Invacare Corporation
Q2 2015 Earnings Call Transcript

Published: 23 Jul 2015

[Operator:]

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

[Lara Mahoney:]

Thank you, Lisa. Joining me on today’s call from Invacare are Matthew Monaghan, our Chairman, 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 subsidiary which manufactured stationary standing assistive devices for use in patient rehabilitation, and was divested on August 29, 2014. Altimate was a part of the North America Home Medical Equipment or HME 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 earnings release that was issued earlier this morning. In particular, I would refer investors to the released to review the definitions of free cash flow and the adjusted earnings items which will be discussed during the call. You can find the release and access to our SEC filings at www.invacare.com. I will now like to turn the call over to Matt Monaghan.

[Matthew E. Monaghan:]

Thank you, Lauren. Good morning. Since joining the company in April, I’ve been traveling throughout North America and Europe to meet our associates, customers and people who use our products. These experiences have validated my belief that Invacare has significant opportunities in-light of the industries compelling fundamental drivers. Positive demography trends in the markets we serve and the proven clinical and financial benefits of home care. As a CEO, I’ve spent the last few months, focusing the organization on two critical priorities. Our first priority is building a strong sustainable quality culture throughout the company. The second priority is generating profitable growth. There are a number of transition activities underway to make that happen, primarily in the North America HME segment, where we are aligning the team to execute. We’ve also positioned ourselves for the future by adjusting our capital structure and narrowing our focus on our long-term strengths as evidence through the real estate sale and leaseback transaction completed in April and the recent divesture of the United States rentals businesses. Before I talk more about our short-term focus and strategy, I would like to review our second quarter 2015 financial results. First let’s review the segments. Our European business, which comprises our full portfolio including mobility and seating, lifestyle and respiratory products at constant currency net sales growth of 2.9%. With the on-going pressure of foreign exchange, net sales declined 16.7% compared to the second quarter of last year. The Asia/Pacific business grew constant currency net sales by 6.7% with growth in both the New Zealand and Australian distribution businesses. Foreign exchange rates reduced net sales by 16% to negative 9.3% on a reported basis compared to the second quarter last year. Now, I’ll cover the two North American segments, where we are focusing most of our transitional activity. In the second quarter, the Institutional Products Group completed the supply chain transition of its long-term care beds facility, driven by increases in bed sales as well as interior design projects, the segment achieved 6.9% constant currency net sales growth and 6.1% reported net sales growth, compared to the second quarter last year. The North American HME business, which is being realigned to achieve its full potential experienced a net sales decline of 10.5% on a constant currency basis and decline of 11.4% on a reported basis compared to second quarter last of year. To offset the sales decline during the quarter, the team continued to manage expenses and still reduced its adjusted net loss $6.2 million compared to the second quarter last year. On the company’s consolidated results constant currency net sales decreased 2.1% for the second quarter compared to the same period last year and decreased by 12.4% on a reported net sales basis compared to last year. Overall, adjusted net loss per share improved to $0.23 from $0.39 last year. The reduction in loss was driven by the decrease in SG&A expense of 17.7% to $82.5 million compared to $1.3 million last year. Foreign currency translation reduced that SG&A expense by $7.3 million or 7.2 percentage points, constant currency SG&A expense decreased 10.5% compared to the second quarter last year. Gross margin as a percentage of net sales was lower by 1 percentage point compared to the second quarter last year, this was driven by unfavorable foreign exchange, freight costs, and negative sales mix. Manufacturing costs were favorable. I’ll now turn the call to Robert Gudbranson to discuss earnings performance for the segments and additional financial results for the second quarter.

