• 02.1
  Operations and Business Environment
• 02.2
  Results of Operations, financial Situation, Assets and Liabilities
• 02.3
  Non-financial Performance Indicators
• 02.4
  Risk Report
• 02.5
  Subsequent Events
• 02.6
  Outlook

02.1

Operations and Business Environment

ECONOMIC ENVIRONMENT

The economic environment worsened noticeably in 2008. Rising prices for raw materials and energy coupled with increasing inflation rates overall had a slightly negative impact on the results of our operations. In the second half of the year, the strong depreciation of many currencies against the U.S. dollar within a short period of time had an adverse effect. We were able to largely compensate for this with improved efficiency and a positive operational development. Economic fluctuations usually have a more moderate effect on the development of the dialysis market than in other industries.

GENERAL ECONOMIC ENVIRONMENT

2008 began with a strong start for the German economy. However, as the year progressed, rising raw materials prices and the appreciation of the euro along with the financial crisis put a damper on business activity. Since the middle of 2008 the global economy has been in an economic slump. The main reasons for the downturn are the collapse of the U.S. real-estate market, the worldwide crisis in the banking sector and in the financial markets, as well as higher inflation due to the rise in prices for various raw materials. Due to the positive development in the first half of the year, the leading German research institutes expected the worldwide gross domestic product to increase by 3 % after an increase of 5 % in 2007.

In many industrialized countries, the economy is already in a recession. Many indicators suggest that the underlying economic trend in the U.S. and Western European countries will be extremely weak. In Japan, too, economic conditions worsened in the last months. Only in emerging countries has production increased considerably in recent months, but even there the rate of expansion has declined considerably.

A primary reason for the economic downturn is the ongoing crisis in the financial sector, triggered by solvency problems in the U.S. mortgage market. Most financial institutions had to make significant value adjustments in the course of 2008. As a result, business relations between banks deteriorated substantially as they made less cash and cash equivalents available to each other. Many banks reacted to their own tight liquidity situation by restricting the credits they gave to companies. The complexity of the problems grew considerably in the course of the year, also with a view towards the overall economy. In response, governments and central banks introduced comprehensive programs in a concerted effort to stabilize the financial sector. These included liquidity and trust-building measures such as direct equity injections, capital guarantees for the issue of new bonds, purchasing programs for non-performing assets, as well as interest rate cuts by central banks on a broad basis.

As in the previous years, the worldwide economic situation varied in 2008. However, the economic growth spread was much wider than in 2007. Of the industrialized countries, the U.S. and Germany developed at the same pace, while growth in Great Britain and Japan slowed down. Among emerging countries, China’s strong growth stood out again.

EXCHANGE RATE DEVELOPMENT

Analogous to the financial markets, developments on the currency markets were marked on the whole by high volatility, i.e. pronounced and rapid fluctuations. The global economic trend was influenced by developments in exchange rates to different degrees over the course of the year. In the first half of 2008, the most important monetary parities were relatively stable. The strong appreciation of a number of these currency rates versus the U.S. dollar benefited exports from the U.S. in the first months of the year. But from September, this changed unexpectedly quickly. Within a short period, the U.S. dollar appreciated substantially against a large number of currencies. This could be seen above all in the reassessment of the economic situation in the individual regions. On the cut-off date on December 31, 2008, the U.S. dollar / euro exchange rate was 4.9 % lower than a year before, while the average for 2008 was 7.3 % higher than in the previous year.

The U.S. dollar and the euro in particular and their relation to each other are important for Fresenius Medical Care, because we earn a large part of our revenue in the U.S. and in the euro zone. In reporting terms, an appreciation of the euro is advantageous for us, as our functional currency is the U.S. dollar and thus the balance sheet values achieved in euros are higher.

