IVC
#Thank you, <UNK>, and good morning.
I'd like to begin today's call by reviewing the consolidated results for the company's second quarter ended June 30, 2016.
During the quarter, we continued to execute our transformation from being a generalist durable medical equipment company to one more focused on solutions for clinically complex and post-acute care.
Primarily as a result of this focus and excluding the impact of the divested rentals businesses, consolidated gross margin as a percentage of net sales improved by 1.2 percentage points and constant currency net sales decreased by 1.6% compared to the second quarter last year.
This result is in line with our expectations as we move away from lower-margin less-differentiated products.
Our short-term metric for assessing the success of our transformation is gross margin improvement as a percentage of net sales.
For the third consecutive quarter the North America/HME segment, where the most significant turnaround work is occurring improved gross margin as a percentage of net sales by 2.5 percentage points compared to the second quarter last year.
This improvement was driven by net sales increases in mobility and seating products, which comprise the majority of our clinically complex portfolio.
Excluding the impact of the divested rentals businesses, consolidated gross profit dollars also increased compared to second quarter last year, largely driven by the Europe segment with contributions from the Asia/Pacific and North America/HME segments.
In the second quarter, SG&A expense decreased by 4.0% to $79.3 million.
Excluding the impacts of the divested rentals businesses and foreign currency translation, SG&A expense increased $2.5 million or 3.2%, compared to the second quarter last year primarily related to increased employment and product liability costs.
The company incurred net interest expense of $3.8 million in the second quarter of 2016 compared to $0.5 million in the second quarter of last year.
The net increase of $3.3 million was primarily due to the convertible debt issuance in the first quarter of 2016.
The increase in interest expense is primarily reflected in the North America/HME segment.
Lower net sales, increased warranty expense, and higher interest expense for our issuance of convertible debt in the first quarter of 2016 led to an adjusted net loss per share of $0.33 in the second quarter of 2016, compared to adjusted net loss per share of $0.25 in the second quarter last year.
Operating loss was $6.3 million compared to a loss of $5.9 million in the second quarter last year.
In the second quarter of 2016, free cash flow was negative $17.4 million driven by the net loss in the period, the final payment of $10.6 million related to a previously disclosed tax liability, and increases in both accounts receivable and inventory.
To give investors a more accurate comparison of free cash flow between the periods, in the release we compare free cash flow in the first six months of 2016 to 2015, which eliminates certain timing differences between the quarters.
Excluding a few discrete items that we note in the release free cash flow for the first six months was negative $45.1 million in 2016 and negative $28.6 million in 2015.
I'll now turn the call over to <UNK> <UNK>, our CFO to discuss the performance of the segments and additional financial results from the quarter.
Thanks, <UNK>.
For the second quarter of 2016, European constant currency net sales increased 5.5% compared to the second quarter last year.
The improvement in constant currency net sales was driven by increases in lifestyle, and the mobility and seating products, partially offset by decreases in respiratory products.
For the second quarter, earnings before income taxes increased by $0.7 million compared to the second quarter last year.
This increase in earnings was primarily due to increased net sales and favorable sales mix partially offset by increased warranty expense and SG&A expense related to employment costs.
Gross margin as a percentage of net sales and gross profit dollars increased in the quarter compared to the second quarter last year.
For the second quarter of 2016, North America/HME constant currency net sales decreased 7.6% compared to the second quarter last year.
The decrease in constant currency net sales was driven by declines in lifestyle and respiratory products partially offset by increases in mobility and seating products.
Loss before income taxes increased by $3.6 million compared to the second quarter last year.
This increase in loss was a result of reduced net sales, increased interest expense, and higher warranty expense partially offset by stronger gross margin as a result of favorable sales mix.
During the quarter, gross margin as a percentage of net sales increased and gross profit dollars were marginally positive to the second quarter last year.
Excluding the net sales impact of the divested rentals businesses constant currency net sales in the IPG segment decreased by 20.2%.
During the second quarter of 2016, the IPG leadership team enhanced its focus on building a post-acute care sales force, including investments in clinical sales training, assessment of customer call points, and recruitment.
Transforming the post-acute care business, principally in the IPG segment, is the second phase of the company's transformation.
Earnings before income taxes compared to the second quarter of last year decreased by $0.8 million.
