Invacare Corporation
Q4 2015 Earnings Call Transcript

Published: 11 Feb 2016

[Operator:]

Good morning, ladies and gentlemen, and thank you for standing by. Welcome to the Invacare Fourth Quarter and Full Year 2015 Conference Call. I would like to remind you that all phones have been placed on mute for the first part of the call. After the management overview, we will open the call to questions. This conference is being recorded Thursday, February 11, 2016. I will now turn the call over to Lara Mahoney, Invacare’s Senior Director of Corporate Communications and Investor Relations. Please go ahead.

[Lara Mahoney:]

Thank you, Myra [ph]. Joining me on today’s call from Invacare are Matthew Monaghan, Chairman, President and Chief Executive Officer; and Rob Gudbranson, Senior Vice President and Chief Financial Officer. 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, the company’s former subsidiary which manufactured stationary standing assistive devices for use in patient rehabilitation, and which was divested on August 29, 2014. Altimate was a part of the North America Home Medical Equipment or HME segment. On July 2, 2015, the company divested its United States medical device rental businesses for long-term care facility, which were a part of the Institutional Products Group or IPG segment. The rental businesses were not deemed discounted operations for reporting purposes, and therefore, are included in the results below unless otherwise noted. 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 today. In particular, I would refer investors to the release for the definitions of free cash flow, constant currency net sales and the adjusted earnings and loss 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 turn the call over to Matt Monaghan.

[Matthew Monaghan:]

Thank you, Lara, and good morning. I will begin today’s call by reviewing the consolidated financial results for the company’s fourth quarter ended December 31, 2015. During this period we made measurable progress towards turning around the business, building on our quality culture and generating profitable growth. Our continued focus on working capital yielded free cash flow of $29.2 million during the quarter which led to free cash flow of $13.9 million for the full year. In the fourth quarter 2015, gross margin which is an important measure as we shift our sales focus to more clinically complex products was higher as a percentage of net sales from continuing operations by 0.7 percentage points compared to the prior year’s fourth quarter. Excluding the benefit of warranty accrual reversal in 2015 and the impact of the divested rentals businesses from 2014 gross margin for the fourth quarter 2015 was higher by 1.1 percentage points compared to the prior year’s fourth’s quarter. This increase was driven by favourable sales mix, partially offset by unfavourable foreign exchange. Constant currency SG&A expense decreased $5.3 million or by 6% compared to the fourth quarter of the prior year. This decrease was driven by the sale of the rentals businesses in the third quarter of 2015 which lowered SG&A by $6 million and by favourable product liability expense. Excluding these items, SG&A increased primarily due to employment costs and the write-off of costs associated with the cancelled legacy software program due to a change in IT strategy. Better gross margin and lower SG&A expense were drivers of an improvement in adjusted net loss per share to $0.06 for the fourth quarter of 2015 compared to an adjusted net loss per share of $0.12 for the fourth quarter of 2014. Importantly, the company generated adjusted operating income of $2.3 million and reported operating income of $1.3 million during the quarter. For the consolidated company and normalizing for the divested rental businesses, constant currency net sales decreased 1.7% for the fourth quarter compared to the same period in the prior year. Increases in Europe and Asia Pacific segments were offset by larger net sales declines in the North America HME and IPG segment. I’ll now turn the call over to our CFO Rob Gudbranson to discuss the performance for the segments and additional financial results for the fourth quarter.

