Fresenius Medical Care AG (FMS) 2004 Q2 法說會逐字稿

I think everybody is back, so let me also have some introductory words for the presentation. So thank you very much to all for joining Fresenius Medical Care Second Quarter and First Half 2004 Analyst Meeting today. Let me start with the forward-looking disclosures I have to mention, the cautionary language regarding forward-looking statements as indicated in the press release, and it's also the end of your presentation. The same language applies to comments made on today's Analyst Meeting and you will be able to refer to our SEC filings for more detail.

In compliance with the Section 401 of Sarbanes-Oxley, we are providing you with a complete bridge of any non U.S. GAAP financial measures that we utilize and relate such to nearest U.S. GAAP measures available, so please use this information that is actually at the end of your presentation and at the investor news. Let me also point out that the whole presentation including the Q&A is being webcasted and the participants from the web will be able to ask questions via the internet so that's from my side, so Ben the floor is yours.

Thank you, Oliver. Again I'd like to welcome everybody to this afternoon to our meeting and I will cover basically the business outlook or the business update, the outlook for 2004, and Larry will cover the financials and then we'll entertain questions and answers afterwards. Before I get started I'd like to thank the management Board, our employees, all of our clinical colleagues for their contributions during this quarter to make it a successful quarter. I am very pleased with the performance around the world.

Now looking at the first slide here, you'll see a summary of our excellent performance for the second quarter. Essentially we had record sales of $1.55 billion. Our operating income increased 16% to 213 million, and our net income was a record of 101 million. This is the first time we have exceeded the 100 million number for a quarter. In the revenue, at constant currency we have 12% growth, and we also have about a 2% on the consolidation of our cardiovascular resources business, which was consolidated for the first time this quarter.

Looking now at the half year numbers, revenue $3.0 billion, up 10% constant currency, operating income up 16%, $411 million, and net income up 28%, again cash flow was excellent, Larry will talk a little more about it in his presentation -- free cash flow was up 15% to 256 million, which is 8% of revenue. Now, I'd like to comment that this good performance came very strongly from North America headed by Mats Wahlstrom and Rice Powell and from the European and Latin American division headed by Emanuele Gatti. So those were the real drivers for this quarter, and I will go into little more on that as we go through the quarter -- as I go through the presentation.

Turning now to the segment growth, North America had a 10% revenue growth, very strong. International had a 21% revenue growth in current currency and a 15% revenue growth in constant currency, again quite good. Looking at the European performance, we saw a 14% constant currency growth in revenue, again clearly above the market. Asia-Pacific, 9% in current currency, 3% in constant; again this reflects some healthcare issues that we have in Japan. As I think most people are familiar with that area, on a biannual basis, the government reduces the healthcare expense with the intention of controlling the healthcare total budget and basically that filters down to dialysis. We know that it's coming, you never quite know exactly how much will come to you, so I'll talk a little more about that, but that basically affected our growth in Japan for this quarter. I'd like to report though that the actual unit sales in the area of PD and hemo were still quite good, and I'll cover that a little more as I go through the presentation.

Turning to Latin America, very strong performance, 38% growth, that's in constant currency, we clearly are doing well in Latin America, and the management team in Latin America is doing quite well, 15% of that came from organic growth and the rest of it came from acquisitions and a FIN 46 consolidation of some dialysis clinics that we operate in Latin America. But if you look at it, a 15% organic growth is very good.

Now let's look at our service business around the world. Our total service now accounts for around 73% of our total revenues. We had a growth of 15% in actual currency, 14% in constant currency. As you look at the U.S., you'll see that we had a growth rate of 9% in the dialysis services, 12% in the total services, which includes the CVR and that represents 90% of the revenue in North America, so again a very strong performance in North America in the service business. If you look at the international, you'll see a very impressive 35% growth in actual currency, 28% in current -- in constant currency. So again in the service part of the business we saw good growth basically around the world and across the segments.

Turning now to the dialysis services itself, and looking at the dialysis services, we had an impressive 8.6% growth in North America -- organic growth in the dialysis services and international we had a 6.3. So those are very good. On average then we are 8.3 for the quarter and that's quite good. In terms of same store treatment, we had a growth of 4.6% in the international segment. We had a 3.4% growth in the North American segment, including Puerto Rico, if you look at just the North American segment without Puerto Rico, it was 3.5%. Our estimate is that's slightly above the market. We had in excess of a 4% growth in center which is really the object of our UltraCare and you will see more and more growth in that area.

Our de novos, we have basically been able build less de novos and have more patients come to our centre from in center part. So we are very pleased, we are starting our marketing program this year with our UltraCare, so everything is on track. And if you look at the entire company, then we had a 4% same store treatment growth. Now we would expect as we go forward that we will see probably growth rate in North America between 3.5-4% and we estimate the market is growing somewhere around between 3-3.5.

Turning now to revenue for treatment, a very good story, we had an additional increase in revenue for treatment, we are at $289 treatment in the U.S., and the international continues to grow, we were at 122, and we performed 4.7 million treatments this quarter which is up about 6%, so it was a very good performance in all aspects in terms of the service business this quarter and clearly the first half. Now just taking a little more time to look at the revenue per treatment growth in North America, that was our focus, is our focus for 2004, we are making very good progress as you'll see from the graph here over last year, we increase by $14 a sequentially, from first quarter we increased by $3. now our target for the year was above $280, we clearly have achieved that target, right now I believe as we look through the rest of the year our target will be to maintain that and maybe increase it slightly, but we are clearly getting up into the $289-290 range and that's essentially where we think we'll be for the rest this year. So again we are quite pleased. Now the other thing I want to mention is that as far as quality, we continue to provide our targeted therapy to our 94% of our patients. We do operate our anemia management program though following douche standards, and so we try to -- the target is around, somewhere around 80% of the patients will have basically hemoglobin's greater or equal to 11, and we are pretty much right on that target. And so basically we are quite pleased then with where we are operating in the North American service business and essentially so far this year.

