Invacare Corporation (IVC) CEO Discusses Q2 2013 Results - Earnings Call Transcript

Jul.25.13 | About: Invacare Corporation (IVC)

Invacare Corporation (NYSE:IVC)

Q2 2013 Earnings Conference Call

July 25, 2013 08:30 am ET

Executives

Gerald B. Blouch - President and Chief Executive Officer

Robert K. Gudbranson - Senior Vice President and Chief Financial Officer

Analysts

Robert M. Goldman - C.L. King & Associates

Jim Sidoti - Sidoti & Company

Operator

Good morning, ladies and gentlemen, and thank you for standing by. Welcome to the Invacare 2013 Second Quarter 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 results.

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 in the Company's earnings release. The Company may not be able to predict and may have little or no control over the factors or events that may influence its financial results.

Also of note, on January 18, 2013, the Company completed the sale of Invacare Supply Group, its domestic medical supplies business. Accordingly, the financial information for all periods excludes the impact of the discontinued operation except for cash flow information which includes the results and impact of the sale of ISG. For more information, see the detailed condensed consolidated financial statements in the earnings release.

On today’s call, the management team will focus on the highlights of the quarter as opposed to covering all the detail which you can read in the release that was issued earlier. In particular, I would refer investors to the Company’s earnings release to review the definition of free cash flow and some of the adjusted earnings items which will be mentioned during the call. You can find the release and access to the Company's SEC filings at www.invacare.com.

Before I turn the call over to Invacare’s President and Chief Executive Officer, Mr. Gerry Blouch, I would remind you that all phone lines have been placed on mute for the first part of the call. After the management's overview, we will open the call to questions. This conference is being recorded Thursday, July 25, 2013.

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

Gerald B. Blouch

Thank you, Jennifer, and good morning. With me on today’s call is Rob Gudbranson, Invacare's Chief Financial Officer. I want to begin today's call by highlighting the progress that we've made related to the Company's consent decree with the United States Food and Drug Administration. As you may recall, under the terms of the consent decree, we must complete three third party certification audits before resuming full operations at our Taylor Street manufacturing and Corporate facility in Elyria, Ohio. Each audit report when completed is submitted to the FDA for their review and acceptance. After the acceptance of the third and final certification report, the agency will commence its audit of the impacted facilities.

We are incredibly proud of the quality systems team that we've assembled and to do the remediation of our compliance systems, our quality systems and support the audit process. Our quality organisation is supported by all of the functions and I sincerely appreciate their efforts as well. All of our associates are focused and committed to the Company's successful completion of our quality audit systems remediation and the progress we've made over the past few months is a testament to that effort.

On May 13, we announced that the FDA accepted the Company's first expert certification report. As a result, we were able to resume manufacturing of parts and components that are used to manufacture products at other Invacare facilities. And recently on July 16, we announced that the FDA accepted the Company's second expert certification report related to design control systems at the Company's Corporate and Taylor Street facilities. With this acceptance, we have resumed engineering activities on critical new product development projects that will help us regain custom power wheelchair market share when we resume full manufacturing operations at our Taylor Street facility. However, I have to note that until we get to that point, that is the resumption of manufacturing, much more engineering and research will continue to be committed to the ongoing work related to remaining quality systems audits.

As a management team, it is our responsibility to balance our current business environment with our vision for the future. With that in mind, we are sustaining resources to ensure we are equipped to successfully complete the final third-party certification audit as well as FDA's inspection. In addition, we want to ensure that we are well-positioned to re-establish profitability, recapture market share and drive enhanced shareholder value when we resume full operations.

Now to reduce the impact of the consent decree on our results, we took actions to reduce costs and achieve positive free cash flow in the second quarter. Specifically, in the last six months, the Company has had a net reduction of approximately 300 associates, primarily in operations. In addition, we are focused to reducing complexity which includes actively reviewing possible divestiture or exiting of businesses that are outside of the Company's core medical device business. Cost reduction initiatives are ongoing including general expense reductions, project delays and infrastructure consolidation.

Nevertheless, our second quarter results were significantly impacted by the consent decree as well as the lack of new product introductions, unfavorable sales mix favoring lower margin products and ongoing investments to support the quality system improvement. While domestic mobility and seating business is the most directly impacted by the consent decree, I have to note that our Canadian operations and the European operations, our trading businesses in Australia and New Zealand and our microprocessor controller business are also affected as well.

