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Fresenius Medical Care AG & Co. KGaA (NYSE:FMS)
Q3 2019 Earnings Call
Oct 29, 2019, 10:30 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Ladies and gentlemen, thank you for standing by. I am Halley, your Chorus Call operator. Welcome and thank you for joining the Fresenius Medical Care Earnings Release for the Third Quarter 2019 Results. [Operator Instructions]

I would now like to turn the conference over to Dominik, Head of Investor Relations. Please go ahead.

Dominik Heger -- Senior Vice President and Head of Investor Relations and Corporate Communications

Thank you, Halley. We would like to welcome all of you to the Fresenius Medical Care earnings call for the third quarter 2019. We appreciate you joining today.

Now, it is my pleasure, as always to start out the call by mentioning our cautionary language that is in our safe harbor statement, as well as in our presentation and in all the materials that we have distributed earlier today. For further details concerning risks and uncertainties, please refer to these documents, as well as to all of our SEC filings. As we do have a hard stop after 60 minutes, I would like to limit the number of questions again to two in order to give everyone the chance to ask questions. It would be great, if you could make this really work.

With us today is, of course, Rice Powell, our CEO and Chairman of the Management Board. Rice will give you a short update on Q3 and the outlook. And of course, also, with us is Mike Brosnan, our Chief Financial Officer, who will give you an update on the financials.

I will now hand over to Rice. The floor is yours.

Rice Powell -- Chief Executive Officer and Chairman of the Management Board

Thank you, Dominik. Hello, everyone. It's great to have with us today. I'll begin my prepared remarks on Slide 4, with a high level overview of our growth in the quarter. As you can see, our growth trend continued in the third quarter. We provided more than 13 million treatments to an ever-increasing number of patients around the globe and were just slightly above 340,000 patients as we ended Q3. We are continuing to expand our infrastructure and education efforts to increase the number of treatments that are being performed in our home setting. I'm going to talk more about this in another slide or so.

Our clinic base has now crossed the 4,000 unit mark and this allows us to capture the growth potential around the world that we see in the various markets. In the medium-to-long term, with the ramp up of our home business, particularly in the United States, we will see a slowdown in the clinic infrastructure expansion. We've talked about that before, but I wanted to rehighlight that today.

You should have also noticed in our press release from this morning that we have appointed Dr. Frank Maddux as our Global Chief Medical Officer coming on to our management board. Obviously, the quality of our treatments is critical and one of the many important reasons that we appointed this role to the management board is to ensure that we continue to strive for better clinical outcomes, to be on the leading edge of the science and the marriage of medicine with our operations in order to provide the very best for our patients.

Turning to Slide 5, and the details of our clinical outcomes. I think the key takeaway is that the quality of our care is the most important driver of our provider business and we're committed to continuing the great outcomes that we have for our patients around the globe. In our segments, North America, Europe, Middle East and Africa, as well as Asia-Pacific, the number of days our patients were hospitalized went down in the quarter on a year-over-year basis, and you can see those figures. I won't read them to you. They are at the very bottom, days in hospital per patient year.

Now, turning to Slide 6, our growth story continues. We have delivered strong organic growth across all regions. In North America, we had very robust growth in our US dialysis business, with a record growth in home dialysis. The significant step up in our product revenue was supported by both core products and in addition the NxStage acquisition and the rollout of those products, if you will.

In the second quarter call, we indicated to you that there was an incremental risk to Program Tear 2 of the ESCOs and this was based on indications that we were beginning to receive from CMS. The final savings for Program Year 2 were published in September and unfortunately, these were lower than the previous indications. As a consequence, we had an incremental adjustment for Program Year 2. Based on the current indications, we've also adjusted for other program years, but we will discuss with the government on these program years and the methodology applied in future meetings.

Let me be as clear as I can be. We are very unhappy. We do not feel that we're getting the level of transparency that we need or the cooperation in understanding the methodology. We were in Washington as late as Friday, talking with them and letting them know how unhappy we are about this and we will continue to do that in the next weeks and months to come.

In September we achieved another milestone in China with the launch of the 4008A dialysis machine. This is an important step in the market with the largest dialysis patient population in the world.

We are on track with our cost improvement measures. Our cost optimization program, which targets to optimize our geographical footprint, specifically within the Fresenius Kidney Care organization in the US, is under way and working, as well as our GEP activities that we've spoken of previously.

If you would please join me in turning to Slide 7, I'd like to highlight that we delivered organic revenue growth of 5.2% in the quarter. We achieved 5% adjusted revenue growth on a constant currency basis, which is in the mid-point of our revenue guidance for the year 2019. And despite the negative impact from the ESCO matter, we were able to deliver 2% net income growth on an adjusted basis, which compares with a minus 6% for the first half of this year.

Taking a look at organic development and turning to Slide 8, our global organic revenue growth of 5% was driven by solid growth in North America and supported by even higher growth in our international businesses. Adjusted for the effects from Sound in 2018, IFRS 16 and NxStage, we delivered in North America revenue growth of approximately 7%. The organic growth in North America was negatively affected by the impact of the ESCO write down.

As expected, we saw stronger momentum in our Europe, Middle East and Africa business in the third quarter, and Asia Pacific was a significant contributor to our revenue growth in the quarter as well.