Now let's turn to the products business. I tried to show this on a worldwide basis. On a worldwide basis we had a 11% growth in products. Again I want to indicate we see the market and revenue growth is somewhere between 4-6%, so clearly we are growing above the market and in constant currency that's 7%, so we are clearly growing above the market in constant currency. Now the real growth driver there has been the international business. It has grown basically at 16%, it's essentially now growing at almost twice the market. Our same store growth in that area at constant currency is 9%, so international group is doing a very good job of growing market share. In fact, to give you some idea that we all suffer from or if you are a tax payer benefit from healthcare reform. But in Germany, I think, we talked last year about we saw healthcare decreases now, this is sort of a way of life for the dialysis field. In the international we have always seen price attrition on a controlled basis year-by-year. But let me say we have always in a position where we change our operating metrics. We have provided the customers with equal or better quality.

Our growth now in Germany, I will show you later was a very strong this quarter, so we try to turn those into positives for us as we are now facing in Japan, I will talk about that later. So our products in Latin America and Germany grown very well and North America, our products have grown 2% if you include the sales through ourselves. But we had a slightly different model in North America, we are in the process of maximizing the margins and the profitability of North America and so we are now emphazising only those products that have technology that we control and basically our major products that we produce. So, we being a full service provider of all kinds of bandage, saline, and various things. We are backing out of those and basically trying to optimize our profitability, and I think that you are seeing that in the growth of North America's profitability.

Now the next slide will give you a little bit of a flavor. Our goal there is to continue to grow above the market; machines, dialyzers, and peritoneal dialysis in the external market because that's really the measurement of how the products group is doing. And you can see over this quarter we grew -- if you put dialisers and machines together we grew at 5%, which is clearly above the marketing revenue. We continue to see strong acceptance of our single-use dialyzer program is best to measure that in units, you can see that that's still clipping along in the double-digit 20% range. And we’ve been very successful with introduction of some of our new PD products in North America. We clearly have grown at 7%, which could be instantly higher than the market, since we are not sure that the market is growing, but any how that’s where we are with the PD. And you can see basically the same type of results for the half year. And so our goal then is to basically be flat on the net available market growth, optimize our profitability and grow the key product, which I have discussed.

Now, we did pass one of the milestone in the second quarter. We have now produced over 100 million dialyzers out of our Ogden plant, since we initiated that plant in 1995 and quite frankly that’s a lot of dialyzers, but it's also a lot of experience and we are really quite pleased with that operation. So that basically gives you an overview then of the products and services.

And now I will turn to another point. I don’t think probably too many people are interested in this, but I will cover it any way. And this is the reimbursement situation in North America. And because we only have limited time I am not going to talk about the EPO monitoring program. I am sure that you can just go back and listen to the replays of all of our colleagues in this field and you can pick up what you need there. So I would just focus on the MMA today if that's alright with you.

Now, before I start, I would like to compliment CMS. I know that’s a rarity but I’d like to do that because I really believe that they are making a very significant move forward here and trying to get the best quality from the expenditures that are being paid by the U.S. Government and by taxpayers. And they have also moved fairly judiciously but quickly in terms of coming up with a new program to pay for basically dialysis. So from that standpoint, now like any new programs there is a lot of details that we haven’t studied yet, there is a lot of database checking that we have to do, so I won't go into all of the pros and cons of it today if that’s alright with you, because quite frankly we are still looking at it, looking at it very carefully.

Now, one of the things that I want to emphasize is there is a 60-day comment period, and I think the industry will comment as a total industry as well as an individual companies, and so we intend to do that. And I think the 60 day is basically in the September 24. Secondly, there are some details that I think are very positive. There is a 1% -- 1.6% reimbursement increase for 2005, that’s the third time we have gotten reimbursement increase for the last 5 years and for the first 16 years, previous to that we got zero, so this is basically a step in right direction.

Now, the other thing is the MMA called for changing the payment prices or revising the prices for separate billable drugs, and taking the profit from that, that we now basically use to cover the losses that we have on the composite rate, putting those into the composite rate. And that was the add-on of the margins that exist today. And so that is in the process and they made some proposals and those are being studied. At the same time, in order to try to understand the effect of different case mix situations, they have actually come up with a proposal to look at the payment program based on case mix and they picked, I think four fairly interesting case mixes basically sex, age, AIDS, and peripheral vascular disease PVT. And they've also given us the codes for those, so those are not -- it’s a transparent type of situation. Now, where we are today, is FMC has operated since 19 or since 2000 on a corporate integrity agreement where we have shared with the U.S. Government, with the various agencies what we have done in the areas of drug utilization. We have also shared with them our high-end monitoring and basically we have shared the entire program and worked with them. We are very comfortable in our databases. We believe that they can be reconciled with the U.S. Government's databases, which we have not done today. And at this point, we are confident in our data, we are confident in the sincerity of the government of what they are trying to do, that quite frankly we see this is a probably a neutral for FMC, but I got to say that until it's finally decided and the regulations finally come out I can't make any more of a comment on it and that at this point in time. So that’s really our position on the Intermed (phonetic) at this point in time. And now I am sure there will be a couple of questions afterwards if you like to.

