RISK AND OPPORTUNITIES MANAGEMENT
With its worldwide activities, Fresenius Medical Care is naturally exposed to a variety of risks which are directly related to the Company’s business. Only by managing these risks we can take advantage of the opportunities they offer. As a provider of life-saving products and therapies, we are only marginally exposed to economic cycles, a key difference between us and, for example, a manufacturer of consumer goods. At the same time, our technical experience and our broad market knowledge provide a sound basis for detecting risks as early and as reliably as possible.
Fresenius Medical Care sees risk management as the ongoing task of determining, analyzing and evaluating the range of potential and actual developments, and, if possible, taking corrective measures. Our extensive risk management system, the principles of which are set by internal guidelines, is an important component of corporate control. It enables management to identify and reduce risks that could threaten the Company’s existence or growth at an early stage, thereby minimizing their impact as far as possible.
Risk management is part of our integrated management information system and is based on Group-wide controlling as well as an internal monitoring system. Regional monitoring systems form the backbone of our risk management system and identify all inherent industry and market-specific risks. Status reports are presented to the Management Board by the responsible risk managers twice a year. They provide qualitative and quantitative appraisals of the likelihood of risks that have been identified as potentially harmful to the Company as well as the potential extent of the possible damage. In addition, the Board is immediately and directly informed of any newly identified risks. Efficient reporting is essential for controlling and monitoring risks as well as for taking precautionary measures. Therefore, the Management of Fresenius Medical Care receives information on a monthly and quarterly basis about the state of the healthcare industry, our operative and non-operative business, as well as analyses of our asset, financial and earnings position.
The purpose of Fresenius Medical Care’s opportunities management is to closely observe individual markets and recognize trends early on, among others. We identify opportunities based on comprehensive quantitative and qualitative analyses of market data, research plans and general health trends. The close cooperation between our strategy and planning departments and those responsible for M&A activities enables us to identify opportunities worldwide at an early stage. We anticipate general economic, market-specific, regional and local trends as early as possible and adjust our business model accordingly. As discussed in the ”Dialysis Market” section, health systems and reimbursement criteria differ from country to country. Opportunities for the future development of Fresenius Medical Care arise from the general positioning of our company as a technologically leading provider on the dialysis market with innovative products and therapies. In connection with our 2005 initiated long-term growth strategy GOAL 10 (see here), we actively acknowledge opportunities that arise. Our company objectives are discussed in the ”Outlook” section.
RISK MANAGEMENT SYSTEM
INTERNAL CONTROLS FOR FINANCIAL REPORTING
We are listed on the New York Stock Exchange and we are required to adhere to the requirements of the Sarbanes- Oxley Act. Section 404 of the Sarbanes-Oxley Act requires the Management Board of companies listed in the U.S. to take responsibility for implementing and adhering to an appropriate internal control system to guarantee reliable financial reporting. As a non-U.S. company or ”foreign private issuer”, we were required to comply with Section 404 of the Sarbanes-Oxley Act beginning on December 31, 2006. Fresenius Medical Care met the requirements one year earlier, on December 31, 2005.
Our internal controls ensure compliance with applicable accounting standards for our financial reporting. The system is based on mechanisms such as automated and manual controls, as well as on the separation of functions and the adherence to guidelines and operational mandates. Furthermore, the assessments carried out by management ensure that risks directly related to financial reporting are identified and that controls are in place to manage these risks. Apart from that, we stay abreast of changes in accounting standards and continuously train people responsible for the preparation of financial information.
The Committee of Sponsoring Organizations of the Treadway Commission’s ”Internal Control Integrated Framework (COSO framework)” forms the basis for evaluating the effectiveness of our internal control system for financial reporting. Following the COSO framework, our internal financial reporting control system is divided into five levels and evaluated accordingly. The control environment, risk evaluation, control activities, information and communication paths, as well as the monitoring of the internal control system are documented, tested and assessed. Our review of the internal control system for financial reporting follows the guidelines published on May 23, 2007 Securities and Exchange Commission (SEC) for the evaluation of the internal control system for financial reporting by management.
Regional project teams coordinate the evaluation of the internal control systems. Management assesses the effectiveness of the internal control system for each fiscal year and publishes its findings in the Annual Report. External advisers are consulted as needed. A steering committee led by our Chief Financial Officer meets regularly to discuss changes and new requirements of the Sarbanes-Oxley Act as well as potential weak points in our system, and to implement further measures. In addition, the Audit Committee of the Supervisory Board reviews the results of the Management Board’s assessment on a regular basis.
As of December 31, 2007, management assessed the effectiveness of the Company’s internal control system for financial reporting. Based on this assessment, management determined that the Company’s internal control system for financial reporting was effective as of December 31, 2007. The effectiveness of the internal control system for financial reporting as of December 31, 2007, has been audited by KPMG Deutsche Treuhand-Gesellschaft Aktiengesellschaft Wirtschaftsprüfungsgesellschaft, an independent registered public accounting firm, and confirmed in all material aspects. For further details see here.