Moving to the Services side of our business on Slide 9, we saw both strong same-market and organic growth in the third quarter. In 2019, the same-market growth in North America continues to perform nicely, with an increase of approximately 4%, and looking at the sequential quarter, looking at Q2 where we were at roughly 3.5%. So we continue to move upwards.

Our development in North America was negatively impacted by the adjustments for accounts receivables that have transitioned to the category of a legal dispute and then that is in the number of EUR84 million. The EMEA Services organization saw a strong organic growth of 7% in the quarter. Asia-Pacific continued the strong growth trends supported by their Care Coordination business out of Australia and the exchange rates and hyperinflation, as we've discussed many times, continued to produce a drag on the results in our Latin American business.

Now, turning to Slide 10, and the Products business. As you can imagine, we are very pleased with the very strong 13% growth at constant currency in the quarter on our Products book of business. In North America, we saw a strong performance of 24%, with support from both the base renal products business, as well as from the NxStage acquisition and the roll out of their portfolio. On an organic basis, growth was at 10%. And also, please keep in mind that the reported numbers are somewhat affected by the IFRS 16 implementation, which really focuses around the hemodialysis equipment.

Europe, Middle East and Africa, our largest Products business, delivered 10% constant currency growth, and this was due to higher sales of dialyzers and bloodlines. And on an organic basis, EMEA produced 11% growth in the quarter. Asia-Pacific, saw 9% constant currency, as well as organic growth, driven by higher sales of their dialyzer and bloodline business. And even in Latin America, our Products sales delivered a 4% organic growth in the quarter.

Before we discuss the financial details of the quarter with Mike, I'd like to move to the outlook on Page 11 of my presentation. I realize this is out of the order we sent you this morning, but I'd still like to, if you will, let me go ahead and make some comments on the outlook. Although not everything went our way in the first nine months of the year, given where we are today, we are confirming our outlook for 2019.

We are very comfortably in the range for our revenue guidance, but with the impact from the ESCOs, that puts us in the lower end of our range from the earning side, and we've mentioned this to you previously. Now, considering 2020 we have just begun our budgeting process for the next year. Any potential carryover, such as the ESCO situation, or something of that nature is going to be worked on as we go through the budgeting process and we'll be updating you as appropriate as we conclude those works and those meetings.

And with this, now, I'd like to hand it over to Mike to take you through the financials for the quarter.

Michael Brosnan -- Chief Financial Officer

Thank you, Rice, and hello, everybody. So I'm on Chart 13 and I'll just walk through the bridge between the Q3 2018 reported numbers over to the reported as well for the current year. So as you can see on the top of the chart with regard the revenues, we've reflected the EUR7 million adjustment that's associated with Sound in the third quarter of 2018. This is purely a revaluation of the first half of Sound revenues adjusted to the year-to-date Q3 average exchange rates. You see that from time to time with our one-off effects.

This gets you to a base for comparison to the current year of EUR4.051 billion. And then, you can see the 5% growth that we had in the quarter, or roughly EUR190 million on a constant currency basis. That 5% growth reflects an organic revenue growth of 5% as well. And that 5% organic revenue growth has already been adjusted for the receivables write-off that took place in the quarter four in the North American business. The revenue development is clearly within the targeted range of 3% to 7%.

Currency translation was favorable with EUR134 million. We are reflecting the transition from the old leasing standard to the new IFRS standard, which is a reduction in revenues in the quarter of EUR35 million and you have the impact of the newly acquired NxStage operations to get to our reported revenues of EUR4.419 billion on the top-line.

Turning to the bottom of the chart and looking at the development of our net income, same protocol. On the left hand side, you see adjustments to the gain from divestitures associated with Care Coordination activities in the quarter of EUR17 million last year. You also may remember that we increased our reserve for the FCPA matter in Q3 of last year to bring it up to the amount we ultimately settled with the government on. So that's the EUR75 million, gets you to a base of EUR343 million.

And again, you can see the growth of EUR6 million, reflecting earnings growth of approximately 2% on a constant currency basis. And again, this reflects the revenue recognition adjustment for the accounts receivable and legal dispute. On a constant currency basis, that's worth EUR79 million, as well as the adjustments that we took associated with the ESCO program. And this was partially offset by remeasurement of the fair value of our Humacyte investment, which was EUR72 million on a constant currency basis.

Following on, as we move to the right, there were favorable currency translation effects of EUR14 million, unfavorable front-loading of the IFRS 16 adjustment of EUR16 million, unfavorable effects associated with the NxStage operation of EUR15 million, some transaction costs associated with the NxStage acquisition, as well as EUR18 million of costs associated with the cost optimization program for the third quarter and a EUR20 million gain associated with divestitures of some of our Care Coordination activities to arrive at net reported income of EUR333 million.

If we turn to the next chart, Chart 14, I'm just briefly going to comment on the as-reported and the adjusted margin development for the quarter. Operating income increased from EUR527 million to EUR595 million on a reported basis. This reflects a margin increase of about 50 basis points from 13% to 13.5%. The main drivers for the margin increase were not surprisingly, the accrual we made in the prior year associated with the FCPA that I commented on a moment ago, the remeasurement effect of the fair value of our Humacyte investment for EUR76 million and a favorable impact from the higher utilization of oral based ancillaries, with favorable margins in the quarter.

