SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended September 30, 2005
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or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from to
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Commission File Number 0-12938
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Invacare Corporation
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Ohio 95-2680965
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(State or other jurisdiction of (IRS Employer Identification No)
incorporation or organization)
One Invacare Way, P.O. Box 4028, Elyria, Ohio 44036
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(Address of principal executive offices)
(440)329-6000
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(Registrant's telephone number, including area code)
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(Former name, former address and former fiscal year, if change since last
report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 12 or 15 (d) of the Securities Exchange Act of 1934 (the
"Exchange Act") during the preceding 12 months (or for such shorter period that
the registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes X No
----- -----
Indicate by check mark if the registrant is an accelerated filer (as defined in
Rule 12b-2 of the Act). Yes X No
----- -----
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date:
As of November 1, 2005, the Company had 30,609,292 Common Shares and 1,111,965
Class B Common Shares outstanding.
<page>
INVACARE CORPORATION
INDEX
Part I. FINANCIAL INFORMATION: Page No.
- ------------------------------ --------
Item 1. Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets -
September 30, 2005 and December 31, 2004.....................3
Condensed Consolidated Statement of Earnings -
Three Months and Nine Months Ended September 30,
2005 and 2004................................................4
Condensed Consolidated Statement of Cash Flows -
Nine Months Ended September 30, 2005 and 2004................5
Notes to Condensed Consolidated Financial
Statements - September 30, 2005..............................6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations...............13
Item 3. Quantitative and Qualitative Disclosures About Market Risk...........25
Item 4. Controls and Procedures..............................................25
Part II. OTHER INFORMATION:
- ---------------------------
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds..........26
Item 6. Exhibits.............................................................26
SIGNATURES....................................................................27
2
Part I. FINANCIAL INFORMATION
Item 1... Financial Statements
<table>
<caption>
INVACARE CORPORATION AND SUBSIDIARIES
Condensed Consolidated Balance Sheets
September 30, December 31,
2005 2004
---- ----
<s> <c> <c>
(unaudited)
ASSETS (In thousands)
- ------
CURRENT ASSETS
..........Cash and cash equivalents $ 5,164 $32,567
..........Marketable securities 273 199
..........Trade receivables, net 287,497 287,950
..........Inventories, net 194,579 175,883
..........Deferred income taxes 19,787 21,730
..........Other current assets 50,822 46,822
------- -------
.......... TOTAL CURRENT ASSETS 558,122 565,151
OTHER ASSETS 46,626 55,634
OTHER INTANGIBLES 114,276 98,212
PROPERTY AND EQUIPMENT, NET 180,746 191,163
GOODWILL 737,157 717,964
------- -------
.......... TOTAL ASSETS $1,636,927 $1,628,124
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
..........Accounts payable $153,362 $149,413
..........Accrued expenses 106,788 98,850
..........Accrued income taxes 7,060 7,816
..........Short-term debt and current maturities of long-term obligations 77,132 2,062
------- -------
.......... TOTAL CURRENT LIABILITIES 344,342 258,141
LONG-TERM DEBT 449,016 547,974
OTHER LONG-TERM OBLIGATIONS 76,377 68,571
SHAREHOLDERS' EQUITY
..........Preferred shares - -
..........Common shares 7,917 7,803
..........Class B common shares 278 278
..........Additional paid-in-capital 137,008 123,793
..........Retained earnings 591,338 550,753
..........Accumulated other comprehensive earnings 70,819 104,629
..........Unearned compensation on stock awards (1,915) (1,557)
..........Treasury shares (38,253) (32,261)
------- -------
.......... TOTAL SHAREHOLDERS' EQUITY 767,192 753,438
------- -------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $1,636,927 $1,628,124
========== ==========
</table>
See notes to condensed consolidated financial statements.
