Invacare Corporation
Q3 2016 Earnings Call Transcript

Published: 31 Oct 2016

[Operator:]

Good morning, ladies and gentlemen and thank you for standing by. Welcome to the Invacare 2016 Third Quarter Conference Call and Webcast. After the management review we will open up the call to questions. Investors and analysts interested in asking questions will need to dial in as questions cannot be submitted via the webcast. For the first part of the call, all phone lines have been placed on mute. This conference is being recorded Monday, October 31, 2016. I will now turn the call over to Lara Mahoney, Invacare’s Senior Director of Corporate Communications and Investor Relations. Please go ahead Ma'am.

[Lara Mahoney:]

Thank you, Amy. Joining me on today's call from Invacare are Matthew Monaghan, Chairman, President and Chief Executive Officer; and Rob Gudbranson, Senior Vice President and Chief Financial Officer. Today in addition to reviewing the third quarter 2016 financial results, we're pleased to give investors an update on our transformation from being a generalist durable medical equipment company to one that focuses on solutions for clinically complex and post-acute care. To help investors follow along, we've created slides to accompany this webcast. For those dialing in, you can find the link to our webcast on www.invacare.com\investorrelations. On our IR page, you will also find a PDF of the webcast slide presentation that we'll refer to during today's call. Before Matt begins, I would like to note that during today's call, we may make forward-looking statements about the company that by their nature address matters that are uncertain. Actual future results may differ materially from those expressed in our statements today due to various uncertainties and I refer you to the cautionary statement included in our webcast slides and in our third quarter earnings release. For an explanation of the items considered to be non-GAAP financial information, that will be discussed on today's call, such as free cash flow, constant currency net sales, adjusted earnings and loss and EBITDA, please see the explanatory note on the first page of our webcast slides and in the related reconciliations in the earnings release posted on our website. Also please note that the company completed divestitures of certain of its businesses in the third quarter of 2016 and in 2015. Those businesses are included in the 2016 and 2015 results that will be discussed on the call unless otherwise noted. Finally investors should be aware that as of the third quarter of 2016, we have redefined the measure by which the company evaluates segment profit or loss to be segment's operating income or loss. This replaces the previous measure, which was earnings or loss before income taxes. We believe this metric more accurately reflects how we manage the business. Please refer to our third quarter earnings release for a full definition of segment operating income or loss. With that, I will now turn the call over to Matt Monaghan.

[Matt Monaghan:]

