Invacare Corporation
Q2 2008 Earnings Call Transcript

Published: 24 Jul 2008

[Operator:]

Good morning ladies and gentlemen, and thank you for standing by. Welcome to the Invacare 2008 second quarter earning conference call. We are now ready to begin the call. Before I turn the call over to Invacare's Chairman and Chief Executive Officer, Mr. Mal Mixon, I would like to remind you that all phone lines have been placed on mute for the first part of the call. After the managements' view, we will open the call open for questions. This conference is being recorded, Thursday, July 24, 2008. I would like to turn the call over to Mr. Mal Mixon, Chairman and Chief Executive Officer. Mr. Mixon, you may now begin.

[Mal Mixon:]

Good morning and thank you very much. For today's call I have with me, Rob Gudbranson, Invacare’s Chief Financial Officer. I’d like to begin with our customary Safe Harbor statement that is 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. Results may differ materially as a result of the risk factors included in the company’s filings with the Securities and Exchange Commission and other factors on which the company has no control. I will now review Invacare’s performance in the second quarter ended June 30, 2008. Earnings per share on a GAAP basis for the second quarter were $0.20 per share, or $6.3 million net earnings as compared to earnings per share for the same period last year of zero pennies, or $100,000 net earnings. Adjusted earnings per share were $0.22 for the second quarter of 2008 as compared to adjusted earnings per share for the same period last year of $0.14. Adjusted net earnings for the quarter were $7 million versus $4.3 million last year. Adjusted earnings before income taxes for the second quarter were $10.9 million as compared to $5 million for the second quarter last year. A significant improvement in adjusted earnings before income taxes was a result of organic sales growth, cost reduction activities and reduced net interest expenses, which were partially offset by increased freight costs and higher commodity costs. Net sales for the second quarter increased 13.7% to $447.2 million versus $393.3 million last year. Foreign currency translation increased net sales by 5 percentage points, and acquisitions increased net sales by less than a percentage point. So, organic net sales for the quarter grew 7.8% over the same period last year driven primarily by performance in North America/Home Medical Equipment and Europe. Reflecting the improved stability of sequential improvement of this business segment, the North America/Home Medical Equipment organic net sales increase of 10.4% for the quarter represents third consecutive quarter-over-quarter increase. European organic net sales grew 7.8%, primarily due to volume increases achieved in most regions with the exception of Germany, where reimbursement and pricing pressures adversely affected sales levels. The company’s strong organic sales growth and cost reduction initiatives allowed us to achieve significant earnings improvement from last year as well as sequentially from the first quarter. Cost reduction and selective price increases continue as top priorities in order to offset commodity cost increases, which have been incurred on a global basis. Second quarter free cash flow strengthened as a result of increased earnings to a positive $11 million for the quarter compared to negative $24 million in the first quarter of this year. With continued increase in profitability and improved working capital management in the second half of the year free cash flow is still projected to be strong for the year. With that, I will turn it over to Rob to review additional financial highlights of the first quarter.

[Rob Gudbranson:]

