Invacare Corporation
Q1 2015 Earnings Call Transcript

Published: 23 Apr 2015

[Operator:]

Good morning ladies and gentlemen and thank you for standing by. Welcome to the Invacare 2015 First Quarter Conference Call. I will have to remind you that all phone lines have been placed on mute for the first part of the call. After the management overview, we will open the call for questions. This conference is being recorded on April -- Thursday, April 23, 2015. I’d now like to turn the call over to Lara Mahoney, Invacare’s Director of Corporate Communications and Investor Relations. Please go ahead.

[Lara Mahoney:]

Thank you, Kyle. Joining me on today’s call is Matthew Monaghan, Invacare’s President and Chief Executive Officer; and Rob Gudbranson, Senior Vice President and Chief Financial Officer. We will begin the call with the customary Safe Harbor Statement that this conference call may include statements regarding anticipated or future developments that are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are those that describe future outcomes or expectations that are usually identified by words such as should, could, plan, intend, expect, continue, forecast, believe, and anticipate and include for example, any statements made regarding our future results. Actual results may differ materially as a result of inherent uncertainties and risks, including the risk factors described in our Form 10-K and other filings with the Securities and Exchange Commission and in our earnings release, and we refer you to those risks factors. We may not be able to predict and may have little or no control over the factors or events that may influence our financial results. Also of note, except for free cash flow, the financial information for all periods excludes the discontinued operations of Altimate Medical Inc., the Company’s former manufacturer of stationary standing assistive license for use in patient rehabilitation, that are divested on August 29, 2014. Altimate was a part of the North America Home Medical Equipment segment. On today's call, we will focus on the highlights of the quarter as opposed to covering all the detail which you can read in the release that was issued earlier today. In particular, I’d refer investors to our earnings release to review the definitions of free cash flow and some of the adjusted earnings items which will be mentioned during the call. You can find the release and access to our SEC filings at www.invacare.com. I’d now like to turn the call over to Matt Monaghan.

[Matthew E. Monaghan:]

Thank you, Lara, and good morning. I started at Invacare as President and Chief Executive Officer on April 1, 2015. I believe that Invacare is in a market with significant opportunity in light of the industry’s compelling fundamental drivers, positive demographic trends and the proven clinical and financial benefits of homecare. And I’m excited to be here. But before we discuss some of my initial impressions, I’d like to review the Company’s consolidated first quarter 2015 results. Excluding the impact of unfavorable foreign currency translation, the Company delivered net sales growth of 2.3% compared to the first quarter of last year driven by increases in European, North America, in Chile, Asia Pacific segments. Gross margin as a percent of net sales for the first quarter of 2015 was lower by 0.5 of a percentage point compared to the first quarter of last year. Excluding the incremental warranty expense of $2.2 million or 0.7 of a percentage point, related to the joystick recall that was recorded in the first quarter of 2014, gross margin as a percentage of net sales for the first quarter of 2015 decreased by 1.2 percentage points as compared to the first quarter of last year. This decline was primarily driven by unfavorable foreign currency transactions and sales mix. As a result to the previous cost reductions and a continued focus on reducing selling, general and administrative costs, SG&A expense decreased by 16.1%, to $81.2 million for the first quarter of 2015 compared to $96.8 million for the first quarter of last year. Foreign currency translation reduced SG&A expense by $5.2 million or 5.3 percentage points. Excluding the impact from foreign currency translation, SG&A expenses decreased 10.8% compared to the first quarter of last. In the first quarter of 2015, adjusted net loss per share was $0.21 compared to an adjusted net loss per share of $0.52 for the first quarter of 2014. The reduction in adjusted net loss for the first quarter of this year was driven primarily by lower SG&A and warranty expense, partially offset by unfavorable foreign currency impacts and a reduced gross margin in part due to unfavorable sales mix. Free cash flow was negative $23.7 million in the first quarter of 2015 compared to negative $8.7 million in the first quarter of 2014. This difference was principally due to $9.1 million in benefit payments related to the 2014 retirements of two executive officers of the Company and to increased accounts receivable driven primarily by net sales growth, excluding the impact of foreign currency translation. I’ll now turn the call over to Rob, to discuss additional financial results for the first quarter.

