thank you.

Helen Giza (CEO and Chair of the Management Board)

Martin, do you want to take the first one?

Martin Fischer (CFO)

Yep.

Helen Giza (CEO and Chair of the Management Board)

I'll take the next two.

Martin Fischer (CFO)

Yes. As it comes to labor inflation,

We are, Robert, we are well on track, so we have certain assumptions built into our guidance. We assumed a 5% kind of inflation being offset by efficiencies and coming down to a net 3%. We do see that confirmed in our first quarter, so it is developing in line as expectations as we also outlined in the expected headwinds. We are confident that we see further easing, as we assumed also throughout 2024.

Helen Giza (CEO and Chair of the Management Board)

Robert, on your question on the outlook for growth, you know, I think we've been pretty consistent that, you know, we feel that the underlying fundamentals in this business are on track. You know, the growing population, the aging population, the increasing incidence of the disease state, still no substitution for dialysis other than small numbers of transplantation. And I think, you know, with our neutral view on GLPs, we're still, you know, I think feeling confident that the, you know, the return to market growth of 2%-3% back to pre-COVID level by the end of 2025 is on track. So we are still confirming that. You know, home. Your question on home, I think we've, you know, we've all been a little frustrated with, you know, the kind of the stagnation in home.

And we all know why, you know, kind of the training ability or kind of training capacity of our staff. What I would say is we have a little bit of an increase, and we're still in that, you know, that low 16%. But I think the trends that we're seeing there now is a little bit of an inflection point in the number of patients being trained. So, more patients coming in for training and, you know, the expectation and hope is that, you know, that will, you know, translate into net patient gains, which is the important number there. So we're making progress. I think we all wish it would be faster.

We know we have an aspirational goal out there, but I think, you know, this is going in tandem with the, you know, the kind of the operational, turnaround, you know, kind of in the, in the clinic efficiencies as well.

Martin Fischer (CFO)

Mm-hmm. Okay, great. Thank you.

Dominik Heger (Head of Investor Relations)

Thank you. The next question comes from Hugo, from BNPP. The line is yours, Hugo.

Hugo Solvet (Research Analyst)

Thanks, Dominik. Hi, guys. Thanks for taking my questions. I have two. Maybe, Helen, first, you mentioned the strong trends in terms of referrals, strong funnel. Just curious, what's the lag here, how long it takes to feed same treatment market growth? And, I didn't catch your earlier answer on the previous question. Would you expect, as soon as Q2 to be at or above 0.5% for same market treatment growth? Second, a follow-up on hemodialysis. Curious to get your thoughts and views on the Improving Access to Home Dialysis Act. Maybe the likelihood to go through and feedback that you're getting from your teams in Washington. Thank you.

Dominik Heger (Head of Investor Relations)

Thank you. Hugo, we couldn't properly hear your first question. I think you asked how long referrals take to reflect in same market treatment growth. Is that correct?

Hugo Solvet (Research Analyst)

That's correct. Yes, thank you.

Helen Giza (CEO and Chair of the Management Board)

Okay. Hi, Hugo. Maybe I'll take these in reverse order as we pull some numbers here. On the last one about the, you know, the Dialysis Act, I don't think, you know, obviously, you know, that we're supportive of what's going on there. We're not expecting that, though, to have, you know, have any more of an impact to us than what we've already got in here. If I recall correctly, it was budget neutral from CMS, so that likely will, you know, kind of maybe reduce the likelihood of getting it through. But I don't think that changes our plans or anything on home.

In terms of, you know, the same market treatment growth, I mean, I'm not gonna guess at what the number is for Q2. I mean, I know the work that's underway. I can see the patient funnel. Obviously, you know, we're expecting it to increase, but I'm, you know, I'm not going to guess at that number right now. We'll give you the update in Q2. And then in terms of your first question on how long it takes to get referrals, I mean, that referral becomes a, you know, a patient you know in a chair, and obviously, you know, the more treatments we have, it plays into the treatment number.

So, you know, pretty quickly, but obviously, you know, one new patient and one treatment adds, you know, a lower number to the numerator, if you will. So, you know, I think obviously we want to make sure that that referral gets scheduled, gets into our clinic, that they're not missing their treatment, and overall, that's adding to the growth. But obviously that does take time to show up in a because of the number of patients, the number of treatments in the base. It takes, you know, one additional patient takes a while to show up in the number. You need a lot of patients to get that back. But we are we're optimistic. I feel really confident with the work the team is doing.