This was partially offset by higher personnel costs, the adjustment associated with accounts receivable, the reason I've mentioned, the ESCO effect, essentially the reduction in our expectations for performance on the ESCOs, which I'm sure we'll talk some more about in the Q&A. And that would get you to the reported results.

On an adjusted basis the light blue, all of the explanations are consistent, but obviously, the base period has been adjusted for the FCPA related charges. As a consequence, you see margins declining from 14.7% to 13.7%, largely associated with the values you see on the right.

Turning to the next chart, and this is my final chart, on cash flows and leverage. The cash flows in the third quarter increased compared to the comparable period due to principally the implementation of IFRS 16. This leads to the reclassification of the repayment portion of the rent payments to financing and consequently, has an improvement in operating cash flows. It was also supported by strong cash collections globally. This results in cash from operations of just under 20% of revenues in Q3 compared to just under 19% in Q3 of 2018.

Looking at the bottom of the page, well, actually pardon me. So looking at CapEx, it has increased slightly by EUR27 million just reflecting a higher spend on our clinical network. Free cash flow at EUR584 million is substantially better than last year. And although we don't show our acquisitions, we invested about EUR68 million in acquisitions, net of divestitures in the quarter.

As a result of our free cash flow development and our acquisition spending, our net debt, which is our debt net of cash excluding, IFRS 16 has increased from EUR5.4 billion at the end of December 2018 to EUR8 billion at the end of September. This include -- including the additional lease liabilities as a result of the implementation of IFRS 16, the debt increased to EUR12.7 billion. You can see our leverage ratios. Without IFRS 16, we're at 2.5 times debt to EBITDA, and including the IFRS 16 adjustments, we are at 3.2 times.

So that's the conclusion of my prepared remarks. I would hand the call back to Dominik.

Dominik Heger -- Senior Vice President and Head of Investor Relations and Corporate Communications

Thank you, Mike. Thank you, Rice for the presentation. I'm happy to turn over after a short presentation to the Q&A.

Questions and Answers:

Operator

[Operator Instructions] First question comes from the line of Sebastian Walker of UBS. Please go ahead.

Sebastian Walker -- UBS -- Analyst

Hi, there. Thanks for taking the questions. So two if I could. Just first on home, so good progress there in terms of patient growth. I was wondering if you could talk through maybe some of the challenges that you've learned through over the past nine months in shifting toward home and as well, if you could confirm whether you are still comfortable with investments using after the first half of 2020? That's the first one.

And then, just secondly, in terms of the Humacyte fair value revaluation, how large was that and what drove the revaluation? Thank you.

Rice Powell -- Chief Executive Officer and Chairman of the Management Board

Sebastian, its Rice. I'll take the first one and then Mike will take Humacyte. So I would say, we're pleased with the progress we've made with NxStage and the integration to-date. Challenges, I think, are exactly as we stated they would be. We are trying to, as I like to say, walk and chew gum at the same time, meaning that we are trying to expand the infrastructure, we're hiring, getting ready to continue to train more patients and so that's always somewhat strenuous when you're trying to do both those things at the same time. As you said, I think, the bulk of the investment in education, training and the centers that we need will be pretty much done probably by mid-year next year, where they will take some time to get into next year before we finish that.

I think what we're learning from this work is, it's imperative that we make sure that we are in constant contact with our physician base and in listening to them as to things that we could tweak in the training, things that we could do better with educational materials, et cetera. So it's the constant communication from what I would say the service side of the business. From the product side of the business, I'm pleased that with the growth, NxStage is doing a good job of the ramp up and being able to stay ahead of the game, if you will, from a supply standpoint. So really, really busy, lots of work, learning as we go, but at this point through Q3 really pleased with the progress that we're making. Mike?

Michael Brosnan -- Chief Financial Officer

Thanks, Rice. Sebastian, relative to Humacyte, this is an investment that we made roughly a year ago. And so from a accounting point of view, we felt the timing was about right to take a look at the carrying value of that investment. We are obliged even for a Company that's not publicly traded to, from time to time, take a look. And we had an independent evaluation done over the course of the third quarter. I think that supported the fact that a revaluation of the investment was in order. I think this is largely the result of -- things seem to be progressing very nicely with the FDA in terms of the company's early products registration process. So, we reflected an adjustment of EUR76 million in current currency for the investment.

Sebastian Walker -- UBS -- Analyst

Thank you.

Operator

The next question is from Veronika Dubajova of Goldman Sachs. Please go ahead.

Veronika Dubajova -- Goldman Sachs -- Analyst

Good afternoon, gentlemen, and thank you for taking my questions. I will keep it to two as well. My first one is on the ESCO accrual reversals. Just maybe Rice, Mike, can you talk about the degree of confidence that you have that this is it? And then maybe just help us think about as we think about 2020. Obviously, given that your benchmarks that CMS is looking at seems to have changed, how should we be thinking about the profitability profile of Care Coordination as a whole? What's the right number for us to bear in mind there? That's my first question. And my second question is the Products growth in the quarter, clearly very impressive. So would love to get your thoughts on how sustainable you think that is.

Michael Brosnan -- Chief Financial Officer

Okay. Veronika, I'll take the first. I think that was one question and two parts, and the second question is -- I think that counts for three on my finger. But I'll take the first one...

Veronika Dubajova -- Goldman Sachs -- Analyst

Sorry.