[Robert K. Gudbranson:]

Thanks, Matt. All the references to earnings or losses before income taxes exclude restructuring costs. For the second quarter of 2015, earnings before income taxes in the European segment decreased $6.1 million compared to last year, primarily due to unfavorable foreign exchange and reduced gross margin which was driven in part by negative sales mix. For the North American HME segment loss before income taxes improved by $6.2 million compared to the second quarter of last year, the reduction in loss f or the quarter as driven by a favorable SG&A expense from lower employment costs and by an improved gross margin as a result of favorable manufacturing and warranty costs. For the Institutional Products Group, earnings before income taxes improved by $1.8 million largely due to favorable SG&A expense, primarily related to lower employment cost and depreciation and amortization expenses. For the second quarter of 2015, Asia-Pacific loss before income taxes decreased by $1.4 million, the reduction in loss before income taxes was largely due to favorable SG&A expense driven by lower employment cost into favorable gross margin driven by lower warranty and freight cost. In the second quarter, free cash flow was positive of $9.5 million compared to negative $8.6 million in the second quarter of last year. The second quarter free cash flow was favorably impacted by $23 million received as a result of the real estate sale and leaseback transaction announced in April 22, 2015. Excluding the cash proceeds from the sale leaseback transaction free cash flow was negative $13.5 million. Free cash flow was unfavorably impacted by increased inventory levels and a $1.9 million payment related to the 2014 retirement of an Executive Officer of the company. Total debt outstanding which includes the convertible debt discounts as described in the release was $49.5 million as of June 30, 2015. The company’s total debt outstanding consisted of zero drawn on the revolving credit facility, $13.4 million in convertible debt and $36.1 million of other debt principally lease liabilities, which increased by approximately $32.3 million as the result of the sale leaseback transaction. During the second quarter, borrowings on the revolving credit facility ranged from a high of $32.9 million to a low of zero with an ending balance of zero. The company’s available borrowing capacity was $46.9 million as of June 30, 2015. As of the end of the second quarter, days sales outstanding were 49 days up from 45 days as of December 31, 2014, and equal to 49 days as of June 30, 2014. At the end of the second quarter, inventory turns were 4.7 down from 4.9 as of December 31, 2014, and down from 4.9 as of June 30, 2014. I will now turn the call over to Matt for some closing comments and then we can address questions.

[Matthew E. Monaghan:]

Thank you, Rob. Since April we've implemented multiple initiatives to advance the company’s two priorities establishing an enhanced quality culture and generating profitable growth. And the first priority remains in progress towards establishing a sustainable enhanced quality culture throughout the organization. I’m very pleased with the working progress of the cross functional teams on our quality implementation plans. While we are not talking about timing of the third-party certification audit, but want to assure you that establishing a strong or corporate quality culture that will enable us to exit the injunctive phase of the consent decree is the number one priority of the organization. To achieve our second priority of generating profitable growth, we are realigning the folks of the team particularly in the North American HME segment as part of it I’ve recently appointed Dean Childers as the Senior Vice President and General Manager of the North America/HME and IPG segments. I worked with Dean for over 10 years in both private equity and medical device organizations. He has a proven ability to assess the company’s strength and opportunities and link customer needs with innovative solutions. I’m glad to have him as part of our team. During my travels I’ve met many customers as well as people who use our products who complement the innovation and technology behind Invacare’s medical devices. We truly do make a difference in people’s lives and market this growth. This reinforces the opportunity ahead of us we are committed to achieving the company’s full potential. I’m pleased to be moving forward on this journey of recovering growth. I want to thank everyone for their time and attention on today’s call. We’ll now open the phone lines for questions.

[Operator:]

[Operator Instructions] And we will take our first question from Matt Mishan from KeyBanc.

[Matthew Mishan:]

Great. Thank you for taking my questions.

[Matthew E. Monaghan:]

Good morning Matt.

[Matthew Mishan:]

Good morning. I’ll start off with in the press release you mentioned that there were transitional issues in North America/HME, could you elaborate on this?

[Matthew E. Monaghan:]

I wouldn’t say transitional issues as a full stop sense. Obviously the company is not in the place it needs to be for financial performance, so we have a number of transitional items underway, we’re looking at all parts of the organization if you go down the financial statement and look at how we generate revenue and how we incur cost in our manufacturing facility, what we’re doing in engineering and so on. It’s a full assessment of how are we orienting ourselves to generate more profitable growth and establish quality culture throughout the company as quickly as possible.

[Matthew Mishan:]

Okay. I just wanted to get a sense of first quarter you were flattish in North America/HME and last year you kind of got a sense that would have marked the bottom of the sales comparisons, what drove the double digit decline in North America/HME in the quarter?

