Invacare's (IVC) CEO Gerry Blouch on Q2 2014 Results - Earnings Call Transcript

Jul.24.14 | About: Invacare Corporation (IVC)

Invacare Corporation (NYSE:IVC)

Q2 2014 Earnings Conference Call

July 24, 2014 08:30 am ET

Executives

Gerry Blouch - President, Chief Executive Officer, Director

Rob Gudbranson - Chief Financial Officer, Senior Vice President, Treasurer

Lara Mahoney - Director of Investor Relations and Corporate Communications

Analysts

Bob Labick - CJS Securities

Matthew Mishan - KeyBanc

Jim Sidoti - Sidoti & Company

Operator

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

I will begin with the cautionary safe harbor statement that this conference call may include statements regarding anticipated or 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, 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 and Exchange Commission, and in the company's earnings release, we refer you those risks factors. The company may not be able to predict and may not have little or no control over the factors or events that may influence this financial results.

As a note, except for free cash flow, the financial information for all periods excludes the impact of 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 Incorporated, 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 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 of the company's SEC filings at www.invacare.com.

Before I turn the call over to Invacare's President and Chief Executive Officer, Mr. Gerald 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 today, Thursday, July 24, 2014.

I would like to turn the call over to Mr. Gerry Blouch, please begin.

Gerry Blouch

Thank you, and good morning. With me on today’s call is Rob Gudbranson, our Chief Financial Officer and Lara Mahoney, Director of Investor Relations and Corporate Communications.

Before we review our second quarter earnings, I would like to take a few moments to discuss this morning's announcement regarding my decision to retire from the company effective July 1, 2014. This was not an easy decision, but I believe it's (Inaudible) for both, me and the company.

It has been a privilege to be a part of Invacare's senior leadership team over the past 24 years, and I am confident despite our short-term challenges, Invacare has an incredibly strong future. Our business is driven by the aging population, our growing prevalence of chronic diseases, and advances in technology, which allow more therapies to be delivered.

Invacare Board of Directors will be launching a comprehensive executive process to identify the next Chief Executive Officer of Invacare. The will retain a leading executive recruiting firm to conduct the national search and plan to do a full review of both, internal and external candidates.

In the meantime, we are fortunate to have Rob Gudbranson take over as Interim President Chief Executive Officer and most of you are very familiar with Rob.

Rob has distinguished himself as Chief Financial Officer over the last six years and he has held many financial positions with increased responsibility prior to that both, at Invacare and other companies.

I worked alongside of Rob for many years and I have full confidence in him and our senior leadership team to drive the necessary business improvements to complete the final third-party certification audit as well turnaround the core business.

This will be my last call and I would like to thank all of our associates for their hard work and perseverance, but also would like to thank the shareholders for their support over the years for which I am very grateful.

With that, I would like to turn the call over to, Rob, to review the second quarter 2014 financial results, and I will signoff.

Rob Gudbranson

Thank you, Gerry. I personally want to thank Gerry for his commitment to Invacare over the past 24 years. He will be missed and we wish him well in retirement. I would now like to shift our focus to the company's financial results for the second quarter of 2014.

At the end of the call, we will review the status relating to the FDA consent decree. Our European business continued to perform well in the second quarter, but it was more than offset by the weak financial results of the North America/HME and the Asia Pacific segments.

Overall adjusted loss per share was $0.36 in the second quarter 2014, compared to an adjusted loss of $0.42 in the second quarter of 2013. The adjusted net loss for the quarter was primarily the result of lower net sales, which was partially offset by an increased gross margin and reduced SG&A expense.

While the adjusted net loss per share for the second quarter 2014 was less than that for the second quarter of 2013, the adjusted net loss per share in the second quarter of 2013 was unfavorably impacted by incremental warranty expense of $3.8 million or $0.12 per share related to the power wheelchair joystick recall and by amortization expense of $1.2 million or $0.04 related to the write-off of debt fees.