3
<page>
<table>
<caption>
INVACARE CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statement of Earnings - (unaudited)
Three Months Ended Nine Months Ended
(In thousands except per share data) September 30, September 30,
2005 2004 2005 2004
------- ------- ------- -------
<s> <c> <c> <c> <c>
Net sales $395,270 $349,507 $1,162,481 $1,010,138
Cost of products sold 276,583 243,431 820,666 708,559
------- ------- ------- -------
Gross profit 118,687 106,076 341,815 301,579
Selling, general and administrative expense 85,909 71,230 258,223 216,214
Charge related to restructuring activities 2,760 - 2,760 -
Interest expense 8,245 3,850 22,016 8,904
Interest income (719) (1,618) (2,524) (3,892)
------- ------- ------- -------
Earnings before Income Taxes 22,492 32,614 61,340 80,353
Income taxes 7,175 10,085 19,570 25,600
------- ------- ------- -------
NET EARNINGS $ 15,317 $ 22,529 $ 41,770 $ 54,753
======= ======= ======= =======
DIVIDENDS DECLARED PER
COMMON SHARE .0125 .0125 .0375 .0375
======= ======= ======= =======
Net Earnings per Share - Basic $ 0.48 $ 0.72 $ 1.33 $ 1.76
======= ======= ======= =======
Weighted Average Shares Outstanding - Basic 31,632 31,122 31,515 31,120
======= ======= ======= =======
Net Earnings per Share - Assuming Dilution $ 0.47 $ 0.70 $ 1.29 $ 1.70
======= ======= ======= =======
Weighted Average Shares Outstanding -
Assuming Dilution 32,450 32,283 32,505 32,272
======= ======= ======= =======
</table>
See notes to condensed consolidated financial statements.
4
<table>
<caption>
INVACARE CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statement of Cash Flows - (unaudited)
Nine Months Ended
September 30,
2005 2004
------- -------
<s> <c> <c>
OPERATING ACTIVITIES (In thousands)
Net earnings $ 41,770 $ 54,753
Adjustments to reconcile net earnings to
net cash provided by operating activities:
Depreciation and amortization 30,698 22,283
Provision for losses on trade and installment receivables 9,910 8,285
Provision for deferred income taxes 5,731 -
Provision for other deferred liabilities 2,078 2,137
Changes in operating assets and liabilities:
Trade receivables (4,885) (11,622)
Installment sales contracts, net (4,233) (1,857)
Inventories (27,868) (8,530)
Other current assets (2,872) 3,475
Accounts payable 11,650 10,116
Accrued expenses (1,161) (5,936)
Other deferred liabilities 1,695 2,076
------- -------
NET CASH PROVIDED BY OPERATING ACTIVITIES 62,513 75,180
INVESTING ACTIVITIES
Purchases of property and equipment (24,924) (28,924)
Proceeds from sale of property and equipment 4,994 -
Other long term assets (872) (3,354)
Business acquisitions, net of cash acquired (58,216) (262,679)
Other (1,450) (2,262)
------- -------
NET CASH USED FOR INVESTING ACTIVITIES (80,468) (297,219)
FINANCING ACTIVITIES
Proceeds from revolving lines of credit, securitization facility and
long-term borrowings 539,045 635,662
Payments on revolving lines of credit, long-term debt
and capital lease obligations (552,330) (426,220)
Net proceeds from exercise of stock options 2,552 5,267
Purchases of treasury stock - (4,430)
Payment of dividends (1,185) (1,103)
------- -------
NET CASH (REQUIRED) PROVIDED BY FINANCING
ACTIVITIES (11,918) 209,176
Effect of exchange rate changes on cash 2,470 (371)
------- -------
Decrease in cash and cash equivalents (27,403) (13,234)
Cash and cash equivalents at beginning of period 32,567 16,074
------- -------
Cash and cash equivalents at end of period $ 5,164 $ 2,840
======= =======
</table>
See notes to condensed consolidated financial statements.
5
INVACARE CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated
Financial Statements
(Unaudited)
September 30, 2005
Nature of Operations - Invacare Corporation and its subsidiaries ("Invacare" or
the "Company") is the leading home medical equipment manufacturer in the world
based on its distribution channels, the breadth of its product line and net
sales. The Company designs, manufactures and distributes an extensive line of
medical equipment for the home health care, retail and extended care markets.