I think we're addressing it the right way. We're pulling apart processes and improving them end to end. I'm optimistic that, you know, it's gonna translate into real growth.

Hugo Solvet (Research Analyst)

Okay. Thank you very much.

Dominik Heger (Head of Investor Relations)

Thank you, Hugo. The next question comes from Anchal, from J.P. Morgan.

Anchal Verma (Equity Research Analyst)

Hi, good afternoon. Thanks for taking my call. My call is on behalf of David Adlington. I have two, please. Firstly, can you please quantify how much of a benefit the VBC was in Q1, and how should we be thinking about that for the rest of the year? And then the second one is just a follow-up on the labor inflation. Could you comment on how much your agency costs have reduced year-over-year, and can you take these agency costs down further?

Helen Giza (CEO and Chair of the Management Board)

Thanks, Anchal. I think I'll take both of those. Yes, the VBC business, as you know, obviously fluctuates up and down, depending on, you know, the kind of the claims and the experience there. I think probably the number that's meaningful for Q1 is that we saw a low double-digit positive amount in the quarter. So, you know, that kind of gives you a sense of, you know, when we talk about the phasing, the earnings contribution in Q1 with low double digits, and I say that's in euros. You know, the kind of the, how that plays out through the rest of the year will depend on that, you know, the kind of the contract and the way the revenue flows.

In terms of, you know, your labor question, you know, as quickly as that temporary labor market rose, you know, in what I lovingly refer to as the hot mess of the summer of 2022, and those rates increased, that all dissipated as well. So, our use of contract labor is down significantly, you know, year-over-year, and quarter-over-quarter. We're using it selectively, I would say, though, you know, where we know that it makes sense to use it. There's really tight controls over using it in certain metro areas, hotspots, or, you know, clear constrained clinics where we need to get temporary labor in. But, you know, definitely down in usage and significantly down in rates.

Anchal Verma (Equity Research Analyst)

Perfect. That's very helpful. Thanks, Helen.

Dominik Heger (Head of Investor Relations)

Thank you. The next question comes from Oliver, from ODDO BHF.

Oliver Metzger (Research Analyst)

Yeah, good afternoon. Thanks for taking my questions. So the first one is also on labor. So recent data suggest a stronger than expected economy in the U.S., also some more positive labor data. So can you elaborate about the current labor shortage situations and also this context, maybe after the bad experience, you, you made two years ago, if the situation deteriorates quickly, have you learned something from two years ago where you can adapt that the consequences might not be as severe? Just talking in an extreme case scenario. Second question is, summer is not far away, so some indication about the next year's bundle rate increase should come. So I assume you have a lot of interactions, CMS and also government. So is there already any tendency, how do you think the next year's bundle rate might look, look like?

Also, in this context, how is your experience about the weak bundle price increase this year to spread into the commercial plans? How is the mechanism also time-wise? Do you see where an immediate impact from CMS price, then a few months later, you see also commercial prices to adapt also a slower increase? So that would be very helpful. Thank you.

Helen Giza (CEO and Chair of the Management Board)

Thanks, Oliver, for both those questions. Yeah, look, I think the labor trends, you know, I think we're balancing, as Martin said, balancing the merit increases and being selective about, you know, where we're paying for that labor, but offset by labor efficiencies. That's key. I think, you know, also, you know, I, I'm really encouraged by another reduction of 500 open positions in Q1. And when I look at now this open position number of, you know, 3,000-3,500, it's still actually at the same kind of split between nurses and PCTs. Our overall turnover is also improving, so that. And I think also about a third of those hires that we now are getting in are, you know, what we call boomerangs, returning employees.

So, you know, the benefit of that is we're making inroads into the open positions. We're hiring back experienced, tenured employees that require less training. And, you know, our overall turnover is improving as well. I think we've also learned a lot from the summer of 2022, I think, in terms of being able, you know, with our metrics, to see those signals early, earlier, in a clinic, and also this, you know, kind of very dedicated use of temporary labor. So, you know, I think the market doesn't feel like it was, but obviously in some areas we're still watching it quite closely. You know, I'd love the crystal ball of what the PPS rate is going to look like.

