Invacare CEO discusses Q4 2012 Results - Earnings Call Transcript

Feb. 8.13 | About: Invacare Corporation (IVC)

Invacare (NYSE:IVC)

Q4 2012 Earnings Call

February 08, 2013 08:30 AM ET

Executives

Gerald Blouch - President and CEO

Rob Gudbranson - CFO, SVP and Treasurer

Analysts

Jim Sidoti - Sidoti & Company

Michael Madsen - Mizuho Securities

Operator

Good morning, ladies and gentlemen, and thank you for standing by. Welcome to the Invacare 2012 Fourth Quarter Conference and yearend Conference Call.

I will begin with the customary safe harbor statement that this conference call may include statements regarding anticipated and future developments that are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are those that describe future outcomes or expectations that are usually identified by words such as should, could, plan, intend, expect, continue, forecast, believe, and anticipate and include for example any statement made regarding the company's future result.

Actual results may differ materially as a result of inherent uncertainties and risks including the risk factors described in the Company's Form 10-K and other filings with the Securities and Exchange Commission and the Company's earnings release. The Company may not be able to predict and may have little or no control over factors or events that may influence its financial result, also of note the company announced the sale of its Invacare Supply Group, ISG medical supplies business during the fourth quarter of 2012.

Accordingly, the results for the quarter and year ended December 31, 2012 include the results of ISG as a discontinued operation. Since ISG was not sold until 2013, a portion of the CEO’s comment will address the results of the continuing operations and Invacare Supply Group as a combined operation for the year ended December 31, 2012.

For more information on the company’s continuing, discontinued, and combined operations, please read the detailed condensed consolidated financial statements in the release. Before I turn the call over to Invacare’s President and Chief Executive Officer, Mr. Gerry Blouch, I would like to remind you that all phones lines have been placed on mute for the first part of the call. After the management overview, we'll open up the call to question.

This conference is being recorded today, Friday, February 8, 2013.

I would now like to turn the call over to Mr. Gerry Blouch, President and Chief Executive Officer. Mr. Blouch, you may begin your conference.

Gerry Blouch

Thank you very much. With me on today’s call is Rob Gudbranson, Invacare's Chief Financial Officer. In the following comments, we will focus on the highlights of the release as opposed to covering all the detail, which you can really read in the release after the call. In particular, I would refer investors to the Company's earnings release to review the definitions of free cash flow and some of the adjusted earnings items, which will be mentioned during the call. You can find the release as usual at www.invacare.com.

Clearly 2012 was one of the most challenging years in the company's history. The year was dominated by our consent decree negotiations with the United States and Drug Administration. The consent decree was approved by the United States district court of Northern Ohio, (inaudible) affect December 21st.

As a reminder, under the terms of the decree the company may manufacture products to fulfill preexisting orders and written quotes. Orders for replacement products or new products that need specific standards for medical necessity and order for products and components to repair products currently in use. However, we are obliged to obtain specific documentation to substantiate these facts. When the consent decree became effective, the company suspended operations at the Taylor Street facility for two days in order to bring the company into compliance with the terms of the decree. This included the process for educating customers and clinicians on the new documentation report. The company began releasing products from the facility as documentation was received and audited. But becoming familiar with the new consent decree protocol is a learning experience for both the Invacare associates and our customers and we continue to refine both the process and our communication.

In 2012, we made significant progress in our ongoing efforts to implementing a comprehensive portfolio of FDA compliant processes and these processes will be standardized across all of Invacare's FDA registered facilities. We focus on our remediation activities; we suspended most new product development for over a year proceeding the commencement of the consent decree.

This resulted in a lack of new products and coupled with the uncertainty among our customers over the Invacare's ability to offer continuous products supplies at the Taylor Street facility resulted in a loss of market share and gross margin pressure as these products are among our highest margin products.

Year over year performance declined in 2012 largely as a result of these challenges, as well as the ongoing pressures particularly at our customer base in North America HME segment and the challenge faced in the Asia Pacific segment. Results for the year were as follows. First, adjusted earnings per share for the year including the Invacare supply group was $0.87 per share in 2012, compared to $2.05 in 2011. Yet the impact of incremental quality system is cost which aggregated (inaudible) per share on an adjusted basis were excluded. Adjusted earnings per share for 2012 including Invacare's supply group would have been $1.33.

Second, organic net sales increased by almost 1% on a combined basis for last year on strong performance from Europe and our institutional products group as well as the Invacare supply group. And third, free cash flow for the year was $49.1 million.

