Invacare Corporation
Q4 2014 Earnings Call Transcript

Published: 5 Feb 2015

[Operator:]

Good morning ladies and gentlemen and welcome to the Invacare 2014 Fourth Quarter Conference Call. I will begin 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 the company's future results. Actual results may differ materially as a result of inherent uncertainties and risks, including the risk factors described in the company's Form 10-K and other filings with the Securities and Exchange Commission and in the company's earnings release, and we refer you to those risks factors. The company may not be able to predict and may have little or no control over the factors or events that may influence its financial results. Also of note, except for free cash flow, the financial information for all periods excludes the impact of discontinued operations. Discontinued operations include Invacare Supply Group, the company’s former domestic medical supplies business that was divested on January 18, 2013. Champion Manufacturing Incorporated, the company’s former domestic medical recliner business for dialysis clinics that was divested on August 6, 2013. And Altimate Medical Incorporated, the company's former manufacturer of stationary standing assistive devices for use in patient rehabilitation, that was divested on August 29, 2014. Champion was a part of the Institutional Products Group segment and Altimate was a part of the North America Home Medical Equipment segment. On today's call, the management team 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. In particular, I would refer investors to the company's earnings release to review the definition 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 the company's SEC filings at www.invacare.com. Before I turn the call over to Invacare's Interim President and Chief Executive Officer and Chief Financial Officer, Mr. Robert K. Gudbranson, I would like to remind you all that phone lines have been placed on mute for the first part of the call. After management overview, we will open the call to questions. This conference is being recorded, Thursday, February 5, 2015. I would like to turn the call over to Mr. Rob Gudbranson. Mr. Gudbranson you may now begin.

[Robert K. Gudbranson:]

Thank you and good morning. With me today on the call is Lara Mahoney, Director of Investor Relations and Corporate Communications. In the fourth quarter, the Invacare Team successfully managed working capital to achieve free cash flow of $11.4 million which led to free cash flow of $8.4 million for the full year. The company further reduced debt total debt outstanding to $22.3 million as of December 31, 2014. As was the case throughout 2014, the European business segment finished the year with another strong quarter. Additionally, the IPG business segment excluding intangible impairment charges and the Asia Pacific segment, both improved earnings before income taxes compared to the fourth quarter of 2013. Now I’d like to further review the company’s consolidated fourth quarter results. In the fourth quarter organic net sales decreased 0.5% as compared to the fourth quarter of 2013, as organic net sales increases in the European, IPG, and Asia Pacific segments were more than offset by an organic net sales decline in the North America HME segment. Gross margin as a percent of net sales for the fourth quarter of 2014, was higher by 0.2 percentage points compared to the prior year’s fourth quarter. However, the fourth quarter of 2013 gross margin included incremental warranty expense of 3.4 million or 1 percentage point, as well as a benefit of 1.4 million or 0.4 percentage points related to an amended value added tax or VAT filing recognized in the European segment. Excluding that incremental warranty expense and VAT benefit from the fourth quarter of 2013, gross margin as a percentage of net sales decreased in the fourth quarter of 2014 by 0.4 percentage points compared to the prior year. This decline was primarily driven by asset write offs attributable to cancelled product launches and to higher freight cost. During the fourth quarter gross margin was also impacted by favorable product and customer mix that was largely offset by pricing pressure. SG&A expense decreased 6.3% to $88.6 million in the fourth quarter of 2014 compared to $94.6 million in the fourth quarter of 2013. Foreign currency translation decreased SG&A expense by 2.7 percentage points. Excluding the impact of foreign currency translation, SG&A expense decreased by 3.6% compared to the fourth quarter of the prior year primarily due to reduced associated costs which included partial benefits from the restructuring that the company announced on August 2014. For the fourth quarter 2014 adjusted net loss per share improved to $0.12 compared to an adjusted net loss per share of $0.22 in the fourth quarter of 2013. The reduction in adjusted net loss for the quarter was driven by an improved gross margin and lower SG&A expense partially offset by reduced net sales. With that summary Lara will now review the additional financial highlights of the fourth quarter.

