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IVC > SEC Filings for IVC > Form 10-K on 15-Mar-2013All Recent SEC Filings

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Form 10-K for INVACARE CORP


15-Mar-2013

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.

OUTLOOK

The company's fiscal year 2012 was dominated by its consent decree negotiations with the FDA which concluded when the consent decree became effective on December 21, 2012. The consent decree of injunction limits the company's manufacture and distribution of custom power and manual wheelchairs, wheelchair components and wheelchair subassemblies at or from its Taylor Street manufacturing facility. The decree also temporarily limits design activities related to wheelchairs and power beds that take place at the impacted Elyria, Ohio facilities.

In order to resume full operations at the impacted Elyria, Ohio facilities, the company must successfully complete a three-step third-party expert certification audit that will be followed by an FDA inspection. The company has initiated the first two of its third-party expert certification audits. The first addresses the equipment and process validation procedures in the Taylor Street manufacturing facility and the second addresses the company's design control procedures at the corporate facility. Barring any unexpected developments or the requirement to perform additional remediation activities as a result of the third-party expert audits, the company expects the first two certification audits to be completed in the first quarter of 2013. At the time of filing this Annual Report on Form 10-K, the third expert certification audit has commenced and the company plans to complete the audit in the second quarter of 2013. Because the FDA has the authority to reinspect at any time, the company cannot determine whether the FDA will elect to inspect after either the first or second third-party expert audits. According to the consent decree, the FDA has thirty
(30) days after receipt of the third expert certification audit results to commence its own inspection. It is not possible for the company to estimate the timing or potential response of the FDA's inspection and subsequent written notification and thus, it is uncertain whether normal operations will resume before the end of 2013. Completing the remediation and receiving the FDA's approval on the second certification audit related to design controls will allow the company to resume design activities and refocus its engineering resources on new product development. Introducing new product solutions to the market will get the company back on track to regaining market share and resuming its globalization program designed to harmonize core product offerings and deliver on its long-term goal of $100 million in cost improvements and re-establish high single-digit operating margins.

Since the consent decree became effective, new orders for power wheelchairs, one of the company's most profitable product lines, have declined substantially compared to the same period last year, primarily due to the consent decree's limitations on the company's ability to manufacture, assemble and distribute wheelchairs at or from its Taylor Street manufacturing facility. As the company has previously disclosed, the consent decree contains several important exceptions, as follows:

a. The company may continue to fulfill orders and written quotes that were already in the company's order fulfillment system as of the December 21, 2012 effective date of the consent decree, as long as the provider completes a form certifying that he or she is aware of the decree and would still like for the company to fulfill the order.

b. The company may manufacture and distribute a user's replacement chair and/or seating system when a user requests the same or newer version of his/her existing product, and the clinician submits a verification of medical necessity form that acknowledges the existence of the consent decree.

c. The company may manufacture and distribute wheelchairs or seating systems from the Taylor Street facility, if a clinical evaluation determines that the product is medically necessary to meet a particular user's needs which cannot be appropriately addressed by another manufacturer's product, and the clinician and the user's physician complete and submit a verification of medical necessity form.

d. Other exemptions exist to allow for ongoing service, repair and warranty replacement of products already in use as long as the provider completes a form certifying that he or she is aware of the consent decree and that the parts and components they receive will be used solely for the service or repair of the company's wheelchairs already in use.

Providers and medical professionals, who are already over-burdened with substantial documentation obligations to satisfy reimbursement requirements, have struggled to complete the additional documentation needed to obtain an Invacare wheelchair or seating system for their users. In addition, the company reviews each signed verification of medical necessity (VMN) form for new and replacement wheelchairs and/or seating systems to ensure that it is appropriately completed. In instances where the VMN form has been found by the company to be improperly completed, or where the explanation of medical necessity is not deemed sufficient to justify the product order, the company rejects the VMN and returns it to the clinician; and the order remains on hold until the company receives the appropriately completed VMN. The company is required to submit to the FDA copies of each approved VMN the company receives during the first 90 days after the effective date of the consent decree. In a letter dated February 6, 2013, the FDA notified the company that, in the FDA's review of approved VMN forms submitted thus far, it found that the

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company failed to reject certain VMN forms which the FDA considered inadequately completed and that similar failures in the future could result in the assessment of liquidated damages under the terms of the consent decree. The company has had discussions with the FDA and has taken actions to address FDA's concerns by enhancing the company's rigorous VMN review process. In addition, the company continues to provide training and feedback to providers and clinicians to educate them on the expectations for properly completing the VMN forms. At the time of filing this Annual Report on Form 10-K, the number of orders which the company has fulfilled with the appropriate VMN documentation requirements is substantially lower than comparable order volume during the same period last year.