The Company's products include standard manual wheelchairs, motorized and
lightweight prescription wheelchairs, seating and positioning systems, motorized
scooters, patient aids, home care beds, low air loss therapy products,
respiratory products and distributed products. The Company is directly affected
by government regulation and reimbursement policies in virtually every country
in which it operates. Changes in regulations and health care policy take place
frequently and can impact the size, growth potential and profitability of
products sold in each market.
Principles of Consolidation - The consolidated financial statements include the
accounts of the Company, its majority owned subsidiaries and a variable interest
entity for which the Company is the primary beneficiary and include all
adjustments, which were of a normal recurring nature, necessary to present
fairly the financial position of the Company as of September 30, 2005 and the
results of its operations for the three months and nine months ended September
30, 2005 and 2004, respectively, and changes in its cash flows for the nine
months ended September 30, 2005 and 2004, respectively. Certain foreign
subsidiaries, represented by the European segment, are consolidated using an.
August 31 quarter end. The results of operations for the three and nine months
ended September 30, 2005, are not necessarily indicative of the results to be
expected for the full year. All significant intercompany transactions are
eliminated.
Reclassifications - Certain reclassifications have been made to the prior years'
consolidated financial statements to conform to the presentation used for the
period ended September 30, 2005.
Use of Estimates - The consolidated financial statements are prepared in
conformity with accounting principles generally accepted in the United States,
which require management to make estimates and assumptions that affect the
amounts reported in the financial statements and accompanying notes. Actual
results may differ from these estimates.
Business Segments - The Company reports its results of operations through three
primary business segments based on geographical area: North America, Europe and
Asia/Pacific. The three reportable segments represent operating groups that sell
products in different geographic regions.
The North America segment sells each of five primary product lines, which
includes: standard, rehab, distributed, respiratory, and continuing care
products. Europe and Asia/Pacific sell the same product lines with the exception
of distributed products. Each business segment sells to the home health care,
retail and extended care markets.
The Company evaluates performance and allocates resources based on profit or
loss from operations before income taxes for each reportable segment. The
accounting policies of each segment are the same as those for the Company's
consolidated financial statements. Intersegment net sales and transfers are
6
<page>
based on the costs to manufacture plus a reasonable profit element. Therefore,
intercompany profit or loss on intersegment net sales and transfers are not
considered in evaluating segment performance. Intersegment net sales for
reportable segments were $23,882,000 and $73,314,000 for the three and nine
months ended September 30, 2005, respectively, and $20,312,000 and $60,691,000
for the same periods in the preceding year.
The information by segment is as follows (in thousands):
<table>
<caption>
Three Months Ended Nine Months Ended
September 30, September 30,
2005 2004 2005 2004
------- ------- ------- -------
<s> <c> <c> <c> <c>
Revenues from external customers
North America $260,871 $251,457 $776,665 $737,780
Europe 111,909 79,889 324,331 224,633
Asia/Pacific 22,490 18,161 61,485 47,725
------- ------- ------- -------
Consolidated $395,270 $349,507 $1,162,481 $1,010,138
======= ======= ======= =======
Earnings (loss) before income taxes
North America $16,098 $27,990 $49,570 $73,753
Europe 10,548 4,984 21,788 9,427
Asia/Pacific (551) 874 (3,855) 1,551
All Other * (3,603) (1,234) (6,163) (4,378)
------- ------- ------- -------
Consolidated $22,492 $32,614 $61,340 $80,353
======= ======= ======= =======
</table>
* Consists of the domestic export unit, unallocated corporate selling,
general and administrative costs, the Invacare captive insurance unit, and
intercompany profits which do not meet the quantitative criteria for
determining reportable segments.
Net Earnings Per Common Share - The following table sets forth the computation
of basic and diluted net earnings per common share for the periods indicated.