[Robert K. Gudbranson:]

Thanks, Matt. All the references to earnings or losses before income tax exclude restructuring costs. Excluding the impact of foreign currency translation, net sales for the European segment increased 4.3% in the first quarter of 2015 related to improvements in all three major product categories. For the first quarter of 2015, earnings before income taxes decreased $2.1 million compared to last year, primarily attributable to unfavorable foreign currency impacts and reduced gross margin driven in part by unfavorable sales mix. Excluding the impact of foreign currency translation, net sales for the North American HME segment increased 1.3% in the first quarter of 2015 due to improvements in all three major product categories. Loss before income taxes improved by $8.5 million compared to the first quarter last year, primarily driven by volume increases, improved manufacturing costs, lower warranty expense and decreased SG&A expense. The reduction in SG&A expense was primarily related to reduced employment costs, depreciation and amortization expense, and consulting costs, including regulatory and compliance costs. The loss before income taxes for the first quarter of 2014 compared to 2015 had $2.7 million in discrete items, including an incremental warranty expense for the joystick recall of $1.3 million and increased expense of $1 million related to the retirement of an executive officer and an additional $400,000 related to bank fees. Excluding the impact of foreign currency translation, net sales for the Institutional Products Group segment decreased 4.1% in the first quarter of 2015 driven primarily by declines in sales of beds and case goods. The decline in bed sales was due, in part, to lower availability of beds during the Company’s supply chain transition. Earnings before income taxes improved by $500,000 largely attributable to reduced SG&A expense, which was mostly driven by reduced employment costs and depreciation and amortization expenses, partially offset by volume declines. For the first quarter of 2015, excluding the impact of foreign currency translation, Asia Pacific net sales increased 1.9% attributable to volume increases in the New Zealand distribution business and at the Company’s subsidiary that produces microprocessor controllers. This was partially offset by volume declines in the Australian distribution business. For the first quarter of 2015, losses before income taxes decreased by $1.6 million. It is worth noting that the first quarter of 2014 included an incremental warranty expense of $900,000 related to the joystick recall. The reduction in loss before income taxes is largely attributable to lower warranty expense, volume increases and lower SG&A expense that was primarily driven by a lower employment costs and depreciation expense. Total debt outstanding which includes the convertible debt discount as described in the release was $24.7 million as of March 31, 2015. The Company’s total debt outstanding consisted of $7.1 million drawn on the revolving credit facility, $13.4 million in convertible debt and $4.2 million of other debt. During the first quarter of 2015, borrowings on the revolving credit facility ranged from a high of $35 million to a low of $7 -- a low of $4 million with the ending balance of $7.1 million. The Company’s available borrowing capacity was $38.5 million as of March 31, 2015. I’ll now turn the call back over to Matt for few closing comments. We can then address questions.

[Matthew E. Monaghan:]

Thank you, Rob. As I mentioned earlier, I believe that Invacare is in a market with significant opportunities and led the industry’s compelling fundamental drivers. I’ve been in medical devices for nearly 20 years starting with General Electric’s medical systems division and carving out of division from Baxter Healthcare, while working with Texas Specific Group and most recently leading Zimmer’s Global Hips Division and Reconstructive Research focusing in orthopedics. Healthcare is a vital part of the economy and it is fundamentally growing in every area of the world. With a push to new [ph] patients out of acute care settings, more and more technologies are moving into the home and long-term care environments. This is Invacare’s strength. And I think my advantage being new to the Company is having a fresh perspective on how we can differentiate ourselves both in technology and services, so we can meet these market needs. However, the way forward, it is not necessarily the way to the past. We need to make changes in key areas of our business in order to take advantage of this growth. In particular, I believe that the North American business needs specific attention to deliver improved financial results. My direct involvement in the business will be critical. And with that in mind, I’ve made a leadership change and now will run the North America HME and IPG businesses directly on interim basis. Turning around to North American business is one of two key priorities for our long-term success. My most important priority is to establish a sustainable quality systems culture that clearly demonstrates the spirit and the [indiscernible] of the U.S FDA requirements and allows us to exit the injunctive phase of the consent decree with the FDA. My preliminary review of our quality system improvements is that our associates are making good progress on the key quality implementation plans that will help us achieve sustainable compliance. I’m familiar with many of the quality systems consultants that the Company has engaged. I believe the Company has a clear vision of its plan forward. As CEO, I’ll ensure the teams to prioritize it appropriately. Over the next 90 to 100 days, I’ll be getting grounded on the fundamentals of our business in developing a plan to move beyond the injunctive phase of the consent decree and accelerating the financial results of the business. The short-term initiatives must happen in order for us to move forward. Beyond that we will be looking at how to take advantage of the great markets in which we operate, we’ll involve our main stakeholders in this strategic process. It’s an exciting time to the Invacare. I want to thank everyone for their time and attention on today’s call. We will now open the phone lines for questions.