Thanks Mal. Good morning. I’ll provide more detail on the operating performance for the company, and then the reported segments followed by a cash flow and balance sheet review. Gross margin as a percent of net sales for the second quarter was lower by 0.2 percentage points compared to last year’s second quarter due to increased freight costs and commodity costs, as well as unfavorable product mix in Europe and discounts associated with higher sales to national providers in the North American HME business. These negative factors were partially offset by cost reduction activities, which generated benefits in the second quarter of $4.8 million. I would point out, however, as compared to the first quarter of 2008 gross margins as a percentage of net sales improved by 0.6 percentage points driven by increased volumes and cost reduction initiatives. Selling general and administrative expense increased 11.4% to $104.5 million in the second quarter, compared to $93.9 million in the second quarter last year. Excluding foreign currency translation and acquisitions SG&A expense increased only 4.4% when compared to the second quarter of last year and that was primarily due to increased bonus and bad debt expense. The company had a higher effective tax rate in the first half of 2008 as compared to the projected rate for the full year 2008 due to the mix of our earnings by country. Specifically, the company could not record tax benefits related to losses in countries which had tax valuation allowances, such as the U.S., while normal tax expense was recognized in countries without tax allowances, in particular Europe. For the quarter ended June 30, 2008, North American HME net sales increased 12.3% to $187.2 million, compared to $166.6 million in the same period last year, driven primarily by sales increases in all principal product lines. For the second quarter, North American HME earnings before income taxes were $7.6 million excluding restructuring charges of less than $0.1 million pretax as compared to earnings before income taxes of $3.0 million last year excluding restructuring charges of $0.4 million pre tax. The substantial increase in earnings before income taxes was primarily the result of increased volumes and cost reduction initiatives partially offset by discounts associated with higher sales to national providers for both the Respiratory and Standard product lines. Invacare’s Supply Group net sales for the second quarter increased 2.9% to $64.5 million compared to $62.7 million for the same period last year driven by an increase in home delivery product -- program sales, increased sales volumes with larger providers and growth in the infusion business. Earnings before income taxes for the second quarter decreased to $0.2 million, as compared to $0.5 million last year, primarily as a result of discounts associated with higher sales to larger providers as well as higher freight costs. Institutional Products Group net sales for the first quarter increased 7.8% to $23.2 million compared to $21.5 million last year. Foreign currency translation increased net sales by 2 percentage points. Earnings before income taxes for the second quarter increased to $0.5 million, excluding restructuring charges as compared to $0.3 million last year, primarily as a result of volume increases and favorable foreign exchange rate movement of the Canadian dollar. In the second quarter, European net sales increased 22.5% to $146 million versus $119 million last year. Foreign currency translation increased net sales by 15 percentage points. For the second quarter, earnings before income taxes were $10.3 million, excluding restructuring charges as compared to $7.8 million last year, excluding restructuring charges. This increase in earnings is attributable to volume increases, cost reduction initiatives and a weakening U.S. dollar. These benefits were partially offset by higher freight costs, an unfavorable product mix towards lower margin product and unfavorable foreign currency impact from the weakness of the British pound as compared to the euro. For the quarter, Asia Pacific net sales increased 13.1% to $26.3 million. Foreign currency increased net sales by 9 percentage points. The net sales improvement was the result of volume increases in the company's distribution businesses in the region and at the company's subsidiary which manufactures microprocessor controllers. For the quarter, earnings before income taxes were $1.1 million, excluding restructuring charges as compared to a loss of $0.6 million last year, again excluding restructuring charges. This increase is attributable to volume increases and continued cost reduction initiatives. As previously announced, the company's cost reduction initiative to move manufacturing from New Zealand to China is on track and nearing completion. Invacare reported $11.4 million of free cash flow in the second quarter of 2008 as compared to the second quarter of 2007 free cash flow of $16.4 million. The decrease is principally due to increased purchase of the property -- the decrease was principally due to increased purchases of property and equipment in 2008 and increased working capital needs due to higher sales. While net cash provided by operating activities was comparable in each period, receivables and inventories were both a drain on operating cash flow during the 2008 second quarter by approximately $19 million and $4 million respectively. The receivables increase is primarily due to higher than expected sales during the second quarter. Inventories increased in the second quarter primarily in the Asia Pacific region to support future sales initiatives and as a result of its outsourcing efforts. I would point out, however, that the DSOs and inventory turns both improved. Days sales outstanding were down 2 days to 60 days versus the second quarter 2007. And inventory turns at 4.9 improved compared to 4.7 as of the end of second quarter 2007. Total debt outstanding was $526.2 million at the end of the second quarter, resulting in a debt-to-total-capitalization ratio of 46.6% versus 48.2% at the end of the first quarter. The company's debt outstanding decreased by $12.5 million compared to the end of the first quarter. The company's leverage ratio is calculated for bank covenant purposes, improved approximately 3.73 times in the second quarter versus 4.96 times at the end of the second quarter last year, a substantial improvement. I refer investors the company’s earnings release to review the definition of free cash flow and some of the adjusted earnings items mentioned above by both Mal and me. You can find the release at Invacare’s website. I will now return the call back to Mal to review Invacare’s guidance for 2008 and to make some concluding comments. We can then address questions.

[Mal Mixon:]

Thanks Rob. I’d now like to review Invacare’s guidance for 2008. Organic growth in net sales of 5% to 6%, excluding the impact of acquisitions and foreign currency translation adjustments, and this has changed from previous guidance of 4% to 5% in the first quarter earnings release. An effective tax rate of 25% on adjusted annual earnings. The company expects that its effective tax rate for each period in 2008 will fluctuate depending on the mix of earnings between countries with and without tax valuation allowances. In the first half, the company could not record tax benefits related to losses in countries which had tax valuation allowances, while normal tax expense was recognized in countries without tax allowances. This led to a higher effective tax rate in the first half than projected for the year since the company projects to improve its performance during the year in countries with tax valuation allowances, as well as in countries without tax valuation allowances. Each quarter, the company expects to experience a sequential decline in the effective tax rate. Adjusted earnings per share of $1.35 to $1.50 remain unchanged. And free cash flow between $40 million and $45 million. We’ve changed this from $40 million and $50 million in the first quarter earnings release due to the higher sales which has caused higher working capital needs associated with those sales. The company continues to execute on its plan for the year, despite global commodity cost increases and increasing reimbursement pressure in Europe. To compensate for rising commodity costs, each of the company’s segments has already completed or is implementing planned selective price increases and freight policy changes for the third quarter. As previously communicated, in 2004 the U.S. Congress mandated that The Centers for Medicare and Medicaid Services or CMS establish a national competitive bidding program for certain items and services in the Medicare Modernization Act of 2003. Following this mandate, CMS established a plan -- a phase one program for national competitive bidding in ten metropolitan areas, which was scheduled for implementation on July 1, 2008. A Congressional review of the program identified risks and inequities in the program, resulting in Congress passing a new law on July 15, 2008 requiring CMS to delay implementation of the program by 18 to 24 months. This action avoided serious disruptions to patient service and provider stability. In addition, high end rehab power wheelchairs and accessories, where Invacare is the market leader, were excluded from any future national competitive bidding program. Further, this new law eliminated a provision of the Deficit Reduction Act of 2005 mandating that beneficiaries assume ownership of oxygen equipment after 36 months of use. This change not only reduces a significant risk to chronic obstructive pulmonary disease patients, but also reduces the risk to providers of investing in new oxygen therapy delivery technologies where Invacare has been the industry leader with products such as the HomeFill oxygen systems and the XPO2 portable oxygen concentrator. These legislative changes are expected to improve the business outlook for the HME industry and Invacare in 2009 and beyond. In order to offset the cost of this delay, Medicare reimbursement to Invacare’s customers for the product categories that were included in the phase one of the now delayed national competitive bidding program will be cut by 9.5% nationwide in January 2009. The product categories impacted were

[Operator:]

(Operator Instructions). Your first question comes from the line of Eric Gommel with Stifel Nicolaus.