Thank you, Lara, and good morning. As Lara mentioned, our company is undertaking a comprehensive transformation that is essential to reinvigorating growth and profitability. We've good feedback from investors over the quarter and I want to put today's quarterly release in the context of the plan we're executing to our investors and prospective investors can more easily understand the long-term value being created. Looking at Slide 2 from our webcast presentation, you will recall that our company makes products that help people move, breath, rest and perform essential hygiene and we focus on areas of congenital, acquired and degenerative condition. These are important parts of care for people with a range of challenges for those who are active in heading to work or school each day and may need additional mobility or respiratory support to those who are cared for in residential care settings at home and in rehabilitation centers. Invacare has been broadly a one stop shop provider of these products for its nearly 40-year history. With the help of Slide 3 I want to describe the compelling need for strategically refocusing our company. On the first graph you'll see a sales margin histogram showing the distribution of economic value for the range of products the company has historically exchanged with its customers. Where customers value durable solution for Aids for Daily Living, we have had good margins to reinvest and continue development of those products. Similarly where more complex clinical issues are being addressed, we have been able to get a proportionally higher return needed to reinvest in the more intense cost of developing those solution. In many countries where the government or private payors focus on total care of care, this exchange of value and our sustainable business model continues to be healthy, but in some markets the economics could be very different. In the United States for example, where reimbursement reductions to our customers have been significant, some customers are now focused more on the cash price for basic living needs and on total cost of care and in some areas customers are opting for single used products to leave behind with each patient, if it is more cost effective than retrieving the product to redeploy with other consumers. As this happens, the market price is being reduced and the market opportunity decreases. The impact of this shift in value is shown on the second graph where the lower end of the sales margin curve is drawn down closer to zero. Invacare is geared to design and produce robot solutions for the needs we serve. So at point, there are certain minimum economics needed to foster good design and execute production, which is part of the company's promise. This shift and the lack of ability for the company to generate a return for these products in certain markets has forced us to relook at our strategy and focus on markets end products where our core capabilities match what markets and ultimately patients are looking for. The best total care solutions and products that solve the toughest clinical issues. With this realignment, we will have better returns needed to reinvent in growth. So where do we add the most value to our customers and the people who use our products, on Slide 4, we have depicted the typical person in a power wheelchair with complex needs. In the case of a person without the use of their legs and partial use of their arms, there is a great need for more than just a wheelchair. Seating and positioning are important starting points for posture control stability and good functional outcomes, from the electronic control system must be matched to specific needs and adjusted to the specific ability. Invacare has best-in-class solutions for these integrated systems and beyond the wheelchair, this person will have special needs throughout the day, including resting in a bed that promotes security, tissue health and ease of care, here she will need safe and easy transfers throughout the day and they have many specialized hygiene needs; in the graph that we have depicted the need for supplementary respiratory support at night or throughout the day. Globally no other company can provide such comprehensive 24-hour support with product solutions for people with complex needs. We have a heritage of innovating in this space and we're reorienting our work that emphasizes in a way that we expect will maximize our returns for growth and reinvestment. So what do we need to do to get there? On Slide 5 we talk about the phases of the transformation, which began in 2015. Since then and through 2019, we have three phases of change to get us to a reshaped well offering enterprise. We won't stop there. There is work and even greater opportunity beyond 2019 and those initial phases, but for now we're focused on this initial period. The three pages of this transformation our first -- our strengths and reorienting our business to match long-term market trend or by Phase 2 building a line, which is about rebuilding the company in alignment with our new direction and finally Phase 3, which is growth and acceleration built on the foundation of phases one and two. We've used this slide a number of times in investor presentations and I won't go through all the details here today, but briefly we are in phase one now, which is especially intensive in the North America HME and IPG segments as you would expect. In this phase we're focused on having a strong balance sheet, expanding talent, accelerating quality efforts, strengthening the North American commercial team, shifting product mix and accelerating innovation. This is clearly an investment phase with significant shifts in the mix of our business. Reductions in sales, gross margin improvement, SG&A increases and cash consumption are all indicators of the work we're doing. In later phases, we expect increasingly broad signs of economic improvement with sales and gross profit growth in Phase 2 and margin, operating income and cash flow growth in phase three. Refocusing the company on these clinical solutions is a significant transformation we expect will lead to good outcome. On Page 6, we lay out our expectations for the company's performance at the end of phase three, which we believe will yield better returns for investors and sustainable long-term growth. By the end of phase three, we expect to have a company with this kind of performance a company that leads the size that is now with $1.1 billion in sales, growing above market with our competitive products and resulting share gain, mix shift will get gross margin as a percent of net sales over 30%, SG&A should be back down in the mid-20% range, reflecting resizing and sales leverage