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IVC > SEC Filings for IVC > Form 10-Q on 6-Nov-2013All Recent SEC Filings

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Form 10-Q for INVACARE CORP


6-Nov-2013

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Continuing Operations.

OUTLOOK

With respect to the status of the consent decree with the United States Food and Drug Administration (FDA), the company has made significant progress on the final, most comprehensive third-party certification audit at the Corporate and Taylor Street facilities in Elyria, Ohio. The company is targeting to have the certification report stating that the company is in compliance with 21 CFR Part 820 of the Quality System Regulation (QSR) completed by the third-party expert and filed with the FDA by mid-November 2013. There remains some scheduling issues and final work to complete in order to reach the targeted timing. In addition, since receiving the FDA's acceptance of the second certification report in July, the company has restarted new product development on critical projects, such as complex power wheelchairs.

The company is actively managing expenses as it works through the consent decree process. Restructuring efforts to make the company more cost competitive continue in line with the company's globalization strategy to reduce complexity within the business and focus on its core medical equipment product lines. Accordingly, the company is considering the possible divestiture or closure of subsidiaries that are outside the company's core equipment business. Cost reduction initiatives continue, including general expense reduction, project delays and infrastructure consolidation. In addition, the company is closely monitoring the roll-out of the second round of National Competitive Bidding ("NCB"), which became effective in 91 additional metropolitan statistical areas in the U.S. on July 1, 2013. The company estimates that, for the first nine months of 2013, approximately $220,000,000 in net sales of its U.S. HME equipment business, the major division within the NA/HME segment, are in products sold to home care providers that are included in the competitive bidding product categories. When the company's products are ordered by HME customers, the company does not know if the products are then billed by the customer for Medicare, Medicaid, private pay reimbursement or sold as cash sales. However, industry studies have shown historically that approximately 40% of HME providers revenues on average are paid by Medicare. Additionally, it is estimated that round one and round two of NCB, which include a total of 100 metropolitan statistical areas, account for approximately 75% of its spending on durable medical equipment. Taking the $220,000,000 of U.S. HME net sales for the first nine months of 2013 of NCB bid categorized product and applying the previously mentioned 40% and then the 75% estimates, the products exposed to NCB could be approximately $66,000,000. This estimate does not include other potential pricing pressures that could also impact HME providers from other payors. At this early stage of the NCB program, it is difficult to estimate the realized impact from NCB on the company's domestic home medical equipment business, since there continues to be uncertainty as the industry realigns and adjusts itself to the small number of bid contracts awarded.

STATUS OF THE CONSENT DECREE

The FDA consent decree at the Corporate and Taylor Street facilities in Elyria, Ohio, requires that a third-party expert perform three separate certification audits. In order to resume full operations, the third-party certification audit reports must be submitted to the FDA for review and acceptance. After the final certification report is provided to the FDA, along with the company's own report as to its compliance with the FDA's QSR as well as the actions taken to correct any violation that may have been brought to the company's attention in the third-party certification report, the company expects the FDA to conduct its own audit of the impacted facilities. The company has already received the FDA's acceptance of two of the three certification reports, and it is targeting to have the final third-party certification report completed and filed with the FDA by mid-November 2013. There remains some scheduling issues and final work to complete in order to reach the targeted timing. According to the consent decree, the FDA is expected to commence its own inspection of the impacted facilities within thirty days of receipt of the third-party expert's final certification report and the company's accompanying report. If, following its inspection, the FDA finds the company to be in compliance, it will issue a written notification permitting the company to resume full operations at the Corporate and Taylor Street facilities. It is not possible for the company to estimate the timing of or potential response from the FDA's inspection. The company will provide investors with an update when the final, third-party expert certification report is filed with the FDA. See the "Contingencies" note to the financial statements contained in Item 1 of this Form 10-Q and "Forward-Looking Statements" contained below in this Item.

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RESULTS OF CONTINUING OPERATIONS

Except for free cash flow, the financial information for all periods excludes the results of discontinued operations. Discontinued operations include Invacare Supply Group (ISG), the company's former domestic medical supplies business that was divested on January 18, 2013 and Champion Manufacturing, Inc. (Champion), the company's former domestic medical recliner business for dialysis clinics that was divested on August 6, 2013. Champion was a part of the Institutional Products Group segment. For more information, see the condensed consolidated financial statements included in this Quarterly Report on Form 10-Q. Champion was sold to Champion Equity Holdings, LLC for $45,000,000 in cash, subject to certain post-closing adjustments. This divestiture was consistent with the company's focus on its globalization strategy to harmonize core global product lines and reduce complexity within its business. The company realized net proceeds from the sale of the Champion business of $42,872,000, net of tax and expenses, which were used to reduce debt outstanding under its revolving credit facility.