Michael Brosnan -- Chief Financial Officer

And then Rice can take the rest. So I appreciate from some of the early reports I was looking, folks need some clarification about the statement that I made in the second quarter. We took a $41 million charge in the second quarter. And at that time, I was asked where we stand going forward, and I said that I thought the worst was behind us. That was based on what we knew at that time. And when you look at the charge we took in Q3, EUR46 million, there is about EUR18 million of that that actually relates to risk we took because we were really expecting the government to see certain parts of the prior year financials, particularly Year 2 our way. And in the third quarter, the government came out, closed out the second year at a level that was disappointing to us, as Rice said. So we had to clean that up and address that. So that actually was a relatively small part of the adjustment we took in Q3 and that's why I said, in Q2 that I thought the worst was behind us, at least in terms of the historical periods.

What was also published in the third quarter is, we received the report from the government for the first quarter of Year 4, that's the first quarter of this calendar year. And we have been seeing savings in our risk-based reporting for years 1, years 2, and years 3. And for the first quarter of this year, the government's reports indicated that it had slipped into a cost position, so the spending for the patients in our program was slightly higher than the benchmark.

We continue to struggle and have questions and have discussions with CMMI about the changes that take place from one quarter to the next in terms of the reporting we get, and also the patient attribution. So we've continued to have those discussions. We did make a change this quarter as a result of the struggles we've had over the last several quarters and we've decided that we will book to the report every quarter. And so in effect what that means is, if we're showing a cost for Q1, we have adjusted our Year 4 year-to-date results for the ESCO program to conform to the most recent reporting we have, which is a very slight cost for the program in the first quarter.

So the balance of that adjustment you are seeing, it's about EUR28 million, basically reflects a year-to-date adjustment for the current period ESCO experience based on the first quarter report we got from the government.

Rice Powell -- Chief Executive Officer and Chairman of the Management Board

Yeah. I mean, Veronika, given what Mike's taking you through, we can't just think this is all sunshine and light. We've got to take a pretty cold heart look at it, which is what we've done. But it's also why we're doubling down relative to being back in DC and continue to push on this, I won't repeat my earlier comments, but we are just not comfortable that we're getting the full story. I'll leave it at that.

Let's turn to a happier note. On the product performance, how sustainable is it? I would say that, we have seen really good performance in EMEA. We've seen some tenders turn on. We've seen fulfillment of tenders go our way. So I'm encouraged. Is it going to be as high in the fourth quarter this year? I can't prognosticate that, but we're going to continue to push forward. As you know, we've got a new machine out in the market in September. It won't take off like a gunshot in the fourth quarter, but I think it will help us because its targeted for emerging market in particular. We took into China first. So we'll have to see how that plays out over time.

So let me say that, I expect, we should have good performance as we look at the fourth quarter and we go into next year, but I wouldn't say it could be as good as it was this past quarter. I just don't have a way to prognosticate that at this point, but we will obviously keep pushing and continue to be excited about what we're seeing what the products folks be able to do. Truly around the world, everybody had a good quarter. So if we can keep every region producing in that way even if the numbers aren't as high as they were at this quarter, it's going to still be a great story.

Veronika Dubajova -- Goldman Sachs -- Analyst

That's great. Thank you. And if I can just very briefly before I go, I want to thank Mike for all of his detailed answers throughout the years, and wish you all the best, Mike. It's been a true pleasure. Thanks.

Michael Brosnan -- Chief Financial Officer

Thank you, Veronika. I appreciate that.

Operator

The next question is from the line of Patrick Wood of Bank of America. Please go ahead.

Patrick Wood -- Bank of America -- Analyst

Perfect. Thank you. I have two pieces, if I can. The first one on the commercial mix, obviously, sounds a little bit better. I'm just curious can you guys put some flesh on the bones as to what's driving that, how you see the mix profile going forward and what you're hearing in general from your private payers? Just a little bit of color around that, would be great.

And then the second one, I don't want to harp on on he topic, but on the ESCO side, I mean, it feels like CMMI is almost trying to make you leave the program. How much is the aggregate value? And apologies if you've already given this and I missed it, but how much of the aggregate value do you have left that you're carrying for the ESCOs in totality, should you decide to exit the program in its entirety? Thanks.

Rice Powell -- Chief Executive Officer and Chairman of the Management Board

Patrick, it's Rice . I'll take the first question, and Mike is going to take the second one. So I would tell you that commercial mix is improved in a very, very nice way year-over-year. I don't know that there is any additional color I can give you from a payer standpoint, I think I don't have anything new to really comment there. I think it's fair to say it was a year ago this call that we talked about the fact we thought our process was broken and needs some repair. What I can tell you is that we did go in and do the work and figured out where we needed to get better, where we needed to refocus and what are the key parameters are that we want measured and I want to see them every month. And that is happening and that's why I am comfortable when I tell you we are considerably better than we were a year ago. I'm not the one to want to say we fixed the problem, it's all done, never to have another issue, but what I would say is, we've done everything that we committed we were going to do and we're seeing it work. And so I'm pleased with that. And I think I would leave it at that. And Mike, on the ESCO.

Michael Brosnan -- Chief Financial Officer

Yeah. Patrick, I think fundamentally what you're asking is, what do we anticipate at this point in terms of a receivable from the government associated with the open ESCO years. Let us take a minute to see if I can give you a definitive answer. I just want to make sure that we're looking at net receivables, not gross.