In the second quarter of 2014, organic net sales declined by 6.1% compared to the same period last year, with the increase in Europe being offset by lower net sales in the other three segments. The company reported negative free cash flow of $8.6 million compared to positive free cash flow of $2.9 million in the second quarter last year. The negative free cash flow in the second quarter this year was primarily driven by the net loss for the period, deferred compensation payments to an executive officer of the company who retired in the first quarter of 2014, and increased accounts receivable, primarily driven by the sales growth in the European segment.

Gross margin as a percentage of net sales in the second quarter this year was higher by 1.3 percentage points compared to last year's second quarter. It's worth noting that the second quarter of 2013 gross margin reflected an incremental warranty expense for the power wheelchair joystick recall $3.8 million pre-tax or 1.1 percentage points.

Excluding the incremental warranty expense in the second quarter 2013, gross margin as a percentage of net sales for the second quarter of 2014 increased 0.2 percentage points as compared to the second quarter last year. This increase was largely driven by product cost reductions, which were partially offset by increased warranty expense and the unfavorable absorption of fixed costs at the company's subsidiary which produces microprocessor controllers and that was as a result of reduced volumes.

SG&A expense decreased by 2.4% to $101.5 million in the second quarter compared to $104.1 million in the second quarter last year. Excluding the impact from foreign currency translation, SG&A expense decreased by 4.1% compared to the second quarter last year, primarily related to a reduction in regulatory and compliance costs and reduced amortization expense.

I will now turn the call over to Lara to discuss additional financial results for the second quarter.

Lara Mahoney

Thank you, Rob. All the references to earnings before tax exclude restructuring costs. The European business segment's organic net sales in the second quarter increased 2.8% related to increases in net sales of all product categories.

Earnings before income taxes increased by $3.9 million, largely attributable to volume increases and a favorable gross margin driven by favorable customer and product mix and lower product costs, including favorable foreign currency transactions. These benefits were partially offset by increased SG&A expense primarily attributable to associate costs.

For the quarter ended June 30, 2014, organic net sales for the North America/HME segment decreased by 12.5%, compared to the second quarter last year, driven by declines in all product categories.

Loss before income taxes for the North America/HME segment increased by $2.2 million, this loss for the quarter was primarily driven by volume declines and a reduced gross margin that was impacted by unfavorable sales mix towards lower margin customers and lower margin products as well as increased warranty expense, primarily related to respiratory products.

When comparing the second quarter 2014 to the second quarter of 2013, it's worth noting that warranty expense for the second quarter of 2013 included an incremental $0.4 million for the joystick recall, which was not repeated in the second quarter of 2014. The loss for the current quarter was partially offset by decreased SG&A expense related to reduced regulatory and compliance costs, reduced associate costs as well as reduced amortization, product liability and bad debt expense.

For the second quarter 2014, organic net sales for the Institutional Products decreased 13.2%, driven primarily by declines in interior design projects and bed sales, which is primarily a result of delays in new product introductions.

Earnings before income taxes increased $5.1 million. The increase in earnings before income taxes was due to reduced SG&A expense, primarily related to lower associate costs and reduced research and development expenses, which offset the volume declines.

In the second quarter, organic net sales for the Asia/Pacific segment decreased 8.8% due to declines in all businesses, but primarily in the company's subsidiary that produces microprocessor controllers. For the second quarter, the Asia/Pacific loss before income taxes improved by $2.5. The decrease in loss before income taxes was related to reduced volumes and unfavorable absorption of fixed costs at the Company's subsidiary which produces microprocessor controllers.

While the loss before income taxes was less in the second quarter of 2014 than that for the second quarter of 2013, warranty expense for the second quarter of 2013 was negatively impacted by $3.4 million for the joystick recall, which did not repeat in the second quarter of 2014.

Total debt outstanding, which includes the convertible debt discount as described in the release was $58.5 million as of June 30, 2014. The company's total debt outstanding consisted of $38.6 million drawn under revolving credit facility, $13.4 million in convertible debt and $6.5 million of other debt.