<table>
<caption>
Three Months Ended Nine Months Ended
September 30, September 30,
2005 2004 2005 2004
------- ------- ------- -------
<s> <c> <c> <c> <c>
(In thousands, except per share data)
Basic
Average common shares outstanding 31,632 31,122 31,515 31,120
Net earnings $15,317 $22,529 $41,770 $54,753
Net earnings per common share $ .48 $ .72 $ 1.33 $ 1.76
Diluted
Average common shares outstanding 31,632 31,122 31,515 31,120
Stock options and awards 818 1,161 990 1,152
------- ------- ------- -------
Average common shares assuming dilution 32,450 32,283 32,505 32,272
Net earnings $15,317 $22,529 $41,770 $54,753
Net earnings per common share $ .47 $ .70 $ 1.29 $ 1.70
</table>
7
<page>
At September 30, 2005, 782,466 and 632,218 shares were excluded from the average
common shares assuming dilution for the three and nine months ended September
30, 2005, as they were anti-dilutive. For the three and nine months ended
September 30, 2005, the majority of the anti-dilutive shares were granted at an
exercise price of $44.30 which was higher than the average fair market value
prices of $40.66 and $43.57, respectively. At September 30, 2004, 140,878 and
60,521 shares were excluded from the average common shares assuming dilution for
the three and nine months ended September 30, 2004, as they were anti-dilutive.
For the three and nine months ended September 30, 2004, the majority of the
anti-dilutive shares were granted at an exercise price of $44.30 which was
higher than the average fair market value prices of $43.81 and $43.16,
respectively.
Concentration of Credit Risk - The Company manufactures and distributes durable
medical equipment and supplies to the home health care, retail and extended care
markets. The Company performs credit evaluations of its customers' financial
condition. Prior to December 2000, the Company financed equipment to certain
customers for periods ranging from 6 to 39 months. In December 2000, Invacare
entered into an agreement with De Lage Landen Inc (DLL), a third party financing
company, to provide the majority of future lease financing to Invacare's
customers. The DLL agreement provides for direct leasing between DLL and the
Invacare customer. The Company retains a limited recourse obligation
($43,933,000 at September 30, 2005) to DLL for events of default under the
contracts (total balance outstanding of $110,088,000 at September 30, 2005).
Financial Accounting Standards Board (FASB) Interpretation No. 45, Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others, requires the Company to record a guarantee
liability as it relates to the limited recourse obligation. As such, the Company
has recorded a liability for this guarantee obligation. The Company monitors the
collections status of these contracts and has provided amounts for estimated
losses in its allowances for doubtful accounts in accordance with FASB Statement
No. 5, Accounting for Contingencies. Credit losses are provided for in the
financial statements.
Substantially all of the Company's receivables are due from health care/medical
equipment dealers and long term care facilities located throughout the United
States, Australia, Canada, New Zealand, Asia and Europe. A significant portion
of products sold to dealers, both foreign and domestic, is ultimately funded
through government reimbursement programs such as Medicare and Medicaid. In
addition, the Company has also seen a significant shift in reimbursement to
customers from managed care entities. As a consequence, changes in these
programs can have an adverse impact on dealer liquidity and profitability. In
addition, reimbursement guidelines in the home health care industry have a
substantial impact on the nature and type of equipment an end user can obtain as
well as the timing of reimbursement and, thus, affect the product mix, pricing
and payment patterns of the Company's customers.
Goodwill and Other Intangibles - The change in goodwill reflected on the balance
sheet from December 31, 2004 to September 30, 2005 was the result of
acquisitions representing an increase in goodwill of $21,999,000 in Europe,
$12,910,000 in North America and $7,265,000 in Asia/Pacific with the remaining
change attributable to currency translation.
Motion Concepts, Inc. ("Motion") was acquired in 2003. Pursuant to the Motion
purchase agreement, the Company agreed to pay contingent consideration based
upon earnings before interest and taxes over the three years subsequent to the
acquisition up to a maximum of approximately $16,000,000. Based upon 2004 and
2005 results, no such consideration was paid. When the contingency related to
8
<page>
the acquisition is settled, if any such consideration is paid, it will increase
the purchase price and reported goodwill.
All of the Company's other intangible assets have definite lives and are
amortized over their useful lives, except for $31,357,000 related to trademarks,
which have indefinite lives. An increase in patents of $6,664,000 was recorded
in the first quarter of 2005 as part of the North American segment, which was a
result of the initial consolidation of the Company's variable interest in
NeuroControl. As a result of acquisitions in the second quarter, $8,050,000 was
recorded as part of the North American segment for: customer lists of
$6,200,000, patents of $1,040,000, and trademarks of $810,000, while the
following intangibles were recorded for the European segment: trademarks with
indefinite lives of $4,840,000, customer lists of $5,500,000 and patents of
$1,400,000.