[Rob Gudbranson:]

Thanks Matt. All the references to earnings or losses before income taxes exclude restructuring cost. In the fourth quarter 2015, constant currency net sales for the Europe segment increased 1.2%, principally due to increased sales of mobility and seating and respiratory products which were partially offset by the decline in sales of lifestyle products. Earnings before income taxes decreased by $3 million compared to last year. The decrease in earnings before income taxes was largely due to unfavourable foreign exchange and a reduced gross margin which was driven in part by negative sales mix. For the fourth quarter 2015, constant currency net sales for the North American HME segment decreased 6.3% as increased sales of mobility and seating products were more than offset by declines in sales of respiratory and lifestyle products. Loss before income taxes for the fourth quarter in North American HME segment was reduced by $2.6 million compared to the same period in the prior year. The improvement was related to a higher gross margin, primarily related to the benefit from warranty accruals, lower manufacturing cost and favourable sales mix. These benefits were partially offset by increased SG&A expense primarily related to the write-off of cost associated with the cancelled legacy software program and to higher employment costs. The increased SG&A expense was partially offset by lower product liability cost. Excluding the net sales impact of the divested rentals businesses, constant currency net sales for [ph] the IPG segment decreased 3.5% driven by reduced sales in therapeutic support services and interior design projects. Excluding the intangible impairment charges of $4.8 million in the fourth quarter of 2014, earnings before income taxes increased $0.7 million in the fourth quarter compared to the same period prior year. This improvement was primarily related to the divestiture of the rental businesses which generated a loss before income taxes in the fourth quarter 2014. In the fourth quarter, Asia Pacific constant currency net sales increased 10.8% due to volume increases at the company’s subsidiary that produces microprocessor controllers and the company’s distribution businesses in Australia and New Zealand. For the fourth quarter, loss before income taxes was reduced by $1.3 million compared to the prior year’s fourth quarter. The reduction in loss before income taxes was due to volume increases and improved gross margin driven by lower manufacturing and freight costs. Total debt outstanding, which includes the convertible debt discount described in the release was $48.3 million as of December 31, 2015. The company's total debt outstanding consisted of $13.4 million in convertible debt and $34.9 million of other debt principally capital lease liabilities. During the fourth quarter, borrowings on the revolving credit facility ranged from a high of $8.9 million to a low of zero with the ending balance of zero. As of December 31, 2015 the available borrowing capacity on the company’s credit agreement was $38.2 million for the U.S. Canada portion and $15.2 million for the European portion. As of December 31, 2015 days sales outstanding were 42 days, which was historically the lowest DSO performance for the company. This compared to 45 days as of December 31, 2014. Inventory turns were 5 as of December 31, 2015 compared to 4.9 as of December 31, 2014. On December 21, 2015 the company entered into a payment plan with the tax authority in Europe related to a previously disclosed and contested tax audit involving year’s financial years prior to 2012 and current taxes payable. Based on year end exchange rates, the company’s aggregate payment obligations was approximately $10.9 million including approximately $0.6 million of interest that will accrue during 2016. The Kate [ph] payment plan provides for 12 monthly instalments over the course of the calendar year 2016 with interest paid as part of the final payment. I’ll now turn the call back over to Matt for a few closing comments. We then can address questions.

[Matthew Monaghan:]