This decrease in earnings was largely due to reduced net sales and a lower gross margin related to increased warranty costs, partially offset by reduced SG&A expense related to employment costs.
In addition to pressure on gross margin as a percentage of net sales during the quarter, gross profit dollars were down compared to the second quarter of last year.
For the second quarter of 2016, Asia Pacific constant currency net sales increased 13.2%.
The improvement was due to net sales increases in the Australian distribution business and the company's subsidiary that produces microprocessor controllers.
For the second quarter, loss before income taxes decreased by $0.6 million compared to the second quarter last year.
The decrease in loss was largely due to favorable gross margin related to reduced manufacturing and freight cost.
Gross margin as percentage of net sales and gross profit dollars increased in the quarter compared to the second quarter last year.
Total debts outstanding as of June 30, 2016 was $197.5 million.
The company's total debt outstanding consisted of $163.4 million in convertible debt and $34.1 million of other debt, principally lease liabilities.
The company has zero drawn on its revolving credit facilities as of June 30, 2016.
The company's cash balances were $125.3 million as of June 30, 2016, compared to $144.7 million on March 31, 2016 and $60.1 million as of December 31, 2015.
Cash balances declined in the second quarter of 2016 compared to the first quarter of 2016, primarily due to negative free cash flow.
The increase in cash balances compared to December 31, 2015 was the result of the net proceeds received from the issuance of convertible debt during the first quarter of 2016.
As of the end of the second quarter, days sales outstanding were 46 days, up from 42 days as of December 31, 2015 and down from 49 days as of June 30, 2015.
At the end of the second quarter, inventory turns were 4.7, as compared to 5.0 as of December 31, 2015 and 4.7 as of June 30, 2015.
I will now turn the call back over to <UNK> for few closing comments.
We can then address questions.
Thank you, <UNK>.
We're pleased with the company's performance in Europe and the Asia Pacific segment and the progress based in the North America/HME segment.
We have more to do in the IPG.
In our recent investor conferences and presentations, we shared our strategic expectation that our North America/HME net sales would continue to decline.
We expected growth margin as a percentage of net sales to improve.
We believe we're on the right track as the segment second quarter financial results continue to be in line with our expectations.
This 2015, we've been transforming our North America/HME business to focus on more clinically complex care with the ability of rehabilitation to sales force, trained to provide clinical solutions with our mobility and seating product portfolio, including increase in access to related products from our subsidiaries.
This will be an ongoing effort of investment and training.
With the North America/HME transformation underway, we have initiated the second phase of the change, which is the enhancement of our post-acute care business affecting principally the IPG segment.
Post-acute care can be provided in a variety of clinical selling outside of hospital.
Over the past quarter, we've began developing our specialized post-acute care sales force with investments in clinical sales training of certain customer call points, and recruitment.
As we continue to pursue our turnaround with additional investments, we expect increase consolidated gross profit dollars over time in addition to the gross margin percentage.
While we are executing this transformation, we will be managing through external uncertainty, including foreign currency fluctuations, as well as continued reimbursement pressures particularly on the ongoing rollout of National Competitive Bidding in the United States.
As we can see more transformation, we remain committed to our number one priority by establishing a quality culture.
As noted in our Form 8-K filing on June 9, 2016, we received feedback from FDA on steps required to proceed with the consent decree.
Our team continues to work on design history file remediation and broader deployment of quality systems improvement, quality will remain at the center of what we do as a company and unfazed to the teams' progress.
I'd also like to share some organizational changes.
Today we announced on Form 8-K that Gordon Sutherland, our Senior Vice President and General Manager of Europe has resigned to take any role.
Gordon joined the Invacare Europe team in 2012 and has led the business segments to deliver consistent results.
I appreciate Gordon's leadership, I wish him good luck in his role.
We're fortunate to have a strong leadership team across the Europe segment and we expect the transition to be smooth.
Also, this morning, we announced upcoming changes from our Board of Directors.
General <UNK> Jones, who joined the board in 2010, has decided to step down effective August 26, 2015.
As a result of the increasing global responsibilities and travel for this other two roles.
In addition, after 30-years of service Michael Delaney has expressed his intend, not sustained for reelection with his terms from the 2017 Annual Meeting.
It has been very helpful for me to come to this company with such deep experience in place on the board.