Net Sales. Consolidated net sales for the quarter ended September 30, 2013 decreased 5.6% to $341,176,000 versus $361,518,000 for the same period last year. Foreign currency translation increased net sales by 1.4 percentage points. Organic net sales for the quarter decreased by 7.0% over the same period a year ago as increases in Europe were more than offset by declines in all other segments. The largest decline in net sales was in the North America/Home Medical Equipment (HME) segment, primarily in mobility and seating products, principally due to the reduced order volume at the company's Taylor Street manufacturing facility resulting from the FDA consent decree. The company estimates that sales of products manufactured at the Taylor Street facility, which includes some products sold outside of the North America/HME segment, were approximately $12.0 million in the third quarter compared to approximately $37.6 million in the third quarter of last year.

Net sales for the nine months ended September 30, 2013 decreased 5.6% to $1,017,373,000 versus $1,077,767,000 for the same period last year. Foreign currency translation increased net sales by 0.6 of a percentage point. Organic net sales for the first nine months of 2013 decreased 6.2% over the same period last year as increases in Europe were more than offset by declines in all other segments. The largest decline in net sales was in the North America/HME segment, primarily in mobility and seating products, principally due to the reduced order volume at the company's Taylor Street manufacturing facility resulting from the FDA consent decree. The company estimates that sales of products manufactured from the Taylor Street facility, which includes some products sold outside of the North America/HME segment, were approximately $43.7 million in the first nine months of the year compared to approximately $114.2 million in the first nine months of last year.

North America/Home Medical Equipment (HME)

North America/HME net sales decreased 11.5% for the quarter to $151,052,000 as compared to $170,701,000 for the same period a year ago with foreign currency translation decreasing net sales by 0.3 of a percentage point. The organic net sales decrease of 11.2% was primarily driven by declines in mobility and seating and lifestyle products. The decline in organic net sales was partially offset by increased net sales in respiratory products, partially driven by a large order of Invacare® HomeFill® oxygen systems by a large national account. The sales decline in mobility and seating products was primarily driven by the impact of the consent decree with the FDA, which limits production of custom power wheelchairs and seating systems at the Taylor Street manufacturing facility. While products ordered from the Taylor Street facility continued to be fulfilled with properly completed verification of medical necessity (VMN) documentation, the number of new orders that were fulfilled in the third quarter of 2013 represented 11.2% of the company's unit volume of domestic power wheelchair shipments from the facility in the same period last year. For the nine months ended September 30, 2013, net sales decreased by 12.3% to $462,261,000 as compared to $527,103,000 for the same period a year ago with foreign currency translation decreasing net sales by 0.1 of a percentage point. The organic net sales decrease of 12.2% was primarily driven by declines in mobility and seating and lifestyle products, partially offset by increased net sales in respiratory products. The sales decline in mobility and seating products was primarily driven by the impact of the consent decree with the FDA, which limits production of custom power wheelchairs and seating systems at the Taylor Street manufacturing facility. The company has provided extended payment terms to certain customers where the volume of business justifies the extended terms.

Institutional Products Group (IPG)

IPG net sales for the quarter decreased 16.3% to $28,083,000 compared to $33,557,000 for the same period last year as foreign currency decreased net sales by 0.2 of a percentage point. Organic net sales decreased by 16.1% due to declines in all product categories. In the third quarter of 2012, organic net sales grew 22.2% compared to third quarter 2011, primarily due to increases in interior design projects for long-term care facilities that did not reoccur in 2013. For the nine months ended September 30, 2013, IPG net sales decreased by 9.0% to $87,135,000 compared to $95,726,000 during the same period last year

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as foreign currency decreased net sales by 0.1 of a percentage point. Organic net sales decreased 8.9% primarily driven by declines in all product lines as prior year net sales were particularly strong due to increases in interior design projects.

Europe

For the quarter, European net sales increased 6.0% to $150,265,000 versus $141,705,000 for the third quarter last year with foreign currency translation increasing net sales by 4.5 percentage points. The organic net sales increase of 1.5% was primarily related to increases in net sales of lifestyle and mobility and seating products, which were partially offset by declines in respiratory products. For the nine months ended September 30, 2013, European net sales increased 7.0% to $429,650,000 versus $401,721,000 for the first nine months of last year as foreign currency translation increased net sales by 2.0 percentage points. Organic net sales increased by 5.0% due to increases in net sales of lifestyle and mobility and seating products, which were partially offset by slight declines in respiratory products.