I will now turn the call back over to Rob for a few closing comments. We then can address the questions.

Rob Gudbranson

Thank you, Lara. At this point, I would like to address status relating to the consent decree.

As we had previously indicated under the terms of the consent decree, we were required to complete three third-party certification audits, which will then be filed by comprehensive FDA inspection before the FDA will permit us to resume full operations at our Taylor Street manufacturing and corporate facilities in Elyria, Ohio.

We have already received the FDA's acceptance of two of the three certification reports.

We are continuing to work on the final expert certification process. We need to better demonstrate that our quality system is sustainably compliant and that each subsystem is properly integrated.

Let's look at our complaint handling subsystem as an example. The current subsystem is resource-intensive and requires data entry in two separate systems. In order to improve the efficiency of the complain handing handling subsystem, we will be combining the two electronic systems in one. Using the expertise of new associates who recently joined the company as well as additional consultants who will be better leveraging one of our existing electronic systems, which will be far more efficient.

The overall certification is a detailed and complex process and we are working hard to be in a position to ultimately demonstrate our compliance to the third-party auditor and subsequently to the FDA. While we are making progress, we cannot predict the timing of the completion of the third-party expert certification report.

During this challenging time, we have three additional critical business priorities which are improving cash flow, restoring profitability in Invacare's North America/ Home Medical Equipment and Asia/Pacific businesses and working to establish a new credit facility with our banks as our existing credit facility matures in October, 2015.

Starting on August 1st, I appreciate the opportunity to lead Invacare as Interim President and CEO. The senior management team, the Board of Directors and I are fully committed to turning around this business.

Before we turn to Q&A, I would like to remind everyone that the purpose of today's call is to discuss topics impacting our second quarter results.

We will now open the phone lines for questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) We will take our first question from Bob Labick, CJS Securities.

Bob Labick - CJS Securities

Good morning.

Rob Gudbranson

Good morning, Bob.

Lara Mahoney

Good morning.

Bob Labick - CJS Securities

Hi. Just wanted to start off and say to Gerry, it was pleasure working with you and learning about Invacare and the industry from you and good luck with your retirement.

Rob Gudbranson

Bob, we will relay that to him. He is not on the call at this point, but we will relay your thoughts.

Bob Labick - CJS Securities

Okay. Great. Thank you. Then Rob, just jumping into the last part of the call, you mentioned, you have hired additional consultants. You said that in the releases as well in order to help with third-party audit certification.

You gave an example of the complaint system a moment ago. Has there been specific feedback from the third-party auditor about certain systems or are you flying blind. Can you give us a sense of how the process is working and the expectations with - how big of a new group have you brought in and just little more detail along that.

Rob Gudbranson

Sure. Glad to do it, Bob, maybe I will just start y by saying, because I think it's an important fact to get. We usually share the quality and regulatory sped that we have at corporate and HME, the home medical equipment division and we spent about in Q2 2014, $6 million in this quarter this year and in Q2 2013, we spent $7.6 million, so the spend is down, but we are making sure to use some specific both, people internally hired and some consultants to help close some gaps and address some of the issues.

We are still working with the third-party auditors as you expect. We have communications with them and we are making sure to try to address issues as they are raised and keep making progress on the audit in general. Does that help, Bob?

Bob Labick - CJS Securities

That helps. That does. Then obviously you have said you don't know the timing and everything else. I guess just the question is, you said you have communication. They are give you specific feedback about areas that you go or you do a whole bunch of stuff and then they say, nope. Then you try again? I am just wondering how much interaction there is.

Rob Gudbranson

It's interactive. They are working with us. We are raising issues. They are raise issues back, clearly it's an ongoing relationship that we want to make sure to address their issues as quickly as possible, but we also want to make sure it's sustainable and it's sufficient. We want to make sure it's is something we can keep going forward on and that's just something we fix short-term.