The main risk areas for the business activities of the Fresenius Medical Care Group are as follows:
RISKS DUE TO ECONOMIC CONDITIONS
Fresenius Medical Care is generally only to a smaller extent affected by economic developments in corresponding markets, because the demand for our products and services remains relatively stable. As a result, changes in demand due to economic conditions have generally only a somewhat small influence on the risk situation of individual business units. However, our international business is influenced by fluctuations in foreign currency exchange rates. We therefore carefully monitor and assess the development of the global economy as well as political, legal and financial conditions. The predominately international markets of the Fresenius Medical Care Group also make it essential for us to conduct continuous, intensive analyses of country-specific risks.
RISKS RELATED TO THE GENERAL ECONOMIC ENVIRONMENT
At present, the development of the global economy presents no substantial danger to Fresenius Medical Care. In 2008, we expect the global economy to develop positively. We anticipate that the growth rate will be only slightly lower than in the reporting year. Further information can be found in the ”Outlook” section.
RISKS IN THE HEALTHCARE INDUSTRY
Risks related to changes in the healthcare market are of major importance to Fresenius Medical Care. The main risks are the development of new products and therapies by competitors, the financing of healthcare systems, and reimbursement in the healthcare sector. Risks are actively minimized by closely monitoring the market, especially the products of our competitors and the introduction of new dialysis-related products. As part of our active risk management, Fresenius Medical Care maintains strategic business units that help us to anticipate and quickly react to new market conditions. Their main activity is to identify, analyze and internally communicate on a regular basis all activities that could affect the dialysis market and the Group’s business. In addition, close ties with the medical and scientific communities enable us to quickly identify and capitalize on technological innovation. This involvement also keeps us up-to-date on alternative treatment methods and enables us to evaluate and, if necessary, adjust our corporate strategy. Consequently, we continuously analyze and evaluate trends and review improvements in research and development. The development of new and innovative products will remain a decisive factor in the dialysis market in the foreseeable future.
Since we operate in a highly regulated environment, changes in the law, such as those relating to reimbursement, can have a major economic and strategic impact on the Group’s business success. This is especially true in the United States, where about 91% of our sales are generated with dialysis services, the majority of which are financed by the public health insurance programs Medicare and Medicaid. Regulatory changes outside our most important market could also have a significant impact on the Company. For this reason, we not only carefully monitor regulatory planning and changes, but also actively work together with government healthcare agencies. Details on the reimbursement system in the public Medicare / Medicaid program in the U.S. can be found in the USA section.
RISKS ASSOCIATED WITH OPERATING ACTIVITIES
We counter potential risks in production, products and services using preventive and quality assurance measures.
PROCUREMENT. Substantial requirements are placed on suppliers to control the risk of low-quality raw materials, consumable goods and other external products. This includes demanding external certification, performing our own inspections of suppliers and sample products, as well as regular quality control checks. Fresenius Medical Care demands high-quality and safe products that are proven to be adequate for their purpose from certified suppliers that meet the Group’s specifications and requirements and have a proven track record. These suppliers are constantly re-evaluated using a supplier assessment system.
We monitor any market-related dependencies of major suppliers and do our best to prevent these. Our strategy calls for a primary and back-up source for every product and raw material required. Where this is not possible, we minimize the risk by entering into long-term contracts to ensure a steady supply and price advantages while avoiding price fluctuations. Fresenius Medical Care is also exposed to general price changes in raw materials. Continuous market analyses are conducted in an effort to anticipate such price movements and quickly counteract any potential negative impact. Further information on procurement processes can be found here.
PRODUCTION. Compliance with internal and legal product and manufacturing regulations is ensured by our Integrated Management System in accordance with ISO 9001, ISO 13485 and Good Manufacturing Practice (GMP) requirements, and implemented according to written process and work instructions. Regular audits are carried out by authorized quality management staff at each of our production sites to ensure adherence to guidelines. The audits include all areas and aspects affecting quality, from management and administration to development, production and customer satisfaction. In 2006, our production site for dialyzers in St. Wendel successfully passed an FDA (Food and Drug Administration) GMP Audit conducted by TÜV Süd Product Service Munich under the mutual recognition agreement between the European Union and the U.S. We have also introduced Lean Six Sigma in some of our plants. This is a management system used to analyze and better coordinate all production processes to permanently reduce the error rate. We intend to achieve even better production results and to further improve the quality of our products and production processes.
MAJOR CUSTOMERS. In addition to a number of stateowned and public health insurance carriers, private health insurers and companies are among Fresenius Medical Care’s customers. The largest private company is DaVita, which is also the world’s second-largest provider in the dialysis services sector.