In 2013, the company expects continued pressure on its organic net sales, cash flow and operating profitability. The key drivers of these pressures include the ongoing quality systems remediation costs, the related diversion of resources, and the limited production at its Taylor Street wheelchair manufacturing facility in Elyria, Ohio, due to the consent decree. In addition, the company has been unable to invest in the development or introduction of new products while it focuses its engineering resources on its quality systems remediation. Further, the consent decree enjoins the company from design activities related to wheelchairs and power beds at its corporate facility until it receives approval from the FDA on the second expert certification audit. As described above, the company educates customers on the new documentation requirements, particularly the more detailed verification of medical necessity forms for new wheelchairs and/or seating systems, the company is experiencing slowness in incoming orders of new wheelchairs from the Taylor Street facility. The company is focused on completing its expert certification audits as quickly and efficiently as possible.

The company also is facing external challenges within its North America/HME segment. In addition to customers coping with prepayment reviews and post-payment audits of power mobility devices from Medicare and Medicaid, the Centers for Medicare and Medicaid Services (CMS) recently announced the bid rates for the second round of National Competitive Bidding (NCB), which are substantially lower than current average prices. The company continues to expect pressure on net sales as providers that were successful bidders in the 91 metropolitan statistical areas finalize the contracting process with CMS. Looking forward, the company is positioned to assist HME providers in managing the price reductions associated with NCB, and it will remain judicious in its extension of credit to customers in these areas. The company has worked closely with providers over the last two years in preparation for NCB, offering programs to assist them in improving their operational efficiency, as well as products that serve to expand market opportunities.

As described elsewhere in this Annual Report on Form 10-K, for the fiscal quarter and the fiscal year ended December 31, 2012, the company had a net loss from continuing operations of $0.34 per share and $0.26 per share, respectively. These results are indicative of the pressures on the company's net sales that were present throughout 2012, even before the FDA consent decree became effective. While, at the time of this filing, the consent decree had been effective for only approximately two months and thus, the effect on customer orders and net sales was not yet clear, the company expects to experience further declines in net sales as a result of the limitations imposed by the consent decree. The company expects to continue to experience decreased net sales in the North America/HME segment until it has successfully completed the previously described third-party expert certification audit and FDA inspection and has received written notification from the FDA that the company may resume full operations. For the North America/HME segment, total Mobility and Seating sales were $278,113,000 for the year ended December 31, 2011 and $244,417,000 for the year ended December 31, 2012. However, not all the product lines included in these amounts were manufactured at the Taylor Street facility. The company does not track net sales by production facility. Therefore, the company has estimated net sales attributable to the Taylor Street facility by segregating the net sales for the North America/HME segment by business unit and product line and then estimating whether the product lines were sourced from the Taylor Street facility. Based on this methodology, the company estimates that total net sales related to products produced at the Taylor Street facility were approximately $172,000,000 for the year ended December 31, 2011 and $147,000,000 for the year ended December 31, 2012. Even after the company receives the FDA notification that it may resume full operations at its Taylor Street facility, it is uncertain as to whether, or how quickly, the company will be able to rebuild net sales to more typical historical levels, irrespective of market conditions. Accordingly, the company expects that these challenges could negatively impact the company's operating results in 2013 to an even greater degree than was experienced in 2012.

DISCONTINUED OPERATIONS

As part of the company's globalization strategy, and to allow the company to focus on its core equipment product lines, the company completed the sale of its medical supplies business, Invacare Supply Group (ISG), on January 18, 2013. The transaction was completed pursuant to a share purchase agreement that was entered into on December 21, 2012. Under the terms of the sale, the company received approximately $150,800,000 in cash, which is subject to final post-closing adjustments, with net proceeds from the sale of approximately $146,600,000, net of expenses.