as we grow, that will lead to operating margins in the upper single digits and the company should be generating at least $100 million of annual EBITDA when we're done. As you'll see on Slide 7, we've already made substantial progress on phase one. I would like to bring your attention to the most recent milestones noted here in green. In terms of strengthening the balance sheet, at the end of the third quarter the balance sheet had over $138 million in cash. Regarding leadership and staffing changes, we've appointed a new general manager for Europe, Ralf Ledda, who has had a remarkably successful career with our important German subsidiary Alber GmbH. Alber is a high-tech subsidiary with holistic excellence being led by Ralf and we're pleased to have him joining us to run all of Europe effective November 1. Also in October, we have restructuring actions in North America, which reflect a change in emphasis in our business. This should impact the company by about $2.6 million of annual savings. We continue to make progress on our quality efforts and we spent a significant amount of energy, strengthening our commercial team. We started with a good team facing a lot of change. We've been investing in North America sales force by attracting new associates with clinical background. They're going through a robust clinical product on-boarding programs that help them hit the ground running. These new team members complement the incumbent sales force, which has also been going through robust clinical training and realignment. I greatly appreciate their hard work and commitment to this transformation. Between our ongoing training and these new additions, our commercial team is having deeper conversations with our customers about clinical needs and care. Regarding our product mix shift, we divested Garden City Medical business for approximately $40 million in cash. That business primarily source for single use products that were moving away from. Divesting this asset helps us focus even further on products and solutions that serve more clinically complex needs. And importantly in innovation, we launched the first wave of our new LiNX power wheelchair electronic system, the world's first wirelessly programmable complex wheelchair control system, which is really important to help therapist do the best job they can to program many parameters for the drivers of those chairs and also help service technicians understand the status of the chair and make more effective service calls. This technology has been in customer evaluation for some time and the feedback has been very positive. In North America, the company launched the Alber Twion power assist device for active manual wheelchair users, which has a novel smartphone interface and leading features for simple daily use. The un-qualitative indicators for progress, it's obviously important to talk about financial measures along the way. On Slide 8, you see key indicators of the three phases of change. These are the channel markers on our journey to phase three. Revenue in the short-term as I mentioned has to come down as we produce less strategic business and focus on growing the part of our business that provides more value and complex rehabilitation and post acute care. Over the long term, obviously sales have to go up. Along the way in the phase one and two, we expect gross margin is going to shift, first with gross margin percent increasing and later with gross profit dollars increasing. In the meantime there may be some periods where the dollars don't exactly follow. This is because we're working to titrate the declining and increasing areas of our business along the way. We are working to keep gross margins moving forward. We've talked about the important investments we're making in our commercial teams and business infrastructure, so in phase one we expect SG&A spending will go up all by a layer reduction as the business is reshaped to fit our new mix and as we get leverage from sales growth. As a result of near-term investments we expect periods of negative cash flow followed by what has to be long term positive cash flow. Importantly because this is a substantial transformation with a lot of moving parts, not every quarter is going to be smoothly interpolated between where we started and where we're going. In terms of metrics, by analogy this is going to be more of a walk through a forest to a destination and walk in a straight line. So let's talk about the third quarter 2016 financial results on Page 9. Constant currency consolidated net sales were down 4.5% for the quarter, compared to last year's third quarter. This comprised the mix of increases in Europe and Asia-Pacific, which were more than offset by declines in the North America HME and IPG segments and while sales were down, we managed to keep gross margin percent flat compared to the third quarter last year. Gross margin was impacted by reduced manufacturing costs and favorable sales mix offset by increases in R&D expense. Gross margin as a percent of net sales increased for the North America HME and IPG segments with declines in Europe and Asia-Pacific segments. Gross profit dollars declined $4.2 million principally in the North America HME segment, largely as a result of sales declines from our continued transformation. Constant current SG&A was up slightly by 0.8%, which is a reflection of our continuing investments. Free cash flow was positive for the quarter at $1.5 million, driven by lower accounts receivable, partially offset by the net loss, increases in inventory and reductions in accounts payable. Finally while the company saw positive product mix shift in certain areas of the business, especially in the North America HME segment that is being transformed, the consolidated net sales decline led to lower gross profit. As a result, EBITDA for the quarter was negative $1.1 million, with our long-term goal of over $100 million in EBITDA there is opportunity work ahead of us. And while not noted on the slide, I would also like to point out that our adjusted net loss per share was $0.37 for the quarter, compared to adjusted net loss per share of $0.13 for the third quarter last year. The increase in adjusted net loss was driven by unfavorable net sales and increased interest expense. The company incurred net interest expense of $4.4 million in the third quarter of 2016 compared to $1.0 million in the third quarter last year. The net increase was primarily due to interest payable on the company's 2016 convertible debt issuance. I'll now turn the call over to our CFO Rob Gudbranson to discuss in more detail the consolidated results, performance of the segments and additional financial results of the third quarter.