Bob Labick - CJS Securities

Okay. Great. Then let's fast-forward to FDA comes back and they approve and you start moving forward with full launch. One of the big initiatives obviously is the globalization initiative and the standardization of your product line across the globe. Can you talk just a little bit about when that process can start?

Do you have to wait till hearing only back from the FDA to start product standardization or can you start sooner than that and not a specific, but generally speaking where do we stand in that process and when can that even begin?

Rob Gudbranson

Bob, I would say we are very early in the process, because as you can imagine, we have pulled many resources of quality, engineering and many other associates into the certification process and that is our big focus in the near-term, and so I would say there have been some activities along the way. We still look at as we get to a point where product maybe is not quite as sufficient in terms of profitability and we got inventory in it that make sense to potentially phase out. We will do so to try to get down to a smaller number of SKUs, but the real benefit of globalization as Gerry has put it out there is to get to the point where we can introduce new platforms and really make progress globally to get that done.

I would say that really needs to happen more when we get through the consent decree and then introduce those products.

Lara Mahoney

I just want to add. Yes, Bob, that is still a very important strategy for the company, but in the short-term, I mean, we need to focus right now on looking at the business and improving free cash flow, restoring profitability in North America/HME and Asia/Pacific, and working to balance that new credit facility as Rob mentioned.

Bob Labick - CJS Securities

Okay. Great. Then last one, just jumping back to, on the last call we discussed, you guys looking at introducing some maybe lower price point products in the lifestyle products, lower feature, lower price point for cash pay. Has that started? I don't know how long that takes to happen. Is that still a focus point and update on the kind of North America lifestyle products?

Rob Gudbranson

Bob, I'll focus on one area. We have introduced a product; I'll call it more on the single-use focus for the manual wheelchair. That is out there. It's available to our sales force in the North America/ HME group, and we will continue to push that.

I think there's a trade-off here. Is the product good for fleet management, if it's something that the provider fees and should see as being valuable to make sure that they have fleet management strategy that gives them benefit both, on the profitability and they are really looking at the lowest cost over the lifecycle of product, but there are cases where it's again more single-use. They might say look, I will take a little bit of a less expensive product and less featured product, so we have looked hard at that, we have done that on the particularly the manual wheelchair and we will continue to look at that going forward.

Bob Labick - CJS Securities

Okay. Great. I will jump back in queue. Thank you very much.

Rob Gudbranson

Thanks Bob.

Operator

We will take our next question from Matthew Mishan, KeyBanc.

Matthew Mishan - KeyBanc

Yes. Thanks, Bob, Lara, for taking my questions and obviously wish Gerry the best of luck with everything going forward.

Rob Gudbranson

Thanks Matt.

Matthew Mishan - KeyBanc

Just first, in December, you put out a press saying the consultants had basically left and they were going to return a couple months later. Is this is similar kind of situation or are they still there?

Rob Gudbranson

We are still in communication with the consultants. We are still working with them and obviously we still have more work to do, but that communication continues and it is important to us and it is important to them. We want to get to the finish line, but we are not there yet.

Matthew Mishan - KeyBanc

In December, when they left, December, January, early where there communication or was there no communication.

Rob Gudbranson

There has been continual communication. I mean, there was a meeting in December. We continue to work. They came back, looked at some additional issues in the New Year. Again, it's an ongoing discussion and we both want to get to the end zone, but we need to do some more work.

Matthew Mishan - KeyBanc

All right. Then the QARA cost, the $6 million in the Q2 '14, does that include the additional consultants that you are bringing in or is that more of a third quarter event?

Rob Gudbranson

No. We had additional consultants in the second quarter exactly where we beat the third quarter. We won't be able to say at this point, but no. We did have the additional consultants in the door doing some work in second quarter also.

Matthew Mishan - KeyBanc

Okay. Two of your initiatives, you talked improving free cash flow and restoring profitability in North America and Asia/Pacific. Can you give some specifics on metrics?