[Operator:]

Thank you. [Operator Instructions] We will take our first question from Bob Labick with CJS Securities.

[Robert Labick:]

Good morning.

[Lara Mahoney:]

Good morning.

[Robert K. Gudbranson:]

Good morning.

[Robert Labick:]

Good morning. Hi. Matt, congratulations on your new role.

[Matthew E. Monaghan:]

Thank you, Bob.

[Robert Labick:]

I wanted to start with one of the last points you raised. You talked about a management change, are you stepping on a interim basis in North America, HME and IPG, was this part of the plan all along or what precipitated it and do you still tell us a little bit more about how it came about?

[Matthew E. Monaghan:]

This was not necessarily part of the plan. Obviously, I have an on boarding plan focused proportionally on the most important parts of the business. North American performance is clearly one of the most important part and it’s vital that we get better performance out of that segment. This is simply a delayering, so I’ve got unfettered access to the functional leaders in that area and I can quickly get an understanding at, help make improvements [ph] directly.

[Robert Labick:]

Okay, great. And it’s probably unfair given your 22 days in office so far to ask, but do you have a timetable for as opposed to specific IMs [ph] that you’re going to address, the timetable for a turnaround in these areas?

[Matthew E. Monaghan:]

I’ve got an internal objective of 90 to 100 day plan which will be a full long-term strategy for the business, but that will be the plan to get the most important things going as we move in.

[Robert Labick:]

Okay, great. And then, Europe obviously there is the FX headwind, but performance has been fantastic in the 4.3% organic growth is very, very strong. You mentioned it was across all segments, but could you talk a little bit more about the key drivers there and if they’re sustainable throughout this year and what you’re looking for not numbers specifically, but on a go-forward basis for this strong growth?

[Robert K. Gudbranson:]

Bob, a couple of things really focused on the fact that we have a very strong team over there. I think we’ve mentioned before that number of the key, I’ll call them country, and business managers who’ve been with Invacare for quite a while and even more importantly in the industry for long time. So again, we have very strong management team. I think the 4.3% organic growth which you indicated was an indication of that team performing. I’d also emphasize that even with the FX pressures, if you look at the earnings before tax margin prior year first quarter, it was about 6.7% of sales and it was 5.9% this first quarter. So although that was down, given again the pressures they’ve got on some of their transactions, purchases on Asia, I think the team is doing well. In terms of looking forward, again we’re relying on that team, but as you know we’re really not giving guidance, but we feel the team is in good position. The one thing I just add which I think people are aware of, but I think its important to just reemphasize is we mentioned in the yearend release we think that there is pressure on currency in the first quarter, the euro was approximately about a buck 18 for first quarter of 2015. And I think we all know that it’s trading at 107 today. So we obviously have more work to do as a management team to offset that pressure and work hard on that, but that is pressure out there that we’re aware of.

[Robert Labick:]

Okay, great. Thanks. And then, one more and I’ll jump back. Could you give us an update just, I guess, regulatory basis on House Resolution 284 as it relates to the binding bids or competitive bidding, if this passed how it might impact your business?

[Lara Mahoney:]

Well, its great news, Bob. I mean, this is the first time Congress is addressing one of the flaws of National Competitive Bidding. Unfortunately the language as I currently stated that the changes for contracts must not be implemented any earlier than January 1, 2017 and not later than January 1, 2019. So, the next opportunity for this [indiscernible] bid build to be influencing on the competitive bidding process would be really the round two reason [ph] that’s effective in 2019, though the industry is working hard and hopeful that will be what influence around one really bid later this year, but --so it’s great for the industry, but we have a little bit of time here before it will have an impact.