Now let's go to the next topic, which is Europe. And again, as I mentioned, Europe and the U.S. are doing very well. And I think I would like to highlight a little more on Europe because it basically has the highest profitability in our company, it has very strong growth rates. And as you can see here we have been able to essentially continue to grow above the market with the products. We have a good model in Europe, which has a combination of service and products and so we can operate in almost every area of the region and do quite well. And as I mentioned we had a 9% increase in constant currency of the products. And in Germany, as I mentioned, we were at 9%, which is clearly way above the market in Germany, we are quite pleased with that.

In terms of our service part of the business, in Spain we are operating and that's our largest -- basically our largest market with respect to service and we are doing quite well at 8% essentially constant currency growth.

Now, the reimbursement environment, we do see it as on the whole positive. We are seeing increases in the number of countries, but basically you have to work that and you have to demonstrate the quality. And finally, the cash flow in Europe has been very strong. So Europe is doing very well. Emanuel and his team are doing quite well. We do expect that to continue because in 2005, the European group will introduce a new series of machines and dialyzers and say disposables, and essentially we think that will continue to carry the momentum in the European theater for the foreseeable future. So Europe is doing very well.

Now, looking at Latin America, I want to say that we have went through some tough times a year or so ago with all the devaluation, but we moved to the service business, I think that was the right move. We are there, our cash flow is good, and now we have seen after focusing on the service businesses in Latin America, it clearly has rebounded. Our profitability looks good. We successfully entered the Mexican product market and we have seen reimbursement increases. So again we saw Latin America now is meeting our goals as far as profitability.

Asia Pacific, in Asia Pacific, out side of Japan we are doing well, but in Japan as I mentioned we are now struggling with the what we call the bi-yearly healthcare reimbursement decrease, okay versus the third one we have live through. And so basically what this has done as I mentioned this has decreased our revenue in Japan and we essentially -- and also, we see the unit sales but we don’t see the revenues sales. Now, I want to say that it usually takes us 6-9 months, or probably in this case more like 9-12 months to make the adjustments that we do in all segments once this comes in to play, and we find out where we end up on essentially the reimbursement. Because in the past we've been lucky enough to have the clinics and other people take most of the reimbursement changes, but now we're not sure whether that will come. So Asia Pacific, Japan specifically, will continue to underperform this year, it's only 2% of our, basically of our, revenues, and so it's some thing that we can certainly -- we always have something like that going on at all times.

Now let's talk about the challenges, I think I've talked with you about Asia Pacific or let's say the Japanese issue and that's the challenge that we have. Quite frankly, we always come out stronger out of those challenges because you end up essentially looking more at your operational costs and you end up doing pretty well. We have plans there, so we have the production in place, so we clearly -- in the PD and in fiber, so we clearly have position and we'll work our way through that.

Europe, as I mentioned, we are expecting them to continue to overperform. North America, we are expecting North America to continue to overperform, and we believe with the strength of those two regions we'll clearly then make up for whatever we have, and as you'll see we raised our guidance because both those regions are doing well. Now over the next 6 months, I am pretty sure most of the CMS draft proposals will become basically regulations. Our goal there is to have them implemented successfully, at least financially from our standpoint and of course quality wise. So we'll work through very diligently on that, our cash flow is obviously the objective and so at the end of the first half of the year, basically what we see is that we are going to and have increased our guidance in revenue to high single digit, and in terms of net income growth, we see now that the guidance would be more like basically mid-teens.

So from that stand point I think I have covered where we are on a global basis in each of the regions. I'd like to turn it over to Larry Rosen, our CFO who will cover more details in the financial area. Larry.

Thank you, Ben. I would like to extend my welcome to all of you here in Bad Homburg, to those on the web and to those joining us on the telephone. The things I would like to talk about are results for the second quarter and the first half, the profit and loss statement, specifically our operating margin developments, and lastly our cash flow and balance sheet development, following up with some details on the change in our outlook for the rest of the year.

If we come back to the P&L that's been summarized, you see we had a record quarter in sales, 1.55 billion; this was an increase of 14% or 12% in constant currency. The strong growth was due to good performance in our key regions, North America and Europe. North America we saw an increase in revenue per treatment that Ben discussed and in Europe we saw a very good performance in both the products and services business, with excellent performance also in Latin America in the service business. We did have the impact for the first time from FIN46; this is the consolidation of entities where we own less than 50% but nevertheless exert management control. Second quarter of this year was the first time that we consolidated those entities, we expect for the full year 2004 an increase in sales volume of about 100 million, slightly more than a 100 million for the whole year and on an annualized basis about $140 million.

The operating income in the second quarter grew by 16% to 213 million, an excellent performance in Q2 with margins reaching 13.7% -- the operating margins and I'll come back to some of the reasons for that good performance. We were up 20 basis points over Q2 of 2003. Net income was a record of 101 million, the first time we are over 100 million, it's a record for the Company, and it was up 27% over last year's Q2.

Let's take a quick look at the second half. There are a couple of specific items I'd like to address. Again we had revenue of 3 billion constant currency growth of 10% for the whole first half, operating income at 411 million, growth of 16%, the operating margin up 40 basis points over the first half of 2003, and net income also up similar 28% for the year. The two items I want to address specifically are SG&A and also our interest expense development. You may have seen that we have increased substantially SG&A as a percent of sales, almost 1% for the half. And there are two main factors leading to that one is mix, where we have faster growth in regions where we have higher SG&A expenses, namely the international region; on the other hand, the other factors in North America, where we have seen some higher marketing and also higher personnel infringe cost for the business, nevertheless despite that development we have been able to increase the EBIT margin.