[Lara Mahoney:]

Thank you, Rob. All the references to earnings before tax exclude restructuring cost. In the fourth quarter of 2014, organic net sales for the European segment increased 7.2%, principally due to increases in lifestyles and respiratory products. These increases were partially offset by a decline in mobility and seating products. Earnings before income taxes increased by $0.9 million compared to last year. The increase in earnings before income taxes was largely attributable to higher sales volumes partially offset by increased SG&A expense which was primarily related to associate cost and unfavorable foreign currency transactions and to higher freight expense. When comparing the fourth quarters of 2014 and 2013 performance, it is worth noting that earnings before income taxes in the fourth quarter of 2013 benefited by $1.4 million related to the previously mentioned value added tax filings. For the fourth quarter of 2014, organic net sales for the North America HME segment decreased 10.7% compared to the fourth quarter of 2013 driven by declines in all product categories. Loss before income taxes for the fourth quarter in North America HME segment improved by $2.5 million in comparison to the same period prior year. The reduction in loss was the result of lower SG&A expense primarily related to reduced associate and bad debt expenses partially offset by volume declines, asset write offs attributable to canceled product launches, and freight cost. When comparing the fourth quarters of 2014 and 2013, it is worth noting that the fourth quarter of 2013 loss before income taxes included an increased warranty expense of $2.2 million for our previously disclosed recall. In the fourth quarter, organic net sales for the Institutional Products Group increased 6.5% driven by growth in interior design projects and therapeutic support purposes. This is partially offset by reduced rental revenue. Excluding intangible impairment charges, earnings before income taxes increased by $0.2 million compared to the fourth quarter of 2013 primarily due to volume increases and reduced associate cost, partially offset by unfavorable customer mix. In the fourth quarter Asia Pacific organic net sales increased 5.5% due to volume increases at the company's distribution businesses in Australia and New Zealand. This was partially offset by declines at the company's subsidiary that produces micro processor controllers. For the fourth quarter, loss before income taxes was reduced by $0.8 million compared to the prior year's fourth quarter. The reduction in loss before income taxes is attributable to volume increases, reduced warranty expense, and lower SG&A expense primarily in associate cost. When comparing the fourth quarter of 2014 and 2013, please note that the fourth quarter of 2013 loss before income taxes included increased warranty expense of $1.2 million related to a previously disclosed recall. Total debt outstanding which includes the convertible debt discount that’s described in the release was $22.3 million as of December 31, 2014. The company’s total debt outstanding consisted of $4 million drawn on the revolving credit facility, $13.4 million in convertible debt, and $4.9 million of other debt. I’ll now turn the call back over to Rob for a few closing comments, we can then address questions.

[Robert K. Gudbranson:]

Thank you Lara, while the company is not giving guidance at this time, it’s important to mention that if the euro continues to be weak versus the U.S. dollar compared to prior year it may negatively impact our 2015 performance, as the European segment was our main driver of profitability and cash flow in 2014. Accordingly we will monitor and manage cash flow particularly closely during this year. The company also will work diligently toward improving the profitability of our North American HME and our Asia Pacific businesses. Now I’d like to take a few moments to address our status relating to the consent decree. With the help and insight of the consulting firm we engaged in 2014, our internal subject matter experts are driving execution of our action plans to improve both the functionality and capabilities of certain quality subsystems. We have identified the root causes of the issues that need to be addressed in order to achieve sustainable compliance and we are working through quality implementation plans that are intended to enable us to achieve the appropriate solution. I am meeting with the teams weekly to drive progress and accountability. I believe we are on the right track but we still have work to do including process improvements for addressing complaint data. Before we can verify the effectiveness of our solutions and complete the third party expert certification about it. I want to thank everyone on the call for their time today and we’ll now open up the phone lines for questions.

[Operator:]

[Operator Instructions]. We’ll take our first question today from Bob Labick with CJS Securities.

[Robert Labick:]

Good morning, congratulations on some nice progress and nice cash flows in the quarter.

[Robert K. Gudbranson:]

Thank you Bob.

[Lara Mahoney:]

Thank you Bob.

[Robert Labick:]

Wanted to start couple of questions but this one, at last call you talked about you are in the process of getting approval or seeking approval for new custom power wheelchair so that you could kind of hit the ground running with new products when the consent decree is ultimately resolved, can you just update us on that progress and what that process will be for new sales and once the consent decree is done?

[Robert K. Gudbranson:]

Sure Bob, I’ll be glad to do that. I think you remember but for everybody’s benefit our core products in the power wheelchairs in the U.S. in particular is a product called the TDX SP. Its premiere product, we believe it is still the best product in the industry but we wanted to do an upgrade to that, probably more of an aesthetic improvement than a major re-change in terms of its functionality. Again feel the functionality is already best in the industry. We did work on an update which we called TDX SP2 and we submitted that for 510(NYSE

[Robert Labick:]

Yes, that's terrific. Thank you and congratulations on getting that approval, that's great. Sticking with the North America, I guess just -- I think there has been some changes in the lifestyles area for you could you just give us an update there and then talk about any new initiatives or the plans to kind of get that back on in 2015?