As of September 30, 2005 and December 31, 2004, other intangibles consisted of
the following (in thousands):
<table>
<caption>
September 30, 2005 December 31, 2004
------------------ -----------------
Historical Accumulated Historical Accumulated
Cost Amortization Cost Amortization
---------- ------------ ---------- ------------
<s> <c> <c> <c> <c>
Customer lists $66,189 $6,812 $57,788 $2,737
Trademarks 31,357 - 27,732 -
License agreements 7,775 5,688 6,518 5,051
Developed technology 6,484 377 5,842 80
Patents 12,349 1,840 4,137 1,443
Other 7,758 2,919 7,348 1,842
------- ------- ------- -------
$131,912 $17,636 $109,365 $11,153
======= ======= ======= =======
</table>
Amortization expense related to other intangibles was $6,483,000 in the first
nine months of 2005 and is estimated to be $9,114,000 in 2006, $8,902,000 in
2007, $8,192,000 in 2008, $7,889,000 in 2009 and $7,768,000 in 2010.
Investment in Affiliated Company - In January 2003, the FASB issued
Interpretation No. 46, Consolidation of Variable Interest Entities ("FIN 46"),
which was revised in December 2003 and, which among other things, deferred the
implementation date of FIN 46 until periods after March 15, 2004. This
interpretation requires consolidation of an entity if the company is subject to
a majority of the risk of loss from the variable interest entity's ("VIE")
activities or entitled to receive a majority of the entity's residual returns,
or both. A company that consolidates a VIE is known as the primary beneficiary
of that entity.
The Company has an investment in NeuroControl, a development stage company,
which is currently pursuing FDA approval to market in the United States a
product focused on the treatment of post-stroke shoulder pain. The amount of net
advances and investment recorded on the Company's books was approximately
$3,000,000 at December 31, 2004. Certain of the Company's officers and directors
(or their affiliates) have minority equity ownership positions in NeuroControl.
Subsequent to December 31, 2004, the Company's board of directors approved an
additional investment by the Company in NeuroControl. Accordingly, the Company
has consolidated this investment prospectively beginning with the quarter ended
March 31, 2005, as the Company is now deemed the primary beneficiary of this VIE
based on the provisions of FIN 46. The other beneficial interest holders have no
recourse against the Company.
9
<page>
Accounting for Stock-Based Compensation - The Company utilizes the
disclosure-only provisions of Statement of Financial Accounting Standards (SFAS)
No. 123, Accounting for Stock-Based Compensation. Accordingly, the Company has
not recognized compensation cost for non-qualified stock options. However, the
Company does record compensation cost on restricted common shares based on the
vesting periods. Had compensation cost for the Company's stock option plans been
determined based on the fair value at the grant date for awards in 2005 and 2004
consistent with the provisions of SFAS No. 123, the Company's net earnings and
earnings per share would have been reduced to the pro forma amounts indicated
below (in thousands, except per share data):
<table>
<caption>
Three Months Ended Nine Months Ended
September 30, September 30,
2005 2004 2005 2004
------- ------- ------- -------
<s> <c> <c> <c> <c>
Net earnings - as reported * $15,317 $22,529 $41,770 $54,753
Less: compensation expense determined based on the
fair-value method for all awards granted at
market value, net of related tax effects 986 929 3,187 2,735
------- ------- ------- -------
Net earnings - pro forma $14,331 $21,600 $38,583 $52,018
======= ======= ======= =======
Earnings per share as reported - basic $.48 $.72 $1.33 $1.76
Earnings per share as reported - assuming dilution $.47 $.70 $1.29 $1.70
Pro forma earnings per share - basic $.45 $.69 $1.22 $1.67
Pro forma earnings per share - assuming dilution $.44 $.67 $1.19 $1.61
* Includes stock compensation expense, net of tax, on
restricted awards granted without cost to recipients of: $145 $137 $428 $389
</table>
Warranty Costs - Generally, the Company's products are covered by warranties
against defects in material and workmanship for periods up to six years from the
date of sale to the customer. Certain components carry a lifetime warranty. A
provision for estimated warranty cost is recorded at the time of sale based upon
actual experience. The Company continuously assesses the adequacy of its product
warranty accrual and makes adjustments as needed. Historical analysis is
primarily used to determine the Company's warranty reserves. Claims history is
reviewed and provisions are adjusted as needed. However, the Company does
consider other events, such as a product recall, which could warrant additional
warranty reserve provision. No material adjustments to warranty reserves were
necessary in the first nine months of 2005.