In terms of interest expense we have some really good news there. We have been able to reduce it substantially over what we had in 2003 and even far below our expectations for the year. The primary reasons go back to our excellent cash flow performance, we will talk a little bit more about that in a minute, so that our net debt is lower than we had expected at this point. We also had some transactions to convert some of our fixed rate debt into variable rate debt, so we have got more exposure to lower interest rate debt. And you might ask the question why would we do that in what seems to be a rising interest rate environment, and its just to get a little bit more balance, we are still at over 70% of fixed rate debt in our debt portfolio and that's still quite a conservative percent to have as fixed rate.

Now, moving on to our next slide and looking more specifically at operating margins, you can see that in North America we've had substantial improvement, we've increased 50 basis points in both the second quarter and the full first half, and it really goes back through the increases in revenue per treatment that we've had and it also is going back through the product margin optimization that we've had in the product business. So, here we have reduced participation in some of the lower margin, non-strategic businesses and really focused on our efforts on the strategic businesses on machines and dialyzers, and we've really gotten also some very good manufacturing efficiencies from having increased volumes in our production plants.

In the international segment, we've had a flat second quarter, even though we were up for the full first half. And here improvements that we've seen in Europe and Latin America have been offset by the decline in the reimbursement rate, which we saw in April of this year in Japan, and that was quite a hefty decline around 11-12%. As Japan does every 2 years, this April we had the biannual reimbursement decrease, so that had a significant impact. In summary though, we've had a quite a good margin development and we are very pleased with the trend.

As we are with this trend as well, our DSO development, we have declined a further 2 days on a sequential basis to 69 days in North America. In the international region, we've stayed at approximately the same level, but on a much lower level than in the past quarters. We have reduced DSO by 7 days in total compared to Q2 of 2003, and for each day of reduction, we gain about $15 million of cash flow. So you can see that the very good cash flow performance that we have had in the last quarters, goes right back to the DSO performance that we have had, this has been a big effort by the organization and it really goes across all regions where we have seen quite an improvement and it’s really been a matter of focusing, a lot on it and sustaining that focus and I compliment the organization on the progress they have been able to make on DSO.

Now turning to the cash flow statement, we have had an improvement in our operating cash flow of around 3% in Q2 of this year, so continued strong performance. Due to spending a little bit more in CapEx than last year, our free cash flow was a little bit down on a quarter comparison, but then also just due to timing, we had a little bit lower acquisitions, so that free cash flow after acquisitions was up around 7% for the quarter. In the quarter, we had 116 million of cash flow after acquisitions and that just about covered the dividend that we paid during the quarter of a $122 million.

Now taking a look at the first half, you see that in operating cash flow, we had a 17% increase or quite a good performance coming back to the DSO performance, also CapEx was 95 million. We still expect to spend around 250 million for the year, so we’ll spend more in the second half than we did in the first half, but that wasn’t entirely unexpected. Free cash flow was up 15% at 256 million and acquisitions were around the same levels as last year, 52 million on target for our guidance of 100 million for the year.

Now, looking at our debt level and leverage ratio, we've really made some good progress here. In the second quarter, we are able to reach a debt to EBITDA target, which you see at the bottom of the page of around 2.5. I am sure you heard us mention 2.5 before this is a target that we've had for quite sometime, and we really have been able to reach it now about 6-12 months ahead of time. This is due to a very good cash flow development. We’ve been able to reduce that level to below what we expected at this time, but it is also due to our very, very good operating performance. Our EBITDA level is higher and as we are able to affect both sides of that ratio, we really get an excellent result when it comes to the debt-to-EBITDA development.

In the first half, you’ll see that we've been able to reduce debt by about $80 million from the 2.72 million to the 2.64 million this is despite having paid the 120 million dividend in the second quarter, so quite a good performance.

Now to conclude, I want to talk about our guidance for the rest of the year in terms of net revenue growth we were at mid single-digit at the beginning of the year and after the first quarter, and we have now upgraded that guidance based on our performance in the first half and also our expectations throughout the second half to high-single digits on a constant currency basis.

Net income growth, we now expect to be in the mid teens, we are guiding towards high single digit or low double-digit and so is now upgraded to mid-teens. This is also based on our very good performance in the first half and also our expectations about the second half.

In terms of operating margins, this means that we would expect to be slightly improved on a comparable basis to 2003. This is basically what we have said at the beginning of the year, but we have upgraded the net income growth because of the stronger growth in revenues and also the better performance on interest expense. So, all in all, a very good quarter, a very good first half and we think it’s a right time to upgrade our guidance for the year, and I thank you very much for your attention and I think we will open the floor now for questions.

Thank you very Larry. Thank you very Ben. Just to remind for benefit of the people joining us via the web, if you have a question, please say our name and the company you are with and hold it very close to your mouth, because otherwise we’ll have trouble to show that. I think Andreas is first.

Andreas Schmidt from Merrill Lynch. Three questions, one is Ben you mentioned that you are launching new machine features and new machines next year. Is it complete new machines or new modules -- or only new modules? Second would it we compatible to old machines for one if its new models -- modules? And finally on that issue will it be priced on a similar level than the existing range of machines, let say, or is there any chance for increases or declines? The second question is, there was very strong product covering in the international business, specifically, can you elaborate a little bit more on what products were so strongly performing and what regions, and who lost the market share, because -- of course, if somebody is winning, somebody losing, and between two states, who is the main loser, and whether that trend could continue. And finally a little more strategic questions, what’s play a dramatic leap big overall in the service business in general, and yesterday we had [Avita] very much influenced by their statements on equal pricing and equal development. With not just looking on [EPO], would asset will go further and will get more importance in overall revenue, is it necessary for you to engage more into [twats] business, and what are the steps in that direction, and/or would it be otherwise a natural consequence that one of this big twat companies might issue at some point of time?

