Invacare's CEO Discusses Q1 2014 Results - Earnings Call Transcript

Apr.25.14 | About: Invacare Corporation (IVC)

Invacare Corporation (NYSE:IVC)

Q1 2014 Results Earnings Conference Call

April 24, 2014 08:30 AM ET

Executives

Gerry Blouch - President and CEO

Rob Gudbranson - Chief Financial Officer

Analysts

Bob Labick - CJS Securities

Jim Sidoti - Sidoti & Company

Matthew Mishan - KeyBanc

Gregory Macosko - Montrose Advisors

Operator

Good morning ladies and gentlemen, and thank you for standing by. Welcome to the Invacare 2014 First Quarter Conference Call.

I will begin with the cautionary 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 statements 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 Exchange Commission, and in the company's earnings release. The company may not be able to predict or may have little or no control over the factors or events that may influence its financial results.

Also of note, except for free cash flow, the financial information for all periods excludes the impact of the discontinued operations. Discontinued operations include Invacare Supply Group, the company’s former domestic medical supplies business that was divested on January 18, 2013 and Champion Manufacturing, Inc., the company’s former domestic medical recliner business for dialysis clinics that was divested on August 6, 2013. Champion was part of the Institutional Products Group segment.

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 like to remind you that all phone lines have been placed on mute for the first part of the call. After the management overview, we will open the call to questions. This conference is being recorded Thursday, April 24, 2014.

I would like to turn the call over to Mr. Gerry Blouch, President and Chief Executive Officer. Mr. Blouch, please go ahead.

Gerry Blouch

Thank you, Augusta and good morning, with me on today’s call is Rob Gudbranson, Invacare’s Chief Financial Officer. We will begin the morning call with the review of the company’s first quarter financial results and will follow with an update on the consent decree. The [high point] of the quarter is our European business segment which continues to performance well for the company.

During the quarter European team achieved growth in both revenues and operating income. The other three business segments North American HME, institutional products group in Asia Pacific continued to be negatively affected by pressures primarily related to the following. The consent decree impact on our Taylor Street and headquarters operation, the lack of new product introductions over the past two years as a result of our focus on quality systems remediation and limitations temporarily imposed by the consent decree as well as unfavorable sales mix favor in lower margin products and lower margin customers. In addition without seeing pressure on utilization of certain life style products with U.S. Medicare market, precipitated by a number of CMS initiatives which I will speak to in more detail in a moment.

Principally as a result of this pressures overall adjusted loss per share was $0.49 in the first quarter of 2014 compared to an adjusted loss per share of $0.41 in the first quarter of 2013. The quarter’s organic net sales declined by 7.2% compared to the same period last year with the increase in European offset by lower net sales for the other three segments. We reported free cash flow of negative $8.7 million which has improved compared to the first quarter of 2013 when cash flow was a negative $36 million.

The first quarter of 2014 free cash flow was primarily driven by the net loss for the period and higher inventory levels, partially offset by an increase in accounts payable. For the first quarter of 2013 free cash flow was negatively impacted by one time items totaling approximately $16 million associated with the sale of the Invacare Supply Group.

Gross margins as a percent of net sales in the first quarter was lower by six tenth of a percentage point compared to last year’s first quarter. Gross margin was positively impacted by improvements in the European and IPG segments but offset by the North American HME segment.

The quarter gross margin reflects an incremental warranty expense for the power wheelchair joystick recall of $2.2 million pre-tax or seven tenth of a percentage point. The joystick recall was launched in October of 2013 and as we previously indicated our reserves subject to adjustments if developments change the company’s estimate of the total cost of that matter.

As the recall progressed during the first quarter we recognize that implementation rates from larger customers in the United States and Canada were higher than previously expected. This led to the adjustment of the warranty expenses which was recorded in North American HME and the Asia Pacific segment. SG&A in the quarter decreased by 5.1% to $98 million compared to $103.2 million in the first quarter of last year. This decrease was primarily driven by a reduction in regulatory and compliance cost attributed to lower spending on third party consultants contributed to first quarter of last year. This in part is due to the fact that we’ve hired more internal personnel with medical device experience, but overall we had reduced associate cost corporate wide.