Asia/Pacific

Asia/Pacific net sales decreased 24.3% for the quarter to $11,776,000 as compared to $15,555,000 for the same period a year ago. Organic net sales decreased 20.1% as foreign currency translation decreased net sales by 4.2 percentage points. For the nine months ended September 30, 2013, Asia/Pacific net sales decreased 28.0% to $38,327,000 versus $53,217,000 for the same period last year as foreign currency translation decreased net sales by one percentage point. Organic net sales decreased by 27.0%. Net sales declined for the three and nine months ended September 30, 2013 as the company's Australian distribution business experienced declines in mobility and seating and lifestyle products and the company's subsidiary which produces microprocessor controllers recognized reduced sales of controllers. Contract manufacturing business with companies outside of the healthcare industry decreased as a result of the company's decision to exit that business.

Gross Profit. Consolidated gross profit as a percentage of net sales for the three and nine months ended September 30, 2013 was 28.4% and 27.9%, respectively, compared to 30.3% and 30.7%, respectively, in the same periods last year. The margin was negatively impacted principally by the North America/HME sales decline in custom power wheelchairs, which is one of the company's higher margin product lines. In addition, the negative impact of reduced order volume through the Taylor Street manufacturing facility caused an unfavorable absorption of fixed costs for this facility. Gross margin also was negatively impacted by sales mix favoring lower margin products and lower margin customers. Gross margin was positively impacted by reduced warranty expense.

For the first nine months of the year, North America/HME gross profit as a percentage of net sales decreased by 5.7 percentage points compared to the same period last year. The decline in margins was primarily as a result of volume declines, unfavorable sales mix favoring lower margin customers and lower margin products and unfavorable absorption of fixed costs at the Taylor Street manufacturing facility related to the impact of the consent decree. While warranty expense for the first nine months of 2013 is favorable to the same period in 2012, North America/HME incurred a charge of approximately $400,000 in the second quarter of 2013 related to anticipated warranty expense related to a power wheelchair joystick recall, which was partially offset by the reversal of accrued warranty expense related to the closure of other field actions.

For the first nine months of the year, IPG gross profit as a percentage of net sales increased 1.5 of a percentage point compared to the same period last year. The increase in margin is primarily attributable to favorable product mix.

For the first nine months of the year, gross profit in Europe as a percentage of net sales increased 0.7 of a percentage point compared to the same period last year. Gross profit was favorably impacted by volume increases, which were partially offset by an unfavorable sales mix favoring lower margin product lines and lower margin customers.

For the first nine months of the year, gross profit in Asia/Pacific as a percentage of net sales decreased by 16.0 percentage points compared to the same period last year. The decline was due to volume declines and an increase in warranty expense of approximately $3,400,000 recorded in the second quarter of 2013 as the result of a power wheelchair joystick recall. Excluding the warranty expense increase, gross profit decreased by 7.2 percentage points compared to the same period last year primarily as a result of volume declines and unfavorable product mix at the company's subsidiary which produces microprocessor controllers.

Selling, General and Administrative. Consolidated selling, general and administrative (SG&A) expenses as a percentage of net sales for the three and nine months ended September 30, 2013 was 28.9% and 30.1%, respectively, compared to 28.6% and 28.5%, respectively, for the same period a year ago. However, SG&A expenses decreased to $4,562,000 or 4.4% for the quarter and $713,000 or 0.2% for the first nine months of the year compared to the same periods a year ago. Foreign currency translation increased expenses by $873,000 in the quarter and by $1,050,000 for the first nine months of the year. Excluding the impact of foreign currency translation, SG&A expenses decreased 5.3% for the quarter and by 0.6% for the first nine months of the year

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compared to the same period a year ago. The dollar decrease, excluding foreign currency translation, was $5,435,000 for the quarter and $1,763,000 for the first nine months of the year compared to the same period a year ago. The SG&A expense decrease for the quarter and first nine months of the year primarily related to a decrease in regulatory and compliance costs. Amortization expense for the first nine months of 2013 includes an increase of $1,216,000 as a result of the write-off of bank fees, previously capitalized, related to the amendment for the company's credit facility finalized during the second quarter of 2013 which reduced the capacity on the facility from $400,000,000 to $250,000,000 effective May 30, 2013. Excluding the impact of foreign currency translation and the write-off of bank fees, SG&A expense decreased by $2,979,000 or 1.0% for the first nine months of the year.