[Eric Gommel:]

Good morning.

[Mal Mixon:]

Good morning, Eric.

[Eric Gommel:]

Yeah. I was curious; I believe some of those price increases that you’ve passed on to customers, I believe were effective July 1st, I’m curious have you been able to gauge the reaction at this point relative to your customers and also maybe how your competitors are responding to that?

[Rob Gudbranson:]

Eric, it’s Rob. I’d say a couple of things. One, it’s early still. We have heard from a number of competitors or through our providers, who heard that a number of competitors are either filing or have said they will file; some have said, they’re going to increase on August 1; others have already done freight increases; some have had selective price increases too. So, we haven’t heard anything dramatic. But again, we’ll have to let that time past and see what we get further on than just July 24th.

[Eric Gommel:]

And then, I’m curious relative to your customers, how much do you think the, I guess, goodwill that you’ve generated in your strong opposition of some of the reimbursement stuff and you participated in lobbying efforts might help you from a competitive standpoint if at all relative to your customers stand loyal to you as a manufacture, do you think that has an impact?

[Mal Mixon:]

I think our customers look to Invacare to represent them at Washington. Most of our customers are small independent providers and they don’t have the money to hire their own lobbyist. The larger companies like Apria, Lincare have representation. And all of this work together really for the good of the industry. We have a trade association, the American Association of Homecare that has strengthened in the last couple of years. And really, we work together as a team. I think my customers very much appreciate what Invacare does in Washington. It’s hard to quantify, but I’ve got many, many e-mails and notes and thank you for what’s happened in the past and what’s happened recently, and we continue to fight for the industry and will continue to do so in the future.

[Eric Gommel:]

And then my last question, and I’ll jump out back into the queue. Relative to your -- you’ve annual guidance and I think the last two quarters there has been a wide variance in the quarterly estimates from Street. I’m curious at what point you might consider giving quarterly guidance and can you give us any color on your expectations maybe for the third quarter?

[Rob Gudbranson:]

Well, I guess I’d say the following Eric, I think we’ve been pretty consistent in the recent past that we prefer to do annual guidance. I think it’s something we continue to discuss internally and there might be a day, I know in the path long ago we used to give -- the most recent quarter and annual guidance. But right now, I think we feel the best way to inform the Street and now try to micromanage the communications is just to keep to annual. I think we’ll stay there for now. In terms of giving color on the third quarter, I guess the answer is we’re just going to give annual. It’s really hard to do that.

[Mal Mixon:]

Eric, just to add to Rob’s remarks, the estimate is the same estimate we gave at the conclusion of 2007, the same we gave when we announced that Rob Gudbranson was joining the Company, the same we gave at the end of the first quarter and it remains the same at the end of the second quarter.

[Eric Gommel:]

Okay. Good quarter guys. Thanks.

[Rob Gudbranson:]

Thank you, Eric.

[Mal Mixon:]

Thank you.

[Operator:]

Your next question comes from the line of Joshua Zable with Natixis.

[Joshua Zable:]

Hey guys, thanks very much for taking my call and congrats on a really, really impressive quarter here.

[Mal Mixon:]

Well, thank you.

[Joshua Zable:]

I have a couple of questions. First some good stuff and then I’m going to be a little nitpicky, because obviously with more good stuff, it’s -- we’ve got a fine stuff to look for here. So, first on the sales, could you just talk about, I mean sales was particularly impressive and given the fact you’ve taken up your sales guidance, I would imagine this past quarter was probably one of large uncertainly out there. I know obviously competitive bidding only affects the 10 MSAs, but obviously it was a huge focus for the entire homecare community. Can you just talk about sort of how you guys drove that kind of sales? I mean obviously with your outlook, is it share gains, is it people feeling better about their business in the homecare industry, or is it a combination of both?