Thank you, Rob. As you can see from the fourth quarter financial results we are making progress towards our priority of generating profitable growth. In 2015, we started to gain traction in the transformation of our United States sales force from a generalist team to one more focused on clinically complex products. This will be an ongoing effort in 2016 with expanded investment, more resources and ongoing training. Also in 2016, we expect the European results to continue to be negatively impacted by foreign currency pressures. In the North America HME segment we expect ongoing turbulence as reimbursement reductions associated with the world rollout of national competitive bidding continued through the first half of this year. We believe that the world areas comprised remaining 50% of Medicare spending on durable medical equipment that had not been influenced by NCB in rounds 1 and 2. Combining these factors with the historical seasonal sales weakness that typically influences our first quarters, we know substantial work remains ahead of us. We are also making progress with our enterprise wide quality culture, most notably our corporate headquarters and Taylor Street manufacturing facility in Elyria, Ohio which are currently under consent decree with the FDA. We have responded to the FDA regarding the previously disclosed Form 483 Observations from the agencies inspection of the company’s compliance with the first two certifications of the consent decree. We’re incorporating our responses for the Agency’s observations in our ongoing quality systems improvements. In addition, on February 9, 2016, the independent expert auditor issued its certification report for the third phase of the consent decree indicating our substantial compliance to the FDA’s quality system regulation. This report was submitted to the FDA this week. According to the terms of the consent decree we much submit our own report to the FDA regarding our compliance status together with our written responses to any observations in the expert’s report. If and when the FDA accepts the reports of both the expert and the company, we expect the agency to re-inspect the impacted facilities. We cannot predict the FDA’s acceptance of these reports nor the amount of any remaining work that maybe needed to meet the FDA’s requirements, so while receiving this third expert certification report is an important milestone; it is only one step forward in our ongoing journey towards the enhanced quality culture. To accelerate the next phase of this journey, in January we welcomed John Watkins as our new Senior Vice President, Quality Assurance and Regulatory Affairs. John is transitioning into the role from Doug Uelmen who joined Invacare in 2011 and will be leaving the company in March 2016. John has an extensive career in quality and regulatory functions driving substantial improvements in complex situations and building efficient and effective system. His experience includes leadership roles in a number of medical device manufacturers including Welch Allyn, Boston Scientific, and Zimmer Biomet. Earlier in this career John spend 21 years as a pilot in United States Air Force both in active duty and the reserves. I want to thank Doug Uelmen for bringing the company to this important transition point of receiving the expert’s third certification report, Doug led the renovation of several key quality processes and the expansion of the company’s quality and regulatory resources and expertise. I continue to be excited by Invacare potential and I want to thanks our associates for their hard work and commitment in 2015 as we want important many important changes within the company. I’m looking forward to more progress in 2016. Thank you for your time and attention on today’s call. We’ll now open the phone lines for questions.

[Operator:]

Thank you, sir. [Operator Instructions] We’ll take our first question from Matt Mishan with KeyBanc.

[Matt Mishan:]

Hey, good morning, Matt and Rob, Lara.

[Matthew Monaghan:]

Good morning. Thanks for calling.

[Matt Mishan:]

My first question, -- first off, congratulations on getting through the third-party expert audit; I know it’s been a bottleneck for you guys for several years now. But I believe if there is set timeline involved in the consent decree, hoping you could remind us of some of the next steps involve in consent decree. And I think part of that was like 30 days after submissions. The FDA would have to conduct their audit of Taylor Street. And over that 30 days from the third-party experts contribution or like third party or from -- yours from Invacare submission?

[Matthew Monaghan:]

Thanks for the question, Matt. It’s an important set of details to probably more clarifying for everyone. So there are two elements that are required in this phase, progress of the consent decree. We need to have qualified expert, vendor, substantial compliance opinion which has been done. That’s the same expert reviews before. That report needs to be submitted to the FDA and accepted by the FDA. And that’s potentially two steps. We’ve submitted it to the FDA, but as we had seen in the prior two certifications there’s the opportunity for clarifying questions or things like that the FDA may require before actually accepts that report, so we’re not to that phase yet, we simply submitted it to the FDA. In addition, the second part of moving forward is the submission of the company’s own report substantiating the steps we’ve taken which lead us to believe that we’re ready for another re-inspection. We’ll submit that report and the FDA has to accept it. There’s also potential for clarifying questions or the rejection of this I suppose. Once they accept both of those than the 30-day clock starts during which the FDA can begin its re-inspection. Beyond that though there is no constraint on timing. You can’t predict how long the audit might take or whether the audit will be successful the first time through.

[Matt Mishan:]

Okay. That’s very helpful. Thank you very much. And on to the roll, rollout of National Competitive Bidding, now that you’re month into it, what do you seeing in some of the initial impacts and how is it been different than the next policy rollout?