Rice Powell -- Chief Executive Officer and Chairman of the Management Board

To answer a piece of your question while we give Mike a moment here, so we are dropping a location or two in the next year's plan. The window has already closed. So at the time -- and that's one of my complaints is, what we were looking at, what we were going to do in the next year's plan, you're doing it in the midst of not having all the information you need. So that window closed sooner than I wish it had, but even among that, we had a location or two that we had made a conscious decision with the physician group that we were not going to continue, mainly because of, at that particular point in time, that practice was beginning to break off and go other places, so it didn't make sense to keep it. Mike?

Michael Brosnan -- Chief Financial Officer

Yeah. So, Patrick, I'd say just to guide you, as we look at our balance sheet position, years 2, years 3, years 4, because Year 2 has not been cleared out yet, it's been closed and we have savings, but it has not been paid out yet. We're looking at about $50 million or $60 million in terms of net receivables from the plan.

Patrick Wood -- Bank of America -- Analyst

That's helpful.

Michael Brosnan -- Chief Financial Officer

Okay.

Patrick Wood -- Bank of America -- Analyst

That's helpful. Thanks guys.

Rice Powell -- Chief Executive Officer and Chairman of the Management Board

You bet.

Operator

The next question is from Michael Jungling of Morgan Stanley. Please go ahead.

Michael Jungling -- Morgan Stanley -- Analyst

Great. Thank you. And good afternoon. I've got two questions please. They're both in relation to hemodialysis. Firstly, have your visits to Washington for home dialysis indicated how CMS will incentivize the uptick of home dialysis? Will the nephrologist do you think be the key focus? And then for the dialysis providers, do you think that they will use a carrot or a stick approach in terms of driving this program under the Presidential Order?

And question number two is also on home. With the push toward home, do we see or do you have preference whether you push PD or HHD, is there something that is for you more interesting, perhaps more commercial and simpler from a logistics perspective? Thank you.

Rice Powell -- Chief Executive Officer and Chairman of the Management Board

Sure, Michael. So, as you know, with the executive order came out the request for a mandatory study to be done, and then there were several voluntary studies that needed to be done as well. Varied in those proposed rules, are incentive programs for transplantation as well as for home. What I would say to you is, and your second question is, are the docs key? And absolutely, the physicians are key. What has been going on is, unanimously among the provider community and with the physician community, we have gone back all in very long well detailed reports, said back to CMMI, CMS that, as they've laid out the voluntary home models, as they've laid out the mandatory, they do not work. They simply have not laid them out in the way the provider community and the physicians' practice medicine.

For instance, in one case in the ETC model proposed, which is the mandatory, they basically were going to either reward or punish the provider for the number of transplants that are done in a certain clinic. And as you well know, we are neither transplant surgeons nor organ procurement folks. So we have no dog in that fracas, if you will. So those are the types of things that we went back and explained, that we need to sit down with you because as you've laid it out, it doesn't work.

I would say that CMS has been responsive to that. We've given them our comments. We are waiting for them to come back and talk to us about what we put in the document. Obviously, the driving date here is January 1, is when the mandatory model would begin to start and it would mean taking half of FMC's patients, which are roughly a 105,000 or 110,000, and I think we've done a pretty good job of getting them to realize nobody is ready for that given the unworkability of the programs. I would tell you to stay tuned, but it is something that we are constantly working and checking on with the folks at CMS.

Relative to growing the business and do I have a preference for home HD or PD? I would tell you we are seeing huge growth in both. Our PD book in the quarter grew about 7% or 8%, whereas the home book was 25% -- home HD was 25% or 30%. So we're seeing a big push toward home. I think there's two things you have to keep in mind. We are pretty agnostic or I am, and it's really a physician decision, but remember PD is a transition therapy. You're using the lining of the stomach as the filter and that filter will stop its ability to filter over time. The filtration process breaks down, and then that patient is either hopefully open for a transplant, or they can go in center, or they have to change the type of access they have from the abdomen to a renal artery as for blood and they can stay at home on HHD.

So I would say to you, I think while we're seeing such great growth from HHD, it's from the fact that many physicians are beginning to understand, do I want to you even have to go through that transition period, but that is really a patient, patient family, physician decision. As I say, we're prepared to grow in either way, but just to give you the fact that what we saw in the third quarter with the numbers.

Michael Jungling -- Morgan Stanley -- Analyst

Thank you.

Operator

The next question is from the line of Ed Ridley-Day of Redburn. Please go ahead.

Ed Ridley-Day -- Redburn -- Analyst

Hi. Good afternoon. Thank you. Can I start by asking regarding the revenue recognition adjustment, could you just give us a bit more color about the payer or payers involved in this legal dispute? And also, could you give us some color on, you mentioned in the release, the weakness in our internal controls on financial reporting and why you were sure that you do not expect to have to restate any of your historic financial accounts?

Michael Brosnan -- Chief Financial Officer

Okay. Ed, I'll take that. It's Mike. Well, first of all, the overall adjustment considers our other government and commercial pay. Just to give you the broad categories, so this is not Medicare, Medicaid. This is really what we consider to be other governmental payers and commercial pay. And these are relationships where we made the decision that the principal arm of the Company that needs to pursue collection is the legal department, not the billing and collections departments. So that's the broad category.