No. It's not just kidding, it's realistic basically. Well, listen, that was only three questions. And so -- It seems like --

Bundled traits--

Okay. I will tell you what I will take the two -- the first one, and if you don’t mind, I will ask Emanuele to talk about where he is getting the market share, but basically what we have, is we are introducing a new system in the international, and both Emanuele and I don’t want to name it yet, because it's being essentially, brought through our own clinics, and that’s one of the benefits of basically being on both the service side and the products side, as you take the first year or so and have those in your own clinic, you work out all the bugs and then you bring it to the market that are very successful. So that will be coming out next year and it will have disposables with it and I don’t believe it will rectifiable to essentially the business in and the products in the international at this point. That’s something we do more for the U.S. because of the reimbursement situation, in international we don’t necessarily do that.

Is it, new lock in systems, offerings like that?

No, there will be some nice features in it and I don’t want to upstage, you will see it next year, after he gets it in our own clinics, we know that its – the costs are right, everything’s right and you will see it to be introduced sometime in 2005. And it has some nice features to it. So from that standpoint, I will leave Emanuele a second to talk about, where he is getting his growth, I think the question is there is no doubt that drugs are an important basically component of dialysis and in the international area, we don’t necessarily get reimbursed for them, and that’s the difference in the reimbursement area. So yes we are looking at that area, and we clearly see that it represents an opportunity for us long-term and so we will be essentially active in that area, but we are not going to take on the major drug companies, and -- but there is nice interesting ideas in the international field and plus -- possibly the U.S. So that is I think two of the 10 questions. Right? Okay.

But to be more specific in the drugs area, its not that you would let’s say link exclusively with the drug company or enforced research, so that you say what can we additionally applied during a dialysis session on other drugs, which nobody thinks about in the moment and things like that. Is that --?

Well is a little more complicated, there are some very definite regulatory aspects to it, and so in region-by-region, we may be at co-marketing partner in some region, we may be a distributor in other regions, we may decide that there is a certain product that is really worthwhile for us have contract manufactured for us -- we have lot of opportunities in the U.S., its not nearly as open, and so right now we are focusing on it for the international and for the future, but there is a lot of ways to go about it. Now the question, I think, that's the drug and I think that's the machine. Emanuele, do you have a mic, can you talk about where you are getting the market share without giving way in secrets.

We had a very strong growth in [inaudible] in the first 6 months, some 15% growth index, so I think is very easy to understand where the market share comes from. And in [inaudible] we are growing in HD not only on the most important ranges in dialyzers, but also on the [inaudible] product. We have seen a big increase in the equipment sales in the first half, I think people are now investing more than last year, and definitely we are gaining market share at the expenses of the other big two in machines. So in principal, I think, if you read the publicly traded company report, you can make your math about market share. I think that I can add that we are gaining market share also from non-listed companies as well on the -- primarily on the Middle East and Eastern European markets.

Thank you, Emanuele.

Charles Weston with Goldman Sachs. I had a few questions, not take too long. Firstly for Larry, could you give us a sense for how you are modeling your interest cost going forward now, in the last couple of quarters this has surprised us quite substantially on the positive side, so it would be very helpful to get a sense for how that will develop for the remainder of this year and also going into 2005 how much sensitivity is related to the interest rate changes we are seeing? Secondly, could I also go back to the comment you made about your SG&A cost increases in the second quarter and an equal improvement in the gross margin, which really looks spectacular. Should we expect this to be the new level of gross margin on SG&A expenses going forward or what type of -- is there any of these factors you mentioned that is not particularly sustainable? And thirdly, could you also comment a bit about the pricing of single-use dialyzers in the U.S. I think you did mention something about strong volume in growth single-use dialyzers but I wasn't really clear that you actually included price in that calculation given that it was volume, probably you didn't, but if you would give some comment on that, that would be very helpful as well? Thank you.

May be I will answer the first two questions, and then Ben will take the third on the pricing of dialyzers in the U.S. In terms of modeling interest costs, if we don't see strong increases in short-term interest rates, then we would not expect to see so much change from quarterly levels of interest expense that we are seeing now. If we would see some moderate increases as we expect particularly on dollar interest rates then we might see some minor increases in interest rates, I don't want to quantify them, but I think it's likely that for the remainder of 2004 they would be minor.

In terms of SG&A increases and GP development, I think that there are clearly some expectations that we have in both areas. In SG&A we have thought about a range of 18-19%, and we are now really at the top of that range. So I would not expect that we'll see SG&A increase dramatically in the future; if anything, I would expect it to decrease back toward the middle or bottom of that range, especially as we have continued sales growth and we continue to get leverage on the fixed cost base, we would expect to see some benefit there as well as with control of the SG&A budgets.

In terms of the GP development, we have seen a quite a good development there, that's more than offset the development in SG&A. We've seen very good manufacturing efficiencies, a lot of the revenue for treatment increases have flowed through to the GP and we would expect to continue to see a good development, although the improvements on a quarter-to -quarter basis are unlikely to be what we've seen in the first half of this year.