Details for the consolidated results for the combined operations in the fourth quarter were as follows. Adjusted earnings per share including discontinued operations of ISG were $0.11 in the fourth quarter. This number includes incremental regulatory and compliance investments that aggregated approximately $5.5 million or $0.10 of adjusted earnings per share. Excluding these costs, adjusted earnings per share from combined operations were $0.21 in the fourth quarter of 2012, compared to $0.69 for the fourth quarter of 2011.

In the fourth quarter, organic net sales combined operations increased 2.3% over the same period last year. Excluding discontinued operations, organic net sales decreased by 2.5% on the fourth quarter compared to the same period last year. As increases in Europe and Institutional Products Group segments were offset by the North America HME and Asia Pacific segments.

Excluding the discontinued operations of ISG, gross margin was as a percent of net sales for the fourth quarter was lower by 2.3% each points, compared to last year’s fourth quarter. The main (inaudible) margin decline issues were related to sales mix towards lower margin product lines as I mentioned previously and lower margin customers, volume declines, increased freight costs and research and development expenses for contract engineering support to augment the fact that our in-house engineers were focused on remediation.

In the fourth quarter, the company had positive free cash flow of $31.2 million; the quarter’s free cash flow was positively impact by cash flow benefits from reductions in networking capital. SG&A expenses excluding discontinued operations of ISG increased to 11.7% to $105.3 million in the fourth quarter compared to last year’s fourth quarter excluding the impact of foreign currency translation and the incremental regulatory compliances costs. I mentioned previously, SG&A expense increased by 7% compared to the fourth quarter of last year primarily related to associate cost offset by reductions in net debt accruals.

With that, I would like to have Rob review additional financial highlights.

Rob Gudbranson

Thanks, Gerry. Before I begin, I’d like to note that the references to earnings before income taxes and the segment descriptions exclude restructuring and impairment charges. For the quarter ended December 31st, 2012, organic net sales for the North America HME segment decreased 9%, compared to last year, driven by declines in all three product categories.

Many of the drivers of the sales declined in the third quarter carried into the fourth quarter including external pressures on the company’s customers related to the second round of competitive bidding, as well as prepayment reviews and post-payment audits from Medicare and Medicaid.

The sales decline for the quarter was also impacted by the lack of new products, in general uncertainty relating to the consent decree for a significant portion of the quarter.

Finally, there was an impact from the company’s two day suspension of the Taylor Street wheel chair manufacturing facility in order to implement compliance controls related to the consent decree that Gerry mentioned earlier in the call.

Earnings before income taxes for the North America HME segment decreased $16.8 million as a result of the incremental cost previously mentioned related to quality system improvements, buying declines, unfavorable sales mix favoring lower margin customers and lower margin products. These factors were partially offset by reduced bad debt expense and favorable foreign currency transactions.

Organic net sales for the Institutional Products improvement increased 4.1% driven by strong net sales for interior design projects for long-term care facilities, dialysis chairs and therapeutic support service products partially offset by declines in institutional beds.

Earnings before income taxes increased by $1.3 million compared to the fourth quarter last year as volume increases and favorable foreign currency transactions were offset principally by increased trade expense and research and development cost.

European organic net sales for the quarter increased 7.9%, principally due to increases across all three product categories. Earnings before income taxes decreased by $3.1 million compared to last year. The decrease in earnings before income taxes was largely attributable to an unfavorable sales mix towards lower margin product lines and lower margin customers, higher warranty expense and increased SG&A expenses, primarily in associate costs. These factors were partially offset by volume increases.

In fourth quarter, Asia Pacific organic net sales for the quarter decreased 29.3% caused primarily by net sales declines in all three subsidiaries in the segment. The Company's Australian and New Zealand distribution businesses experienced declines in mobility and seating and lifestyle products. The decline in the company’s subsidiary which produces microprocessor controllers was primarily related to its contract manufacturing business for companies outside the healthcare industry.

For the fourth quarter, earnings before income taxes decreased by $4.5 million to a loss compared to last year’s fourth quarter profits. The decrease in earnings before income taxes is primarily attributable to the reduction in net sales volumes for each of the businesses in this segment.

Total debt outstanding which includes the convertible debt discount is described in the release was $238.1 million as of yearend, the company’s total debt outstanding consists of $217.5 million drawn in the revolving credit facility, 13.4 million in inconvertible debt and 7.2 million of other debt.

I'll now turn the call back over to Gerry for a few closing comments. We then can address questions.

Gerry Blouch

Thank you, Rob. As we look towards 2013, I am encouraged by our progress on the company's quality systems remediation. Validation of these changes of course is subject to the FDA review and approval but we've come a long way over the past year. In order to fulfill, resume full operations at Taylor Street and corporate facilities, the terms of the consent decree require three expert certification audits followed by a comprehensive FDA inspection.