General Jones with his insights into government and international affairs, as well as his guidance on culture based on his years of leadership with the United States government, has been a great resource.
Mike Delaney has given the company invaluable insight into the consumers of our products from his personal experiences, as well as those from his careered with the Paralyzed Veterans of America.
On behalf of Invacare, I want to thank both of them for their contributions and commitments.
This is an exciting time for Invacare, the remaining opportunities ahead of us and we are proud our machine to provide clinical solutions to the growing number of people and need of our products.
As the markets for our solutions expand, we're transforming our companies to be able to advance to that opportunity.
Thank you for your time and attention on today's call.
We will now open the phone lines for questions.
Holly, let's open the phone lines for questions.
Hi, <UNK>.
Good morning.
Sure, <UNK>.
We've been talking about this for number of quarters to really selectively focus on things that provide distinguished and differentiated care on our solutions.
And we call a number of elements of the business that we are doing lots of Aids for Daily Living.
It's difficult for us to put a precise number on that, because part of the differentiation is not only the product, but deciding on which those are sold.
As we've discussed in our investor relations presentations, as customers in certain segments continue to look for highly durable robust products.
We continue to meet them at a price point, that we've recommended, the intersection where Invacare plays very well in some channels.
The set is more for single use products where our products aren't just well positioned, because we are about robust long-term design conclusions.
We've ---+ and that has changed to critically complex selling and customer engagements really, since July of last year, and I think for three quarters now this being the third, we have in the results of the decline in that business in the first quarter that part of the business was down quite substantially more so than the second quarter.
Second quarter, we see continued decline, but to a lesser extent.
And we assume at some point, we will inverse into more normal levels of sales of ongoing customers and products.
Well, we don't looking guidance for the back half of the year, but you are right, seasonally the business has typically been cash consummated in the first-half.
And cash accretive in the second half.
I think, last year it uses a comparison of which we had some one-time costs of retirement payments in sales we expect.
Our free cash flow in the first half was an consumption of $22 million and for the full year, last year, we generated over $13 million, so we were offsetting that in the second half.
So we expect that the same external factors generally are applying this year.
And we look forward to improvements in the second half, which you're right.
We're also making investments and when we make those investments in the commercial teams, which are in the form of payroll kind of expenses for new sales reps who are not yet accretive, but all the equipment demonstration units expand and things for them, to get out in the effective.
It can be six to 12 months before they have a full book of business really trying to kind of results we expect.
We're pleased with the uptick in effectiveness of our sales transformation, our new sales associates.
But it's still pretty early in that transformation.
So we'll expect their affectivity to improve over the next couple of few quarters.
^ <UNK>, the only thing I'd add to that is just put a little more color on the prior year.
Now that we don't include restructuring the first half was about $28.6 million in terms of the drain.
And for the full year, we generated $11.9 million, and I think <UNK>'s exactly on the point, which is the second half is positive.
And what I've done there, I mean, covered separately is I pulled out all the impacts from the retirement payments and the sale-leaseback from last year, because that's really a better indicator of where the business went.
So again, we did it in a release for the first-half of 2015 of $28.6 million in the back half let us have a positive $11.9 million, but again at this point we're really not talking about 2016.
Every quarter, we obviously accumulate all the transactions that make up the quarter, so we can't exactly say where they are.
But that's ---+ I think the last two quarters of performance and margin shift reflect a fundamental shift in the type of transactions that we're doing to serve customers very well with our complex rehabilitation product.
They come at higher gross margin, because they're highly customized and they deliver more value for our customers.
And I think that is a fundamental shift that can continue in future quarters.
we're really ---+ the analogy is we're really paying interest on the construction loan before we've occupied the house.
We've incurred SG&A increases, which we're mindful of.
We've got to make good returns on those.
Our substantive sales force increases in personnel, really occurred at the beginning of second quarter, and it's early in their tenure to be accretive yet, so that's the gap that we're seeing right now.
Thanks, <UNK>.
Okay.
Timing and gross margins in the future, so I would layer a few rows of thinking on top of a calendar to talk about the timing.
So if you'll remember ---+ our listeners may remember from second and third quarter last year, we talked about the investment beginning to be made in the incumbent sales force in terms of assessments, skills training, clinical training, quota development with the new portfolio of products.
So I think we're relatively well seeded in terms of building affectivity of the incumbent sales force.