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The company will recognize, in its financial statements for the first quarter ended March 31, 2013, a net after-tax gain of approximately $40,600,000 ($60,400,000 pre-tax) from the sale transaction, which represents the excess of the net sales price over the book value of the assets and liabilities of ISG as of the date of completion of the disposition. The company utilized the proceeds from the sale to reduce debt outstanding under its revolving credit facility in the first quarter of 2013. Going forward, the sale of this business is expected to be dilutive to the company's results.

As a result of the company's decision to sell the business in December 2012, the assets and liabilities of ISG were reflected as assets and liabilities held for sale at the end of 2012 and 2011. Assets and liabilities held for sale were comprised of the following:

(In thousands)                       December 31, 2012      December 31, 2011
Trade receivables, net              $            44,196    $            37,583
Inventories, net                                  25,165                24,042
Other current assets                               9,355                 5,988
Goodwill                                          23,073                     -
Property, plant and equipment, net                 1,368                     -
Assets held for sale - current      $           103,157    $            67,613
Assets held for sale - non-current  $                 -    $            24,445

Accounts payable                    $            17,692    $            12,354
Accrued expenses                                  4,602                  3,902
Accrued income taxes                              1,064                    680
Liabilities held for sale - current $            23,358    $            16,936

Unless otherwise noted, the following discussions of the net results of the company and its segments exclude the discontinued operation of ISG.

RESULTS OF CONTINUING OPERATIONS

2012 Versus 2011

Net Sales. Consolidated net sales for 2012 declined 3.1% for the year, to $1,455,461,000 from $1,501,639,000 in 2011. Foreign currency translation decreased net sales 2.5 percentage points while an acquisition increased net sales by 1.1 percentage points. Organic net sales declined 1.7% which was driven by decreases in the North America/HME and Asia Pacific segments partially offset by increases in the Europe and IPG segments.

North America/Home Medical Equipment (North America/HME)

NA/HME net sales decreased 7.2% in 2012 versus the prior year to $693,285,000 from $746,782,000 with foreign currency translation decreasing net sales by 0.1 of a percentage point. The organic net sales decrease of 7.1% was driven by reductions in all three sales categories: mobility and seating, respiratory therapy and lifestyle products. The net sales in this segment were impacted by uncertainty related to the FDA consent decree and the lack of new products as a result of refocusing engineering resources on remediation related to the consent decree. In addition, in the second half of the year there were also external pressures on the company's customers relating to the second round of National Competitive Bidding, as well as prepayment reviews and post-payment audits from Medicare and Medicaid.

Institutional Products Group (IPG)

IPG net sales increased 19.8% in 2012 over the prior year to $148,648,000 from $124,121,000. Foreign currency translation had no material impact on net sales while an acquisition increased net sales by 13.1 percentage points. The organic net sales increase of 6.7% was largely driven by net sales increases in interior design projects for long-term care facilities and dialysis chairs, which were partially offset by declines in institutional beds.

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Europe

European net sales increased 0.4% in 2012 compared to the prior year to $546,543,000 from $544,537,000 with foreign currency translation decreasing net sales by 6.6 percentage points. Organic net sales increased 7.0 percentage points, which was primarily attributable to increases in respiratory therapy products partially offset by declines in lifestyle and mobility and seating products.

Asia/Pacific

Asia/Pacific net sales decreased 22.3% in 2012 from the prior year to $66,985,000 from $86,199,000. Foreign currency translation increased net sales by 0.7 of a percentage point. The organic net sales decline of 23.0 percentage points was driven primarily by volume declines in the company's Australian and New Zealand distribution businesses as well as in the company's subsidiary, which produces microprocessor controllers. Changes in exchange rates, particularly with the Euro and U.S. Dollar, have had, and may continue to have, a significant impact on sales in this segment.

Gross Profit. Consolidated gross profit as a percentage of net sales was 30.6% in 2012 as compared to 32.0% in 2011. The margin decline was principally related to sales mix favoring lower margin product lines and lower margin customers, reduced volumes and increased research and development expenses partially offset by the benefit of the company's 2011 acquisition of a rental business. Gross profit as a percentage of net sales for the IPG segment was favorable as compared to the prior year with NA/HME, European and Asia/Pacific segments unfavorable to the prior year.

NA/HME gross profit as a percentage of net sales declined 2.1 percentage points in 2012 from the prior year. The decline in margins was principally due to an unfavorable sales mix favoring lower margin customers and product lines, reduced volumes and increased research and development expenses, primarily focused on FDA remediation.