[Mal Mixon:]

Well, first of all, we have put together a really outstanding management team in this division. And they are doing one hell of a job. It took us a while to get our supply lines balanced from China. Today our product availability is in the 95% plus in-stock. We adjusted our pricing last year to be competitive with the imports. We’ve come out quietly with a lot of new and improved products and new price points. The quality is probably the best in Invacare’s history. At a time when our competitors are weakening, I think our customers appreciate what we’re doing in Washington. And we’ve really got an outstanding team growing. The two cities that were to experience competitive bidding, we did in fact see a significant slowing of sales in those ten cities, or orders I should say, because customers were very uncertain whether the thing is going forward or not. The losers didn’t want to buy and the winners were afraid to buy. So we had mentioned previously this wasn’t a material event for our results and I think our results for the second quarter show that it was not a material event. But that’s behind us now and those cities are growing back to normal. Clearly, we believe we’re taking share of market, but it’s still a healthy market. And we also believe that there’s the little impact from the previous policies where a rental equipment like beds and standard wheelchairs become the -- owned by the patient after 13 months and those don’t go back into rental, so that providers are buying more new products. But all in all, it was consistent across the line in standard products and our rehab division and concentrators and HomeFill in Europe and Australia and Canada, a really robust order period. And we’re obviously hopeful that this will continue and I think Rob has put an estimate of increase just a little bit to more than 5 to 6% range.

[Joshua Zable:]

And then I guess just as a quick follow-up along those lines. I mean anecdotally, I know the delays sort of just happen, so it’s probably difficult to gauge. But anecdotally, from your sales people or what not, do you feel like in general the industry is kind of breathe the sigh of relief here and maybe is kind of going back to business a little bit, or was it really just affecting those ten MSAs? I know obviously a very small part of your business now those guys are going back to business as usual, but everybody else is kind of just humming along as they were?

[Mal Mixon:]

Yeah, I think most of the country, it has been business as usual. I think those 10 cities were different and unique, and there is a huge sigh of relief in those 10 cities and the next 70, which would have happen July of 2009, certainly heave the sigh of relief, although their business had continued normally. So, I think overall this lifts a big cloud off the industry. No ones for certain what this means in the end, but only President Bush and his administration have really been pushing this policy, and number of my lobbyist feel that with a new President and a new Congress we have a chance to remove it permanently. But for now, we’ve got 2.5 years of breathing room where the only thing that can happen would be these ten test sites would rebid, but under completely different rules on a completely different set of conditions. So, any way you look at it, our industry is very thankful that Congress listen and they are paying for it. The industry is paying for it with a 9.5% reduction in the first quarter of January of next year. So, this wasn’t a gift. The industry said, look, we’ll pay for it, but let’s pay for it in a different way. We don’t have these horrible 26% cuts in these products rolling out across the country eliminating 70% of the customer. So, to me, it’s just -- it’s a wonderful thing that’s happened here and the industry can hopefully live a little more normal life now for the next couple of years.

[Joshua Zable:]

Great. And then just getting back to the 9.5% cut, obviously you guys are putting some price increases through. So, obviously I imagine that shouldn’t affect your business given that you’re seeing price increase. They all know what’s coming. I imagine they’re just probably figuring out how to do higher volumes and not push back on prices, is that a safe assumption?

[Mal Mixon:]

Well these aren’t huge price increases. I think everyone is aware of what’s happening out there with gasoline and steel, aluminium, plastics. We are seeing it throughout industry and I don’t feel our customers feel we’re trying to gouge them. We’re simply trying to cover these escalating costs and I believe that the price increases are going in smoothly. We did put a small increase in, in January, so this is our second one this year. But they are not huge price increases. And we had to do it and we decided that we would take whatever consequences result from it. But so far, I think our customers have been pretty understanding about it.

[Joshua Zable:]

Okay. And then just on those costs, obviously you guys alluded to that obviously affects the margin, you guys have reiterated your guidance for the year a little bit higher sales. Is it safe to assume that, I guess, obviously the price increases are going through, but the material costs are a little higher, so that’s kind of where we’re getting -- we’re getting more sales than we thought and maybe a little bit higher cost than we thought, is that kind of the right...

[Mal Mixon:]

I think the way you should look at it is that we’ve set out and gave you a plan for the year and we didn’t plan on these -- the extent on the escalating costs, but we’ve offset those escalating costs with price increases, which really brings us back to the original promises that we’ve made. Rob, do you want to add any further color to that?

[Rob Gudbranson:]

No, it’s a good answer. And the only thing I’d say, Josh is, yeah, maybe for the math, you can ultimately assume if we’ve got a little more in the sales line and margins suffering a bit, but Mal is right. I mean we’ve targeted to put price increases through that would offset the cost. But again, you see that we’re sequentially improving the gross margin, and your model it might be that it’s not quite a strong of margin as you originally had.

[Joshua Zable:]

Great. And then final question and thanks so much for taking them. Just on the free cash flow, just nitpicky. I imagine lowering the free cash flow due to higher volumes is a high class prompt to have, is that...

[Rob Gudbranson:]

Yes.

[Joshua Zable:]

-- everything is good there, just higher volumes than expected?

[Rob Gudbranson:]

We would agree. And especially, I mean, I think we feel lot more concerned if we’ve seen something happening on DSOs and turns, but we’ve improved both. So, I think we are managing it pretty well. But with the higher sales we do have some more working capital needs. But we’re very alert to the fact that we want to deliver two things to shareholders, EPS and free cash flow. So we’re targeting to still be in the range, but we had to bring down the top a little bit just in light of what you said, the high class -- a high class problem.

[Joshua Zable:]

-- when you’re trying to refinance with the banks at some point whenever that is?