And those have been the large drivers of the mixed shift in gross margin improvement in quarters four, one, and two.
We talked about the increase in the sales force and further developments, and the increase in sales force of new personnel really began in the second quarter 2016 and those folks go through many weeks of training getting out into their new territory, starting to build a book of business.
I view those sales folks to be effective over a six to 12 month period.
So the second row of ---+ layering of timing is kind of six to 12 months that begins let's say beginning of first ---+ sorry, beginning of second quarter of this year.
And then, I think, if you look at the commercial changes, we really saw the big step down in sales of our Aids for Daily Living business to begin in the first quarter of this year principally in the HME segment.
And at some point you anniversary into a years' worth of those kind of changes.
So you might take a 12 month row and say, these are kind of the sales winnowing that happened in that segment beginning in first quarter of this year.
So those are kind of the three layers I think about affecting North America/HME segment.
And then, we are staggering the same kind of transformation in the IPG segment and that's really begun in the second quarter of this year.
And you'll see probably a similar multi-period pattern.
The second part of your question was about gross margin in the future, and I think, in our investor presentation and in some of the discussions we've had, we've been able to describe the historic market in which we play, which had a relatively normal shaped bell curve of product profitability tenured around the Company's reported average.
And historically, that's been a little tighter distribution, where we were able to make good gross margin in the full range of products.
Over the last few years of national competitive bidding with other external pressures, the left hand less profitable side of that curve has gone down into the lower gross margin dollar segment, but we still have a half of a bell curve of profit by product that's above average.
And we're really trying to focus on our skills, which are bringing great customized products and products that deliver demonstrably different clinical care.
And those are typically above average in gross margin, which reflects the value that we bring to the marketplace.
So that is the kind of gross margin shift that we should be able to see over the medium and long term.
Sure.
IPG, as folks may know, is more of a B2B capital sale.
We do make smaller transactions for replacement and small changes that operators make.
But the folks who operate these post-acute long-term care facilities are typically buying on a fleet basis maybe for a larger renovation product, their long cycle projects and our selling cycle is the capital cycle to a large extent.
What we had in the second quarter of this year was a stack up of couple of things that both went negative.
The one that we knew would happen would be the decline in the sales teams effectiveness as we took them out of the marketplace, did selling, the skills assessment, the kind of things we had done in complex rehab a year period.
The thing that we were unable to predict exactly was the lumpiness of the timing of the things that work out in size and timing of projects, or things that get delayed or the bids that we lose, and we just had both of those go the same negative way this quarter.
I don't think that's a consistent expectation going on, but we continue to evaluate that business as we transform it.
Yes.
We continued to have a constructive engagement with the FDA.
And as I've mentioned, boy, we're all about quality and not just to tick and tie the tactics to solve the problem with a consent decree, but really to drive meaningful results in the culture and operation, and processes, because we want this to be not only in improvement, because we get beyond the consent decree, but it's got to be a sustainable competitive difference that Invacare has for its customers that over the long term has to lead to better customer engagements, share growth, and other positive economic factors that benefit shareholders.
And we are all about that.
The consent decree is sort of updated from the feedback the FDA gave us at the beginning of June in terms of the related next steps that we have to undertake principally around design history file remediation as a means to demonstrate our processes for executing the design control part of the federal requirement, Section A 2030.
Those are relatively straightforward and we have the opportunity now to go back and very clearly document the improvements in our design history files and our processes, so we can demonstrate to the FDA.
Once that's done, we can move into the third section.
But I think as we've really demonstrated now for three quarters in a row, the Company isn't about the consent decree.
And I'm really pleased that the response we've gotten from the investors in market, that see that we're able to do a tremendous amount to deliver better economic returns to our customers in spite of the consent decree.
We are really not about the consent decree.
We have a tremendous amount of value to offer.
Quality is our priority and the consent decree is (inaudible) activity in Cleveland.
But I'll tell you, it's sort of a two-part discussion, where we take the FDA's requirements very seriously.
I take quality culture extremely seriously and we're deploying that.
But at the same time that can't be an excuse for anybody in the Company to underperform.
So while we're tackling the consent decree and doing all the right things, we're driving the business to improve, and we're now in the third quarter showing we can do that.
Thanks, Bob.
We can, <UNK>.
Good morning.