[Matthew Monaghan:]

So, I think as we look back to the prior rollout of NCD, we do as we’ve always done and disclose before we sure to look at the receivables accounts and bad debt, credit exposure we have as a number of businesses phase, significant reduction in reimbursement. So that’s a potential headwind. We’ve had a good success historically, but we know this could change again, so we’re watchful for that. In addition, it’s an opportunities for us to collaborate with customers in solutions that help them save cost. We always talk to them about things like wholesale, which avoid the delivery charges and network expenses, there are customers may have more traditional methods of providing respiratory care. So with an opportunity, but there are also some challenges of 50% reduction in reimbursement revenue, you can imagine very significant from any of our providers.

[Matt Mishan:]

Okay, great. And lastly, I thought that free cash improvement in the quarter was – actually I think it was your best free cash flow quarters since fourth quarter of 2012. Could you walk through some of the moving pieces of that improvement and maybe some of the working capital changes that you’ve made that was altered in that performance?

[Matthew Monaghan:]

Sure. We’re going to do that. Couple of things, one, if you look at DSOs, we were actually very proud of our DSO number last year when we hit 45 days at the end of 2014. But having said that, the teams are even better this year and that was really global effort, Europe, North America and Asia-Pacific, a lot of focus on the fact that move a little bit better on DSOs, we move little bit better on customers, makes a big difference. So again 45 was a phenomenal year last year, but at 42 days this year did very, very well. So, I want to emphasize first that was really proactive management. The other thing that helps us a little bit is that organically constant currency net sales for the fourth quarter were down 1.7%. If we’re doing a good job reflecting and sales aren’t growing that helps us too, obviously that could go the other way as we expect to grow overtime, but for this particular quarter that was a benefit. So, I think first I’d say receivables very, very strong. The other thing I would emphasize is that in the difficult environment only from the vantage point that we weren’t blowing through the sales numbers. The team and the manufacturing and sourcing side did a very good job of controlling inventory. So again we manage to get back to five times returns. I don’t think any of us would emphasize that – would claim that, that’s world-class, but that’s good improvement in particularly in an environment where we’ve had a little bit of mix in terms of sales. We’re doing better and the mobility and seating for instance in North America but struggled a bit on the life style and respiratory. So, we’re trying to manage that through and have the right product and that bring in more product. Again team did a good job on that front. So I’d say we did well on both of those fronts, but generally good focus throughout the free cash flow statement.

[Matt Mishan:]

And Rob, just a quick follow-up and then I’m going to jump in the queue. I understand it’s not world-class, but is it sustainable or is there’s something that would – would some of the improvement would be reverse out next year?

[Rob Gudbranson:]

You know, I’d emphasize for you that from our vantage point again the goals always improved of that number. I think, yeah, there’s always could be timing issues, but I think if we’re thinking more medium term, I don’t think any of us are perceiving in the five that’s where we want to be, that something we should improve off of.

[Matt Mishan:]

Thank you very much.

[Matthew Monaghan:]

I think I’ll add to that -- a little color to that. Some of the underlying changes that we made are definitely sustainable. We’re looking at -- we have finished good transformation, so these are just one time that make [Indiscernible]. Good point.

[Matt Mishan:]

All right. Thanks Matt.

[Matthew Monaghan:]

Thank you, Matt.

[Operator:]

We move now to Bob Labick with CJS Securities.

[Bob Labick:]

Good morning.

[Lara Mahoney:]

Hey, Bob.

[Bob Labick:]

Good morning. And may I offer my congratulations too on the expert’s third-party certification report.

[Matthew Monaghan:]

Thank you, Bob. Good morning.

[Bob Labick:]

Good morning. Just wanting to start – you talked little bit about the timeframes, I know that’s difficult that best to understand, but could you give us a sense of your expectations when you might submit your report? Is that Q1 or Q2 or is that naturally a second half of 2016 or just obviously not by day or week, but by quarter when you might expect to report – to submit your report to the FDA?

[Rob Gudbranson:]

Well, I don’t want to put the current report for the force here since it is a constructive ongoing dialogue with the FDA, but you can imagine that along in parallel with the third-party certification report we’ve been preparing this. So it shouldn’t be too long, but I wouldn’t want to surprise the FDA with what we submit. So there is a dialogue that goes along with that.