Spending was also adversely impacted by an amortization expense of $1.1 million to write-off debt fees related to an amendment to our bank credit agreement and $1 million related to retirement of the executive officer of the company. Excluding these items, SG&A expense decreased by 7.1% compared to first quarter of last year.

Before I turn the call over to Rob to review additional financial highlights of the first quarter, I’d like to take a few moments to discuss the evolving market dynamics that are impacting our lifestyle product category in the U.S.

The situation within the lifestyle market at the moment is a result of interactions of several initiatives by CMS, first Competitive Bidding has caused many bid winners to abandon certain products and geographies due to inadequate margins. Second, pre and post payment audits have caused providers to be far more conservative in fulfilling demand. And third, recently expanded documentation requirements for approving medical necessity have not been supported with effective advanced orientation material by CMS. This result has been a market decline for marginal users that’s the patients whose needs are on the margin which was the intent of CMS and consumers who are lost in the gaps, which wasn’t our intent, and was decided whether to do without or purchase product themselves. So, the Medicare utilization is down, there appears to be a meaningful shift towards retail sales for certain lifestyle products. And we’ll continue to evaluate this market shift and our distribution footprint.

I will now turn the call over to Rob to discuss additional financial results for the first quarter.

Rob Gudbranson

Thanks Gerry. All the references to earnings or loss before income taxes exclude restructuring costs. For the first quarter ended March 31, 2014, the European business segment’s organic net sales increased by 1.4%, primarily related to growth in net sales of Lifestyle products and mobility and seating products, this was partially offset by a sales decline in respiratory products. Earnings before income taxes increased by $3.7 million, largely attributable to volume increases; favorable product mix; favorable product costs; and decreased SG&A expense.

For the first quarter, organic net sales for the North American HME segment decreased by 14.4%, driven by declines in all product categories. Although the decrease was primarily driven by equal declines in mobility and seating products and lifestyle products. Loss before income taxes increased by $6.5 million, the loss was primarily driven by volume declines, unfavorable sales mix towards lower margin customers and lower margin products.

Incremental warranty expense of $1.3 million related to the power wheelchair joystick recall, higher amortization expense of $1.1 million to the write-off debt fees and an increased expense of $1 million related to the retirement of an executive officer of the company. These factors were partially offset by decreased SG&A expense related to reduce regulatory in compliance costs and reduced associate costs.

For the first quarter, organic net sales for the IPG segment decreased by 13.7%, driven primarily by declines in bed sales and sales related to interior design projects. Earnings before income taxes increased by $0.1 million. This increase in earnings before income taxes was largely attributable to reduced research and development expenses and reduced SG&A expense primarily related to lower associated costs.

In the first quarter, organic net sales for the Asia Pacific segment increased by 0.4% primarily attributable to growth in the company's Australian distribution business. Loss before income taxes increased by $1.1 million, the increase in loss before income taxes was primarily attributable to incremental warranty expense of $0.9 million related to the power wheelchair joystick recall and related to unfavorable absorption of fixed costs at the company’s subsidiary which produces microprocessor controllers as a result of reduced volumes.

Total debt outstanding, which includes the convertible debt discount as described in the release was $51.1 million as of March 31, 2014. The company’s total debt consists of $31.8 million drawn under revolving credit facility, $13.4 million in convertible debt and $6.3 million of other debt. The company’s ratio of debt to adjusted EBITDA as defined in the press release was 2.7 as of March 31, 2014 compared to 2.3 as of December 31, 2013 and 1.8 as of March 31, 2013.

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

Gerry Blouch

Thank you Rob. At this point, I would like to address our status relating to the consent decree. We have previously indicated that under the terms of the consent decree, we must complete three third-party certification audits, which will then be followed by a comprehensive FDA inspection before the FDA will permit us to resume full operations in our Taylor Street manufacturing and corporate facilities in Elyria, Ohio.