And what we're talking about is, let's say very broadly speaking that almost all the value comes from baker's dozen, 12 or 13 relationships. And then there's a variety of others that are very, very small amounts. The nature of the weakness, the nature of the internal control weaknesses is, as we looked at this, we concluded that the judgments that we were applying were a bit too heavily weighted toward the legal view and didn't really have a stronger finance view, where we might have considered to constrain the revenues at the time we moved the receivable into the legal review category and then constrain it again when it moves from that status into an actual legal dispute in court. So that's the conceptual framework. And we concluded that we needed to rebalance the emphasis on who had the stronger view in terms of collectability at the point in time that we moved the receivable from billing and collections into legal.

Ed Ridley-Day -- Redburn -- Analyst

Thanks, Mike. Thank you, Mike. That's helpful. But in terms of your counter-parties why are those receivables in dispute/

Michael Brosnan -- Chief Financial Officer

Well, let me answer the second part of your first question before I do that, because you asked me what our level of confidence was in terms of not requiring any prior period adjustments. So once we identified this is a material weakness, we performed a lot of additional procedures to satisfy ourselves what value should be constrained for that book of business, and that's how we arrived at roughly the EUR84 million. That also included looking at all the prior periods and making a determination, if there was any material adjustment related to prior fiscal years and we concluded there was not. So what I would say today on the call is, there will not be a prior period adjustment related to this issue.

So if you don't mind, Ed, can you go back and just restate your follow-up question?

Ed Ridley-Day -- Redburn -- Analyst

And thank you for that. And yes, in terms of your counter-parties, is there any color that you can give us on why these receivables are in dispute? Ultimately this is money that you believe you're owed.

Michael Brosnan -- Chief Financial Officer

I can't quote. Each one of these circumstances is somewhat unique, but I would say that, fundamentally, services in the healthcare provider side in the US are typically billed as a percent of bill charges. And you have various arrangements with your payers, some of them quite complex. And very often with your payers, you have more than one plan with those payers, so there can sometimes be some confusion between which plan relates to what percent of that charges. And I think that, in its essence, creates some of the complexity, where you can end up with a legitimate disagreement between the provider and the payer in terms of what's owed.

Rice Powell -- Chief Executive Officer and Chairman of the Management Board

In our history, Ed, we've had a couple of these disputes and you can probably go back in time and see where they really truly ended up in court, and we got those things settled, if you will. Many times these things get fixed before there is a real issue. But as Mike said, this is not a real simple piece of our business, it's a lot of plans, a lot of work goes into it. So I think that's probably as much as we need to say.

Michael Brosnan -- Chief Financial Officer

Yeah. And while we're on the topic, just so that none of you are surprised, because we have defined this as a material weakness, you will see an administrative process as we go through over the course of the next several days. We will need to amend our 2018 20-F, as it relates to our internal controls, SOX declarations. So we will essentially go back and amend that to indicate that we did have a material weakness and you will see us also amend some of the narrative in Q1 and Q2 of this year, at the same time or shortly thereafter, we'll file the Q3 6-K. So if you have your systems pinging, you'll see some activity in terms of amended reports, but there is no change to the financial reports for any of those periods. It's just the narrative around our internal control system.

Ed Ridley-Day -- Redburn -- Analyst

Thank you, both. I'll get back in the queue.

Operator

The next question is from Tom Jones of Berenberg. Please go ahead.

Tom Jones -- Berenberg -- Analyst

Good afternoon, Rice, Mike. Thanks for taking my two questions. The first was on risk business. I think I can get a sense from your tone what your appetite for further risk business on the government side is, but how is the experience with the ESCOs impacted your willingness in [Indecipherable] to do risk-based business, risk sharing and capitated payments, wherever you want to call it on the commercial side?

And then the second question I had, was related to home dialysis, but specifically around skilled nursing facilities. I think most investors tend to think of dialysis as either at the patient's home or in a center. But there is a halfway house of patients sitting in skilled nursing facilities. I know you mentioned this at the time of the NxStage acquisition a while back, but I just wondered, now you've owned the business for a while, how you're thinking about that opportunity in the SNPs?

Rice Powell -- Chief Executive Officer and Chairman of the Management Board

Sure, Tom, I'll take a shot at those. So taking risk is not going to go away and it's something that we think that we can do a good job of. You couldn't tell it by this program with the ESCOs at the moment, but again that's a shared savings and I'll let that lay in my earlier comments. But I would tell you, we are confident that we can do this. We have some commercial arrangements that are small, that we are doing this. And part of the frustration for us is when we look at how that commercial book is performing, it is working, and we take that and we inform ourselves, well why isn't it working on the ESCO side. And when we kind of have that conversation with CMMI, we just don't get any recognition from there, guys, we're doing this same day, we do your work for different set of folks and it's going just fine. So, you tell me what the difference is. So we're not going to be back out of being willing to take risk. It just depends on who you are taking the risk with. Why don't I say it that way.

Tom Jones -- Berenberg -- Analyst

Fair enough. And then maybe just a quick follow-up before we move on to the SNPs. On the risk side, it seems a little odd that on one side, you've got the President and that's the boss of the Department of Health, kind of pushing, or trying to push you toward risk sharing models. And then on the other side of the equation, you've got perhaps the more junior institution in CMS, CMMI seemingly doing their very best to foul everything up. To what extent do you think there is some potential for pressure to be bought on CMS from higher authorities to make this whole program work a bit better?