Our production sites are predominantly decentralized to enable us to meet the demand in our dialysis product business. Due to our plants in the U.S., Japan, and Europe, we are less affected by long-term currency fluctuations; transaction risks are kept to a minimum as costs and revenue are generated in the same currency. But significantly more volatile exchange rates mean that even Fresenius Medical Care is more affected by the sensitivity to these exchange rates. In the field of dialysis care, which accounts for a larger share of business than dialysis products, the transaction risk is minimal as business is local and thus conducted in the respective currency area.

UNITED STATES

In the U.S., growth slowed down slightly in year-to-year terms. The gross domestic product increased by 1.3 %, driven by public investments and in particular by ongoing strong export activity. In addition to a significant reduction in stocks, investment in housing construction again had an adverse effect. Price trends were influenced to a high degree by fluctuations in the price of raw materials, particularly oil. The inflation rate climbed from 2.9 % in 2007 to 3.9 % in the year under review. In the course of 2008, the Federal Reserve slashed the key interest rate, the Federal Funds Rate, by a total of around 400 basis points in several steps to an almost historic low and a new target corridor of 0 % to 0.25 %.

EUROPE

In Europe, the real gross domestic product declined substantially in the second half of 2008, after moderate growth had been recorded in the first six months. For the year as a whole, Europe's GDP rose slightly by 0.9 %, compared to an increase of 2.6 % in the previous year. The inflation rate soared to a historic high due to the higher cost of raw materials coupled with the depreciation of the U.S. dollar against the euro. The European Central Bank (ECB) countered the pessimistic economic outlook in connection with the financial crisis by taking numerous measures to boost liquidity. In the space of a few weeks, the ECB lowered its key interest rates by 200 basis points in the last four months of the year, after the inflation risk had abated as a result of falling prices for energy and other raw materials as well as the negative economic forecast.

After a flying start to the year, the German economy lost momentum as the year progressed. This was due to the financial crisis, rising prices for raw materials and the appreciation of the euro in comparison to other currencies. Export demand, which previously had been one of the main pillars of growth, declined significantly, not only as a result of the adverse exchange rate situation, but also due to the downturn in the global economy in general. Despite the marked reluctance of companies to invest, employment in Germany rose slightly in 2008, with unemployment figures dropping from 3.4 million in 2007 to 3.3 million in 2008.

In Great Britain, economic growth tailed off sharply due to the country’s high dependency on the financial sector. The GDP grew by 0.8 %, compared to 3.0 % the year before. The new European eu member countries generally showed a positive economic development, with an average growth of 4.5 %, although the growth rate in the individual countries varied considerably. Russia continued to post very dynamic growth. Driven by strong domestic demand as well as high income from the oil and gas business, Russia’s GDP climbed by 6.8 %. At the same time, however, inflation increased substantially.

ASIA

The Japanese economy continued to deteriorate. Due to a lack of impetus from abroad, domestic demand declined further. Higher energy and food prices also had an adverse effect. The GDP rose by just 0.1 % in 2008, following a 2 % increase the previous year.

Emerging countries in Asia showed comparatively robust growth, although at a significantly slower rate. China’s growth rate of the GDP had been declining constantly, albeit moderately, since the middle of 2007. The country’s sluggish economic growth reflects the slight drop in demand on the main markets and the ongoing appreciation of the Chinese currency against other currencies. Growth is driven by private consumption and increasing investments in infrastructure. China’s GDP rose by 9.6 % in 2008, compared to 11.9 % in the previous year. The economies of the remaining countries in East Asia also grew: by 4.4 % in 2008 compared to 4.8 % in 2007.

LATIN AMERICA

Latin America displayed steady economic growth. Its GDP rose to 4.4 %, almost reaching the previous year’s growth rate. However, the economies of the different countries in the region developed in a highly heterogeneous way. As raw materials producers and energy suppliers, most of the countries in the region continued to profit from the high raw materials prices. The economic outlook seems stable in many countries, only in Mexico is the outlook clouded due to the country’s strong dependence on the development of the U.S. economy.

Further information can be found in the „Comparison of the Actual Business Results with Forecasts” section and in the „Outlook” section.