[Bob Labick:]

Okay. Fair enough. And do you outline the additional milestones that you will tell us about as we go forward because at one point you had said that you wanted to wait for positive predictive value in terms of timing before you talked about these things. So, I’m just trying to get a sense of what should we look for coming out next, as we continue to monitor our progress unless?

[Matthew Monaghan:]

It’s a great question and we evaluate a lot of things along the way and then we can -- whether it’s right for disclosure enough. Probably two parts of this. It’s an important milestone that will reflects a lot of work that the company has done to improve its quality systems but we understand that it’s only one little step in a long journey and a lot of improvements that’s going to continue for a long time. But in parallel, you could imagine that in this type of work, there are many people involved in the local facilities, probably hundreds. And so from a Reg FD standpoint, it becomes increasingly difficult for us to keep all those people engaged and informed but they will not have it get out into the public in an unusual way. So, we choose to disclose at this time, so everybody’s got transparency to what’s going on. In the future, we will continue to examine those same kinds of factors.

[Bob Labick:]

Thank you. Good. And just taking a step back and obviously the custom power wheelchair sales have been impacted from all of this. Can you give us a sense of your thoughts on what your current market position is and your timeframe to regain your prior market position?

[Matthew Monaghan:]

We have various versions of market share. I don’t know that any of them are anchored well enough to really talk about in the marketplace. Also we are the only public company in this space. So, we are challenged by that dynamic. We have good products and powered mobility still has clinically unique technologies that comes out of our Taylor Street facility. You can see from our report. We are still selling robustly from Taylor Street and then as we’ve mentioned previously, we have the rolling motion product that came out earlier in 2015. We are having good results with that with both positions, so they can each win in the marketplace. So, I think generally, we are increasing but to actually anchor it to a market share gain is difficult for us.

[Bob Labick:]

Okay. Very fair. And do you still think that the North American/HME business once this is openly wrapped up, not trying to tie to a timeframe can be a mid single-digit EBIT or a better business?

[Matthew Monaghan:]

I continue to look at our European business that has really good leadership and unfettered access to the full portfolio of products. I think the composition of European markets in total represents essentially what North America looks like, if you compare the government of the 8 channel, private pay, Medicare, Medicaid payments. And when I look at those results, I think you can estimate what it might look like for the whole company.

[Bob Labick:]

Okay. Great. And speaking of Europe, very strong organic growth, just taking out the FX impact, I think it was 3.5%. Can you talk about what the drivers were for that? Is it new products, is it new customers, is it simply just demographic growth and what do you expect over the next several years there in terms of the organic side of it? I won’t ask you to predict the currency.

[Rob Gudbranson:]

Yeah. I guess I would say the following. First, I would emphasize again, I think we have really good team there. It’s been in place for a long time. You look back. Historically, we’ve had two different acquisitions. We’ve had a combination of -- I will call internally, Invacare’s grown and people from two different acquisitions within Europe, sizeable acquisitions over the last 15 years. So that’s given us quite a good team and the team that’s been in place. I think a lot of that -- you mentioned the 3.5% organic growth for the 12 months. Fourth quarter, it was 1.2%. For many, many quarters, they have delivered good growth. We would expect that to continue if we are looking out longer term. I think a lot of it is in the marketplace doing well with the products we have. I think we’ve mentioned before that we take -- they have a new product with the base that’s maybe North America that they sell throughout. Europe was exceeding. That has done very well in terms of that capability. So there have been some new products but our goal is to give them more new products over time but again, between management, their position in the marketplace, fighting every day, that teams delivered organic growth for quite a while.

[Matthew Monaghan:]

And I think they have a nice mix of products and teams that their products were typically catering for the sub business based and then the commercial teams of that country, they have got a very dynamic of seeing what works and the dynamics of one country and figuring out how to apply that in other countries that work really well together.