SG&A expenses for North America/HME decreased 6.0% or $3,146,000 for the quarter and decreased 0.4% or $581,000 for the three and nine months ended September 30, 2013 as compared to the same periods a year ago. Foreign currency translation decreased SG&A expenses by $198,000 or 0.4 of a percentage point for the quarter and decreased SG&A expenses by $312,000 or 0.2 of a percentage point for the first nine months of the year. Excluding the foreign currency translation, SG&A expenses decreased $2,948,000 or 5.6 percentage points for the quarter and decreased $269,000 or 0.2 of a percentage point for the first nine months of the year. The expense decrease for both the quarter and year to date was principally due to decreased regulatory and compliance costs partially offset by higher associate costs for the first nine months of 2013.

SG&A expenses for IPG decreased by 9.8% or $1,181,000 for the quarter and increased by 1.4% or $474,000 for the first nine months of 2013 compared to the same periods a year ago. Foreign currency translation did not have a material impact for the quarter or year to date. The SG&A expense decrease for the quarter was primarily attributable to the absence of the acquisition earn-out expense that was recorded in the third quarter of last year due to the profitability achievement of a rentals acquisition. The increase in SG&A expense in the first nine months of 2013 was primarily attributable to increased associate costs.

European SG&A expenses increased by 7.5% or $2,275,000 for the quarter and increased by 7.3% or $6,711,000 compared to the same periods a year ago. Foreign currency translation increased SG&A expenses by approximately $1,419,000 or 4.7 percentage points for the quarter and increased SG&A expenses by approximately $1,660,000 or 1.8 percentage points for the first nine months of 2013. Excluding the foreign currency translation impact, SG&A expenses increased by $856,000 or 2.8% for the quarter and increased by $5,051,000 or 5.5% in the first nine months of 2013 primarily due to increased associate costs and foreign currency transactions.

Asia/Pacific SG&A expenses decreased 31.3% or $2,510,000 and for the quarter and decreased 30.0% or $7,317,000 for the first nine months of 2013 as compared to the same periods a year ago. Foreign currency translation decreased SG&A expenses by approximately $330,000 or 4.1 percentage points for the quarter and decreased SG&A expenses by approximately $273,000 or 1.1 percentage points for the first nine months of 2013. Excluding the foreign currency translation impact, SG&A expenses decreased by $2,180,000 or 27.2% for the quarter and decreased by $7,044,000 or 28.9% in the first nine months of 2013 principally as a result of reduced personnel costs resulting from restructuring activities in 2012.

Charge Related to Restructuring Activities. Restructuring continued during the quarter resulting in restructuring charges of $1,884,000 and $6,998,000 for the three and nine months ended September 30, 2013, respectively, principally for severance in NA/HME and to a lesser extent Europe and Asia/Pacific as a result of the permanent elimination of certain positions. The majority of the outstanding restructuring accruals at September 30, 2013 are expected to be paid out within the next twelve months.

Asset Write-downs Related to Intangible Assets. In the third quarter of 2013, the company decided to cease business operations at its subsidiary that offered repair services to U.S. homecare and long-term care medical equipment providers. As a result, the company recognized an intangible impairment write-down charge of $167,000 related to a customer list intangible asset in the HA/HME Segment.

Interest. Interest expense decreased to $745,000 and $2,677,000 for the third quarter and for the first nine months of 2013 compared to $2,114,000 and $6,339,000 for the same periods a year ago, representing a 64.8% and 57.8% decrease, respectively. This decline is primarily attributable to reduced debt levels and lower borrowing costs in 2013 as compared to 2012. Interest income decreased due to a reduction in the volume of financing provided to customers to $58,000 and $239,000 for the third quarter and for the first nine months of 2013, respectively, compared to $166,000 and $610,000 for the comparable periods in 2012.

Income Taxes. The company had an effective tax rate of 16.2% and 12.3% on losses before tax from continuing operations for the three and nine month periods ended September 30, 2013, respectively, compared to an expected benefit at the U.S. statutory rate of 35%. The company's effective tax rate for the three and nine months ended September 30, 2013 was greater than the U.S. federal statutory rate, principally due to losses overseas without tax benefit due to valuation allowance, foreign dividends which reduced the domestic intra-period allocation benefit in continuing operations, and the recording of a discrete adjustment of $3,143,000 related to a federal domestic valuation allowance adjustment. The rate was benefited by taxes outside the United States,

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excluding countries with valuation allowances that are in losses in 2013, recorded at a lower effective rate than the U.S. statutory rate. The company had an effective tax rate of 81.3% and 97.5% on earnings before tax from continuing operations for the three and nine month period ended September 30, 2012, respectively, compared to an expected rate at the U.S. statutory rate of 35%. The company's effective tax rate for the three and nine months ended September 30, 2012 was greater than the U.S. federal statutory rate, principally due to a foreign discrete tax adjustment of $9,173,000 ($0.29 per share), recorded in the first nine months of 2012, of which $3,178,000 was interest, related to prior year periods under audit, which is being contested by the company. This adjustment was partially offset by foreign earnings taxed at an effective rate lower than the U.S. statutory rate principally due to foreign taxes recognized at rates below the U.S. statutory rate.