[Robert Labick:]

Okay, great. Thanks very much.

[Matthew E. Monaghan:]

Thanks, Bob.

[Operator:]

We’ll take our next question from Matthew Mishan with KeyBanc.

[Matthew Mishan:]

Great. Thank you for taking my questions.

[Matthew E. Monaghan:]

Good morning, Matt.

[Matthew Mishan:]

Hey. I guess excluding Taylor Street in North America HME segment, it looks like you’re no longer comparing against the large home fill order and you’re over a year into national competitive bidding and I believe that the health comps were flat there versus double digit declines pretty much all of last year. You think you’ve reached a floor in the underlying business?

[Matthew E. Monaghan:]

Lara, I guess have said a couple of things. One, you heard it completely right. [Indiscernible] the organic declines last year, they were difficult and then she said they were double digits. So, we’re glad to see the organic growth to 1.3% in North America HME segment. I think at this point a data point of one probably makes a tough line to draw. But I would say we’re very focused on the fact that we need to show that we can grow that business to ourselves, to our associates and to our shareholders. But again, I think we’ll celebrate where we are right now and then we will see how we do going forward this year as we report.

[Matthew Mishan:]

And how did the expansion of the Probasics brand contribute in the quarter?

[Matthew E. Monaghan:]

Matt, that’s very early still. I think indicated in the last call or at least in a number of different forms that it’s going to take some time to rollout those products and get them fully through the Invacare systems, for the Invacare sales force, the single user strategy for benefits of other participants on the call is a good one. I think that we had pressure in that category of lifestyle, but again it’s going to take some time. So I’d say its too early to really judge that yet, particularly given the fact that the port delay out in the West Coast really kept us getting some into [indiscernible]. So very early on phase on that still, but we’re working hard on that project.

[Matthew Mishan:]

Okay. In last quarter you had talked about actions around complete handling as far as the consent decree goes. Can you give us an update on some of the progress you’ve made maybe around the complaint handling?

[Matthew E. Monaghan:]

Without getting too deep into the details there and there are a lot of details. I’ll say the team is oriented towards a streamline process and we’re making really good progress on moving forward in Phase III of our quality improvement program.

[Matthew Mishan:]

Okay. And I also believe you have a new wheelchair that was under consideration that you’re going to be marketing potentially under your motion concept subsidiary. Have you gone forward with that? And if so maybe comment on short-term and longer term strategic positioning there versus necessarily your resumption in Taylor Street?

[Matthew E. Monaghan:]

Sure. I think what you saw we’re referring to is the extreme max share [ph] from our Motion Concepts business headquarter in Canada. It’s a great production ready concept chair. As you know Motion Concepts makes best in class seating and they make those with various OEM basis, and that combination that you saw that’s really great attribute. We’re not quite ready to bring that production, but we think there is a lot of opportunity there and that represents the fundamental technological pipeline that Invacare has continued to have despite the consent decree.

[Robert K. Gudbranson:]

The only thing I would add to that Matt just to give a little bit of clarity, is the base actually will be manufactured by a third party. They’ll be responsible for that base, but in terms of both its performance and in terms of its compliance. And then Motion will use the seating. So as Matt said, this is very typical for Motion that will do the power seating, they’ll do the seating on the product, and they’ll put -- marry that with the base from a third party. We just want to make sure that’s clear. If we move ahead with that that’s how it will be responsible.

[Matthew Mishan:]

Okay. And then last question for me before I jump in the queue. What were the QARA costs in the quarter?

[Robert K. Gudbranson:]

Good question. I think we were $4.7 million in terms of our performance -- our spend in Q1, 2015. And I should emphasize for callers that’s a combination of corporate and our home medical equipment business, that’s not worldwide QARA spend, but it’s the number we normally reference on these calls. So its $4.7 million this year, Q1 last year; for your benefit Matt it was $6.3 million. So we’re down which we mentioned in the release.

[Matthew Mishan:]

All right. Thank you very much and welcome, Matt.

[Robert K. Gudbranson:]

Thanks, Matt.