[Mal Mixon:]

Well, the banking industry right now is certainly in a state of flux. And thank goodness we got our financing done in the first quarter of ‘07. But we expect some time next year hopefully to be in a much stronger position to talk to our banks about a refinancing and Rob, I’ll let you comment any further on that.

[Rob Gudbranson:]

I mean, it’s all -- I think if we continue to perform as we’ve done in the last couple of quarters, we’re clearly going to get to a point where we would be able to refinance; the issue is going to be whether the markets are there. So, we’ll have to wait and see.

[Joshua Zable:]

Right. Well, guys, thanks so much for taking my questions. Really congrats on a great quarter, especially in a very difficult environment, and great job getting competitive bidding away. We all appreciate it.

[Mal Mixon:]

All right. Thank you.

[Operator:]

Your next question comes from the line of Peter Larson with Columbia Management.

[Peter Larson:]

Good morning.

[Mal Mixon:]

Good morning.

[Rob Gudbranson:]

Good morning.

[Peter Larson:]

Just a few things here. With respect to bad debts, they’ve been in line with expectation and do you consider yourself reasonably adequately reserved for them?

[Rob Gudbranson:]

Pete, it’s Rob. Yes, we do. We feel we’re very good position and Ian Live has reviewed it very thoroughly with us. The issue and the reason why we increased some of the bad debts specifically in the quarter is related to an account that we referenced in the first quarter in our 10-Q that we had a large exposure to. We put some more money against that. I think it was the right conservative action to take and we feel we are covered on that account between the liquidation value and the additional reserves. We actually feel very good where we are sitting today.

[Mal Mixon:]

Also, I would add, this is Mal, by removing competitive bidding. I think that also removes a risk overhang on the industry from losing bidders that now won’t occur.

[Peter Larson:]

Okay. And my recollection is cost cutting -- cost cutting continues unabated through the balance of the year?

[Rob Gudbranson:]

Yes, we did 4.8 million in the -- in terms of our cost reduction projects in the second quarter, and we’re doing sort of six months with 8.5 million. That plan was originally back-end loaded for the full 20, but we’re on schedule for that. It’s going well. Clearly, Pete, we had to go with some pricing increases in light of steel, aluminum, freight and then the other thing, which I’d mentioned on the first quarter which is very important too is when you’re buying from primarily China and the RMB continues to strengthen, you get a lot of pressure from local manufactures that they want to raise rates too just because of the RMB. So...

[Peter Larson:]

Right.

[Rob Gudbranson:]

We’ve got a lot of pressure on those fronts. So I wouldn’t -- the 20 million is still intact, but clearly we have to put another piece of the puzzle in, in light of some of these cost increases.

[Peter Larson:]

In the marketplace have you seen any competitive response to HomeFill that’s worth anything?

[Mal Mixon:]

I think HomeFill continues to be attractive as an alternative, particularly with these rising freight costs and cost of delivery are growing up, up, up, and our homecare system is a non-delivery model. I was particularly concerned about this equipment transfer requirement. It’s -- you’re talking about a 2000, $2500 item, and 22% of patients go past 36 months. So, the providers, even the extent to which we’ve sold today know that about 20% of their units would -- ownership would have passed to the patient. So, we’ve now gotten that removed and I think that’s a very positive development for HomeFill. So, I think the outlook for technology is absolutely outstanding both for our HomeFill unit and our portable concentrator. We’ve also introduced the world’s lightest 5-liter portable concentrator at 6 pounds. And we’re excited about being the market leader, having commanding share of market and we have other new products planned down the road in the next two years to solidify and strengthen our position in that area.

[Peter Larson:]

So, there is nobody out there that’s come out with a unit that is competitive at the same level of HomeFill?

[Mal Mixon:]

Well, interestingly enough, we -- I think we still have about 95% market share. So...

[Peter Larson:]

Okay.

[Mal Mixon:]

You have a couple of competitors that really haven’t -- haven’t really taken hold. Our unit is by far and away outstanding. And I might add, Pete that, we had one little company in Taiwan that knocked it off and we were able to get through the courts to get injunction against the Company. They filed a complaint with the patent office, and we just recently not only won the case, but we were allowed four new claims, four new patent claims on our HomeFill. So, I think it’s pretty well protected, and we’re continuing to develop and improve the technology. Patents slow and impede, they don’t stop anyone. So, we’ve recognized we got to stay on top, technologically ahead, and so we’re pretty bullish on this technology, where it’s headed.

[Peter Larson:]

And I know the debt levels are up there, and I know your plan in the short-term is to pay down debt. But when is the point in which you might consider acquisitions?

[Mal Mixon:]

We’ll probably do a couple of little small ones this year, nothing material. Our covenants, as they currently stand, broaden our ability to make acquisitions beginning January of ‘09. And we’re still looking at some of our assets that we might want to redeploy by paying down some debt. So, we’re -- we’re working to get that debt back down to where we are a gold class borrower with the banks, so we can get our rates down and get rid of some of these, hopefully got out in the market and recapture some of that high yield debt with just a revolver debt and swap it.

[Rob Gudbranson:]

And Pete, I’d just add that agreeing with Mal here what we -- what we’re key focused on is again that free cash flow number two, because that gets our debt to a position where we will, as Mal said, be able to be low enough on our leverage covenant that we can continue to have an increase. That leverage ratio is what drives how much acquisition we can do. So...