[Rob Gudbranson:]

Thanks Matt. For the third quarter of 2016 Europe constant currency net sales increased 4.4% compared to the third quarter last year. The improvement in constant currency net sales was driven by all three major product categories. For the third quarter, operating earnings decreased by $2 million, compared to the third quarter last year. This decrease in operating earnings was primarily due to increased SG&A expense related to employment costs and a slightly lower gross profit impacted by unfavorable sales mix and pricing. These impacts were partially offset by increased net sales and reduced manufacturing and warranty costs. Gross margin as a percent of net sales and gross profit dollars both decreased in the quarter compared to the third quarter last year. For the third quarter, North America HME constant currency net sales decreased 14.5% compared to the third quarter last year. The decrease in constant currency net sales was driven by lifestyle and respiratory products, partially offset by increases in mobility and seating products. North America HME's operating loss increased by $2.6 million as a result of reduced net sales and increased R&D expense, partially offset by stronger gross margin and reduced SG&A. The increase in gross margin was a result of favorable sales mix while reduced SG&A related primarily to lower regulatory and employment costs. For the quarter, gross margin as a percentage of net sales increased slightly and gross profit dollars decreased compared to the third quarter last year. Constant currency net sales in the IPG segment decreased by 12.9% due to case goods and interior design projects. Operating earnings were up slightly, largely due to the reduced SG&A related to employment costs and a favorable gross margin due to reduced freight costs, largely offset by net sales declines. During the quarter, gross margin as a percentage of net sales increased and gross profit dollars decreased compared to the third quarter last year. For the third quarter of 2016, Asia Pacific constant currency net sales increased 0.5%. The improvement in constant currency net sales was due to the net sales increase in the New Zealand distribution business. For the third quarter, operating loss increased $0.2 million largely due to an unfavorable gross margin related to increased R&D expenses. Gross margin as a percentage of net sales and gross profit dollars decreased in the quarter compared to third quarter last year. Total debt outstanding as of September 30, 2016, was $197.2 million. The company's total debt outstanding consisted of $163.4 million in convertible debt and $33.8 million of other debt, principally lease liabilities. The company had euro drawn on its revolving credit facilities as of September 30, 2016. The company's cash balances were $138.4 million as of September 30, 2016 compared to $125.3 million as of June 30, 2016 and $60.1 million as of December 31, 2015. Cash balances increased in the third quarter of 2016 compared to the second quarter of 2016, primarily due to cash proceeds from the sale of Garden City Medical. The increase in cash balances compared to December 31, 2015, was principally the result of the net proceeds received from the issuance of convertible debt in the first quarter of 2016. As of the end of the third quarter, day sales outstanding were 45 days up from 42 days as of December 31, 2015 and down from 46 days as of September 30, 2015. At the end of the third quarter, inventory turns were 4.4 times as compared to 4.9 as of December 30, 2015 and 4.6 times as of September 30, 2015. I'll now turn the call back over to Matt for a few closing comments. We then can address questions.

[Matt Monaghan:]

Thank you, Rob. So as we have discussed over several quarters, this is a journey to a great destination and I want to reflect on the pattern of performance that we see. Page 12 is the [indiscernible] ratio page, which is where we show whether we're doing what we said we would do. You may be thinking, the strategy sounds good, the market is very interesting, I like the transformation plan the house is actually all playing out. So on Page 12, we look at the same metrics discussed earlier versus the last four quarter of results. On this page you see sales continuing to come down over four quarters, which primarily reflects the shift in sales mentioned earlier, gross margin as a percent of net sales. Here we're looking for improvement from mix shift. You see three or fourth quarter of positive growth. In this last quarter, we saw more of a transition, but still balancing it flat after a lot of shift in sales. Gross profit dollar, the mix of up and down, that have been roughly within $4 million of breakeven contribution, with constant currency SG&A you can see the reflection of the investments we've been making with free cash flow. This has been positive and negative in recent quarters, which is the combination of the semiannual cash flow seasonality of our business and the investments we've been making. Now fourth quarter last year was tremendously positive as we enter the year with great working capital levels, stacked in Invacare's more generally cash accretive part of the year. In the third quarter this year we got back to positive cash flow. So looking at these composite metrics over the past four quarters, we believe this reflects consistent execution of our substantial transformation. Turning finally to Page 13 for a recap, the transformation of the company continues with a net sales decline including the shift away from non-core plus accretive sale and increases in strategic areas. The gross margin percent shift, especially in North America HME shows the effective our work there. Overall we kept gross margin in balance and flat with last year and cash flow was positive for the quarter. In addition we've appointed a new leader of our Europe business starting November 1. We talked about the foundational new electronic platform LiNX, which we launched in Europe to bring new advanced wireless control technologies to complex our wheelchair and give an example of our technology in the manual active category with the launch of Alber Twion power add-ons and we continue to take the necessary steps to reshape the business as our strategic actions take hold. I appreciate everybody's support for the quarter and taking time to be on the call this morning. We have time for questions.

[Operator:]

[Operator Instructions] And our first question is from Matt Mishan from KeyBanc.

[Matt Mishan:]

Hey, good morning Matt, Rob, Lara.

[Matt Monaghan:]

Hey Matt.

[Matt Mishan:]

Hey, could you help us parse out the decline in North America HME between the ongoing rationalization and maybe the underlying performance of the business?

[Matt Monaghan:]

Well I think principally we've been focused on North America HME and that's the same kind of calling that we've been doing for some time and as we talked about last quarter Matt, IPG is following that transformation a few quarters later and we started broadly last year and really accelerated the HME business earlier this year and then the second quarter we guided the IPG segment. I think we probably still see a little bit of softness in respiratory and the lingering effects of national competitive bidding but beyond that, it's the same as we've seen recently around. I don't know Rob if you have other quick comments.