[Bob Labick:]

Okay. Great. Thank you very much.

[Matthew Monaghan:]

Okay. Thank you, Bob.

[Operator:]

[Operator Instructions] We move next to Jim Sidoti of Sidoti & Company.

[Jim Sidoti:]

Good morning. Can you hear me?

[Matthew Monaghan:]

We can. Good morning, Jim.

[Lara Mahoney:]

Good morning.

[Jim Sidoti:]

Great. Great. So it’s good week for Ohio people it seems like.

[Matthew Monaghan:]

It is.

[Jim Sidoti:]

Couple things. The 483s that you disclosed previously, can you just give us a little more color what they were related to and if they were resolved by the time of this third-party auditor’s report or address by the time of third-party auditor’s report?

[Matthew Monaghan:]

I’m not sure to what level of, what amount of time we can spend getting into the details of each of the Form-483 observations. I will say on one hand, they are not trivial. On the other hand, I will say the FDA issues about 4,700 Form-483s each year and these are serious important areas at the same time and we are building plans to make sure we accommodate improvements that the FDA’s outlined, very good audit work done by the FDA and so you can hope for an engagement like that and we are taking those very seriously going forward. In terms of resolution to Form-483 observations, the process typically is the FDA leads behind the Form-483, which are the local inspector’s observations. A company typically has 15 business days to respond. We took the opportunity to respond and then in parallel, the government prepares its own report and then there is the opportunity for a dialogue and going forward. There isn’t typically a distinct closure process with Form-483 observation as I’m sure you know.

[Jim Sidoti:]

Right. So when the independent auditors submitted their report, were those issues addressed in that report?

[Matthew Monaghan:]

Those audits were going on in parallel.

[Jim Sidoti:]

Okay. So those -- the independent auditors report does not includes any items specific to the 483s.

[Matthew Monaghan:]

Yeah. The 483 was the response of that. It was the inspector’s observations of their own audit and at the same time, the independent expert was in the building to its audit and it produced its report. We will call the FDA’s audit scope was primarily certification one and certification two of the consent decree.

[Jim Sidoti:]

Okay. All right. And then Rob, a question for you, sounds like the medical device tax will not be in effect in ’16 and ’17. Can you give us a sense on how that’s going to impact you on the gross margin line or the SG&A line?

[Rob Gudbranson:]

It won’t be terribly material. It will help us on the IPG business but it won’t be anything that you would see dramatically differently over the course of the quarters. Not a great impact as it was from the beginning.

[Jim Sidoti:]

All right. And then the cash flow number that you gave for the year, did that include the $14 million severance payment you made this year?

[Rob Gudbranson:]

Just to clarify, during the course of the year, we had a variety of payments to the four Senior Executives. That was a combined for the year at $24.7 million and that was in there. Additionally just for clarity purposes, what also was in there was the benefit from the sale of leaseback transaction which was $23 million. So again, $24.7 million during the course of the year as a combined payment out for earned benefits for the four Senior Executives and then additionally, they get $23 million through the PP&E, through our sale leaseback transaction. So net-net, they were pretty close but $24.7 was the million.

[Jim Sidoti:]

Okay. So it was around the $2 million, I guess?

[Rob Gudbranson:]

That is correct.

[Jim Sidoti:]

Okay.

[Rob Gudbranson:]

We will save $1.7 million but yes.

[Jim Sidoti:]

All right. Thank you.

[Matthew Monaghan:]

Next question.

[Operator:]

And Mr. Monaghan, that concludes our question-and-answer session. I would like to turn the call back over to you for any additional or closing remarks.

[Matthew Monaghan:]

Thank you Myra and thank everyone for your time and attention today. On the call Rob, Lara and I are available for any follow-up questions. Have a good day.

[Operator:]

Ladies and gentlemen, that does conclude our conference for today. Again we thank everyone for joining us.