Primarily as a result of these pressures, adjusted loss per share in the quarter was $0.27 per share. This compares to adjusted earnings per share of $0.19 per share in the second quarter of 2012. In the quarter, organic net sales declined 5.4% compared to the same period last year with a strong performance from Europe being more than offset by lower sales in all other segments. Gross margin as a percent of sales for the second quarter was lower by 2.9 percentage points compared to last year's second quarter. The margin was negatively impacted principally by the North America/HME sales decline in custom power wheelchairs, and the related absorption of our fixed costs in our Taylor Street facility. Gross margin also was negatively impacted by sales mix, as I said before, favoring lower margin products and customers. Despite these pressures, the Company was able to achieve positive free cash flow in the quarter of $2.9 million.

In the quarter, SG&A expense increased by 0.4% to $104.9 million compared to $104.5 million in the second quarter of last year. The SG&A increase is primarily a result of increases in associate costs and increased amortization expense. The increase in amortization expense of $1.2 million reflects the write-off of previously capitalized bank fees. The write-off was necessitated by the May 30, 2013 amendment of the Company's credit facility in which the Company voluntarily reduced facility size from $400 million to $250 million. Foreign currency translation decreased SG&A expense by 0.4 percentage point. Excluding the impact of the foreign currency translation and the write-off of bank fees, SG&A expense actually decreased by 0.4 percentage point in the quarter.

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

Robert K. Gudbranson

Thanks Gerry. All my references to earnings before income taxes will exclude restructuring charges for both his current quarter and last year's quarter. For the quarter ended June 30, 2013, organic net sales for North America/HME decreased by 11.5% compared to last year driven by declines in mobility and seating and lifestyle products. These pressures were partially offset by increased net sales in respiratory products, which were partially driven by a large order of Invacare HomeFill Oxygen Systems by a national account. The sales decline in mobility and seating products was largely attributable to the impact of the FDA consent decree.

Earnings before income taxes for North America/HME segment decreased $14.5 million, primarily as a result of volume declines, unfavorable sales mix favoring lower margin customers and lower margin products, as well as the unfavorable absorption of fixed costs at the Taylor Street manufacturing facility relating to the declines in mobility and seating products. The loss was also impacted by increased SG&A expense related to associate costs and increased amortization expense. In addition, the loss was impacted by an accrual of $0.4 million related to anticipated warranty expense from a power wheelchair component performance issue. The Company's proposed action plan related to this issue is currently under review by the FDA.

For the second quarter 2013, organic net sales for the Institutional Products Group decreased 2.1% compared to last year, driven primarily by declines in bed products. This was partially offset by increases in medical recliners sold into dialysis clinics and interior design projects for long-term care facilities. Earnings before income taxes decreased by $1.4 million compared to the second quarter last year, largely attributable to volume declines and increased associate costs.

The European business segment continued its strong performance with organic net sales increasing 5.8% in the second quarter compared to last year, primarily related to increases in net sales of lifestyle and mobility and seating products. This was partially offset by declines in respiratory products. Earnings before income taxes increased by $0.6 million compared to last year. The increase in earnings before income taxes was largely attributable to volume increases, which were partially offset by an unfavorable sales mix favoring lower margin product lines and lower margin customers, as well as increased SG&A expenses, primarily related to associate costs.

In the second quarter, Asia/Pacific organic net sales decreased 31.7%. The Company's Australian distribution business experienced declines in mobility and seating and lifestyle products. The net sales decline in the Company's subsidiary which produces microprocessor controllers was related to reduced sales of controllers and sales of its contract manufacturing business for companies outside of the healthcare industry. For the second quarter, loss before income taxes increased by $0.9 million compared to last year's second quarter.

The increase in loss before income taxes was primarily attributable to the Company's subsidiary which produces microprocessor controllers as a result of volume declines. The loss for the second quarter was less than the second quarter last year for the Company's Australian and New Zealand distribution businesses as a result of a significant restructure to the business implemented in the fourth quarter of last year. The improvement was driven by aggressive SG&A reductions in the distribution businesses as a result of significant restructure to the business implemented in that time period.

Total debt outstanding, which includes the convertible debt discount as described in the release, was $118.1 million as of June 30, 2013. The Company's total debt outstanding at the end of the second quarter consists of $98 million drawn on the revolving credit facility, $13.4 million in convertible debt and $6.7 million of other debt.

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

Gerald B. Blouch

Thank you, Rob. I want to reiterate that our first priority is to successfully complete the final third-party certification audit, but I want to assure you that we continue to explore opportunities to stabilize the business during this time. We have a strong team in place and we are learning as we go through the third-party audit process, we continue to make enhancements as we are stabilizing a very robust execution and I'm pleased with the progress we're making. The process is working. The third-party expert is to review our quality systems with the same rigor as the FDA and we view this positively. The expert expects nothing less than full compliance of their quality systems and that's in line with our expectations. Our intent is to be fully prepared for the FDA when they commence their audit.