We have already received the FDA’s acceptance of two of three certifications. And we are continuing to work on the third expert certification audit process, this audit is the most comprehensive in challenging other three third party certification audits encompassing all areas of our corporate at Taylor Street -quality systems.

With respect to comprehensive nature of the audit process and we are working, we respect the comprehensive nature of the audit process that we are diligently with the third party auditor with the ultimate goal of demonstrating our compliance with the FDA. While we are making progress we cannot predict the timing of the completion of the third party expert certification.

When the FDA completes its own audit and finds the company to be in compliance (inaudible) notification for many in the company to resume full operation into corporate and Taylor Street facilities. While this is a complex and exhaustic process we are diligently working our way through it. I appreciate the ongoing efforts of our associates to drive this effort and support the audit process.

On behalf of the company, I appreciate your time and attention during this call. And we will now open the phone lines for questions. Augusta?

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). Our first question will come from Bob Labick of CJS Securities

Bob Labick - CJS Securities

Good morning.

Gerry Blouch

Hey, Bob.

Bob Labick - CJS Securities

Hi. Wanted to start with the question on the prepost audits on the Medicare side. If you could maybe just take a few minutes to elaborate on the impact on your customers? Is Medicare calling into question the necessity for the lifestyle products or the cost or how is this impacting your customers and I guess you mentioned the shift to retail a little bit too, is that an opportunity for you or what do you see changing to address this impact?

Gerry Blouch

Okay. Several questions there, but it is not a cost issue, it’s more of a utilization issue. CMS has expressed concerns over utilization, it’s principal tool to address that risk or exposure as been to require more comprehensive diligence on documenting medical necessity and that with the launch of the latest updated round of competitive bidding pretty much concurrent with that they asked us the rules. So and as I said that was compounded by the fact that there was the process of educating clinicians as to what the new protocols were appears to have been less than fully robust. So the issue is not cost the issue is utilization and CMS is legitimate need to ensure that people who are entitled to equipment are getting the equipment, but also ensure at the same time it’s not a gratuitous process and people who are not entitled don’t get it.

So the objective is legitimate, I think one of problems is you had the conversions of two events and you had competitive bidding being closed off and new winners and losers being identified. So you have process of transferring patients from legacy providers if they don’t want a grandfather and referrals sources we are learning to the new authorized providers, clinicians learning about new documentation. So you had a perfect storm at a lot of change going on simultaneously. And like I said it created gaps and some see people who might have in a more casual documentary environment may have gotten equipment are not getting it today. So that’s the nature of it.

The first tangible evidence of that was the GAO report that came out recently where the word is, industry doesn’t have real time awareness (inaudible) report indicating that demand was down in many categories which would have been -- varies to lifestyle product category.

So some people who should have that things are faced with hospitals are faced with like discharge and even though they don’t have all the piece of equipment they want we keep them here, even though I don’t get more money for that. If I have been discharged as a patient and I need some things that I haven’t that the system hasn’t been able to document for me to get, do I buy it myself or do I just wait. So it’s a model right now.

And when I said retail that cash business would have been just as at we have our own providers who do retail business. So some of that business is flowing to cash business at retail through the provider channel part of it is knocking into your corner drug store and picking up something that you wish you’ve done to discharge, but you didn’t get and prior to the detailing. And I can speak to that from personal experience, I mean mother who are Medicare and had a transition of provider care and understand what it means to be lost in the trouble.

So (inaudible) time retailing. I think retailing the retailing will continue to evolve to be a more meaningful part of home medical device and it’s an area that we're looking at and particularly detailing like part of retailing. Did I answer question Bob.

Bob Labick - CJS Securities

Yes. No doubt that’s very helpful color, I appreciate that. And then just speaking with I guess kind of the second part of that national competitive bidding. Can you talk a little bit about what you are seeing on the impact of your customer base, in aggregate thoughts of consolidation and in a change over and how is that playing out and how much longer do we have to go with that and how it’s been impacting you?