As far as pricing, basically the series dialyzers, we are holding prices in the $9-10 range, and again that's driven by us. If you compare that to a reuse dialyzer you would generally get somewhere in the $15-20 price for the reuse dialyzer, obviously, you sell tenders for more of the single-use dialyzer, but that's the price range that we are looking at.

Okay and just an add on question to Larry's comment on the revenue per treatment having improved your gross margin, should we then assume that this improvement of $14 year-over-year is primarily driven by payer improvements rather than drug utilization or what assumption should we make?

Yeah, primarily I think -- again remember the $14 last year we changed the Zemplar billing program, so that knocked it down to that point in time, and then we came back. So, if you look at it in terms of where we are and just take the last $3 or $4 or the last sequence here, I would say that it's somewhere in the 50% contracting and 50% as we tightened our optimization of our drugs right to the top of the douche, which we did, so that's really where you look at the last few dollars came from. Okay and going forward as I said, I don't see much in the way because the contracts now will be worked up for next year. So we've gotten a nice jump out of the contracts for this year.

Okay, if you allow me to ask one final question very quickly. The net debt calculation I presume does not include any payments to the WR Grace Settlement Trust so far or --?

That's correct. For this year we think it's highly unlikely that -- that there would be a requirement for payment this year. We are planning for it really for 2005.

Thank you.

But remember we don't have an interest obligation on that, so if they want to slow down and do a 2007 that's alright with us.

Okay and next question is for Gary.

Hey, first question on the new consolidation of the Cardiovascular Resources business, and some other dialysis clinics, could you provide a split here? I guess, the major part is the Cardiovascular Resources business. Second question relates to this business area, overall should we expect it to be more stable in the future or should we forecast maybe a decline in sales number in forthcoming quarters? And final question on this area, I guess, it's fully included in the service business? And then there is another question, I have, on the -- Ben, you mentioned some positive change in reimbursement rates in the European regions, maybe, you can provide some examples here?

Okay, Larry, I think, I got to -- why don't you take the first on the CVR and I will talk about, why we are -- what we are doing with it.

Your assumption is correct, that CVR accounts for larger part of the FIN 46 entries, around two thirds or 70% of it is CVR. And your assumption is also correct that it's -- all of the entities are included in the service segment. There is no particular reason, why we would expect a decline in the future in terms of the magnitude of these businesses; on the other hand, we wouldn't expect them to grow more quickly than the rest of the portfolio.

But am I right, that this business declined in the past 2 years, because if I remember correctly then your sales volume you acquired a few years ago, was a little bit higher?

Let me give you a little flavor of that. Remember two years ago, we joined with the financial partner and bought 45% of the CVR business. Our intention at that time was to look at that as an outlook for other extracorporeal technology in such as the artificial liver, such as the number of things that we can do without going into the product side and competing in the product market and go through the service. It had very low with zero basically EBIT margins at that time. We had done a very good job of growing it. It's not quite equal to the dialysis market, yet the revenue has been basically in the bandwidth of maybe 95-100% of what it was. With FIN46 we need to consolidate it that wasn’t necessarily in our -- we need another year. So now at this point, we will assess it and we will make some decisions, but our intention was to get the margin up and then see what we could expand from our dialysis extracorporeal experience into that business, and so that's where we are. For the purposes of modeling, I keep it where it is in the 100 million, and obviously it's in the numbers as far as the margins, so we have made up for whatever margin shortfall it had we have had made up with the rest of the business. So we are looking at it now as for the future. I think does that answer, okay -- and then Larry you want to comment where you have been successful on increasing revenue for treatment?

We have regular renegotiations on the more or less yearly basis in majority of countries where we operate service business. I think, as what mentioned in that regard to reimbursement increases in Portugal, France, Italy. We are waiting for Spain. We got the substantial reimbursement increase in Turkey, and in the new countries we get better prices in U.K. due to some kind of a hotspot areas where we have a very big nursing shortage.

What's the average increase, can you comment on that?

I think principally in the European Union one looks at the inflation as a benchmark. In some cases we’ve got retroactive reimbursement increases, and in some cases like last year in Italy we got on the other hand the more or less the real inflation adjustments in most of these countries rather than the official inflation that is normally around 2%.

Thank you Emanuel.

Next question is for Peter Spaniel (phonetic).

Hello, Peter Spaniel (phonetic). I have two questions, first on the financial side, that you are now -- you reached the target debt-to-EBITDA level 2.5. Is there a direct link to rating upgrade or when can we expect an upgrade of your investment grading? And same question on the 1.6% increase due to the MMA, can we expect that next year the Medicare business shows an increase by 1.6% or there other affects kind of counter this increase or is it even a more positive rate increase in your expectation?

Okay, we clearly are quite pleased to have reached this long-range target. It is an interim target, I think in order to achieve ratings upgrades, in particular if you go from non-investment grade, or we are the highest level of non-investment grade to jump over to investment grade. I think you have to show some sustainability, some consistency, which we obviously have been. We have been on a very good path in reducing the leverage ratio and other important ratios on a quarter-by-quarter basis. We are in continuous discussion with the rating agencies. We have meetings with them, plan for the fall. We will go through them, through with them comprehensively, our outlook for the next year as we go through our budget process. And we really can't pinpoint any particular point in time when we’d crossover to investment grade, but we think it’s a matter of when and not if.

The second question with respect to the Medicare 2005 reimbursement. As I mentioned our position is that, I feel that we are neutral on the MMA, so I would the 1.6 to be on top of that. So that’s our, basically our assessment at this point. Now a lot has to be done with the MMA, which I have mentioned, but that’s essentially where we would like to end up. Okay, next question Mr. Spaniel [ph].