[Rob Gudbranson:]

No Matt, I agree with that. I'll just add -- just a little more color, I emphasize Matt that if you look at mobility and seating as we mentioned, that had a sales increase. As Matt mentioned lifestyles and respiratory were both under some pressure on the sales line. That inevitably led to some pressure on the gross profit as we've talked about in the release. I think the SG&A is actually slightly down. So we're showing some good decisions there and I think also this performance led to some decisions to maybe call it rightsizing the business. We don't necessarily treat that lightly. So that's something that we don't do. We like to do and we do it properly by making sure that we're treating the associates who are leaving with the proper treatment and severance and other support but that $2.4 million annualized action was primarily focused in North America.

[Matt Mishan:]

Okay. Got it. And then just a follow-up to that, you spend a lot of time talking about your complex rehab portfolio and the aid for daily living products, but I think I am not necessarily sure where respiratory stands and what you're doing to improve the performance of respiratory, but I don't know, that's to say let's wait for the impact of national competitive bidding to be behind us. Can you tell me little bit more about how to improve the respiratory performance?

[Matt Monaghan:]

Yes, I guess two parts of that. One part I think with the final rule out of the last big step down in reimbursement, which took effect in July, number of customers are starting to see the full P&L in their business impacting that, though a lot of probably scrutiny of their P&L we see as we expected some increased interest in home fill, which can substantially improve profitability for our customers who are willing to shift away from the infrastructure required to drop off and pick up oxygen canisters each week. So that's relatively positive, but I don't think that part of the market has really shaken up let's say. We're still too close to those step downs, but with that reimbursement shift in the rural areas, those are affecting customers who have the highest number of unproductive windshield hours or miles driven to serve an average customer. So we think that impact will be substantial in forcing customers to really consider how best to operate their business. And then the second part is we think this is still an important part of investment in our innovation pipeline. The company has a long heritage of [Seminole] developments in this space and we got a pipeline that over periods of time here in the future will have other developments that will keep that product portfolio right on.

[Matt Mishan:]

Okay. Great. And then moving to Europe, can you give us a little more color on the margin declines over there and whether or not we should expect that to be like an ongoing headwind or is that something that's just transitory?

[Matt Monaghan:]

I think just transitory. Sales went up, so occasionally you get little margin bump along the way. I don't think there is anything structural there that we're looking at Rob.

[Rob Gudbranson:]

Yes Matt, the only thing I would agree with Matt's summary, they were down and in terms of the gross margin percent, I think as we said that's pretty much mixed. Sometimes that mix has been for some quarters and sometimes against us, but again was a 4.4% sales increase on a constant currency basis. They were just slightly down under gross profit dollars and that's an important metric for that business right now and again those slightly down again we're really seeing that there isn’t a major issue there in terms of what we saw Q3.

[Matt Mishan:]

Okay. Great. And then last question for me, what are some of the next -- on the consent decree around the -- around how you're looking at it and what are the next announcements that you are substantially making with that?

[Matt Monaghan:]

Good question. So folks will remember in June we received feedback from the FDA in the next stage of work that we had accomplished. We're absolutely focused on doing that which is around design history file remediation. We assume that will take us few or several quarters to get that work done to present to FDA and then from there we're back on the normal schedule that everyone understands the basis two and three of the audit program. As far as disclosures go, when we get a meaningful milestone, we'll talk about that. We have so many people involved in the work that's non-public in nature than we typically look at the risk of Reg FD and we make a disclosure that way but we're in middle of that intensive work right now.

[Matt Mishan:]

All right. Thank you very much.

[Matt Monaghan:]

Sure. Thanks Matt.

[Operator:]

[Operator Instructions] We'll take our next question from CJS Securities and Bob Labick. Please go ahead sir.

[Bob Labick:]

Good morning.

[Matt Monaghan:]

Good morning, Bob.

[Lara Mahoney:]

Good morning, Bob.

[Bob Labick:]

I wanted to start with North America, just as it relates to the pivot to more complex solutions I guess two-part question, can you talk about how your customers are reacting to your shift and the second part is, is there a direct route for you to sell clinically complex or you're going to stay 100% through your existing network of distribution?