[Peter Larson:]

Right.

[Rob Gudbranson:]

We’ll continue to improve that and we’ll have more flexibility.

[Mal Mixon:]

I think, for every negative thing that happens to you, there’s something good times comes out it. I think the fact that we couldn’t make many acquisitions the last two years has made us really focus on what we have and really start to bringing out cost and improving performance. And really, I think you see in this news release, our businesses are all starting to improve and add profit to the corporation. And so, we really want to get our house back in order before we think of again on an acquisition trail.

[Peter Larson:]

Okay. Thanks.

[Mal Mixon:]

Thank you.

[Operator:]

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

[Gregory Williams:]

Good morning everyone, and thanks for taking my call. Can you just talk a little bit about the reimbursement pressures you mentioned in the script in Europe? Is this like increased competition or your government pair countries facing budgetary pressures or something else there?

[Rob Gudbranson:]

Greg, it’s Rob. In Germany, we’re seeing a couple of different things. That typically is very a price competitive market. There have been some pricing pressures, particularly in certain product lines. We’ve seen some decrease in terms of complexity of some of power wheelchairs, so the reimbursement stream focused on sort of lower ASP product or maybe a little -- little defeatured. So we’ve seen some of that. And then additionally, Germany is -- I wouldn’t want to use the term competitive bidding, per say, but Germany also has an attempt leading into ‘09 to try to get the providers to, as opposed to the U.S. where you sort of bid and didn’t know you’ll get where they actually put some specific amounts of wheelchairs or back lifts or some other products out there for the providers to compete on, and if you have the right bid, you get it. So, there has been a combination of pricing pressure from both those aspects, both from the reimbursement side and then additionally some of the products become defeatured. So, something we’re dealing with and will continue to deal with.

[Mal Mixon:]

Greg, the nice thing about Europe is, it’s not like America, where we have a national policy that affects all 50 states. DC is still run country-by-country, and we’ve never had a reimbursement problem that affected all of Europe. We have these little issues in various countries from time-to-time, and currently, there’s a German issue, but very robust markets in other areas. So, all in all, not a serious problem.

[Rob Gudbranson:]

And then to build on Mal’s comment, again, we would like to make sure to play everything else, so we don’t surprise investors and analysts. But the takeaway is, you see how strong Europe performed. I mean, the constant dollar to 7.8 and we performed in every other major region, basically every other country. So, it was very strong quarter for Europe and they’re to be congratulated.

[Gregory Williams:]

Okay. Yeah, I see that. I mean it was impressive organic growth there. So you’re saying Germany is more of an isolated event?

[Mal Mixon:]

Yes, yes.

[Gregory Williams:]

Okay. Great. And then just another question. I know it’s more of a 2009 and beyond story, but are there any updates into entering the sleep market?

[Mal Mixon:]

We are hard at work on R&D trying to develop products that will be exciting to the marketplace not just a me too product. And we don’t really have any set timetable at this point. But Invacare has far from given up in this market. It’s been a bit of an irritant to me that that we haven’t been successful as I’d like to see it. Frankly, the only product category where we’re not a major player and when you look at the massive distribution capability we have, there is really no reason that over time Invacare should be a player. And secondly, I don’t know if you’re aware of the changing role that diagnostics may have where you’ll be able to get a diagnosis in the home rather than going to a sleep center now that the sleep physicians obviously will fight this and want to get their fees. But as technology improves with the device where it automatically adjusts to the apnea event of the patient during the night and there are some really sophisticated in-home diagnostic testing equipment now. There’s a movement, I believe, report that over time you won’t have to go to a sleep lab. But we’re a long way from getting there. But nevertheless, Invacare hopes to be a player, but any projections that you’ve seen or talk to Rob about have nothing to do with sleep.

[Gregory Williams:]

Okay. So you’re saying there’s no sleep sales really baked into ‘09 numbers?

[Mal Mixon:]

No. We haven’t given any...

[Gregory Williams:]

Well, you haven’t ‘09, that’s right. But -- okay, definitely not for ‘08 then?

[Mal Mixon:]

No.

[Rob Gudbranson:]

No, not for ‘08 and we’re still working going forward. As we get further along, we’ll be able to give you more color, Greg, but not today.

[Gregory Williams:]

Okay. Sound good. Thanks guys.

[Rob Gudbranson:]

Thank you.

[Operator:]

Your next question comes from the line Jason Rodgers with Great Lakes Review.

[Jason Rodgers:]

Good morning guys. Congratulations on the good results.

[Mal Mixon:]

Thank you.

[Jason Rodgers:]

The -- do you have the numbers for HomeFill? What it -- the percentage increase or decrease in the quarter?

[Mal Mixon:]

You know, really, we don’t care to keep breaking out our individual product categories any longer. And the sales have been kind of up and down because nationals will be in and out, and right now, we have one national account that’s a major buyer of such things making a major conversion there. They’ve told me they have eliminated over 100 trucks and drivers so far by putting in our systems. And -- but overall, when the year is over, our HomeFill sales will be significantly improved over last year, and -- but we’re not breaking that out any further any longer.