[Robert K. Gudbranson:]

A couple of things, I think we mentioned in the last time too but we are still in progress. I would tell you that there were probably two major changes, one of the change was a personnel change and our Manager who was running the lifestyles product for North America HME was changed out. We gave it to a Manager who had proven himself strong in our respiratory area. And I think that change will work for us in terms of what we are focusing on cost reductions, right products, and our ability to improve that business going forward. One of the key things that, that new Manager plus the gentleman who runs North America for us had really focused on is that probably didn’t have as great a line as we would have potentially liked in terms of addressing two different parts of lifestyle market. We focus very much on what we call fleet management as Invacare and at Invacare we focus on total lifecycle cost. I think that's worth well, probably more so on the higher costs, the higher ASP products where lifecycle cost really does matter. And it is in the customer, our provider suite for long period of time. But I think there are some lower average selling price items like maybe a very much standard steel wheelchair where the price was well enough that we started to refer to some of those products as single user in the sense if they go out on one patient for long enough and the reimbursement on that goes for long enough period, the provider makes enough money. They are not as concerned about total lifecycle cost. They are looking more at upfront acquisition cost. And so that single user market is an area we focused on, we are starting to focus on for the fourth quarter. We will be rolling out more products in the first half of this year, 2015. And I would emphasize just for everybody's benefit, these are not products that we are sourcing for the first time. We have a smaller division that has always been in this category that has a brand name called Probasics. We are going to make that product line available to not just that division but to the whole Invacare sales force. So I think we have a good game plan, I think we have a good game plan with the management change which is important to have the right leader. And then additionally a product change to address that part of the market where I think we need to have a better offering. So again I will stop there unless there is another question.

[Robert Labick:]

No problem, perfect. And my last one and I will get back in queue but also you had some news I guess this January regarding a hit on the credit agreement refinancing and what not, could you tell us the benefits of the new agreement that you have?

[Robert K. Gudbranson:]

Sure, one I would like to thank the banks for their support in going forward. We have originally a bank group in the old facility from 2010 that is 13 banks. They served well for us but that was a very big bank group for what it become smaller facility. We now got that down to four banks that I think are very good fit for Invacare and we believe we are the right company for them to be putting their capital forward to support. We have now an asset based lending facility, so we don’t have the financial covenants we had before which were a leverage primarily and an interest coverage ratio. As our EBITDA has declined over the last couple of years, those are very sensitive calculations given that there are some debt, that pretty much all we have in place on convertible debt and some capital leases. And so that sensitivity had reached a point where the covenant costs were difficult. To be sure that we would always reach in case we had an issue pop up, maybe like third quarter 2014 when we had to book 9.3 million on some recall issues. So, we are now an asset based facility that's I think better for us, better for the banks. They have put facility in place and we’re pleased to continue there. So that would be my answer, if you got other questions I’m glad to answer.

[Robert Labick:]

No, that’s perfect. Thank you very much.

[Robert K. Gudbranson:]

Thank you, Bob.

[Operator:]

We’ll go next to Matt Mishan with KeyBanc.

[Matthew Mishan:]

Hey, great. Thank you for taking my questions. So first I am going to start off with the consent decree and then I think some of the language in the press release. I think previously you indicated that you were working on four subsystems, you had mentioned kind of complaint handling and a corrective in for that actions as two of those. I think in the press release it looks like you are focused primarily now on complaint data. Should we taking that as maybe there is a little bit of narrower focus as far as what’s left to be done?

[Robert K. Gudbranson:]

Good question Matt, couple of comments. One, we have many –- you’re right, there is originally four subsystems we talked to the consultant about. I would point out there many subsystems other than that which we will have to make sure to refraction and be prepared for the third party auditor. But the four were really the focal point. I’d say we probably made good progress on three of those, including CAPA. That’s not to say we haven’t made good progress on complaints, I’d say that’s probably where we are putting most of our energy right now. So I think you probably read that correctly.

[Matthew Mishan:]

Okay and I think you also mentioned that you were going to, you are going to need to give the third party auditors kind of the heads up that before they were kind of prepared to come back and just to make sure that we’re kind of -- have you kind of given them the heads up yet, this maybe a timeframe where you may have to come back?

[Robert K. Gudbranson:]

We’re still working through issues and we stay in some communication with them obviously at various points in time. But we got to make sure we’re ready with verification effectiveness and then we’ll really line them up. But in terms of making sure they are aware of what we are doing, that’s important but important thing first is make sure our effectiveness is really there and we’re bringing them at the right time.