Rob Gudbranson

Let's start with cash flow. I think one of the things we continue to look hard at is making sure, for instance, on capital expenditures we are as close as we can be, we are as tight as we can be. There are things we clearly need to do and that would include both, for our manufacturing plants and for our new products and product updates.

We are not going to put ourselves in position of not being competitive and yet we need to be very tight on that capital expenditure, but I think people internally understand how important it is to conserve cash.

We are also making sure that when we are looking at our relationships with suppliers and customers, we are doing a good job both, in getting right terms from suppliers that's fair to both parties, but they were collecting timely and our financial services group does a very good job of collecting the cash on a timely basis

I think on free cash flow and the blocking and tackling, the most important aspect though of free cash flow is our operating income or at this point an operating loss. If we can limit that operating loss, that is one of the best ways quickly to improve our free cash flow, so on that front, we have very strong manager for our North American segment, who has been with the company for, I believe, 4-plus years.

I am going to work very closely with him at looking at cost savings. We are going to review everything. We are going to make sure that we are spending and we have the right support for the business as it currently sits and not assuming the CD is going to clear by certain days.

Additionally, we have two very strong managers down in both, in the Asia/Pacific area. One leading our division that makes the microprocessor controllers and the other one leading our distribution businesses in Australia and New Zealand, they are both, very engaged to look at their costs and again realize that we need to improve our performance given the fact that we don't know when we are going to clear the CD, so again we are going to look very tightly at what spend we have, and what we can defer and what we can get rid of.

These are not easy decisions, but I can speak for myself and for those three managers, the one for North America/HME and the two for Asia/Pacific. We are very much engaged in making those tough decisions and we need to do so.

Matthew Mishan - KeyBanc

Okay. Then bigger picture, I guess. I think the second round of the larger metropolitan areas that national competitive bidding is looking like it's going to beginning sort of end of this year. What is your sense of the ability of some of the current legislation has to make some sensible improvements in to the bidding process to be enacted maybe before round two goes into effect.

Rob Gudbranson

We have got good support in Washington to try to make various actions. I would say, we are hopeful that there could be some change, but I would say we are counting on the fact we have to live in the current environment and we are going to see that we are ready and prepared for that.

The thing that I would emphasize is, I think, and Lara, correct me if I am wrong here. We are already up to 100 MSAs and more than 75% Medicare spend. The fact that it might go further, we are going to make the additional bids going forward. We are already kind of there, and we need to live in that environment.

I am not doubting that we will continue to work hard and I would hope that congress with our industry support your support and Invacare support would look at resetting all this bidding given issues we have raise before, but I'm not sure we can count on that. It would be a nice benefit from the industry and we will keep fighting for that, but I'm not sure we can count on that when we are doing our planning.

Matthew Mishan - KeyBanc

All right. Thank you for taking my questions.

Rob Gudbranson

Thanks, Matt.

Operator

(Operator Instructions) Our next question, Jim Sidoti from Sidoti & Company.

Jim Sidoti - Sidoti & Company

Good morning. Can you hear me?

Rob Gudbranson

Yes, Jim.

Jim Sidoti - Sidoti & Company

Great. Rob, can you talk a little about the sales force in place in North America for these motorized wheelchairs, especially since the consent decree was put in place. Are they still important to selling other products or has that sales force been cut and how soon after the consent decree is lifted will they be ready to get back into the market?

Rob Gudbranson

A couple of things, Jim, one, our North America/HME, if we are talking specifically, the power wheelchairs, that group sells the whole product line, so we have them selling what we call mobility and seating, which has the power wheelchairs, they are selling lifestyle and they are selling respiratory, so they are fully engaged in finding sales wherever they can find them.

I would emphasize too though that is, I think, most of the investors know, but just to reconfirm. We have the ability under the consent decree to continue to make power wheelchairs for specific situations. That would be the replacement chairs. Additionally, that would be where there is a verification and medical necessity that our chair is the right chair for the situation.