Gerry Blouch

There was a massive is abstract word, but I think massive probably qualifies in terms of the reduction and qualified I don’t know, the reduction and approve suppliers for Medicare, but at the same time the introduction of new players who have never been in the business before. Some of whom didn’t have local licensing, local locations and then in participation on local market and that’s it. So we’ve got a lot of new faces in the market in a massive shift of business from providers and it’s been a fairly change to figure out where the business is migrating to. And I think we’ve done a reasonably thorough job in there, but it’s not clear this time, that we're going to track down all the new players.

So that’s huge and there is some, probably the most and that’s been significantly disruptive to some market, the most notable one that’s been written about it, Hawaii where they were. I suppose it’s a paradise, a lot of people from outside of Hawaii did and it happened in almost all markets, if not all markets, but Hawaii presented a major logistics problem for people who won bids to get themselves set up. And there was huge disservice for a time. And CMS actually went back in and authorized a couple of new providers to cover the wide market.

So, the question is what are we seeing? The business, competitive bidding, I think that the most interesting thing is which has been documented in the letter from a CEO of a one of our prominent customers, we haven’t asked permission to mention that but it's a public document, and if you want, Laura can help you track that down.

But they talked about market that again competitive bidding, the bid rates for each individual market based upon the average bid of the people who CMS determined were provided an adequate base of suppliers that service the market.

Some people dropped out and some people, the gamesmen they have been just to see what the average would be and then track the price down, when they replace a bidder with someone new, they don't change the price. So, there is, there are folks who bid legitimately but the average was bidding a lot of them to have a sustainable business model or certain products in certain geographic markets and as documented and people have just walked away.

And so there is a lot of dislocation going on and then kind of there is some of the gap problems that I referred to. So, and the gaps, it's not, by and large, it doesn't appear to be in a very sophisticated expensive equipment, so by and large it seems that the average person can access to on the web and drug stores from a medical equipment provider, whether or not he is authorized, even if they're not authorized, still bill Medicare, they are still authorized, they still can sell products retail.

So, it's a challenge, I don't think it’s -- it doesn’t appear as we said in past. the demand, the needs don’t change, how those needs are fulfilled and by what channel is the adjustment at Invacare that all manufacturers have to make.

Bob Labick - CJS

Okay, great. Last question, I will get back in queue. Earlier in the quarter, I think in February you discussed the London and Canada operations and setting that down and moving it through some of your other facilities and outsourcing some of your operations and manufacturing from there as well. Can you talk a little bit about how that is progressing and perhaps maybe part of the roadmap towards globalization and where your globalization plan stands?

Gerry Blouch

It’s -- and with the last question, we kind of have ourselves in a [freeze frame] globalization because our number one priority the resources and systems and was remediation. So as we kind of moved through the process and have stabilized and validate a lot of the QSR procedures, we have with the QSR, we have now moved back into some of the one Invacare and that one Invacare is definitely the manner and philosophy that will need the company to stronger and stronger global future. So it is a piece that as was identified piece all along. So, the train is starting to move, that project specifically is moving through the project and progressing on a timely manner.

Bob Labick - CJS

Okay, terrific. Thank you very much.

Operator

Our next question will come from Jim Sidoti of Sidoti & Company.

Jim Sidoti - Sidoti & Company

Good morning, can you hear me?

Gerry Blouch

Yes, Jim

Jim Sidoti - Sidoti & Company

Can you give us an update on how the respiratory therapy products did in the quarter?

Gerry Blouch

Respiratory therapy was pretty solid, particularly the highlight is HomeFill which is our -- it’s nice entry, thank you for that to talk about our response to competitive bidding, we got a two-fold response to competitive bidding, the number one is fleet management, the total lifetime cost of the product. So we continue to believe that if you are going go through competitive bidding on the cheap you are going to be -- with the time, you will regret that. And that’s the neck of again some common providers and again that’s included in the document I mentioned about, again Laura can serve you with that. So we stand by that. Having said that, there are some value points that we think we need if not pricing on existing products, value propositions because reimbursement codes are fairly broad, and working to broaden reimbursement code. And we have some products coming to market and we’ll address that. And HomeFill, back to respiratory, HomeFill is a device that quite, the upfront cost provider is greater than conventional methods but the downstream cost, the backend cost, the benefits there far exceed the cost of that investment and we are seeing more demand shift towards that modality for a ambulatory action.