We're taking the time now to ensure we get this right and we are fully committed to achieving a comprehensive and sustainable compliance environment. With that in mind, we expect the final third-party certification audit to be complete and filed with the FDA by mid-November. As we stated previously, when the final certification report is accepted by the FDA, the agency will conduct its own inspection of the impacted facilities, and upon successful completion of this audit, and after we have received written notification from the FDA that our Corporate and Taylor Street facilities are in full compliance, we will resume full operation.

We sincerely appreciate your support and give an update to the investors at our next quarterly earnings release. I want to assure you that our Board and management team is committed to making the right decisions to achieve a comprehensive and sustainable quality system. We are also committed to ensuring that Company is well-positioned to re-establish profitability and shareholder value once we resume full operations. On behalf of the Company, I appreciate your time and attention during this call and we will now open up the phone lines for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Robert Goldman with C.L. King.

Robert M. Goldman - C.L. King & Associates

Couple of questions. First on this mention of reviewing possible divestitures or closures that are outside the Company's core equipment business, could you help us understand what you view as your core equipment business, and give us some sense of what Invacare has that's outside that core?

Robert K. Gudbranson

At this point, I think what I'd really focus you on is what we've already done. So, Invacare Supply Group say towards the middle of last year, we really looked hard at whether that was something we wanted to continue to invest capital in. It's a good business, we had great associates there, and we had a good leader, but at the same time, it was time to look hard at putting our capital to use in things that were going to be in the long-term, and Supply clearly did not fit our core equipment focus. So we've taken that transaction, obviously closed that in January, and able to focus that money in terms of paying down our debt and having that available for growth going forward. So again, I think I'd focus on our history, I think in light of the fact we don't want to have individual associates concerned about what we're doing next, we're not going to mention specific businesses but we continue to look hard at, and I see one of my key jobs is where do we allocate capital and where do we make sure that we're going to put money going forward.

Robert M. Goldman - C.L. King & Associates

Right, no, that divestiture, Rob, was sort of an obvious misfit to the core business but is there anything even approaching the magnitude and size of that divestiture as we look forward?

Robert K. Gudbranson

I think clearly at this point it would probably be things that were smaller, but again, we'll continue to look.

Robert M. Goldman - C.L. King & Associates

Okay. And then Rob on free cash flow, which certainly was impressive and was positive in this quarter, but it's been jumping around a lot, significantly negative in the first quarter, modestly positive in the second quarter. So are we at a point now where in fact you'll have positive free cash flow going forward or was the second quarter really the anomaly and the first quarter was more the norm?

Robert K. Gudbranson

Let's go back real quickly for the benefit of the investors and people on the call and talk about the first quarter. It was very negative. We are typically, depending on the quarter, slightly negative in the first quarter, but a good portion of that was related to specific things and closing out ISG. So there was substantial money there between, ballpark I think we've said at the time, $16 million related to ISG in terms of cash flow drain that included these, but a big portion of that was some working capital changes at the end of the quarter, end of the January when we sold the business. In addition, we had $7.7 million, if I remember correctly, drain in demand inventory.

So if you put those various pieces together, I'm not saying it wasn't a drain, still it was, but the operating drain from sort of continued business would have been a lot smaller. This quarter we managed to generate about $11 million in inventory benefit, so we went the right way on that. So again, I think from our vantage point, we did a lot of the right things in the quarter, second quarter, we're not talking about guidance going forward just given all the uncertainties of the business, it's been a while since we've given guidance, but again a gareat job by the team to generate $2.9 million of free cash flow.

Robert M. Goldman - C.L. King & Associates

I get the sense, Rob, that the first quarter might be viewed as unnaturally negative and the second quarter unsustainably positive.

Robert K. Gudbranson

Yes, at this point, I'd say we generated a strong free cash flow in the second quarter. I think it was a good performance by the team, but I would say we're just going to at this point not give guidance for the rest of this year, so I've got to sort of defer that question.

Robert M. Goldman - C.L. King & Associates

And then finally for me, on the consent decree and the certification audit, the mid-November timeframe that you gave, when you had mentioned that there'll be a slight delay in submitting this certification audit, you noted at the time you found some things and you very properly had to review them and get the reduction in a row. Have you now isolated what those issues are, do you now know what the fix is, so that this mid-November date is based on that knowledge or is the mid-November date your best guess without yet knowing what the issues and the fixes are?