I would emphasize that sales force is still in the door talking to what I would call rehab facilities, rehab providers. Additionally, there are a number of products in our mobility and seating that are not impacted by the Taylor Street consent decree.

For instance, their seating products, their custom manual products that they can continue to sell and they do, so I want to make sure everybody understands when we clear consent decree, our sales force is still talking to the same providers, they are still talking to the same rehab facility. Obviously, we would rather be doing a bigger business with them on everything what we are doing today, but they are out there.

Then maybe the last question you asked is whether they have gotten smaller, the sales force have declined over this time period. Just as the business has come down, we do have fewer sales professionals in the field, but that we have a very strong sales force. They have hung in there with us and they have done a good job in terms of being prepared going forward for when we get out consent decree.

Jim Sidoti - Sidoti & Company

Okay. Good.

Rob Gudbranson

Does that help, Jim?

Jim Sidoti - Sidoti & Company

Yes. That's exactly what I was asking. On the Respiratory business, I know you had a real good second quarter in 2013. Can you remind me how was the third quarter in '13?

Rob Gudbranson

I would have to go back on that. I would agree with you that second quarter last year, we had a large order from a national account for both, HomeFill and portable concentrators and that tends to be a situation where it's a little uneven and we didn't have the HomeFill repeat for a national customer, where we have done very well with our independent some smaller providers on HomeFill, HomeFill was fine for the second quarter 2014, but the portable concentrator were weaker in the second quarter of 2014, so yes, that's the comparison I would give.

Jim Sidoti - Sidoti & Company

Okay. Then is it feasible to assume that the North American business can be profitable without the consent decree being lifted or you think you are going to need for that to be lifted before get back to profitability in North America.

Rob Gudbranson

We are going to target to limit that loss in the near-term and do what we can clearly to get back to profitability. I think at this point I would say we will give more vision on that over time. We are not giving guidance right now, but clearly the message is clear to investors and it is clear to our associates.

We need to make sure to improve our profitability or limit our losses without waiting for the CD. We are at the point where it's clear we are going to have to take some tough actions and some tough decisions. Again, that senior team is engaged in that and I will work with them carefully to make sure we did the right trade-off there.

Jim Sidoti - Sidoti & Company

All right, then my last question on the Asia business, the microprocessor controllers continue to be weak. I assume that's because of the consent decree. Do you think that that will bounce back as soon as the consent decree gets lifted.

Rob Gudbranson

A couple of things, one, yes, it is very much driven by the situation, the consent decree. I would point out to you when we do get through the consent decree that business and North American/HME business will take some time to recover.

Normally in the U.S. holding for power wheelchairs it's sort of a 60-day to 90-day cycle with our providers. You have to get in their quote system again for the wheelchairs were not available for today and that will I believe will put us in there, relatively quickly, but at the same time there will be some lag there and that will be a lag for both players, but we will be pushing hard to get out there.

Additionally, I should point out, Jim, that we are working and we don't have a time schedule yet, but we are working on an update for our TD XSP, wheelchair which is still I would argue today is the premier chair in the marketplace, but we are looking to update that and have an important change to that as soon as possible after the consent decree lifts and I think that will be very important.

It's always easier to go onto the customer and explain to them you got a new product and not just your bag. I think, customers will work with us either way, but again that will depend a lot on how long it takes us to get out of the consent decree.

Jim Sidoti - Sidoti & Company

Great. Thank you very much.

Rob Gudbranson

Thanks, Jim.

Operator

We have no further questions in the queue. I will turn the call back over to Mr. Rob Gudbranson.

Rob Gudbranson

Thanks very much. Again, I would like to remind you that the senior management team, the Board of Directors and I are fully committed to turning around business during this challenging time as we complete the third-party certification audit. I thank you all for your time.

Lara Mahoney

Thank you.

Operator

This does conclude today's conference. Thank you for your participation.

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