The first two of the three expert certification audits started in December and are still in progress. We expect to complete these audits within the first quarter and complete the third audit in the second quarter 2013. With the satisfactory completion of the first certification audit related to equipment and process valid procedures at the Taylor Street facility, the company will be permitted to resume the manufacturing, the components and parts in its Taylor Street facility for further manufacture of devices produced at other Invacare facilities.

With the satisfactory completion of the second certification on it, related to design controls, the company will be able to resume design activities of wheelchairs and power bits. Resumption of normal operations at the Taylor Street facility would then be subject to the completion of a third party certification audit, an FDA inspection, and receipt of the FDA's written confirmation that the facilities are in compliance.

As difficult as this year has been, our quality system investments will make us a stronger company and they will also facilitate and benefit from complexity reduction. This will drive the $100 million of structural benefits that we intend to achieve from our globalization program. The center piece of our globalization plan is the consolidation of product platforms. So we're looking forward with great energy to reenergizing the new product development process as quickly as possible. Despite industry challenges included in the recent announcement, pricing, including recent announced pricing for the second round of national competitive bidding in the domestic market, the fundamentals of home care is wrong. The aging of the population and growing prevalence of chronic disease will positively impact demand. Also the Affordable Care Act calls for hospitals to reduce length of stay which will move patients below our cost settings such as home care and long term care. Homecare is the trifecta of healthcare. Patients want to be at home, there's better clinical outcomes at home and home care is more cost effective than institutional care. We are confident after we emerge from the remediation process that we will continue to strengthen our product portfolios, serve the needs of the market with innovative and cost effective solutions and restore our profitability to historic levels. On behalf of the company I appreciate your time and attention during this call. We will now open up the phone line to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes of line of Jim Sidoti from Sidoti & Company.

Jim Sidoti - Sidoti & Company

Alright, first question, compliance cost, I just want to get it straight because I think there might have been a type error with the press release. You showed its $0.10 in the quarter and $0.46 for the year?

Gerry Blouch

Yes.

Jim Sidoti - Sidoti & Company

Okay. Can you give us some sense now that you’ve completed the remediation effort part of it, now you're in the audit stage? What happens to those costs going forward, do they…

Gerry Blouch

Just reiterating comments we've made in the past, the bulk of those costs are for third-party experts. I told you the number of consultants we've got working on this should be will boggle your mind, and that blurs into that as an expensive process. But as we complete the remediation, those will start to ramp down and we got a ramp down program that was submitted to me within the last two weeks.

Jim Sidoti - Sidoti & Company

So, today are there as many as they were in the fourth quarter of 2012?

Gerry Blouch

There are not in the ones that are there as fewer staff members working on the project.

Jim Sidoti - Sidoti & Company

Okay. So, that cost should start to ramp down as we get to 2013.

Gerry Blouch

Yes.

Jim Sidoti - Sidoti & Company

Okay. And then in Asia Pacific you've had several quarters there where sales have declined, I think you lost the contract in Australia, when does that anniversary?

Gerry Blouch

Good question Jim. That'll anniversary probably in the third quarter, late third quarter, fourth quarter of next year. As important as the contract and it’s a little more complicated than that, but is important the contract is frankly, we announced last quarter that we re-structured that business we took, and we consolidated around a tighter core of profitable sustainable business outside of that contract which we actually didn’t lose, we pushed away from so we've done restructuring. We unfortunately had to release the half of our associates in Australia, but we’ve got a tighter leaner business and we’re moving forward from that platform.

Jim Sidoti - Sidoti & Company

Okay but volumes in Asia-Pacific will decline and sounds like at least to the first half of ’13?

Gerry Blouch

Yes but more importantly we had serious as Rob related, we’ve had some serious ratings there, and I think that the tradeoff will serve us well and make you happier as an investor.

Jim Sidoti - Sidoti & Company

And then you mentioned, there was I guess some order delays, people were concerned about competitive bidding and concerned about what effect the consent decree would have. I know you're only one month into ’13 and the bidding rates are only a couple or week old or two weeks old. But are you seeing that continuing, are you seeing any of that start to reverse?

Gerry Blouch

It’s a new ballgame now, you’ve got two different points in there. On the issue of uncertainty, while customers had uncertainty and some of them, it gives the cycle on orders in rehab can be very long, because they submit quotes and then they have to those quotes and submit them to a payer, a insurance company, and get approval because their cost of product, there is no fixed code because they’re all unique, one of a kind solution.