Rice Powell -- Chief Executive Officer and Chairman of the Management Board

So two comments there. A, political, ESCOs were in Obama administration program, the executive order is a Republican and I think that does make some difference as to how willing they are to deal with future state and where it's going. I don't think it's [Indecipherable] that we have an executive order and they want us to really incent us to do home and transplant and do more CKD work, were all for all of that. But out of the gate, as they design these voluntary models and the mandatory model, they didn't come ask us enough upfront.

I call that a little bit of a junior mistake, but we've all weighed in, we've all told them we support, but you got to pay attention to how we run the business. You can't ask us to do something that contorts the way we do the business, because there are patients at the end of this process. And so we're waiting to see how that's going to pan out and how well we are going to be listened to, Tom, and if we're not, then we will play in the voluntary side of this.

Now, back to you piece on SNFs, yes, we believe that is an opportunity for us. There has been some back and forth on regulation development, on SNFs and how it's going to be done. I would say that the whole of the dialysis industry isn't necessarily on the same page because we have some skill sets that others don't from the provider community because of our vertical integration. So I think you probably know where I'm going with this, but we believe that those regulations are going to be fair, they will be right, they support what we're doing and to your point, it is a service that we provide by doing it in the skilled nursing facilities and is in the best interest of that patient and not loading them up into an ambulance and taking them somewhere.

So we're going to continue to push on that. We think we can do it and we can do it well. And we're just continuing to talk about that and make sure that the regulators understand that this is a viable piece of the business that should be regulated in the appropriate way to do the right thing for the patient.

Ed Ridley-Day -- Redburn -- Analyst

Perfect. That's very helpful. Thanks Rice.

Rice Powell -- Chief Executive Officer and Chairman of the Management Board

You bet.

Operator

The next question is from James Vane-Tempest of Jefferies International. Please go ahead.

James Vane-Tempest -- Jefferies International -- Analyst

Yeah. Hi. Thanks for taking my questions. I have two if I can, please. With the signing of AB 290 a few weeks ago in California, I'm just curious how about -- what the impact is from here and what you're hearing about potentially other states looking at this development? And then, secondly, on the ESCOs again. I mean, I understand the challenges you're seeing in the US, but how does that factor into your thinking in further developing your ex-US Care Coordination business in the mid term, which is currently doing quite well? Thank you.

Rice Powell -- Chief Executive Officer and Chairman of the Management Board

Hey, James. It's Rice. I'll take those. So AB 290, yes, it's signed. Newsom signed it. As you know, we've been out for a while with the impact of that on us in the high single-digit millions. So we will see where it goes from there. As you recall that Bill had a whole bunch of amendments on it, mostly around I think trying to induce, if you will, the American Kidney Fund, go out and get another OIG opinion and figure out where premium assistance sits. AKF has said they're not going to do that. It's not necessary to do it because the OIG opinion we have is still alive and well. And so AKF has said, they're not going to do it.

So where that deal could have been delayed in implementation, it's now going to implement January 1, 2020, as a result of there being no work on the AKF's part relative to revisiting something that's been revisited a couple of times and the OIG has said, as long as you perform this way, the AKF and the providers are doing exactly what they should be doing with premium assistance. So I think for us, we are in the same place we were last quarter, quarter before that, when we gave you our estimate of high single million dollar impact.

As far as the ESCOs, ex-US, we are not doing anything remotely close in any other part of the world to what we've been doing with the ESCOs. So we are still bullish and looking at opportunity. We know a lot more now than we did when we started, so if somebody in, say, Germany or Australia came to us, and said, hey, let's do a shared service sort of thing. I'm not sure we would probably stand-in for that. But it shouldn't color your thinking on the opportunity rest of world because we've always said Care Coordination is likely to be different than the way it is in the US and I think that still bears itself out. But we're nowhere anywhere close to doing something like the ESCOs in the international markets at this point.

James Vane-Tempest -- Jefferies International -- Analyst

That's great. Thank you.

Operator

The next question is from Hans Bostrom of Credit Suisse. Please go ahead.

Hans Bostrom -- Credit Suisse -- Analyst

Good afternoon. A couple of questions please. You mentioned the increased use of ancillaries as a reason for your improving margins. I'm just wondering why that might have changed year-on-year and whether you see any changes in regulation, inclusions into the bundle in the coming year that might change that profit contribution? And secondly, it seems you had a pretty favorable deviation, certainly relative to my expectations from your both tax and borrowing costs. So I wonder whether these lower levels are sustainable on a quarterly basis going forward? Thank you.

Rice Powell -- Chief Executive Officer and Chairman of the Management Board

Yeah. Hans, it's Rice. On the portion from a big picture and we'll have to look and see if there's any detail on the ancillaries, but I'm not aware of anything substantive changing there. But to your question, if this is a way on calcimimetics in the bundle, or where is that going to go? As you know, that's been pushed out to like 2024 at this point. So we always wonder when they're going to look at, does something else going to the bundle. Haven't had any discussion on that of late. And as you know, the proposed Medicare reimbursement rates for next year, which should become final here in the next week or so, early days of November, there was nothing dealing with that at the time. So I don't think there is a change relative to what's moving into bundle at this point that we can see, but I don't doubt that down the road that could come to be. And then, Mike, I'll let you do tax and borrowing costs.