Yes, we actually announced at the beginning of the call, Laure mentioned it, but I'm happy to re-cover it.
We're going to stop on both free cash flow where we used to take restructuring activities, cash spend on restructuring activities.
We used to use that as an add-back for free cash flow.
We're not going to do that any longer.
So we've made that adjustment.
I think it's cleaner, <UNK>, to be honest.
Additionally, we made a change on the adjusted earnings, the restructuring charges we used to be an add-back, but we're going to leave that in as an expense.
This is something we have to manage.
So again, I think it will be cleaner both on the adjusted earnings and on free cash flow.
But you're right we did make adjustments on both of those.
You know, I think it's two-fold, Bob, ideally we're going to do the right thing.
So we're not going to not pursue restructuring.
It's the right thing to do.
But at the same time I think you have -.
when we have restructuring that occurs in some measure every quarter, adding that back, I think at some point it doesn't make a lot of sense.
So I think it's more a way of looking at it than necessarily an indication we're going to do more or less restructuring.
And, <UNK>, this is <UNK>.
I guess, I'd add to <UNK>'s comments, and I want to drive a culture internally where we are talking about the same things that shareholders see and that's real cash at the end of the day, real earnings at the end of the day and we've got to make restructuring fit into our programs.
We're really in a business that's going to have long-term renovation and we have to get used to accommodating those in the way we talk about our progress.
There is not a precise way to estimate it, but I'll give you some ways we look at it.
It's not a trivial exercise like you might see in an international operation that can be done within a week.
That can happen.
I think in this case, if you look at last year, the FDA had inspectors here for five months.
So it's of let's say a similar scope.
It was the Cert 1 and Cert 2 consent decree.
This will be Cert 3.
So our best guess is it could be five months, it could be nine months, it could be longer, it could be shorter, but I don't think it could be extremely short.
And there is no real way to tell.
When we look at other Company's experience, there too many other factors to make those comparable estimates.
So we kind of look at last year as the best median indicator.
Yes, it's an interesting question to answer, given all the moving parts we have in our limited guidance.
So our operating mechanism on a strategic basis and then what we do weekly and monthly to manage is really to look at where the business needs to go in terms of fundamental improvement in meeting customer needs that are clinically complex because that's where the Company can get the best return for its investment in resources and expertise in building highly unique customized solutions and things that really make a difference.
We are a medical device patient-centered company.
This isn't an economic transformation.
It's really a patient-centric transformation that has positive solid sustainable long-term economic gains for shareholders.
So as we go through that process, we look at what we can do in terms of gross margin to make our engineering work more sustainable in terms of delivering results.
And I think what you see in the last three quarters is indicative of where we can go in the future and the market certainly can sustain that, because the market of patients who need that kind of care globally is very robust.
The amount of SG&A that we spend is determined by how gross margin dollars shift within a month.
So we strive for gross margin percent improvements in the short-term.
We look at how customer contracts had allowed it to anniversary in a particular month.
We look at the dollars that will be contributed from the gross margin line and we modulate our spending in SG&A accordingly.
I think the level of SG&A spending now is enabling us to build the sales force that we need and make the right kinds of investments.
Depending on where the appreciation lays, but clearly in terms of a cash flow, we also meter CapEx spending that same way.
Historically the company ---+ in recent history, the Company has had relatively suppressed CapEx spending.
In 2015, for example, it was less than 0.7% of sales.
CapEx needs to probably come up a little bit ---+ 1% of sales or 2%.
We don't have catch-up CapEx spending to get to, but we'll asymptotically come up to a more reasonable level.
And we modulate that also monthly based on our contribution margins.
Another way people can look at the kind of the long-term efficacy of the income generation of the Company is to look at our European segment, which is really a version of unfettered access of our products in a very competitive marketplace, where we continue to see sales gains and good earnings contribution in a competitive marketplace.
So that's kind of the way I would triangulate.
Okay.
Thank you, <UNK>.
Well, as I stated in my closing comments.
It is an exciting time for Invacare, because we're well positioned in this marketplace to advantage of the -.
being at the destination of the transformation of healthcare spending out of acute care space into the places where we succeed.
We do have a wonderful portfolio of differentiated products that can contribute positively on behalf of shareholders and we look forward to taking advantage of that.
Thanks for your time and attention today.
We'll be available for calls.