[Matthew E. Monaghan:]

I think there were number of issues in the transition related to sales force focus, reorienting our priorities, the kind of assessment that teams have to do to determine what we're planning on doing and then realign with what we’re now planning on doing going forward. I would also talk about the lifestyle single user product line transition which continued through second quarter that was somewhat hampered by longer duration deployment of inventory, because of the West Coast port strike which didn’t allow that inventories to come in, there were a number of minor issues like that that cumulated to that decline.

[Matthew Mishan:]

Okay. And you also mentioned increased inventory levels, what is driving the increased inventory levels?

[Matthew E. Monaghan:]

I think part of the increased inventory levels were new forecasting for the single user lifestyle products and then a fair amount of inventory that was stuck in transits through the transition of those products to North America including that West Coast port strike.

[Matthew Mishan:]

Okay. And just last question for me on the consent decree, I know you didn’t want to talk about the timing of but are the third party auditors would return, have you given them notice that you like them to come back at some point over the interim and where you add as far as your thinking are we close to bring them back?

[Matthew E. Monaghan:]

We are completely focused on building this culture and a lot of things underway and I’m not going to talk about the presence or absence of auditors or other artifacts along the way because I think they just don’t have any positive predictive value on the timing or a likelihood of an exit any point in time. So I appreciate everyone’s curiosity, I can absolutely assure you it is the number one thing we are focused on, but really not going to talk about those details until there something that has that positive predictive value we’re looking for.

[Matthew Mishan:]

Hi great. I will jump back in queue. Thank you.

[Matthew E. Monaghan:]

All right, thanks Matt.

[Operator:]

And we will take our next question from Bob Labick from CJS Securities.

[Robert J. Labick:]

Good morning.

[Matthew E. Monaghan:]

Good morning Bob.

[Robert K. Gudbranson:]

Hey Bob.

[Robert J. Labick:]

Hi I want to start in the quarter you talked about the margins in Europe being impacted by mix and I guess maybe little FX too, can you just talk a little bit about the mix there and where it might be going and how we can try to better forecast that going forward and more importantly the opportunity for recovery of margins in Europe?

[Robert K. Gudbranson:]

Bob it is Rob, I will cover that just to put in context earnings before tax were $12.3 million last year second quarter and we are down about $6.1 million. So the biggest driver and I would say easily 80% plus is a combination of FX translation and FX transaction. So the big issue for the quarter and we will just use one currency that we have many in Europe, the Euro last year averaged about 138 and this year second quarter it averaged about 109. So that is about the 21% hit, so translation hurt us and then additionally transaction hit us too. So again big driver for the quarter would have been by far FX, we didn’t mention the sales mix similar to first quarter we didn’t have a combination mix on product and mix on customers that didn’t quite go our way for instance some of the bigger buying groups were stronger in certain countries and additionally you looked at product that we might for instance for example here first quarter was - the power wheelchairs we were selling more the lower margin power wheelchairs and the higher margin just be as a gather mix of request from customers. So not a major issue on mix, obviously important enough to mention the big issue for the quarter was FX. Did that help, Bob?

[Robert J. Labick:]

Yes, very helpful. Great. Thank you. And then, and we talked a little bit a performance, Matt, you just mentioned that you brought in a new person to run North America HME, can you, I guess give us little more of that person’s background and then also if you’ve the change yet layout the primary steps to getting HME back on track.

[Matthew E. Monaghan:]

Sure. So Dean Childers, I’ve as I mentioned work with for roughly 10 years, he’s got a background in finance and manufacturing and operational leadership in warehousing and distribution, sales, logistics and then also in helping lead sales organization to innovative solutions, as markets have changed. In our first couple of assignments together we’re working opportunities together, Dean has done a really wonderful job of quickly accessing issues and then implementing transitions very pointedly. And since then we’ve worked together in other areas where the kinds of solutions he has been able to bring to market our relatively sophisticated in matching how medical devices are achieving more holistic solutions and so on. I’m very pleased to be working with him. The second part of your questioner, what sort of issues are going on I think you can go through the financial statements from top to bottom and look at how we’re going to think about selling in the new medical device, since here where we have a paradigm shift of accountability by our providers and payers around the world, we need to be aligned with that. We need to match the way we sell products in terms of the cost incurred and the consultative selling proportional to the clinical complexity of the solutions we have, we’ve got a little for opportunities to simplify the way we do business and to be a very customer friendly organization doing business with as easy as possible. And then I think, in terms of the new product development engine, there is a great backlog of products and innovative things that we have to bring out and I expect to do that with more agility and a complete focus on quality. So that launches are very successful.