[Matt Monaghan:]

We look as our customers as great partners in this industry and Bob as you know and others I am sure know, there are nearly an infinite combination of product features that can be assembled to suit a particular individual's needs in terms of complex care. So we think we're very aligned with our customers in terms of putting very well trained clinicians and technical sales people Invacare setting, so we can really bring right to that conversation, the deepest level of understanding and dialogue about configurations and options that are available and we've already seen results in terms of our ability to quickly help patients in need we have some of the best products. At the end of the day, you need lots of people with wrenches and service centers and we don't do reimbursement in the United States. So we absolutely need that partnership with our customers and I think likewise they're very well served by us having more people in the field to help them solve patient's needs.

[Bob Labick:]

Okay. Great. And then can you give us an update on the sales force hiring and training? You mentioned that in the release in the call a little bit, how long do you think until, how long does it take to get the right number of folks on Board till you reach, so they become more productive or reach breakeven etcetera? What's the timing behind that?

[Matt Monaghan:]

Probably two parts to that answer, one is the hiring really started in April this year. The training was essentially done, the first bolus of training was done by August. So that's the first big cohort that moves through the system and effectivity is probably on average nine months let's say, six months if you have somebody who is quickly familiar with the product and goes to a familiar territory and if maybe closer to 12 months or someone who is familiar with the product, but is getting into a new territory. So on average let's say maybe nine month for effectivity, but then in terms of number of sales folks, there's that one cohort or big bolus that went through the system in second and third quarter, will continue to increase our sales team over the long term as we look at certain metropolitan areas that we want to saturate more deeply and we have other opportunities. But right now we've got the team largely in place on the complex rehab. As we mentioned on I think the prior call from last quarter, we're starting to use the same kind of work in our post acute care business, which has different customer call points and different product. So we're going to have another set of folks going through that program.

[Bob Labick:]

Okay. Great. And then shifting back to Europe for a second, you discussed little bit of mix change and then some higher SG&A that led to the operating income decline year-over-year. From the outside, how do we see that model that and what's the best way to model profitability of the European segment and eventually North America going forward?

[Rob Gudbranson:]

That's a good question Bob. So let me take a shot at it, it's Rob. On Europe I think one of the things I would really like to emphasize for the quarter is if you look at that operating income as a percent of sales, it was about 8.1%. Last year it was 9.7%. That was one of our best quarter ever in terms of percent. So I really want to make sure to emphasize that the team is doing well in the third quarter of 2016, clearly down. We're reporting it down and rightly so, but again I do want to emphasize that was very, very strong third quarter last year. The toughest thing probably as we look forward is we probably get some currency pressures that we're aware of. The euro is hanging in there reasonably well. If I look at the euro for third quarter this year versus third quarter last year, third quarter this year it was about $1.12, third quarter last year about $1.11 and right now it's trading I think $1.09 ballpark. So little more pressure there may be couple percent. The one that I think a lot of multinationals are looking at is the FX on the pound, that was $1.35 this quarter third quarter '16 versus $1.56 last year. So that's a big hit in terms of movement and cost us some money on translation, but also hurts us on transaction. So since then, this comes from $1.35 to I think it's $1.21 high today. So probably get another 10% pressure there. So I think if I were thinking about it from that way, I think again margins holding up reasonably well. The team is doing well. We got a new leader who hits the ground running. Those are all very good things. Got a little FX pressure, but given that we're not necessarily giving guidance at this point, I leave that to those maybe key points that we would make.

[Bob Labick:]

Okay. Great. Thank you.

[Matt Monaghan:]

Thanks Bob.

[Operator:]

And next we have James Sidoti with Sidoti & Company. Please go ahead sir.

[Jim Sidoti:]

Good morning. Can you hear me.

[Matt Monaghan:]

Yes Jim. Good morning.

[Jim Sidoti:]

Great. Great. So just following up on the consent decree, based on the fact you didn't really talk too much about it in your script and the commentary in the press release was pretty similar to three months ago. I assume that it's status quo hear you're continuing to work and that there were no major changes in the quarter, is that correct?

[Matt Monaghan:]

Yes absolutely, it's a big focus for us. I don't want it to be a distraction for folks that have to do other things. So we don't put it at the center of what we're discussing, but for folks that are working on it, it is good focus and progress along the way, where one of these interim quarters where we don't have a milestone we expect to cross.

[Jim Sidoti:]

All right and some of the changes you're making in Europe. Some of the new product that you're releasing in Europe, can we assume that once the consent decree is lifted, you'll be able to sell those products in the U.S. as well?

[Matt Monaghan:]

Yes I think there is a lot of opportunity for all these products globally. It turns out to fit on a European platform very immediately. So for example with LiNX we started that in July this year, great results so far.