IPG gross profit as a percentage of net sales increased 1.8 percentage points in 2012 from the prior year. The increase in margin is primarily attributable to volume increases, the favorable impact from the rental acquisition, which was finalized in the fourth quarter of 2011 and reduced freight costs partially offset by increased research and development expenses. The increased research and development expenses for this segment include the costs of contracted engineering on negative pressure wound therapy products.

Gross profit in Europe as a percentage of net sales declined 1.8 percentage points in 2012 from the prior year. The decrease was primarily a result of unfavorable product mix toward lower margin product and lower margin customers and increased warranty expenses.

Gross profit in Asia/Pacific as a percentage of net sales declined 3.7 percentage points in 2012 from the prior year. The decline was primarily as a result of the significant volume declines in each of the businesses in this segment.

Selling, General and Administrative. Consolidated selling, general and administrative (SG&A) expenses as a percentage of net sales were 28.5% in 2012 and 26.4% in 2011. The overall dollar increase was $17,970,000 or 4.5%, with foreign currency translation decreasing expenses by $8,313,000, or 2.1 percentage points, and an acquisition increasing expenses by $10,263,000, or 2.6 percentage points. Excluding the acquisition and the impact of foreign currency translation, SG&A expenses increased $16,020,000 or 4.0%. This increase is primarily attributable to increased regulatory and compliance costs related to quality systems improvements of $22,757,000. Excluding an acquisition, the impact of foreign currency translation and the increased regulatory and compliance costs, SG&A expense decreased $6,737,000, or 1.7 percentage points, primarily as a result of reduced bad debt and associate costs.

SG&A expenses for NA/HME increased 4.9%, or $9,779,000, in 2012 compared to 2011 with foreign currency translation decreasing SG&A expense by $215,000. Excluding the foreign currency translation, SG&A expense increased $9,994,000 or 5.0% due to increased regulatory and compliance costs related to quality systems improvements of $22,757,000, partially offset by reduced bad debt and associate costs.

SG&A expenses for IPG increased by 34.0%, or $11,821,000, in 2012 compared to 2011. An acquisition increased SG&A expenses by 29.5 percentage points, or $10,263,000, while foreign currency translation decreased expense by $22,000, or 0.1 of a percentage point. Excluding the impact of an acquisition and foreign currency translation, SG&A expenses increased by $1,580,000, or 4.5%, due to increased associate costs, including commission expense and unfavorable currency transaction effects associated with the Canadian Dollar versus the U.S. Dollar.

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European SG&A expenses decreased by 2.9%, or $3,741,000, in 2012 compared to 2011. Foreign currency translation decreased SG&A expenses by approximately $8,293,000. Excluding the foreign currency translation impact, SG&A expenses increased by $4,552,000, or 3.5%, primarily related to increased associate costs and bad debt expense partially offset by favorable foreign currency transaction effects.

Asia/Pacific SG&A expenses increased 0.4%, or $111,000, in 2012 compared to 2011. Foreign currency translation increased expenses by $217,000. Excluding the foreign currency translation impact, SG&A expenses decreased $106,000, or 0.3%, primarily due to reduced bad debt expenses.

Asset write-downs to intangible assets. In accordance with ASC 350, Intangibles
- Goodwill and Other, the company reviews intangibles for impairment. As a result of the company's 2012 annual intangible impairment review, an impairment charge of $96,000 ($96,000 after tax) was recorded related to a patent in the NA/HME segment. In addition, total impairment charges of $677,000 ($602,000 after tax) were recorded in the IPG segment: $398,000 ($398,000 after tax) related to developed technology and $279,000 ($204,000 after tax) related to a trademark impairment.

In 2011, the company recorded intangible impairment charges of $1,761,000 related to certain intangible assets in the NA/HME, IPG, Europe and Asia/Pacific segments. In addition, as a result of the company's annual impairment test of goodwill, the company recorded an impairment charge of $39,729,000 ($39,729,000 after tax) in the Asia/Pacific segment as a result of reduced forecasted profitability and $7,990,000 ($7,336,000 after tax) in the NA/HME segment as a result of the impact from the FDA consent decree.