And the absent agreement and approval of the FDA, we had no basis for saying that don’t worry about it, now that turned out, they allowed us because they didn’t want to create disruption and they allowed us to fulfill outstanding quotes and orders on the books at the time the consent decree went into effect. Going forward, however, I kind of detailed the effective circumstances that under which they will allow us to continue to fulfill orders, but that requires documentation and it's certainly not as fulsome and business as usual.

Jim Sidoti - Sidoti & Company

All right.

Gerry Blouch

On competitive bidding, I said, there is nothing new right now. It doesn’t go into effect until July. At least you’ve got people now that there was uncertainty as we discussed in the past when we were in the market that was faced with round two competitor bidding and you didn’t know whether you're going to win or lose, our customers are smart business people. So, they were more reluctant to load up on product but now the winners know who they are and the people at least know whether they’re in the game or out of the game, that uncertainty is relieved. but the next step in the process is for people who had been told by CMS that they are in bidding process, they have to confirm whether or not they intend to accept the bid, and there is always some dropouts, so it will be a protracted period where CMS will adjust the portfolio, winners and losers based upon who accepts and who drops out. So there is a lot of grinding, administrative work between now and July 1st that will have to be accomplished by CMS before it even kicks off.

Jim Sidoti - Sidoti & Company

And I know you are reluctant to give any kind of guidance until the consent decree is listed, but in terms of profitability, do you think you will be profitable, your first half of '13.

Robert Gudbranson

Jim, let me take a try on that, this it’s Rob. I think the key thing to do is let`s just talk about the segments generally as opposed to trying to give guidance which clearly we're not going to do. If you look at the fourth quarter performance of IPG in Europe, they both did well. Obviously Europe was down slightly and IPG was up. But at the same time, I’d say those two divisions are really performing well. So I’d really focus then on the other three, one of which is now discontinued.

As Gerry has related and he has made sure we know it is job No.1; for North America HME we got to do remediation. For us to be able to improve profitability we have to get through the issues with the FDA. In Asia-Pacific, Gerry also mentioned and that was focus for Gerry and for me at the end of the year. We've done restructuring; it is underway, additional restructuring, be it some of that for our contract manufacturing business, will last into this and additional quarter. So we're taking the right actions there to get that back on track.

And then ultimately with ISG, it wasn’t the strategic fit. It gives us financial flexibility. So I guess I’d rather respond as opposed to trying to give guidance when clearly we're not as part of being able to give guidance. I’d rather tell investors what we're doing in terms of continuing to support IPG in Europe which are performing. The remediation focus for North America HME, the restructuring for Asia-Pacific and again, the flexibility that selling ISG gave us.

Jim Sidoti - Sidoti & Company

All right, so it sounds like if we look out nine to 12 months, hopefully the consent decree is lifted, the Asia-Pacific division is back in the green. Your other two businesses seem to be holding up right now, that you clearly should be better at that point than you were at the end of 2012.

Robert Gudbranson

We will see where we go but at this point we are not going to give guidance. Just going to tell what we are focused on and which area has got the direction.

Operator

Your question comes from the line of (inaudible).

Unidentified Analyst

Congratulations on putting a tough 2012 behind you and with the timeline of the two expert audits and then the third one in the second quarter, it sounds like there's some light at the end of the tunnel for you, so that's nice to see. My question relates to the adjusted EPS number you gave of 133.

Gerry Blouch

Yes.

Unidentified Analyst

Is that the $0.87 from combined operations plus the $0.46 of incremental after tax regulatory compliance cost?

Gerry Blouch

Exactly.

Unidentified Analyst

Okay so you’ve done a good job for guiding us to the earning's power of the business, take out the compliance, the tax issues, the restructuring and you get to that adjusted number. I'm wondering if you can help us understand the impact from both a mixed perspective on the inability to cell power wheelchairs and then also designing new products and what that did to your gross margins in 2012.

Gerry Blouch

Directionally, I mean we spent a lot of time with the Board of Directors explaining the date, some of that is aspirational speculative. so designing products is a close second behind the uncertainty of our customers in all honesty but I couldn't prove that to you, that's more based upon meeting with customers and gauging the decibel levels on their frustrations that we haven't come out with something new or is the frustration of, Gerry, I'd give you an order but can you guarantee me that the consent decree won't go into effect tomorrow and also go back to square one, get it close to somebody else, I'd say that they were both significant deals to me like new products were more significant but because people buy and large did stick with us but that's totally subjective.

Unidentified Analyst

And well, assuming the consent decrees lifted after the third audit and the second quarter, would that give you the permission again to begin designing new products?