[Lara Mahoney:]

And the Alber Twion product that Matt mentioned is the launch in North America. So we had a lot of great new products that we've launched over the past year really just from our subsidiaries that are now available across our entire North American sales force as part of the transformation of breaking down some of the various barriers that have previously existed in our subsidiary silos.

[Jim Sidoti:]

All right. And I know you don't want to get too specific on timing, but can you just give us a sense, do you think you'll be starting Phase two at some point in 2017?

[Matt Monaghan:]

Well Phase two of the transformation.

[Jim Sidoti:]

Right.

[Matt Monaghan:]

There isn’t a particular day on the calendar where one stops and the other ends. So if you think about the layers of transformation, we started broadly with the North American commercial team in July 2015 with a new compensation plan, the new focus on a subset of products. We started 2016 with even more emphasis on certain products that we wanted to move forward, more strong emphasis of other products. We started with hiring of sales team for more complex rehab part of the business in April and so you can imagine there is this stream of things that happen over the next several quarters in that business. In the second quarter, we started a similar process with our IPG business and that's got probably the same overall timeline, but that started in the second quarter this year as opposed to a couple of quarters earlier. So that will go through periods in 2017. Along the way through where we see subsidiaries and certain product lines that we can start increasing, we do that anyways and there are whole parts of our business that don't have to go through this transformation at all.

[Jim Sidoti:]

Okay. All right. Thank you.

[Matt Monaghan:]

Thanks Jim.

[Operator:]

[Gregory from Advisors] is up next. Please go ahead sir.

[Unidentified Analyst:]

Yes. Thank you. Hi Matt, Rob, Lara

[Matt Monaghan:]

Good morning, Greg.

[Unidentified Analyst:]

Just a couple questions, I did log on a little late, I hope I didn't miss anything there, but with respect -- two things, with respect to the gross margins particularly in North America, you two operations have been sold, but those operations are still there for the quarter. Can you give us an idea of how that will affect gross margins next year?

[Rob Gudbranson:]

So Greg, it's Rob. Just in the third quarter just to be clear, the rentals business was sold in July 02, 2015, So for all intents and purposes, it was gone. So we're not having an impact in the third quarter on the rentals business and Greg that was really the key one from the vantage point that it was very different business. It was exceptionally high gross margin as a rental business compared to our normal equipment business. Hitting the second business that's been sold to is the Garden City Medical, that was in for the whole third quarter, but again the apples to apples for the third quarter were pretty good and again going back to rental going forward, yeah we'll have to give some visibility to Garden City Medical going out, but their margins are not so different as the rentals was which was very high margin.

[Matt Monaghan:]

It was different in SG&A.

[Rob Gudbranson:]

So again I think we'll give visibility to that Greg, but again third quarter was pretty clean.

[Unidentified Analyst:]

Okay. And then with regard to R&D, give us some color as to how that affected the quarter if you could and what they're doing now that's increased that spending?

[Matt Monaghan:]

Yeah I guess there are two parts of it, obviously around the company we have many groups of engineers and engineering activities that are advancing our product portfolio and that at the same time especially in North America we have engineers working on design history file remediation and in this quarter we elected to keep the product portfolio enhancements going on at the same time emphasizing our effort to keep the commitments on our DHF remediation to make sure that's not as timely as possible. So we elected to do that which resulted in a slight increase in R&D. I don't know Rob if you want to talk a little bit more about that.

[Rob Gudbranson:]

Yeah I think a couple things, one, we were up in actual dollars spent and to Matt's point it was a mix. The majority was focused on North America and very much focused on the design history of file remediation, but also I would emphasize that there was a substantial portion, which was down in Asia Pacific that was focused too on new products. So again I want to make sure that we're really getting both pieces of that. We got to continue support the work on the CD and the DHF, but we are continuing to put money into the dollars into new products. That's really focusing on R&D dollars. Now let's talk about R&D percent, because the sales have come down substantially this quarter, the percent of having R&D still be slightly up was even bigger in terms of a headwind. So again I think right things to do. I don't think we want to necessarily cut back on R&D in this environment. We want to do the right things. We want to do the right things on remediation, but just mathematically it works out to be a little more headwind than you might expect. So we mentioned that in the release.

[Unidentified Analyst:]

All right. Thanks very much.

[Matt Monaghan:]

Good question. Thanks Greg.

[Operator:]

[Operator Instructions] We do have a follow-up question from Matt Mishan from KeyBanc. Please go ahead sir.