The first question on the outlook, maybe for the second half of this year, Larry, you mentioned that basically you at the upper end of SG&A see cost margins may be expanding further though, is there upside in your margins for the second half of this year compared to the second half of last year? And obviously given the financial results this pin point points to modeling the net income for the full year? And secondly, on M&A, maybe you could explain the difference between you and Dabetta (phonetic) who wanted a few times and get -- they're pretty dramatically about the impact, so maybe it's interesting what to do different compare to them? And finally on a much longer-term outlook, what would you see as the single biggest risk to your case because I mean you have now various on the line momentum and I don’t know may you could comment few people are still concerned about themselves and like renal transplantation, all of these fancy issues? Thanks.

Take the second half and I'll take the others.

I'll start with the first one now. I guess the first comment is that second half of last year was clearly much stronger than first half of last year, so to get the kind of sequential improvement is much more difficult because it was just a better half. A lot of the improvements and really good performance that we are seeing now started in the second half of last year so the comparison won't be quite as good. On a like-to-like basis, we would not expect operating margin levels to be worse than last year. Remember we have the FIN46 impact, which is impacting our margins by around 20 basis points and so when we say like-to-like, we mean if you take out the impact of FIN46. Nevertheless, that implies for the year that we would expect the operating margin performance to be the same as last year to a slight improvement compared to last year on a full year basis.

With respect to your question, with respect to the Veda (phonetic), I have to tell you I am not really certain that I know the arguments from the Veda (phonetic), so I think at this point, I would decline doing the comparison because I don’t think it would be fair to them. I have indicated to you why I feel that we believe it can be neutral, what we have known about this now for six or eight months, so if I missed some points, let me just say what I believe, we can accomplish and I will have to over time learn whatever their position is. As far as long-term threats to our industry, I think that's always something that all of us think about. We have a program to monitor it. I am an engineer, so I am not a doctor, so I will give you my impression of it and then you can basically be a probably better expert than I am. But interestingly, we started -- the artificial kidney business was started 50 years before we actually had the first successful clinical run, and I remember in the 60s when we did that they had done the first actually dialysis back in 1910, okay, so there was a 50 year gap from the time they improved that on one-time on a patient to actually become a clinical reality, then it took another 10-15 years to essentially find its way into really serving a large number of patients. So I have heard about xenographs now for 20 years. My guess on xenographs is xenotransplantation is probably lost ground in the last five years, not gained it because of all the retrograde viruses, the physiological problems, the rejections, so I see that actually losing ground. Now the next issue that always comes up is organosynthesis, which is essentially a renal transplantation that started earlier and if you talk to the people who are doing that there is now a journal out on it. They are comparing their time frame with the start of dialysis. So, it's really kind of interesting. They say, oh look at the dialysis, 50 years to get there. Don’t hurry, as we’ll probably get there and some where around 30 to 50 years, so I don’t see either one of those threatening our business in the foreseeable future and bio regeneration is another thing, but it's again I can’t see that it's within the time frame of 20 years. So, what the fun part of that is, there is a couple of vessel engineers still around and we think that we can have a portable kidney that will work better than all those by the time they will get that done.

So that’s really the fun part of this -- if I get 50 years to get that I would dig it or die. So any how it's really not, we’ve studied very carefully, we watch it we think we’ll get our project done before they do and that’s really where I am.

Thank you. Next question is from Marcus Wieprecht.

Marcus Wieprecht from Main First Bank. Actually two questions, simple one may be on your operating expenses for treatement in North America. It was a little bit higher than I expected with $252 in the second quarter, that’s 4.6% year-over-year growth even more than in Q1 where you had actually this $3 to $4 let’s say exception impact from the pension plan fees. May you could remind us a little bit on what are key drivers for this strong growth here is it salary or wages or are there other factors. And also more long-term question, what would be your guess on -- what could be the peak margins may be in the business in the dialyser service business in general mainly in the US and so what would you think the government or the healthcare system would allow profitable companies in the best case scenario? Thanks.

Why don’t we have Larry, why don’t you go and pick those?

Okay on the cost per treatment, you are right, we did see a significant increase in Q2 of this year versus Q2 of last year, was around $11 per treatment. About half of that is due to higher labor and fringe cost in the U.S., we did have the one-time effect in the first quarter, in the second quarter, we had the impact of really that the business has been over performing and we have been accruing for higher bonuses for this year. So we are seeing the, really the impact of the very good performance of the business. That’s about half of the total increase. About another quarter, is what Ben talked about before in terms of drug optimization, so we have increased slightly the amount of drugs and that’s gone into the cost per treatment. About another quarter has been spent on increased marketing expenses, particularly on the Ultra Care program for single use dialysis. So that’s the primary part of the increase. In terms of peak margins, I don’t think I want to give an estimate for the whole company, in North America we have talked about a target range of 14-15%, we have just entered into the bottom of that range after a long period, below 14% and we think that that 14-15 is sustainable on – and that we’ll be in that range in the future. We may drop below for a quarter, but I think it’s sustainable for North America. International is a little bit more hard to predict and I think I wouldn’t want to give a range for a peak for the international segment.

Next question is from Andreas.

Andreas Schmidt from Merrill Lynch. Only one question the you mentioned if I an neutral with I understood it correctly but you said going forward U.S. same-store treatment growth rate is around 3-4% in the coming quarters what about the other [drug] concept, you spend a lot in there it’s a convincing thing, shouldn’t it lead to a higher growth rates.