[Matthew Mishan:]

Alright, I tried. And moving on to kind of North America HME, if I look at the last couple of years sequentially from the third quarter to the fourth quarter it looks as if there has been a bit of a seasonal decline in sales, and this quarter it looks like sequentially it was up a little bit and should we be taking that as maybe a little bit of sign of strength in the business or how should we kind of read it seasonally?

[Robert K. Gudbranson:]

I think there are always some moving parts there. There is no doubt on that, I guess my reaction would be to Matt to say that we clearly with the 10.7% organic sales decline I guess I’d say we still got work to do. And so I wouldn’t want to draw any major conclusions on sequential one and we’re showing that kind of weakness and in all lines. So we got more work to do. I would point out on respiratory that we were still comparing to very tough comparisons to the fourth quarter last year when we had a big order built from a big account in their respiratory category. Respiratory has always been up and down in terms of its capability. So there really was a better explanation in that category but still struggling in lifestyles and a little weakness too and ability in seating. So I think when we are showing that I wouldn’t want to draw too much on a sequential comparisons.

[Matthew Mishan:]

And the European organic comparison of 7%, was there anything that was kind of onetime there or how would you characterize like what drove the improvement there?

[Robert K. Gudbranson:]

I think it was just strong performance pretty much across all of Europe. As Lara mentioned in her summary and particularly two product lines, but no I wouldn’t say there was anything that was particularly what I’d ever call one time on that front. But I’d say the performance pretty much all this year has been very strong there. We got a very strong team over there but I look back in first quarter, second quarter, third quarter, we showed one and two and close to 3% organic sales growth, just had very strong quarter and fourth quarter 2014.

[Matthew Mishan:]

Okay and then just modeling question, what were the tailor suite sales for the quarter and what were the QARI [ph] cost?

[Robert K. Gudbranson:]

Lets hit the QARI [ph] first and again for purposes of people who aren’t on the call at the time we typically share the QARI cost with what we call corporate in the U.S. and HME business and those costs in fourth quarter 2014 were 4.9 million and that compared to 5 million in Q4 2013. So we are just down a teeny bit in terms of that performance. And then we typically share two of the tailor street sourced product, this doesn’t just go to North America HME but for the quarter. I think we had the release, it was 11.3 million versus 11.8 million in Q4 2013. So, just slightly down.

[Matthew Mishan:]

Alright, thank you. I will jump back in queue.

[Robert K. Gudbranson:]

Thank you.

[Operator:]

[Operator Instructions]. We will go next to Jim Sidoti with Sidoti & Company.

[Jim Sidoti:]

Good morning, can you hear me.

[Robert K. Gudbranson:]

Yes Jim.

[Lara Mahoney:]

Hi, Jim.

[Jim Sidoti:]

Good morning. Just couple of questions, one on the consent decree, were there any new issues that came up during the quarter or was there work concentrated on just resolving the issues you already knew about?

[Robert K. Gudbranson:]

I would say that there was no issue that was new on the consent decree. I would point out that during the fourth quarter we did have the FDA, did what we believe to be a normal audit of our Florida location, our Stanford location which is under a warning letter. Took that exceptionally seriously as you can imagine. I think that audit went well, that we are four observations down there. But we addressed those, responded on a timely basis, and we continue to deal with those issues. So, no there wouldn’t be obviously Jim, related to the consent decree and I don’t think any new issues appear in the consent decree. But for the purposes of investors I would relay that we did have that audit and are answering questions accordingly.

[Jim Sidoti:]

Okay, were there 43 from that audit?

[Robert K. Gudbranson:]

There were four observations and so four 43s and we responded on those and continue to update the FDA to show them our seriousness in addressing issues. And show them the progress we have made in that plant and that facility over the last couple of years in terms of making it better run and better quality of systems.

[Jim Sidoti:]

Okay, and then my second question was, you mentioned the impact of the stronger dollar and potential impact on 2015. Now I know Europe is about half of your business right now but you have a lot of costs over there. I mean can you give us some sense on what the natural hedges are there or in place and how the stronger dollar affects earnings?