Gerald B. Blouch

No, good question Bob. We have set at one pace, talk to characterize the issue, it's been one of unnecessarily complex procedures. We went back with a clean sheet of paper and we made all of our quality systems and the audit processes is first to come and look at the processes themselves and what the document process is and test as to whether they followed it is compliant, and in fact all of the processes were found to be compliant and they followed. The problem was, we had a level of complexity that was far beyond what was necessary to be compliant, and in fact created untold opportunities to have noncompliance, and what we adhere first to is not [indiscernible]. So we've gone back and we've remediated those processes, we've re-done training and we've implemented those processes and the third-party expert has reviewed that work and is close to finalizing the documentation of the new processes and the work and we're comfortable that we have that under control. So it's the long version of, yes. The heavy lifting is done and there is very little uncertainty going forward with respect to that.

Robert M. Goldman - C.L. King & Associates

Okay, thank you very much, Gerry.

Operator

Your next question comes from the line of Jim Sidoti with Sidoti & Company.

Jim Sidoti - Sidoti & Company

Good morning, can you hear me?

Gerald B. Blouch

Yes sir.

Jim Sidoti - Sidoti & Company

It sounds like less is more when it comes to quality control procedures.

Gerald B. Blouch

Amen, Amen. It was a hard to learn lesson.

Jim Sidoti - Sidoti & Company

Alright, couple of questions. On the quarter, you said shipments from the Ohio plant were down I think to about 10% where they were a year ago, can you give me a dollar number on that?

Robert K. Gudbranson

We haven't broken out the dollar number. What we have given visibility to in the release is the sales in terms of our Taylor Street related product and I believe the numbers we have there they declined from second quarter last year of $39 million to about $15 million this year. So that's the number we are sharing out to give visibility to where we're at.

Jim Sidoti - Sidoti & Company

Okay, alright. And the income tax paid in the quarter, I assume that was all in Europe?

Robert K. Gudbranson

Europe is your biggest piece. When we look at adjusted earnings, I'm assuming that's where you're looking, Europe is your biggest piece. We also have Canada where we make money and there are some other small pieces but Europe would be the important piece.

Jim Sidoti - Sidoti & Company

Okay. And then in terms of the timing now for this third audit, it sounds like this third audit is in the order of magnitude more complex than the first two and that's why it's taking you longer to get that complete. Now does that mean that when the FDA comes to accept or to verify the audit, the time it takes for them to do that will also be longer than it has been for the first two?

Gerald B. Blouch

Yes, but the first two were rather comped, but it is a step function, more complex, and that will take longer, but I don't think we can give you any markers on how long it took but it will be longer but that's…

Robert K. Gudbranson

The only thing I'd add, Jim, just you know is after the cert one and the cert two, they've reviewed our data and asked questions on cert three, as Gerry said earlier. They're going to review our information and the report from the third-party expert and then they're going to actually do their own audit, so they're going to come here.

Jim Sidoti - Sidoti & Company

So to get cert three, it sounds like it will be quite a bit longer than it took to get cert one and cert two.

Robert K. Gudbranson

We are not giving specific indication of what will happen post mid-November because the answer is that's in the FDA's hands and they'll take the time they need to evaluate it.

Jim Sidoti - Sidoti & Company

Okay, alright, but it sounds like there is more work required to get cert three than there was to get cert one and cert two?

Robert K. Gudbranson

Certainly.

Jim Sidoti - Sidoti & Company

Okay, alright. I know it just started and it's only three or four weeks into it but have you seen any impact from competitive bidding, the expansion of competitive bidding?

Gerald B. Blouch

It's really too early to tell. We alluded to the softness in the lifestyle products category but we also alluded to pick up in increasing demand for our HomeFill product which is the most cost-effective solution for any ambulatory oxygen (inaudible), but I wouldn't – (indiscernible) thought it was material in the second quarter, we would have said it was material, but no clear compelling movement there. And three weeks into it, not much has changed in that regard.

Jim Sidoti - Sidoti & Company

Alright, okay. Alright, well that's it for me.

Gerald B. Blouch

Thank you.

Operator

(Operator Instructions) We have no further questions at this time and I will now turn the conference back over to Mr. Blouch.

Gerald B. Blouch

Thank you very much. Again, I want to ensure our shareholders that our Board and management team are committed to making the right decisions to ensure the Company's investments in comprehensive sustainable quality systems are successful. We are also committed to ensuring the Company's position to re-establish profitability and shareholder value once we resume full operation at Taylor Street and Corporate facilities. We appreciate your time and attention during this call.

Operator

Thank you. This does conclude today's conference call and you may now disconnect.

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