[Robert J. Labick:]

Okay. Great. And taking a step back just to kind of bigger picture stuff, may be you could tell us little bit about, now you’ve been there 100 days plus the biggest surprises maybe positives and or negatives after the 100 days that you’ve been in your currency.

[Matthew E. Monaghan:]

Yes. Surprise. I don’t if there are surprises per se, but I’ve really pleased the deep clinical understanding that our employees have and the vitality of our sales channel and how customer perceive our brand. They continue to hold our brand in very high regard. We have some of the best solutions for the most clinically complex medical situations that end users or patients are in. and our customers look to Invacare for providing that high range of products. I’m also pleased to see how the company has embraced that transition to single user products and have worked with other parts of our sales channel and customer base as they go through a migration in their world of how they conduct business. That has been really positive, I think what’s also been very pleasing is the legacy of product development and innovation is still a very fundamental part of Invacare as it has been for 30 plus years and that’s still very much alive.

[Robert J. Labick:]

Okay. Great. And then one last one, I’ll get back in queue.

[Matthew E. Monaghan:]

Sure.

[Robert J. Labick:]

It’s probably, I guess, a little early for you to be able to do this on a quantitative basis but just speak about globally I mean in the past the company has had a discussion about $100 million in cost savings from globalization and so from your seat now what are your thoughts on the ability to get significant cost savings and what will it take to do that, not trying to hold you to a number but just your impressions of that opportunity.

[Matthew E. Monaghan:]

Sure. Invacare is comprised of over 50 acquisitions that occurred over the company’s history and I think the company culture has been very strong in terms of fostering innovation and entrepreneurialism on those small relatively regional or local levels based on all those little businesses that have great clinical solutions. My idea of a great company going forward is to have solid global platforms where those efficiencies make sense, but still be a company that has perceived as an agile locally competitive company in its markets, because we do compete against smaller players in a number of markets that do have the potential to be as a agile, we can too. In between having great strong global platforms and still acting locally, there have to be synergies to come out of the company as we work more quickly, we have better products and we are relevant in all those markets. I don’t know whether it’s the number you have mentioned I haven’t done the reconciliation back to that number, I think that comes after a structural look which comes after a strategic look at how we move forward in the first, second and third years going forward. In the short-term the quality culture enhancements are number one focus and we’re putting together plans to understand how we can do the layering of global excellence and regional excellence and from that we’ll get to what those cost reductions or profitability changes are. I am sure they are out there.

[Robert J. Labick:]

Great, thanks very much.

[Matthew E. Monaghan:]

Sure, thanks Bob.

[Operator:]

[Operator Instructions] And we will now take a question from Jim Sidoti from Sidoti & Company.

[James Sidoti:]

Good morning, can you hear me?

[Matthew E. Monaghan:]

Yes Jim. Good morning.

[James Sidoti:]

Great, great. So I guess I was surprised like everyone else, I have covered the company several years and second quarter is typically stronger than first quarter on a top and bottom line, are there any one times that hurt the business in the second quarter or helped the business in the first quarter that accounted for this?

[Matthew E. Monaghan:]

I will give you my version of that Rob will then give comments, I think I look at the business in the segments first as I mentioned in this morning I think Europe we have the full portfolio of products looks like Invacare in total, I think North America where we have ongoing focus for quality enhancements we obviously have the impairment of the injunctive phase of the consent decree, we have more transition going on and you can imagine that when you change some things other things change consequentially and I think the second quarter results in the North America/HME segment reflect the consumption of some of our attention as we migrate from all the thing we used to do to fewer number of focus things in the future. So it is not surprising but look to be good managers we have got to continue to deliver bottom line improvement which is why we continue to focus on overall cost containment and try to hold or improve and we did improve the overall bottom line in terms of earnings from that segment.