[Robert K. Gudbranson:]

Sure, I will be glad to. Let's talk about two different pieces of foreign currency exposure. There is foreign currency translation which is just how much you earn a year over in euro and how much of that comes back in dollars. In 2014 the average euro rate was about 1.34 and I think I had looked this morning but I think it is trading at 1.14. So, just if you make a euro over there you will always have a translations in euro weak or strong against the dollar that comes back. The bigger issue I think that you are really raising is, how do we normally have a cross over in Europe. In general most of our costs are local costs. So if we think about sales or even gross margin COGS, a lot of it is local. We do source some product from Europe, from the U.S. and China to certain degree. More so from China and certain degree from the U.S., in U.S. dollars ultimately. We do hedge that transaction exposure, typically have depending on the year between 50% and 80% of that hedged as best as we forecasted it going forward. So we always have some hedge on the transaction front. We saw some exposure there too in terms of those purchases but otherwise the answer ultimately is the real issue beyond that is the translation which again I gave you just an indication of the euro exposure. Euro is not the only currency but you could ballpark 60% plus for their profit is euro based. Sterling would be next and some of the Scandinavian currency. So, if those currencies weaken, those earnings and purposely the cash flow are lower.

[Jim Sidoti:]

Okay, thank you.

[Robert K. Gudbranson:]

Thank you.

[Operator:]

We will go next to Gregory Macosko with Montrose Advisors.

[Gregory Macosko:]

Yes, thank you. Good morning Lara and Rob.

[Robert K. Gudbranson:]

Good morning.

[Gregory Macosko:]

With regard to just a follow up on Jim's question with regard to Europe, nice growth there. How is it looking in December-January, is it in local currency obviously, is it continuing or are you still foreseeing that kind of growth at all?

[Robert K. Gudbranson:]

Greg, I understand the question but we typically don’t talk about the current quarter. It is I think you’re just referencing, they actually are on a one month lag so their December was one month long and their month two was January but we are not talking about the current quarter.

[Gregory Macosko:]

Okay and then with regard to the calling on the dealers, etc in the U.S., talk about the sales force, how many people do you have there, has that changed much in the last year, do you have the same numbers, is it down a bit, up a bit?

[Robert K. Gudbranson:]

I’m going to focus on our HME business, our U.S. homecare business. That sales force has come down pretty substantially. We have ballpark I want to say in the low 70s in terms of sales people and regional managers out there. That’s substantially down from years before and that’s a situation where I am pleased to say we haven’t lost critical sales people. I think we have held on generally pretty well. Inevitably there are some changeovers but all our regional leaders are still here. They are still working hard for Invacare and so we’ve held on to lot of those key players. But we had some attrition and positions open and people maybe not work out particularly junior levels. We’ve now refilled those categories given the sales performance in HME and home medical equipment in the U.S. because it doesn’t make sense given the sale size we got. So it’s been this downsized pretty dramatically and the ball park in that set low 70s in terms of support on the sales side.

[Gregory Macosko:]

Okay and then finally talk about Asia Pacific a little bit. Nice organic growth there on the distribution side, what you dropped out of the contract manufacturing in the non-healthcare area, was that business unprofitable and how did that affect profitability and talk about the profitability there given a lot of the growth is distribution that you mentioned.

[Robert K. Gudbranson:]

Lets -- glad to answer your question Greg, let’s put the two pieces Asia Pacific apart. First we have a business run by one manager that is called basically the same home medical equipment business and even focuses on Australia and New Zealand and he sells the same basically a similar product lines into those marketplaces as we would in the U.S. or Europe or anywhere else. And so he’s got that business. That business is where we saw the sales growth particularly in Australia and we saw good performance. The other business which you’re referencing with contract manufacturing is our dynamic controls business out of New Zealand. Their focus historically had been focused on our power wheelchair controllers and scooter controllers both for Invacare and for the marketplace. So they had other manufacturers that they provide and still provide the power wheelchair controller to. Additionally they made respiratory boards for Invacare for our respiratory equipment. They did have as you rightly pointed out a contract manufacturing business. That business was an attempt to say look, they make a lot of electronic boards, they can do it for a lot other customers. To be blunt that was a huge distraction for the management team, not generating cash flow and the profit that made sense. So as we’re looking to refocus that business brought them down and got them out of that capability, got that working capital freed up and stayed focus on what really matters longer term which is supporting Invacare’s respiratory business and Invacare’s power wheelchair business both in Europe and in United States, and supporting the OEMs who are buying power wheelchair controllers too. So that will be sort of the focus I would give you.

[Gregory Macosko:]

Thanks.

[Robert K. Gudbranson:]

Thank you.

[Operator:]

With no other questions in queue Mr. Gudbranson, I’ll turn it back to you for closing remarks.

[Robert K. Gudbranson:]

Thank you, Debbie. Again on behalf of the company I appreciate your time and attention during this call. If you have any additional questions please feel free to reach out to me or to Lara. Thank you for your time.

[Lara Mahoney:]

Thank you.

[Operator:]

Ladies and gentlemen, thank you for your participation. This does conclude today's conference.