Rob Gudbranson

Hey Joe, the only other thing I would add would be just I mean we did reference in both Europe and the U.S. that we had some weakness there. But I think Gerry hit the key point particularly when we talk about the U.S. HomeFill was still a very positive performance. In comparing to prior year, I think hopefully people won’t remember but the flu season was incredibly strong last year, so the fact that we might not show exactly the same performance this year should not be a shocker but you’re absolutely right, the HomeFill product line is still very good play for us going forward.

Jim Sidoti - Sidoti & Company

All right. And then can you just give us a little more color on the third audit? I think on the last call you had the issue with some of the processing or the complaints or that was really holding it up, is that still the issue and…

Gerry Blouch

I think the part of what needed to be remediated was in complaints and we’ve been -- and we’ve added some people to, we added some contractors to drive that down, we’ve realigned our order intake customer service complaint team to have specialists and complaints which is ultimately giving us now much more timely and accurate coding, the complaints which helps risk assessment process, so we’ve made a lot of good changes there. But all audit and again view as a three step process, the process is as designed as written compliant with QSR A; B, are you following those processes; and C, do they see the adjacencies. They’re not silos, it’s a integrated system. So by nature, I believed into other things (inaudible) the process we’re working through.

Jim Sidoti - Sidoti & Company

So, the next time will get an update I guess will be when this audit is submitted to the FDA?

Gerry Blouch

The third party experts reports, it’s been with the FDA along with our report, at the company with our report, we have, the protocol is we have to provide an update and the changes that we address that issues leading up to the consent decree, and if there is any comments in the third party’s report that we have to address those as well. So, vis-à-vis when that report is submitted or (inaudible) release.

Jim Sidoti - Sidoti & Company

Okay. All right thank you.

Operator

(Operator Instructions). We’ll go next Matthew Mishan of KeyBanc.

Matthew Mishan - KeyBanc

Thank you, Gerry for taking my questions.

Gerry Blouch

Pleasure Matt.

Matthew Mishan - KeyBanc

I’m just trying to get a sense of incrementally from the second half of last year to the first quarter, what was the change -- like what was the impact of the increasing audits in National Competitive Bidding? I know you’d said that you had a large order of HomeFill that was helping you guys out towards the back half of last year. And did things really incrementally changed from the fourth quarter to the first quarter or was it, was HomeFill kind of masking things?

Gerry Blouch

Well, that’s a good question. Rob do you want to address that.

Rob Gudbranson

I think what I’d say is a couple of things, one let’s talk about maybe the lines and performance, a lot new profit and income statement. First of all, let’s look at the reverse margin. I mean we are down a little bit, but you have to remember that from fourth quarter let’s say the first quarter, we had some noise in both quarters on the warranty. That said we're started right range in terms of our gross margin and then I’d say on the SG&A even though we were little bit up, Gerry referenced and I referenced in fact that we had some one-time events in terms of additional cost of their retirements and the banks fees which we know would have coming but if you back those out were similar. So I think when we look at the performance in income statement, no big surprises. I think what you normally see, if we look fourth quarter, first quarter in terms of sales, is we see much weaker first quarter.

So I don’t think there is any necessarily masking performance. I think we’ve had some pressure during the year in Lifestyles, I think we also had a very strong, as I mentioned earlier flu season last year first quarter. So again, I don’t think there is anything particularly masking it. I think the issue is again normal movement is sales are weaker in the first quarter, gross margin was somewhat close, but not shocking, that to be little bit lower at least on a reported basis and I think we controlled SG&A.

So, I think from my vantage point, it looked like a pretty logical quarter one movement Q4 to Q1. But maybe that's and not addressing your question.

Gerry Blouch

I think just emphasizing two points Rob, there's normal seasonality, which there is a host of theories as to why, but in the industry, going from the fourth calendar quarter to the first calendar quarter is down. The only bright spot, if you will, the only lift is normally in the first quarter that we see is which Rob mentioned, which this year was weak. And the fourth quarter last year was buoyed a bit by the big order that you mentioned for HomeFill.