Debt Finance Charges and Fees. In 2012, the company extinguished $500,000 in principal amount of its outstanding 4.125% convertible senior subordinated debentures due in February 2027. This early debt extinguishment resulted in debt fees and premium expenses of $312,000 comprised of $301,000 of premiums paid and losses recorded as a result of early debt extinguishment and $11,000 of expense related to deferred financing fee write-offs, which were previously capitalized.

In 2011, the company extinguished $63,351,000 in principal amount of its outstanding 4.125% convertible senior subordinated debentures due in February 2027. This early debt extinguishment resulted in debt fees and premium expenses of $24,200,000 comprised of $22,646,000 of premiums paid and losses recorded as a result of early debt extinguishment and $1,554,000 of expenses related to deferred financing fee write-offs, which were previously capitalized.

All of the debt finance charges and fees in 2012 and 2011 are included in the All Other segment.

Charge Related to Restructuring Activities. The company's restructuring charges were necessitated primarily by continued declines in Medicare and Medicaid reimbursement by the U.S. government, as well as similar healthcare reimbursement pressures abroad, which negatively affect the company's customers (e.g. home health care providers), coupled with continued pricing pressures faced by the company as a result of outsourcing by competitors to lower cost locations. While the company's restructuring efforts have been executed on a timely basis, resulting in operating cost savings, the savings have been more than offset by continued margin decline, principally as a result of product mix, and higher regulatory and compliance costs related to quality system improvements which are unrelated to the restructuring actions. The company expects any near-term cost savings from restructuring will be more than offset by higher regulatory and compliance costs related to quality system improvements at least until the company has completed its quality systems remediation efforts.

The company's restructuring commenced in the second quarter of 2011 with the company's decision to close the Hong, Denmark assembly facility as part of the company's ongoing globalization initiative to reduce complexity in the company's supply chain which is intended to reduce expenses to help offset pricing pressures. In the third quarter of 2011, the company continued to execute on the closure of the Hong, Denmark assembly facility and initiated the closure of a smaller facility in the U.S. Charges for the quarter ended December 31, 2011 were primarily incurred at the company's corporate headquarters for severance, with additional costs incurred as a result of the closure of the Hong, Denmark facility. The facility closures were completed in 2012 in addition to the elimination of various positions principally in the North America/Home Medical Equipment (HME) and Asia/Pacific segments.

Charges for the year ended December 31, 2011 totaled $10,534,000 including charges for severance ($8,352,000), contract exit costs primarily related to the closure of the Hong, Denmark assembly facility ($1,788,000) and inventory write-offs ($277,000) recorded in cost of products sold and miscellaneous costs ($117,000). The majority of the 2011 North America/HME charges were incurred for severance, primarily at the corporate headquarters as the result of the elimination of various positions principally in sales and administration in Elyria, Ohio. These eliminations were permanent reductions in workforce which primarily resulted in reduced selling, general and administrative expenses. In Europe, the charges were the result of the closure of the company's Hong, Denmark facility. The assembly activities were transferred to other company facilities or outsourced to third parties. This

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closure enabled the company to reduce fixed operating costs related to the facility and reduce headcount with the transfer of a portion of the production to other company facilities. The majority of the 2011 charges have now been paid out and were funded with operating cash flows.

Charges for the year ended December 31, 2012 totaled $11,395,000, of which $491,000 was recorded in cost of goods sold, since it related to inventory markdowns in the Asia/Pacific segment, and the remaining charge amount was included in Charges Related to Restructuring Activities in the Consolidated Statement of Operations. The charges include severance ($6,775,000), lease termination costs ($1,725,000), building and asset write-downs, primarily related to the closure of the Hong, Denmark assembly facility, and other miscellaneous charges in Europe and Asia/Pacific ($2,404,000) and inventory write-offs ($491,000) in Asia/Pacific recorded in cost of goods sold. Severance charges were primarily incurred in the North America/HME segment ($4,242,000), Asia/Pacific segment ($1,681,000) and Europe segment ($817,000). The charges were incurred as a result of the elimination of various positions as part of the company's globalization initiatives. In addition, a portion of the North America/HME segment severance was related to positions eliminated, principally in sales and marketing as well as manufacturing, at the company's Taylor Street facility as a result of the FDA consent decree. The savings from these charges will be reflected primarily in reduced selling, general and administrative expenses and manufacturing expenses for the company. In Europe, positions were eliminated as a result of finalizing the exit from the manufacturing facility in Denmark and an elimination of a senior management position in Switzerland. In . . .

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