[Operator:]

We’ll take our next question from Jim Sidoti with Sidoti & Company.

[Jim Sidoti:]

Good morning. Can you hear me?

[Matthew E. Monaghan:]

We can, Jim. Good morning.

[Jim Sidoti:]

Great. So, lets just start with -- usually the decline in QA expense in the quarter. I assume it’s a decline in consulting expense. Can we read anything into that in terms of progress you’re making towards a consent decree? Is the fact that you have less consultants in the house now mean that you think you’re closer, and what's the next milestone?

[Robert K. Gudbranson:]

I think I guess, I’ll focus on the following Jim. I think we tried real hard during the last year to make sure our spent is the right spent. So, I think we saw some decline towards the end of Q4 last year and that’s continued at this point. I wouldn’t necessarily read into the spend whether that tells you anything about the timing. I think the important thing for the shareholders is we’re trying hard to do the right things, spend the money wisely, you’re supposed to just spend money and add a lot of consultants. I think the other thing is an indication we’re trying over time to make sure we have stronger associates internally so that associates owners [indiscernible] by the way and not third-party players. But in terms of reading between the lines and timing I think the answer is we’re just trying to be smart on our spent.

[Jim Sidoti:]

Okay. So I assume the next milestone would be the start of that third audit?

[Robert K. Gudbranson:]

The third -- you’re talking about the third party consulting and third party external audit?

[Jim Sidoti:]

Exactly.

[Robert K. Gudbranson:]

Okay. Yes, those are the next steps and again in terms of timing, we’ll not going to talk about that today. But I can guarantee both Matt and our focus are getting to that as quickly as possible.

[Jim Sidoti:]

And will you let us know when that audit starts or will you wait until it’s completed to let us know?

[Robert K. Gudbranson:]

No, I think we’re going to wait in terms of committing to any sort of timing until we have better visibility, but my guess is will probably be when we complete. But let’s wait and see how we get through that as opposed to committing to any terms of communication to that.

[Jim Sidoti:]

Okay. And then on the IPG Group, the supply issue that you referenced. Is that something that will continue to impact you in the second and third quarter or was that a one time event?

[Matthew E. Monaghan:]

Well as you know we’re transitioning bed production among facilities and affiliates and suppliers, and we’re in the ramp up phase of that. So, we expect to out of that as volumes ramp up through that new source of supply and we think we should be in the normal range accretive.

[Jim Sidoti:]

Okay. And then in terms of the improvement in the sales out of the Taylor Street, was that – what happened there. Was there more reorders of outdoor chairs or what prompted that?

[Matthew E. Monaghan:]

Yes, just for the benefit of the people on the call, and we have the ability under our Taylor Street facility even though we’re in injunctive phase of the consent decree. We have the ability to still do replacement product and additionally new orders coming through and as long as those are clearly medical necessity and a verification of medical necessity assigned. So I guess the reaction I would have is, we had some uptick which is good. I think it’s really Jim, more than anything an indication that we’re sort of in a steady phase but I’d also remind everybody we’re drastically down from where we were, because injunctive phase has impacted us substantially. So when I think about our unit volume coming to North America HME we start of floating depending on the quarter in sort of the 10% or 11% level from where we were back in 2012. That’s a substantial hit and why we’re very focused in getting through that.

[Jim Sidoti:]

All right. And then the last question, just on general terms, the European business has done very, very well in the past five quarters or so. Now what's the big difference there with the HME business in North America? Is it primarily just the fact that you can't ship the out of Taylor Street, and if you could do you think you would have similar results in U.S?

[Matthew E. Monaghan:]

A couple of things. One, I think both businesses are good long-term businesses. I think I’d have to say very clearly, that yes that’s a huge impact. I think we’ve shared on earlier calls that the sales through Taylor Street were in vicinity of a $174 million before this all started and got down to I believe last year around $43 million, so a huge impact in terms of the sales line. I know we don’t breakout margin, that’s a very profitable piece of us. So we have work to do to obviously get out of the injunctive phase with the consent decree. I would be very forthright though, Jim that we also had pressures on lifestyles which is why we talked about the need for a better single user product line and the Probasics brand. So, there are things that picks beyond just mobility and seating but clearly that’s a huge impact.