LIQUIDITY AND CAPITAL RESOURCES

The company continues to maintain an adequate liquidity position through its unused bank lines of credit (see Long-Term Debt in the Notes to Condensed Consolidated Financial Statements included in this report) and working capital management.

The company's total debt outstanding, inclusive of the debt discount included in equity in accordance with FSB APB 14-1, decreased by $179,200,000 to $58,943,000 at September 30, 2013 from $238,143,000 as of December 31, 2012. The company's balance sheet reflects the impact of ASC 470-20, which reduced debt and increased equity by $2,874,000 and $3,341,000 as of September 30, 2013 and December 31, 2012, respectively. The debt decrease during the first nine months was principally a result of using the proceeds from the sale of ISG in the first quarter and Champion in the third quarter to reduce debt outstanding under the company's revolving credit facility. The company's cash and cash equivalents were $32,625,000 at September 30, 2013, down from $38,791,000 as of December 31, 2012. At September 30, 2013, the company had outstanding borrowings of $38,968,000 on its revolving credit facility versus $217,494,000 as of December 31, 2012.

The company's borrowing capacity and cash on hand were utilized for normal operations during the period ended September 30, 2013. Debt repurchases, acquisitions, divestitures, the timing of vendor payments, the granting of extended payment terms to significant national accounts and other activity can have a significant impact on the company's cash flow and borrowings outstanding such that the debt reported at the end of a given period may be materially different than debt levels during a given period. For the nine months ended September 30, 2013, the outstanding borrowings on the company's revolving credit facility varied from a low of $39,000,000 to a high of $267,900,000. While the company has cash balances in various jurisdictions around the world, there are no material restrictions under the credit facility regarding the use of such cash for dividends within the company, loans or other purposes.

On May 30, 2013, the company entered into a Fourth Amendment ("the Amendment") to its Credit Agreement. Pursuant to the Amendment, the Credit Agreement was amended to: (i) decrease the aggregate principal amount of the revolving credit facility to $250,000,000 from $400,000,000, and limit the company's borrowings under the revolving credit facility to an amount not to exceed $200,000,000 aggregate principal amount through December 31, 2013; (ii) increase the maximum leverage ratio (consolidated funded indebtedness to consolidated EBITDA, each as defined in the Credit Agreement, as amended) to 4.00 to 1.00 from 3.50 to 1.00 until January 1, 2014, when the maximum leverage ratio will revert back to 3.50 to 1.00; (iii) decrease the minimum interest coverage ratio (consolidated EBITDA to consolidated interest charges, each as defined in the Credit Agreement, as amended) to 3.00 to 1.00 from 3.50 to 1.00 until January 1, 2014, when the minimum interest coverage ratio will revert back to 3.50 to 1.00; (iv) in calculating consolidated EBITDA for purposes of determining the ratios, provide for the add back to consolidated EBITDA of up to an additional $15,000,000 for future one-time cash restructuring charges and (v) provide for an increase of (A) 25 basis points in the margin applicable to determining the interest rate on borrowings under the revolving credit facility and letter of credit fees and (B) 10 basis points in the commitment fee, all during periods when the leverage ratio exceeds 3.50 to 1.00. Compliance with the ratios is tested at the end of the quarter in accordance with the credit agreement. As a result of the amendment, the company incurred $436,000 in fees in the second quarter of 2013 which were capitalized and are being amortized through October, 2015. In addition, as a result of reducing the capacity of the facility from $400,000,000 to $250,000,000, the company wrote-off $1,216,000 in fees previously capitalized in the second quarter of 2013, which is reflected in the expense of the North America / HME segment.

The company's senior secured revolving credit agreement, as amended, (the "Credit Agreement") provides for a $250,000,000 senior secured revolving credit facility maturing in October 2015. Pursuant to the terms of the Credit Agreement, the company may from time to time borrow, repay and re-borrow up to an aggregate outstanding amount at any one time of $200,000,000 through December 31, 2013 and $250,000,000 thereafter, subject to customary conditions. The . . .

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