Gerry Blouch

Actually we could begin at the timing after the completion of the second audit. So we don't have to wait till the comprehensive audit is done. so that's a little better than that.

Unidentified Analyst

So, you could start designing in the first quarter, assuming knowing audits are favorable?

Gerry Blouch

With the acknowledgements and expectancy of the FDA as a review with the third party expert audit, no.

Operator

(Operator Instructions) Your next question comes from the line of Michael Madsen from Mizuho Securities.

Michael Madsen - Mizuho Securities

I guess, I just wanted to ask a few questions about competitive bidding. Just wondering what you expect to happen to the customer base with competitive bidding. It seems like it would travel some consolidation among the HMEs, I’m just wondering if you are in agreement with that. And then as that consolidation happens, I’m just wondering if your customers are buying great volume of product, I was wondering if you think that’s going to have any impact on your pricing.

Gerry Blouch

It certainly will. I think that as sub-text in the whole process that is aimed towards reducing the number of providers, at least servicing Medicare and get to the specific numbers of (inaudible) the specific numbers but the number on providers that were granted or awarded contracts was less than a 1,000 and there is many more than that in the marketplace. So, folks who make the living on Medicare will be significantly lower than have in the past. Having said that, to people it’s been obvious that that direction of (inaudible) is going and it's geological but it is what it is and customers have been diversifying their revenue base to forestall the risk of that.

But holistically, we saw between today and the first round, we saw a reduction, a consolidation, double digit as I recall the numbers up to 15% reduction in the number of providers that that are build tools for us. And that will continue to go on. Having said that, it’s still a very fractured market. So, we’re not facing the same situation and no one else who’s got to sell to lows or home depot and ace. So we’re still a long way from hyper consolidation but it’s moving in that direction and near term I wouldn’t expect that to be the prevailing driver of pricing.

Michael Madsen - Mizuho Securities

So you don’t expect the consolidation to have an impact on, for bidding I guess just more generally to have an impact on your pricing. I know obviously these products generally speaking over the years have come down pretty significantly with time, not for the reason Medicare is doing the bidding process I guess but the key thing there is, particularly if we can enter the September quarter that there is any additional pressure there?

Gerry Blouch

This is business 101, it's not customers that make you reduce your pricing, its competitors who make you reduce your pricing and the consolidation of competitors was dramatically accelerated through the 90s obviously. So there is not that many left and I don’t know that there is a lot of room but more importantly, the sway, the inference of the comment you made of a provider’s cost, the cost of equipment is typically a small portion of their cost. If you buy a concentrator for taken over $450 it’s going to depending on whether ownership transfer, is it going to last five years, you divide that cost over 16 months, it’s really pretty insignificant. So, I wouldn’t say, you said that CMS has not realized that manufacturers have reduced their pricing to providers, that’s true, but again the frustration for providers that CMS doesn’t understand the services and the other support cost associated with conducting their business in a way that ensures that Medicare patients have full services, full quality and all the support that they need.

So, a bit of a ramble but the most important thing, if there is any provider out there who has any expectations that having endured a price reduction greater than several times the cost of the equipment, that there is anything the manufacturers can do to help them in a meaningful way other than pay them to take the product, they're toast. Either the issue for us because there will be a consolidation issue for us, is mapping a very strong and confident credit department. We have an internal rating process for the credit worthiness of our customers and mapping those against the winners and the pricing, the pricing within categories with a HCPCS code very dramatically.

So the one of the least useful numbers out there right now is the aggregate average price decline, I mean that’s good for the government to understand how much money they are ostensibly going to save but it’s useless from our end point in knowing where the risk is. we have to drill that down by HCPCS code by market to understand map that against the credit worthiness of our customers to know where our risks are and the issue for us is will you be able to pay us. So take EO-291 semi-electric bed, the range and pricing difference is at a monthly reimbursement is a 40% spread. So we're much more concerned about Deltona than we are Worchester, Mass. So it's very granular. We did the fire drill with ground one and we skated through that with no credit write-downs that are losses of any great consequence. So the factor 10 more complicated this time. I rambled about I was helpful.

Operator

(Operator Instructions). There are no further questions; I would now like to turn the call over to Mr. Gerry Blouch for closing remarks.

Gerry Blouch

I'd like to thank you all for calling in, and also thank you for support and continued interest. This has been again a very difficult time, but we are getting closer, we can see the opportunities moving forward and focus on those and we're, as I said before we're optimistic that we're going to get this puppy back on track and restore profitability to our historic levels, thank you.

Operator

Ladies and gentlemen, this does conclude today's conference call, you may now disconnect. Thank you and have a great day.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!