[James Sidoti:]

Alright. Can you talk about the changes with a little more specific with some specifics, are you changing sales territories, are you changing the number of sales people, is it just the sales management change or can you just give us a little more color as to what those changes are?

[Matthew E. Monaghan:]

True, the charge overall is sales effectivity, which is everything from opportunity alignment to training and knowledge base to brushing up on consultative skilling sales skills to making sure that our sales team is very in-tune with clinical outcomes that we can provide with our great solution. So I think all of those are all kind of brushing up on sales acumen and then overall we want to make sure that we are aligning our consultative skills based sales organization towards the appropriate mix of clinical complex solutions and looking for efficiencies to drive everywhere else in the organization in terms of how we provide products and solutions to market. And that takes time, it is not surprising that it happened and had some impact on the quarter; we expect improvements in the future.

[James Sidoti:]

So would you say that sales force spent less time out in the field and more time back in getting retrained and that was part of the reason why the business was down?

[Matthew E. Monaghan:]

I think yes we didn’t buy lot of plane tickets to bring people back to headquarters but there was certainly a measurable amount of time in opportunity assessment, the kind of CRM programming that you do, customer relationship management program that you do and assessment of the effectiveness of sales hours towards sales opportunities and making sure we are always able to provide the best clinical outcomes proportionate to what our products and solutions can do. And this absolutely consumes time.

[James Sidoti:]

Okay. And has the overall number of sales people changed?

[Matthew E. Monaghan:]

Not any differently than what other normal basis not holistically no.

[James Sidoti:]

Okay. And then…

[Robert K. Gudbranson:]

Just back to your original question about one-times and there weren’t any particular one-time benefits or impacts on the second quarter, it was relatively clean quarter but then again I just for the benefits of the shareholders or people listening on the call, adjusted earnings per share loss in the second quarter was $0.23 and for the year-to-date its [$0.44]. So we are right very close to where we were on the first quarter and given the performance on the sales line for North America/HME, I would say that that’s a good performance from that vantage point, again I think we could manage what we could managed in the quarter.

[James Sidoti:]

Okay. All right and then your last question regarding the FDA is the next time we will get an update when the third order is complete or do you think you will give us an update prior to that?

[Matthew E. Monaghan:]

Yes. When we have something that I think it has positive predictive value that really indicates where we are and the outcome with respect to the injunctive phase of the consent decree we will absolutely do that. My focus and what we can control is building this quality culture, I obviously can’t speak on behalf of the FDA, it’s our objective to give them an opportunity to audit us and have good evidence of how we are embracing what we need to do, but timing of that is TBD. We will be back with shareholders and public announcements when there is something that has real predictive value.

[James Sidoti:]

So, but that would be something with real predictive value correct if you completed the third audit?

[Matthew E. Monaghan:]

Well either there is a timeframe, so the moment we complete the audit there may not be anything, at some point when that is completed there are reports, there is exchange of information with the FDA for example and then ultimately a resolution. So where within that timeline we will have a specific indication of outcome I don’t know.

[James Sidoti:]

Okay. Do you think we would hear something when the FDA begins their audit or do you think there is a chance we may not hear anything until the FDA has signed off on everything?

[Matthew E. Monaghan:]

Yes the latter I think as part of the privilege of selling a medical device the FDA can come in anytime and the FDA’s presence or absence in the company ours or anyone’s is not particularly indicative on any point of time. So we may not see anything until it is all over and we have an affirmation or some other change in our circumstances.

[James Sidoti:]

Okay. All right. Thank you.

[Matthew E. Monaghan:]

Yes thanks Jim. End of the Q&A

[Operator:]

And with no more questions in the queue today, I would like to turn the conference over to Matt Monaghan for any additional comments or closing remarks.

[Matthew E. Monaghan:]

Well Once again I want to thank everybody’s support and attention this morning, we look really forward to growing this business and continuing to dialog with you on changes in the company. Thanks again for your help and hope you have a good day.

[Operator:]

And ladies and gentlemen, this does conclude today’s conference and we thank you for your participation.