Fresenius Medical Care achieved about 1% of its total revenue with DaVita in 2007. Therefore we assess the risk arising from relationships with major customers to be relatively small.
SERVICES. The medical services we provide to patients at our dialysis clinics present inherent risks. In this context, operational risks include, for example, in the area of hygiene. We counteract these with strict organizational and operational procedures, ongoing personnel training and patient-oriented methods. Our ISO 9001 certified clinic quality management system is linked with our Integrated Management System (IMS) as detailed here. The ISO 9001 certificate attests to Good Dialysis Practice. In the U.S., we have successfully implemented the standards outlined in the Kidney Disease Outcome Quality Initiative (KDOQI) and the Center for Medicare and Medicaid Services (CMS) clinical performance measures using our internal quality enhancement program. In addition to internal assessments of treatment data, annual internal audits of our processes provide a solid foundation for continuous improvement. Our clinic quality management system is also audited each year by external certification institutes such as the German TÜV or Medicare (CMS) and CMS Networks throughout the U.S. As a consequence, quality flaws and risks can be identified quickly and remedied in a timely manner.
The IMS also covers environmental management, as manufacturing dialysis products requires the use of environmental resources and running dialysis centers produces clinical waste. An environmental management system, certified under the ISO 14001 standard, has therefore been implemented in production sites and dialysis clinics to help protect the environment and resources while identifying potential savings for raw materials. Please see the ”Quality and Environmental Management” section for further details.
DEBTORS. The risk of late or non-payment is reduced by evaluating the credit standing of new customers and reviewing the credit limits of our existing ones. Outstanding payments are monitored while assessing the possibility of default. Please see here for further details on accounts receivable and allowances for doubtful accounts.
OTHER OPERATIVE RISKS. Potential risks, such as those arising from the construction of new production sites or the introduction of new technologies, are countered through careful planning and continual progress reviews. When building new production sites, we use internal milestones which are monitored constantly. Further risk management measures limit the effect of environmental factors on dialysis services. Many of our own dialysis clinics have emergency generators that allow the continuation of life-saving dialysis treatments even in the case of a complete power failure. Furthermore, in the U.S., for example, a Fresenius Medical Care emergency team steps in during natural disasters such as hurricanes to professionally coordinate relief efforts and enable dialysis treatment for patients in the affected regions.
We counter potential risks outside the operative business using the quality control measures in the following areas:
STRATEGY. Fresenius Medical Care has developed a long-term growth strategy, GOAL 10, which is explained here. The Management Board and Supervisory Board as well as the senior management of Fresenius Medical Care meet regularly to discuss, review and - if necessary - redefine the growth strategy of the Company.
GOAL 10 also includes the horizontal expansion of Fresenius Medical Care in the field of dialysis-related drugs. Although renal drugs such as PhosLo have a proven track record in the treatment of dialysis patients, they may still have an impact on the risk exposure of Fresenius Medical Care.
RESEARCH AND DEVELOPMENT. Failing to achieve goals or achieving goals later than anticipated is an inherent risk in the development of new products and therapies. Comprehensive, cost-intensive preclinical and clinical studies are necessary before a new product can receive regulatory approval. Fresenius Medical Care counteracts risks in research and development projects by regularly analyzing and assessing development trends and reviewing the progress of the projects. Furthermore, we ensure that the legal regulations governing clinical and chemical-pharmaceutical research and development are strictly adhered to. Our dialysis products research team develops new products and technologies in close cooperation with representatives from the medical and scientific community. In case a marketable product emerges or is nearing completion, commercial relationships are evaluated. For further details on the risk on xenotransplantation please see the ”Dialysis Market” section.
PERSONNEL RISKS. Fresenius Medical Care has developed guidelines and codes of conduct for its employees worldwide to establish authoritative standards for our internal and external communication. With these guidelines and our compliance program, we aim to fulfil our own expectations and those of our partners, while aligning our business activities to recognized standards as well as local laws and regulations. Further details on our compliance program can be found here.
Employees who are entrusted with confidential or insider information are under obligation to comply with relevant guidelines and handle the information responsibly.
Our success depends to a large extent on the dedication, motivation and abilities of our employees. The risk of a shortage of qualified personnel is counteracted by pre-emptive measures, such as employee development programs and comprehensive recruiting. We offer our employees performance-related pay and attractive social benefits. Further details can be found here.
In addition, we have launched several initiatives to further increase job satisfaction among clinical staff and to improve motivation and retention of qualified staff in our clinics. The initiatives involve implementing improvement measures where they are needed, based on a thorough satisfaction analysis. To deal with the general shortage of trained clinical personnel, we use targeted marketing programs to locate qualified and motivated personnel for our clinics and thus ensure a high standard of treatment quality. Comprehensive training programs such as the F.I.D.N., which is discussed here, also counteract a possible shortage of clinic personnel. Risks in the area of personnel marketing are seen as being insignificant due to risk management strategies.