[Matt Mishan:]

Okay. Thank you. Just a couple of quick clarifications for me, what were sales at Taylor Street and then what were mobility and seating in North America HME up and if you could quantify those in the quarter?

[Matt Monaghan:]

Well mobility and seating we never really give specific level, just because of competitive reasons. As we said North America HME we were down in life styles, down in respiratory. Those were down pretty substantially and mobility and seating was up. It wasn’t up dramatically, but it was up, so that should cover that issue. The other question was Matt if you remind me.

[Matt Mishan:]

Yes, sales at Taylor Street.

[Matt Monaghan:]

That was about $9.9 million last year and I think last year similar time, it was about $10.9 million ballpark. So down a little bit, but I would emphasize that mobility and seating being up and again there are a lot of other areas where we're focused on moving those products. Clearly focused on Taylor Street but at the same time, those would be the two numbers.

[Rob Gudbranson:]

Like [Rody] for example, which fits in that same space at Taylor Street, but comes out of our motion concepts division, which isn’t reflected in that number.

[Matt Mishan:]

Okay. Got it. And then the QA RA cost in the quarter and if you could, could you quantify on a percentage of sales what exposure you do have to the pound?

[Rob Gudbranson:]

If I remember correctly, I think the $3.6 million is what we had for this quarter, which was down pretty substantially

[Lara Mahoney:]

From $5.3 million last year.

[Rob Gudbranson:]

Yes, we were down about more almost pushing $2 million down. So nice decrease there. In terms of percent of sales, really don't look at that per se on that basis. I think we really look at it as getting most value for the dollars we're putting to use and again we're really focused on making sure that John Watkins and the quality team have what they need to proceed. As we mentioned earlier, we also are focused on the fact that some of the spend needs to be in other areas like engineering, working on North America -- in North America on the design history files. So again it's a measure but it's not the only measure I focus on.

[Matt Mishan:]

Okay. Yes. I think I got mixed -- I think we got mixed up there. The other thing percentage of sales to the U.K. or the pound.

[Rob Gudbranson:]

Oh, sorry, sorry, I misread you. I thought you were thinking about some bench point. No, we haven't broken that out at this point Matt. So we've not given visibility to that, but I think it's important you're aware of the pressures and the fact that the GBP has gotten another 10% down from where it was before. I think that's part of the reason why you saw in the third quarter the fact that the currency was a headwind is really driven by the U.S. dollar GBP. So you might be able to back into a little bit, but at this point, we've not broken that up.

[Matt Mishan:]

Yeah. But given the size and the magnitude of the change in the Pound, could you at least help us out in trying to ballpark it for us.

[Rob Gudbranson:]

Ballpark what?

[Matt Mishan:]

Can you just try and ballpark the magnitude of that sales decline is significant. So if we could have any chance you can ballpark it on a percentage of European sales may be and any way you can help us out with that?

[Rob Gudbranson:]

Understood, we will give it some thought. It's not our biggest translation currency, so it's in dollars and Euros are ahead of GBP and we have a factory in Wales as people would know, but the mix of products that we consume in the GBP territory is bigger from outside of that factory. So we don't have that natural hedge.

[Matt Monaghan:]

I think the bigger issue Matt as well, the bigger issues is probably less of your translation, the translation is important and that it impacts us. I think the bigger issue is that the vast majority of what they buy comes from plants in euro land, plant in Swiss land for us and one coming out of Sweden among other exposure. So we hedge those as best we can, but when you get a big movement and we're looking at an additional year out, you obviously got to look at those hedges again. So the bigger issue Matt is probably less pure translation. It's probably more the exposure of the transaction.

[Rob Gudbranson:]

But already having an excess to that facility gives us as a management team a long-term option to optimize as best we can what's going to happen on with Brexit and the currency effect.

[Matt Mishan:]

Okay. That makes a lot of sense. Thank you very much guys.

[Matt Monaghan:]

Thanks.

[Operator:]

It appears there are no further questions at this time. I would like to turn the conference back to our presenters for any additional or closing remarks.

[Matt Monaghan:]

No. Thank you. Thanks to everybody for joining us this morning. We're endeavoring to communicate more fully with everyone, so they understand the context of the transformation. We've changed our earnings release call to today which we thought was a day where fewer companies release their results. We try to do webcast so that you can see a visual presentation in addition to just hearing us. We welcome your good comments and your support as we move forward. Thanks very much.

[Operator:]

This concludes today's conference. Thank you for your participation. You may now disconnect.