So, the flow quarter to quarter fourth to first was probably a little more accentuated than the normal.

Matthew Mishan - KeyBanc

Okay. And then just moving on to Europe, what kind that this past three quarters if you are finding that in that 1% to 3% on organic basis. And I know you hesitated to give guidance on Europe, but is that the right range to kind of look at Europe now for on an ongoing basis that kind of 1% to 3% organically?

Rob Gudbranson

Again you answered the question by saying we're not really giving the guidance, but I guess what I referenced back is that the team has done very well and we've been able to have some new products over there. They had particularly strong growth organically in the first two quarters last year. And third quarter and fourth quarter sort of 1.5%, 2.8% and now it’s 1.4% in the first quarter.

So, I think it's been pretty consistent with maybe some stronger quarters in the history. Looking at Q1 and Q2 last year when it was almost 8% and 6%. So again those are sort of where they performed so far, I think we will dodge going forward but I think we have good faith in the management team there that will work hard to continue perform.

Matthew Mishan - KeyBanc

And then I am sorry if I missed this, I was doing a little bit work at the very beginning of the call. But did you say what the QA RA costs were in the quarter?

Rob Gudbranson

No we didn’t, but since you asked we would point out and Gerry mentioned in his statements that it was down but it was $6.3 million this quarter versus $7.6 million first quarter last year. So as he mentioned in his comments we had lower costs on external and we have hired in some people to invest more talent in size, yes, we are down from 7.6 to 6.3.

Matthew Mishan - KeyBanc

Last question from me. Product launches, and I know that you are kind of stuck at least on power wheelchair siding for (inaudible) but are there any new product launches in some of the other groups and that we should pay attention to for kind of back half of the year?

Gerry Blouch

Again we started with a trickle of launches last year and we got more coming this year, but we are not giving guidance. So we are siding to fill the pipeline up and gradually getting back to a normal tempo of new product introductions.

Matthew Mishan - KeyBanc

All right, thank you guys.

Gerry Blouch

Thank you Matthew.

Operator

(Operator Instructions). We will go next to Gregory Macosko of Montrose Advisors.

Gregory Macosko - Montrose Advisors

Yes, thank you.

Gerry Blouch

Hey Greg.

Gregory Macosko - Montrose Advisors

Hey, hi. How are you?

Gerry Blouch

Good. How are you?

Gregory Macosko - Montrose Advisors

Good. Just with regard to the utilization issue, sorry about the noise. Are you following up with documentation or helping them, the dealer to resolve that documentation problem? And the second in that regard is, have you felt any impact on the retail side, are you sensing it from the purchases there and the like?

Gerry Blouch

Our retail business which is for us, there isn’t much that we can do or are doing to help the providers because for us to go in and reach thousands of clinicians would be impractical. They have the documentation, they have been going through the training process and that’s a call pattern that they already have, there is not much we can do to that would be cost effective or useful there.

We are seeing, they’re seeing our retail business increase. And so that has gone up whether that’s directly attributed to this, it’s hard to tell, it’s something we sense. But and if it’s going to number of providers, we never have visibility to how are providers reimbursed. And we believe that some of that business is being captured by traditional providers who are -- they drop off the things that they have documentation or they are asked to say have other things, will provide that but explains the patients that they will have to pay cash for it. So it’s a lot of threats; the single threat that is clearly retail, detailing and that is up to say that that’s directly as a result of it or there is other issues about would be stretched. But the piece that’s clearly retail, we do see some improvement.

Bob Labick - CJS Securities

Thank you.

Gerry Blouch

Okay, good to hear from you.

Operator

And it appears we no other questions in the queue at this time.

Gerry Blouch

Okay, very good. I appreciate everybody’s time and attention. And I want to assure the callers that the shareholders, our Board and management are committed to making a right decision to ensure the company has continued progress and demonstrating a comprehensive and sustainable quality system, the FDA. And we appreciate your time and attention during the call. Have a good day.

Operator

That does conclude today’s conference. Thank you all for your participation.

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