ACQUISITIONS AND INVESTMENTS. Potential financial risks arising from acquisitions and capital expenditures are identified early on by performing careful, in-depth reviews with the help of external and internal professionals. Potential acquisitions and investments are analyzed at regular intervals by an internal committee (AIC - Acquisition Investment Committee) using internal guidelines based on various key factors such as performance ratios, cash flow and Return on Invested Capital (ROIC). The efficiency of acquisitions and investments is also monitored on the basis of these key figures.
PARAMETERS FOR ACQUISITION AND INVESTMENT DECISIONS (EXCERPT)
|Internal interest rate||> FME discount rate1|
|Internal interest rate||> 15 %|
|Amortization period||≤ 10 years|
|EBITDA multiplier||≤ 5.5|
> 0 (only applies to
|1) The discount rate level varies depending on the region or country in which the acquisition or investment is made.|
IT RISKS. Fresenius Medical Care uses the latest hardware and software to reduce potential risks from information technology (IT). Our IT infrastructure is highly reliable and stable. Potential IT risks are covered by a detailed disaster recovery plan, which is tested and improved on a regular basis. Fresenius Medical Care operates three geographically separated data centers with associated disaster recovery plans, thus further reducing the potential impact of a disaster at any one site. We use a mirrored infrastructure for critical systems, including clinical systems and communication servers. To avoid organizational risks such as manipulation or unauthorized access to sensitive data and programs, we use access protection by means of passwords. In addition, internal procedures must be observed that govern authorization assignment and are monitored to ensure that they comply with section 404 of the Sarbanes-Oxley Act. Operational and security audits are renewed annually.
LEGAL RISKS. Risks associated with litigation are constantly identified, assessed and communicated within our organization. Fresenius Medical Care is involved in various legal proceedings resulting from our business operations. For details on ongoing proceedings and further information on the legal risks that Fresenius Medical Care is exposed to, please refer to Note 18.
FINANCIAL RISKS. We actively manage foreign currency and interest rate exposures that result from our business activities. Risk management is based on strategies defined in close cooperation with the Management Board. These include, for example, guidelines covering all steps and levels of the risk management process. They define responsibilities for the determination of risks, the careful use of financial instruments for hedging purposes, and for accurate financial reporting. In order to manage the risks from foreign exchange rate and interest rate fluctuations we also use derivative financial instruments. These, however, are restricted to hedging exposures in relation to underlying transactions. Transactions for the purpose of trading or speculation are not allowed. All transactions are conducted with highly rated financial institutions as approved by the Management Board.
We use interest rate hedging instruments to reduce the impact of interest rate increases from our floating-rate financial liabilities. We also apply such instruments to hedge the fair value of parts of our fixed-rate borrowings. The aggregate nominal value of the respective hedge contracts was $3.919 billion as of December 31, 2007. Hence we are hedged to a large extent against interest rate fluctuations. As of December 31, 2007, 80% of the Group’s financial debt was protected against increases in interest rates either by fixed-rate borrowings or by interest rate hedges. Only 20% was exposed to interest rate risk.
Our foreign exchange exposures primarily result from transactions such as sales and purchases in foreign currencies between Group companies located in different regions and currency areas. Most of the transaction exposures arise from sales of products from Group companies in the euro zone to other international business units. The foreign exchange risks are therefore related to changes of the euro against various other currencies. To hedge those risks we generally use foreign exchange forward contracts. The aggregate nominal value of foreign exchange derivatives as of December 31, 2007 was $708 million. Please the section ”Liquidity and Capital Resources” for further details.
The Management Board’s evaluation of general risk is based on Fresenius Medical Care’s risk management system, which is subject to regular external reviews and scrutiny from management. The effectiveness of the risk management system is monitored and improved if necessary as part of the Group-wide review of the Integrated Management System. The Management Board will continue to expand the risk management system as well as the review of the related management system to identify, examine and evaluate potential risks even more quickly for a timely and appropriate response.
Potential risks include factors partly or wholly out of our control, which we regularly analyze, such as the overall development of national and global economies. They also include factors within our control - such as operating risks - which can be anticipated and analyzed early on by our risk management system and counteractive measures introduced if necessary.
Based on the general principles for estimating risk factors described here, we currently assume that none of these risks will lead to a long-term and significant impairment of the asset, financial and earnings position of Fresenius Medical Care. Furthermore, no material changes in risks were identified compared to 2006. We have established a structure which will allow us to quickly identify developing risk situations.
Information on external rating agencies’ rating of the company can be found in the ”Results of Operations, Financial Situation, Assets and Liabilities” section.