Yes that’s a good question the way we look at it now as we get our marketing program going. This is primarily hemodialysis and so we are seeing our in-center growth now in excess of 4% and growing. The PD I'd say its not growing within our own clinic so our target would be 10-15% above the market. My estimate of the market right now when you add everything together is around 3.4%, if you take PD and everything put together so if we sustain and as this marketing program rolls out this year. We think we'll grow 10-15% above market on a sustained basis and that’s going to be somewhere between 3.5-4% totally in this area.

Why do you think you loose on PD or why do you don’t want to have PD going as strong as in the market.

Well it isn’t you know, quite frankly PD is a inferior therapy for certain size patients and ultra care is a very good therapy so we are clearly seeing more in our clinics more movements towards hemodialysis. Okay now and we've not taken the position of forcing people to PD to balance it because quite frankly hemo is best for them and that’s what we wanted. There are groups that won’t build clinics and essentially you make them go to PD that's not with our philosophy. We’ll spend the money, build the clinics, and let them have the best therapy.

I think its also be fair to mention that ultra care marketing program rollout is really just ending across the whole country and across all clinics, so you know, I think may be we had to see the full impact of that roll out on the potential growth that we may have compared to the market in North America.

Just may be to prove that the system [inaudible] I also have a question from the internet Ben and that fits with the last question, somebody asked is referring to slide 10 with the 20% growth in sales in single use dialysis is that a result of some agreement of some segment of the US market converting to single use, if yes, it’s the independence and concerning our own clinics single use, do you see an increase in the mix of commercial patients versus Medicare actually.

Okay I think there are two questions, the growth in the groups that are shifting to single user are independence. We are now in excess of 40-50% we do have a number of non-profit units looking at it in terms of basically studying single use. The groups that are totally against it I think you know, who they are and that’s fine with us from the standpoint of has it increased our commercial mix, no I can’t say that it has. Because basically that's a regional situation and we won’t see the effect of that for basically a longer point of time, but it clears and part of market gin program that [marshalling his group] putting together and we’re clearly doing quite well in increasing our revenue in the commercial segment, which obviously is happening here. So, I think, it's on track, but the main -- other outside purchases of single use are theindependents and a number of non profits. So, is that, do you have other questions?

You know, I have one more, lastly.

one more. Okay.

It's final one, you won’t believe it, actually I have to really -- congrats again to Ben and the whole team for a good quarter numbers. Thank you. Just wondering, what's behind these second quarter --

That was my mother, I have -- Thanks, mom.

Thanks for sending. The second quarter growth in US cost per treatment, and we covered that but also what the expectations are going forward?

I think, we would expect the cost for treatment certainly to moderate as well, we expect the average for the year, to be somewhere close where we were in the second quarter.

Did mom have anything else to say?

I have one more, but that’s -- I am going to save it for later. [inaudible].

[inaudible] you have converted the long-term debts to short-term debts so that you could improve your financial result, if it happens that the interest rate on the short term were increased, do you have made any actions, that you’d hedge these positions, or what have you done if you come into the scenario that interest rates might hike up. And the other question is concerning the same stock growth year-over-year in the international segment. In 2003, there was an increase of about 8.1% and it decreased to 4.6% in the second quarter of 2004. Could you explain the decrease of this figure?

I'll take the last one and then Larry you take the debt. Yeah, as I mentioned I think a couple of years ago our emphasis in Latin America where we're seeing a double-digit same-store growth in the international, we said that we basically we were going to focus on profitability, take care of the economic situation. So most of our growth now is basically in the European theater, which like the U.S. is growing in the 4% range except for basically Eastern Europe. So that's a shift to where we put our emphasis in the last couple of years in terms of the growth rate.

So on the question on interest rates, I mentioned before that we really were starting with a very conservative mix in our debt portfolio, we had over 90% of our debt with fixed rate exposure, less than 10%, with variable rate exposures, so that was very, very conservative, in particular given the steepness of the yield curve and the lower variable rates that were available. We have shifted to about 70% fixed, 30% variable, so we have a little bit more exposure to variable interest rates, lower interest rates. But still at 70-30 we consider it quite a conservative mix, that's appropriate for a company with as much debt as we have a $2.5 billion, but still quite conservative. Any foreseeable increase in interest rates would not have a very material effect on us, and we have not chosen to hedge on that part of the portfolio that's exposed to variable rates.

That is something that we certainly follow, and if you saw a steep rise we could actually do that but at this point in time the calculations indicate that's a much better move.

Gary you could also add we did not change the maturity, because I heard long-term and short-term before that's not about -- it's all about fixed and variables not about maturity dates, just to be sure there is no misunderstanding

Yes I have another for Emanuele actually. Could you provide us with the revenue split on the U.S. market from Medicaid in commercial payers and also how large proportion of total revenues stems from separately billable drugs today and what's the proportion of [Etol] in the U.S. market in terms of revenue strengths?

I can probably cover two-thirds of those. If you look at the patient mix I think its about 78% Medicare, Medicaid together and 22% commercial; if you look at the revenue its about 64% Medicare Medicaid, and essentially the difference there which would be 36%. So that's sort of the split that we have today as far as the drug component, I think, that we generally run in the range of around 25%, but I have to actually check that, there hasn't been basically that much of a change

24.

Okay so we are in that range. We've been pretty consistent with that for over the years?

Any more questions? That’s not the case. So thank you very much for your attention. Thanks a lot on the name of the managements and take care and hope to see you next time. Thank you very much.

Thank you and see you next quarter.