I jest about that, of course, but I think, you know, what we know is MedPAC has put out a suggested 1.8%. You know, I hope that, you know, after these high spikes of cost inflation and things being a little out of control over the last few years, as things settle down, the reimbursement rates and the mechanisms that we, you know, that we have relied on for years come back into play and, you know, I don't know, common sense or normality plays out. Saying that, we haven't built our guidance on egregious increases. So, I think as you've said, I know, as we've said, and been quite consistent, we have assumed moderate overall rate increases, and if they're higher, great.

So, you know, I think we're being cautiously conservative there, and appropriately so until we know anything else.

Oliver Metzger (Research Analyst)

Okay, thank you. Regarding the spillover from the bundle rate into the commercial contracts, what's your.

Helen Giza (CEO and Chair of the Management Board)

Oh, yeah, sorry, I missed that, I missed that second part of that question. My apologies. Look, the commercial rate, well, both MA and commercial are obviously contracted separately. You know, we obviously take into account what, you know, when we're entering into any negotiation, you know, to kind of taking the impact of the PPS rate, you know, as a baseline into those negotiations and always, you know, a kind of a healthy trade-off between, you know, volume and price, network adequacy, and coverage. So, you know, I think, you know, our overall guidance is moderate overall rate increases.

So, you know, I think the, you know, what we with our, we have a new head of contracting strategy who, you know, is really, really terrific, and I think overall, you know, helping us with our, you know, future contracting strategy here. They're not all automatically linked to the PPS rate. I think you know that. You know, some have escalators in them and CPI. So they're all quite different, but overall, as I said, we're assuming a moderate increase of the 1%-2% rate. So yeah, I think everything looks good and on track there.

Oliver Metzger (Research Analyst)

Okay, great. Thank you very much.

Dominik Heger (Head of Investor Relations)

We have time for one last caller, Falko from Deutsche Bank.

Falko Friedrichs (Stock Analyst)

Thank you very much. Helen, I have two clarification questions on guidance, please. Firstly, on the same-store treatment growth guidance, and specifically the upper end, the 2%. Can we still consider that as a realistic average growth rate for this year, or should we rather view this as a potential exit rate? And then look at the lower end, the 0.5%-1%, as a realistic average growth for this year. And then secondly, I was a little surprised that you confirmed your 2025 EBIT margin target again today. Is there actually still a realistic scenario in which you can get to a 14% margin next year?

If that's not the case, I'm just a little surprised that sort of you keep this type of aggressive hurdle here. Thank you.

Helen Giza (CEO and Chair of the Management Board)

Thanks, Falko. Yeah, I think it's a fair question, and it's obviously one that we are working through in real time, you know, on the back of a flat same market treatment growth in Q1. Obviously, you know, we've got a guidance range out there. I think it's fair to assume that that 2% is more of an exit rate than an average rate, at this point. And I think, you know, obviously, as we get another quarter under our belt, we will, you know, refine or adjust or update accordingly. You know, on your second question, I don't feel it's aggressive. We clearly have a range out there for our EBIT margin.

I think I've been pretty consistent in my commitment to try and, you know, give an update on, you know, that band itself, by half one. I think that is still my plan. You know me by now, I'm trying to take it a quarter at a time. I'm really pleased with the progress. It's on track. And, you know, the financials and bottom line performance are clearly speaking for themselves. I know there's a question out there of what's it gonna take to get to the top end of those EBIT margins, but I think, you know, the progress that we're making will continue to inform that.

For now, I'm not gonna change it today, but clearly, it's top of mind for me, knowing that by the time I get to half one, the end of 2025 is only 18 months away. So we'll continue to provide the appropriate color, and, you know, kind of how we're seeing those guidance ranges as the year goes on.

Falko Friedrichs (Stock Analyst)

Okay. Thank you, Helen.

Helen Giza (CEO and Chair of the Management Board)

You bet, Falko.

Dominik Heger (Head of Investor Relations)

So we do run out of time. Thank you, everyone, for this contribution. This is great for I know what you all have a busy day. Thank you very much. Well, I appreciate that, and we'll meet you on the road and or latest next quarter. Thank you.

Helen Giza (CEO and Chair of the Management Board)

Thanks, everyone. Thanks for your continued support. Take care.

Martin Fischer (CFO)

Take care.

Operator (participant)

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