Invacare Corporation (NYSE: IVC) is the leading manufacturer and distributor of medical equipment and supplies used in the home including wheelchairs, home care beds, and home oxygen systems. The company has a distribution network of 25,000 home healthcare providers worldwide. This is a well established industry that is benefiting from a number of demographic trends in its key markets (laid out nicely in the 10-K). It has managed to generate on average $90 million in free cash flow over the last four years, which compares to a market cap of just $500 million, representing an 18% free cash flow yield. It has utilized this free cash flow mainly in deleveraging, reducing it debt load by approximately half over the period, to a current D/E of 0.42x.
As a manufacturer and seller of medical devices, the company is under the jurisdiction of the FDA, which regulates labeling, design and manufacturing. In early 2011, the company made the following announcement:
In December 2010, the Company received a warning letter from the Food and Drug Administration (FDA) related to documentation and procedures at the Company’s Sanford, Florida, facility. The letter does not call into question the safety or efficacy of Invacare products, and production has not been impacted. In fact, of the complaints that are detailed in the letter to illustrate the FDA’s points on documentation, investigations to date show that no injuries or deaths were caused by a product defect. That said, the Company does have areas to improve and it is taking these issues very seriously. The Company has added resources to ensure it is addressing all of the FDA’s concerns in a timely manner. The costs related to making the process improvements are not expected to be material and have been included in the Company’s 2011 operating plan and guidance.
No deaths or injuries, but some documentation processes needed improvement. So far, so good, except the actual FDA inspection report does state the following (emphasis added):
Firm has failed to take adequate corrective action in response to reports of entrapment involving Invacare medical beds sometimes resulting in death.
Anyway, the market largely shrugged this off. It does appear that the company satisfied the FDA regarding its Sanford, Florida location. But then in December, 2011, the company made this announcement:
INVACARE CORPORATION ANNOUNCES DISCUSSIONS WITH THE FDA
Elyria, Ohio, December 8, 2011 – Invacare Corporation (NYSE: IVC) today announced that the U.S. Food and Drug Administration (FDA) has requested that the Company negotiate and agree to a consent decree of injunction relating to previously disclosed inspectional observations at the Company’s corporate facility and its wheelchair manufacturing facility in Elyria, Ohio. The FDA has proposed a consent decree that would require suspension of certain operations at the facilities until they are determined by the FDA to be in compliance. Invacare has confirmed that it intends to enter into discussions with the FDA regarding the terms of the consent decree.
As the industry leader in the manufacture and distribution of innovative home and long-term care medical products, Invacare is committed to full compliance with FDA regulations, and it intends to work cooperatively with the FDA to resolve the agency’s concerns. Over the past year, the Company has made systemic improvements in its FDA compliance processes. The Company also has added internal resources and engaged outside experts with proven medical device regulatory experience in order to accelerate these improvements.
“Suspension of certain operations” was enough to spook the market, with shares falling 28.6% on the day of the announcement. Unfortunately, this has been the extent of the company’s disclosure.
In this letter from Invacare to the FDA, Invacare notes that it had received “FDA 483′s” on its Elyria, Ohio headquarters and manufacturing facilities (A Form FDA 483 is, according to Wikipedia, a report of observations from an inspection of a facility):
In addition to the attached response, lnvacare has responded to two FDA 483′s on January 11, 2011, related to our corporate headquarters at One lnvacare Way, Elyria, Ohio and our Taylor Street manufacturing facility in Elyria, Ohio.
Unfortunately, these reports and the company’s responses have not been made public (or at least I have been unable to find them; let me know if you do!). This page shows all of the company’s correspondence, but relating mainly to the Sanford facility. The only documents I can find two Adverse Event Reports stating that two powered wheelchairs manufactured in the Taylor Street location malfunctioned:
- TDX SC powered wheelchair Adverse Event Report can be found here. Details on this product can be found here.
- FDX-MCG powered wheelchair Adverse Event Report can be found here. Details on this product can be found here.
Unfortunately, these reports are vague (“Patient Outcome: Other”), and do not detail the nature of the malfunction, so we cannot determine how serious this is. We don’t know if the the entire manufacturing facility is being shut down pending changes, or if only these two product lines are being suspended, or something else entirely. We don’t even know for certain whether the FDA action is related to these wheelchair malfunctions. With little information about the source of non-compliance and how much of the company’s manufacturing is affected, we are left with little to be certain of until the company decides to disclose more. The market has evidently taken a “sell first, ask questions later” approach, which sometimes leads to value opportunities.
There are a few things we could do to make (very) rough guesses. One would be to look at the Taylor Street manufacturing facility (identified in the quoted letter above) in light of the company’s total manufacturing operations. From the last 10-K, we know that the manufacturing facility on Taylor Street is 251,656 sq. ft, representing just 11.3% of the total 2,235,016 sq ft of facilities that have manufacturing listed as one of their uses. So, if the entire facility were shut down for some period (say, one full year), we could then form an estimate based on the value of those lost sales. To be sure, estimates based on this are fraught with potential mistakes. It could be that this facility is the source of a disproportionate amount of profits, or produces products that are a key part of the company’s strategy and will thus have a disproportionate effect on the company.
Another strategy would be to make some estimates based on the wheelchair sales as compared to total sales. This entails some troubling assumptions about profitability by product line, but it might get us in the right direction. We know that power wheelchairs (of which the TDX SC and FDX-MCG are just two of many products in various lines) fall under Rehab Products (which also includes manual wheelchairs, scooters, and seating and positioning products such as cushions), which accounted for $288.8 million of the company’s $1.722 billion in revenue last year, or 16.7%. One could make assumptions about the proportion of these sales that are related to the affected products, but this still leaves us with uncertainty about whether FDA action is related to only these products.
The fact is, we don’t know enough about this, and the company has not done itself any favors by failing to get out in front of the issue with greater disclosure to allow investors to determine the likely consequences of the FDA actions. Until more information is released, we are left with a stable company capable of consistently producing strong free cash flows and with the strongest balance sheet it has had in many years, but stuck under a cloud of its own making.
Some things to note: inside ownership is decent, at 7.8% of common share and 99.6% of Class B super-voting shares. This represents economic interest (assuming the Class B shares were converted on a one-for-one basis as entitled to Common Shares) of approximately 11.74% of the company, or about $59 million in value at today’s prices. This is significant, and should align management’s interests with other shareholders.
Additionally, there has been evidence of proactive steps toward improving compliance and quality control within the company.
What do you think of IVC? Have you found information that would shed more light on the FDA action? How would you assess the consequences?