Michael Brosnan -- Chief Financial Officer

Okay. Yeah, Hans, we are seeing a generally lower interest expense. Obviously, rates continue to be at historical lows, I think in particular in Europe. So we've been able to take advantage of that over the course of the last couple of years through the sale of Sound, which generated substantial cash, allowed us to do a substantial amount of our financing for NxStage using those funds. And where we have had to rebalance our debt portfolio, we've been able to do with the favorable rates over the course of the last 12 months to 18 months,. So it's hard to predict what will happen as we go forward, but I think most of the commentary that you read now anticipates lower rates continuing in Europe for some time. And as we look at refinancing activities over the course of the next, let's say, six months or so, it would seem to me to be in a favorable rate environment for what we can get accomplished in that time. So we may continue to see some benefit in terms of year-on-year interest costs.

And on the tax side, I've mentioned in my review of net income that we had about a EUR20 million benefit associated with our Care Coordination divestitures. That actually was a tax benefit related to finalizing, some of the tax positions on our Sound divestiture from last year. So that's why you see a lower effective tax rate in the third quarter.

Hans Bostrom -- Credit Suisse -- Analyst

Thanks.

Operator

The final question comes from the line of Hassan Al-Wakeel of Barclays. Please go ahead.

Hassan Al-Wakeel -- Barclays -- Analyst

Thank you very much for taking my questions. I have two, please. Firstly, you've talked extensively about back-end loaded benefit from efficiency and cost optimization savings. I wonder if there's been any significant benefit in Q3 or should we still continue to expect the bulk to come through in Q4?And secondly on ESCOs, apologies if I missed it, but could you comment on what you expect the 2020 Care Coordination margins to look like? Thank you.

Rice Powell -- Chief Executive Officer and Chairman of the Management Board

Yeah. So Hassan, its Rice. On the cost optimization, it is heavily weighted into Q4. We did see some improvement in Q3, but there is lots of work that goes on in Q4 to bring that in where we want it to be. And if you just think about, again, what are we doing, we are getting out of office space that we don't need and we're also looking in rationalizing our clinic footprints. And so that from the day you decide you might want to do something different with a clinic, it takes a while to actually get the OK to move the patients and get that done before you are then able to make that happen. So that's why it's so back end organized. And then on the ESCO, Mike, 2020 margin in Care Coordination. Yeah.

Michael Brosnan -- Chief Financial Officer

Yeah. So we will probably address that in February.

Rice Powell -- Chief Executive Officer and Chairman of the Management Board

Yeah. Why don't you let us come back to that Hassan, because right now, it would be hard to prognosticate something that far out in time. I think we need to finish up what we've got going on here to come back and we will do that as part of our normal process going into the new year.

Hassan Al-Wakeel -- Barclays -- Analyst

Maybe if I can then just add on that, are you able to disclose what roughly the ESCO contribution to the Care Coordination profits in the year was?

Michael Brosnan -- Chief Financial Officer

Well, I think ESCOs with the adjustments we've taken in the second quarter and third quarter is roughly almost EUR90 million, so it substantially diluted the margin for the Care Coordination business this year.

Hassan Al-Wakeel -- Barclays -- Analyst

Thank you very much.

Michael Brosnan -- Chief Financial Officer

So, EUR46 million in Q2 and EUREUR41 million in Q3. Yeah.

Rice Powell -- Chief Executive Officer and Chairman of the Management Board

Puts you right there at EUR90 million.

Operator

And there are no further questions at this time. I hand back to Dominik for closing comments.

Dominik Heger -- Senior Vice President and Head of Investor Relations and Corporate Communications

Okay. Perfect. So [Technical Issues] questions. But before we close the call, I would like to hand back to Rice to check if he has maybe some comments.

Rice Powell -- Chief Executive Officer and Chairman of the Management Board

Yes. One final comment, if I may. I'd like to ask all of you that are listening to join me in thanking Mike for a tremendous amount of contribution, many of which were critical to the success of FMC in Mike's 20 years here, and we want to wish you the best as you make your transition into the next phase. Thank you.

Michael Brosnan -- Chief Financial Officer

So, thank you Rice. Thank you, everybody. It's been a pleasure. I've enjoyed all of my chats with all of you on the phone. Thank you very much. It's been a lot of fun and a great learning experience for me. Take care.

Rice Powell -- Chief Executive Officer and Chairman of the Management Board

Thanks, folks. We will conclude the call at this point.

Dominik Heger -- Senior Vice President and Head of Investor Relations and Corporate Communications

Thank you. Bye-bye

Bye-bye.

Operator

[Operator Closing Remarks]

Duration: 57 minutes

Call participants:

Dominik Heger -- Senior Vice President and Head of Investor Relations and Corporate Communications

Rice Powell -- Chief Executive Officer and Chairman of the Management Board

Michael Brosnan -- Chief Financial Officer

Sebastian Walker -- UBS -- Analyst

Veronika Dubajova -- Goldman Sachs -- Analyst

Patrick Wood -- Bank of America -- Analyst

Michael Jungling -- Morgan Stanley -- Analyst

Ed Ridley-Day -- Redburn -- Analyst

Tom Jones -- Berenberg -- Analyst

James Vane-Tempest -- Jefferies International -- Analyst

Hans Bostrom -- Credit Suisse -- Analyst

Hassan Al-Wakeel -- Barclays -- Analyst

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