[Jason Rodgers:]

Okay. And any early indications on the XPO2? I know it’s early in the process, but...

[Mal Mixon:]

It’s a little too early and also, we’re waiting our FAA approval to carry it on the airplanes. But early reaction to it has been very positive, and it’s not going to be a material event for the Company, but it’s a nice profit margin. I think that all of portable concentrators probably only make up 3% penetration of portable patients so far. So the future of portable concentrator really lies ahead. But we’re excited about it and we will have other new products to add to the line as we go forward in the next 18 months. So we expect to be the clear leader in oxygen technology.

[Jason Rodgers:]

Okay. And do you have a -- what’s the interest rate on your debt was for the quarter?

[Rob Gudbranson:]

The blend was about 7%, Jason. That’s all -- that’s all the debt including the high yield.

[Jason Rodgers:]

Okay. And regarding the price increases, I don’t know if you have a range of increases that you implemented?

[Rob Gudbranson:]

It’s really hard to answer that, because yeah, we’ve got so many, as you can see from our segment break out. We’ve got so many different divisions, so in terms of giving you a number it really wouldn’t even be meaningful.

[Jason Rodgers:]

And you -- but do you think that they have fully offset the raw material price increases or...?

[Rob Gudbranson:]

We’ve targeted to get ourselves back to where we were.

[Mal Mixon:]

Obviously, the price has to carry for the balance of the year, but our early indications are that they are holding and have not been a problem, and that was the case in the first quarter with the small increases we put in effect.

[Jason Rodgers:]

Okay. And finally, looking at the 9% cut in January -- beginning January ‘09, I just wondered if you had an estimate of what’s the impact to your sale would be?

[Mal Mixon:]

Yeah. Whatever we say at point would be conjuncture. Our pricing is driven more by competitors and competitive action really than by the customers. Our customers always want lower prices and better deals, and I think that now that we’re positioned competitive with our foreign competitors, we’re hearing a lot of noise from them that their costs are going up, the freight cost from China, the floating won. So I -- my feeling is our competitors don’t have a lot of room to go lower and that’s more of a factor than the actual cut. So, I can tell you that our outlook is a lot more positive with a 99% cut across the board than with the 26% cut in 70 MSAs next year.

[Rob Gudbranson:]

As a potential, correct.

[Mal Mixon:]

Yeah.

[Rob Gudbranson:]

And Jason, we haven’t given any guidance for ‘09 yet. So it’s really hard to answer for your question beyond a -- sort of a qualitative answer Mal gave.

[Jason Rodgers:]

Okay. Thank you very much.

[Rob Gudbranson:]

Thank you.

[Operator:]

Your next question comes from the line of Tom Lewis with Century Management.

[Tom Lewis:]

Yes, good morning guys.

[Rob Gudbranson:]

Good morning.

[Mal Mixon:]

Good morning.

[Tom Lewis:]

I just kind of following up on just a -- I was hoping you could help us to think about the impact of why 9.5% reimbursement cut, on the surface isn’t this dyer as it sounds, could you remind us how much of your business is Medicare, and tell us what you understand about the degree to which where is Medicare, whether it’s normal for Medicare to be picking up the whole check or just maybe what amounts to a co-payment that might go up or something like that and does Medicaid play into these markets as well?

[Mal Mixon:]

Keep in mind that we are once removed from these reimbursement cuts...

[Tom Lewis:]

Yeah, that I understand.

[Mal Mixon:]

Yeah, we sell two providers.

[Tom Lewis:]

Yes.

[Mal Mixon:]

And they bill Medicare 80% of the cost and they bill the patient called the co-pay, 20%. I don’t have the exact statistics, but we believe the industry revenue strength overall is roughly a 40% Medicare; a 10% Medicaid; 40% private insurance; and 10% cash and carry or other. However, with the Medicare advantage plans, you have more Medicare patients starting to enroll into the private Medicare Advantage program. So the Medicare percentage may in fact be lower than that in terms of direct billing to Medicare. One can assume overtime that -- not instantly, but overtime, Medicaid tends to look at what Medicare policies are to set their reimbursement, and private insurance have generally negotiated rights based on volume. So this is a system that’s been in effect for a long time, there is really no significant change, there is a lot of pressure by Congress all across the whole Medicare system to try to reduce payments. And last year, we were effective in preventing any further cuts and really this year again, we will be -- we were successful because we were dealing with something that was legislated several years ago that happened this year. And I’m not saying every single customer out there is -- our customers aren’t excited about a 9.5% reduction, nobody could be, but compared to this program that -- let’s see a message created which they call competitive bidding that they much preferred to have that cut, and something they can plan on and deal with, and I think a lot of our providers are already starting to look at how they can pay cost out of theirs just like Invacare has, and how they can be more efficient and at the same time Invacare offers multiple price points on various products. So, really we have the most cost effective products in the world, and we have the best products in the world. So we served the whole continuum of care and that’s a rather long way to answer, but I hope that’s helpful to you on the market.

[Tom Lewis:]

Yeah, it is. It is. Just one little midpoint there though, the 20% reimbursement, is that something that’s mandated by Medicare or is that just kind of the way the market works out?