[Jim Sidoti:]

Do you have similar pressures in Europe or is it not an issue there?

[Matthew E. Monaghan:]

They are still listed in a row. First of all they’re performing well in power. We have a German assembly plant that continues to manufacture and assemble, and that business is doing well. Additionally on the lifestyles, there are some pressures there, but I think generally that marketplace and the performance of the team has been strong. So again, are there pressures throughout all medical devices in terms of the reimbursement and pricing pressures, yes. But I think the answer is we have more to fix say in North America, but these issues are important issue worldwide.

[Jim Sidoti:]

And do you think in North America the pressure is at least leveled off or do you think you’re continuing to see more pressure in 2015 and 2016?

[Matthew E. Monaghan:]

I think Jim, we’ll show you performance over time as opposed to necessarily project going forward but clearly we’re focused on trying to deliver that improved performance on both those fronts.

[Jim Sidoti:]

Thank you.

[Matthew E. Monaghan:]

Thanks, Jim.

[Operator:]

[Operator Instructions] And we’ll take our next question from Gregory Macosko with Montrose Advisors.

[Gregory Macosko:]

Yes, thank you. Yes, welcome aboard Matt. I’m pleased to hear you’re taking a fresh perspective.

[Matthew E. Monaghan:]

Good morning, Greg. Thanks.

[Gregory Macosko:]

Yes. Just with regard to the SG&A and restructuring. Clearly the SG&A was down a lot, but compare that with respect to how much is kind of core and ongoing and obviously a lot of that is related to the FDA and all that. But can you give us a sense of, it was relative to the $1.1 million restructuring charges, are those restructuring ongoing and are we still -- are we seeing some, any kind of a consolidation on the SG&A line relative to that?

[Robert K. Gudbranson:]

Well, Greg lets just start and revisit where we’re at. We’re down I think approximately $15.6 million on reported SG&A and over $10 million on organic. I think we’ve done some important things including last August the reduction in force that was very critical. It was a fun decision but I think it was important one for the management team in May. I think we’ve done the right things on that front. I think additionally you heard a minute ago that the QARA cost though it was still $4.7 million for corporate and HME were down from $6.3 million first quarter last year. So I think we’re doing all the right things. I think with Matt here we’ll continue to look at what SG&A makes sense. And we’re going to manage that particularly in light of some of the currency pressures we talked about to make sure that we’re doing the right things and spending the right money. In terms of really saying what's core SG&A today, I think that’s going to depend a lot on how we do on the top line too. So, I think we’ve done the right actions. I think the team is very focused on not spending any more than we can really afford. And when you look at the performance of the adjusted operating income or I’ll call it say adjusted earnings, we really lowered that loss substantially, and more work to be done.

[Gregory Macosko:]

Okay. And then with regard to Asia Pacific was up 1.9%. Talk about the micro-processing there. I knew that, that’s an area where you supply yourself as well as external. Could you talk about kind of what is driving that business, are we external sales growing or is it more internally driven?

[Robert K. Gudbranson:]

They’re doing fine on the external front. Greg, I think for them really to turn and if we really look at the critical number for that in a group Asia Pacific we really need to get back to being able to order and from North America HME for the joysticks for the micro-processor. So I’d say it’s very clear in online that part of fixing Asia Pacific is to continue to get through the injunctive phase of the CD. I think we’ve made some progress on distribution businesses in terms of profitability, but we’ve got some more room to move there too. So I think we’ve made progress in both businesses but I have to say very clearly to really fix the business of the micro-processor controller division, its going to be critical to get out of the injunctive phase of the CD in North America.

[Gregory Macosko:]

Thank you.

[Robert K. Gudbranson:]

Thanks, Greg. End of Q&A

[Operator:]

And it appears we have no further questions in queue at this time. I would now like to turn the conference back over to Matt Monaghan for any additional or closing remarks.

[Matthew E. Monaghan:]

We’d like to thank everybody for their time and attention today during the call. Rob, Lara and I are available for any follow-up questions. If you have any, please let us know. Have a good day.

[Lara Mahoney:]

Thank you.

[Operator:]

And this does conclude today's conference call. Thank you all for your participation. You may now disconnect.