[Rob Gudbranson:]

I think, Tom, if I heard you right, you were saying that you’re referencing the first 10 MSAs in the 26% cut?

[Tom Lewis:]

No, no, no. When you -- to the extent that there is co-payment on...

[Mal Mixon:]

The co-payment.

[Tom Lewis:]

That’s a Medicare, is that 20% because Medicare said so, or is that 20% because it’s kind of the competitive market -- I’m -- what I’m getting at is that’s something that...

[Mal Mixon:]

It’s because the Medicare has -- it’s because Medicare said so.

[Tom Lewis:]

Okay.

[Mal Mixon:]

That’s the law.

[Tom Lewis:]

Yeah, fine.

[Mal Mixon:]

And you’re required, you’re required to attempt to collect it, but you’re not required to collect it.

[Tom Lewis:]

Okay.

[Mal Mixon:]

Which means you have to go out and try to collect it, but if a person is totally emergent and has no money.

[Tom Lewis:]

Right.

[Mal Mixon:]

Then you still have the right to live on the 80% charge, now again on the old days, if you go back to the industry I think our customers were a little bit careless about collecting the 20% but today they really work hard to collect it and I think you’re going to understand why with the cuts.

[Tom Lewis:]

Okay. That’s all very helpful as far as understanding how your products gets to where it’s needed, and thanks a lot it’s a pleasure watching you guys execute.

[Mal Mixon:]

Thank you.

[Rob Gudbranson:]

Thank you.

[Operator:]

Your next question comes from the line of [Joel Hogan] with Banc of America.

[Joel Hogan:]

Hey, guys. Congrats on a good quarter.

[Mal Mixon:]

Thank you.

[Joel Hogan:]

You mentioned the quality of your products recently and that it’s the best that has been, are there any concerns with China and there were a lot of other companies have -- had issues and quality controls over there, what are you guys doing to prevent that?

[Mal Mixon:]

Well, I think that’s the bit of misnomer, we’re finding that our China quality is every bit is good if not better than anything we can do in the United States or Mexico or Europe. The Chinese are very, very dedicated to build a good product. A lot of people think that you can only put commodity kind of products in China, it’s not true we’re building some of our most complex engineered products there such as HomeFill, our Concentrators, our Motorized Wheelchairs, and I just got back from China recently where we just completed our second new factory there. We’re moving our electronics from New Zealand to China; and the quality again on those -- on those electronics are absolutely outstanding. And I’m not talking about just feel good quality, but statistically measured quality. So that is not an issue for Invacare maybe for other companies, but -- but not for us.

[Rob Gudbranson:]

And just what one other addition there is, we spend a lot of time with -- we have a Hong Kong purchasing office to focus on the -- this items that we source to, so we got a lot of people who have feet on the ground in addition to our own manufacturing we have people to follow up on suppliers, so I wouldn’t say -- wouldn’t say absolutely perfect everywhere, but we’ve got the ability to jump in quickly and finish your race.

[Mal Mixon:]

We probably have 40 to 50 qualified suppliers in that region, qualified meaning that we can go into their factories and approve their process on the floor -- on the ground and not have to do incoming inspection, back here or in our factories. So what’s evolved over the last there years that Invacare has changed from an integrated manufacturer to primarily the assembly now because these parts and components like motors and gearboxes and so forth are being built in China and shipped to our factories all around the world. And for example, our Concentrator, a key component is a compressor, so we went to our supplier and they built a factory right next to our factory. So the exact same compressor that we were buying in the U.S. is they were building in China and shipping about 200 yards down the street to our factory. So we’ve had outstanding results with quality in China.

[Joel Hogan:]

That’s great. Good news. And another question, given the increase in gas prices, as well as simply the increasing cost of keeping trucks up and cost of tires and everything else. Do you guys expect to see an increase in HomeFill?

[Mal Mixon:]

Depreciation is acquired. Honestly, the economics of HomeFill are to me a very compelling and rather than have me tell you about it, you might want to call Larry Higby and Apria, who is our largest customer and yet -- get their perspective on it. And Rob could give you some names of other customers -- smaller customers around the U.S., if you are interested. They can tell you why they’ve made the change and how the economics are playing out for them. But the issue is mainly one of -- how do you transition from one system to the other a lot of companies have sub-cost, they are very profitable, and they have got a heavy investment and the old way of making oxygen and the issue is how do you transition to the new way. And a lot of our customers today are people who weren’t in oxygen before they moved into it, because HomeFill allows them to offer an exciting product to patients and referral source, so there is still a lot of doctors out there -- they don’t even know about the technology. So, we are trying to do our best to educate the physician community to what’s good for their patients, and -- but clearly the gasoline cost spiral is increasing delivery cost, and I believe overtime it will be beneficial to our HomeFill systems.

[Joel Hogan:]

Okay. Thanks.

[Operator:]

There are no further questions at this time. I will now turn the call back to you, Mr. Mixon for any additional comments.

[Mal Mixon:]

I will just wrap up by saying I appreciate your questions and we've had a good quarter. We expect to complete the year as we have stated in the outlook and we look forward to talking with you again at the end of the third quarter.

[Rob Gudbranson:]

Thank you.

[Operator:]

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