The following is a reconciliation of the changes in accrued warranty costs for
the reporting period (in thousands):
Balance as of January 1, 2005 $ 13,998
Warranties provided during the period 7,959
Settlements made during the period (7,192)
Changes in liability for pre-existing warranties during
the period, including expirations 572
------
Balance as of September 30, 2005 $ 15,337
======
Charge Related to Restructuring Activities - On July 28, 2005, the Company
announced cost reductions and profit improvement actions, which included:
reducing global headcount by 230 personnel, outsourcing improvements utilizing
the Company's China manufacturing capability and third parties, shifting
substantial resources from product development to manufacturing cost reduction
activities and product rationalization, reducing freight exposure through
10
<page>
freight auctions and changing the freight policy, general expense reductions,
and exiting four facilities.
To date, the Company has made substantial progress on its restructuring
activities, including exiting four facilities and eliminating approximately 170
positions through September 30, 2005, which resulted in restructuring charges of
$2,760,000, primarily for severance, of which $2,200,000 was incurred in North
American, $300,000 in Asia/Pacific and $260,000 in Europe. This amount is
reflected on the Charge Related to Restructuring Activities in the Condensed
Consolidated Statement of Earnings as part of operations.
Comprehensive Earnings - Total comprehensive earnings were as follows (in
thousands):
<table>
<caption>
Three Months Ended Nine Months Ended
September 30, September 30,
2005 2004 2005 2004
------- ------- ------- -------
<s> <c> <c> <c> <c>
Net earnings $15,317 $22,529 $41,770 $54,753
Foreign currency translation gain (loss) 7,457 6,842 (31,627) 7,465
Unrealized gain (loss) on available for sale securities 39 (16) 49 (13)
Current period unrealized gain (loss) on cash flow hedges 2,105 (1,015) (2,232) (3,368)
------- ------- ------- -------
Total comprehensive earnings $24,918 $ 28,340 $7,960 $58,837
======= ======= ======= =======
</table>
Inventories - Inventories consist of the following components (in thousands):
September 30, December 31,
2005 2004
------- -------
Raw materials $ 60,702 $ 60,548
Work in process 14,385 16,156
Finished goods 119,492 99,179
------- -------
$194,579 $175,883
======= =======
The final inventory determination under the LIFO method is made at the end of
each fiscal year based on the inventory levels and cost at that point;
therefore, interim LIFO determinations are based on management's estimates of
expected year-end inventory levels and costs.
Property and Equipment - Property and equipment consist of the following (in
thousands):
September 30, December 31,
2005 2004
------- -------
Machinery and equipment $252,744 $243,335
Land, buildings and improvements 86,398 95,041
Furniture and fixtures 29,003 27,494
Leasehold improvements 15,575 14,275
------- -------
383,720 380,145
Less allowance for depreciation (202,974) (188,982)
------- -------
$180,746 $191,163
======= =======
11
<page>
Financing Arrangements - On September 29, 2005, the Company and the other
parties to its Note Purchase Agreements dated as of February 27, 1998 and
October 1, 2003, entered into certain amendments to those agreements that, among
other things: (i) required the Company to at all times maintain at least a
$350,000,000 revolving credit facility, (ii) amended the maximum permitted
amount of debt, and (iii) amended certain defined terms, including the
definition of "Consolidated Total Assets" and "Debt." In addition, the amendment
to the 1998 Purchase Agreement changed certain covenants of the Company relating
to incurrence of debt, liens and asset sales. In addition, on August 12, 2005,
the Company entered into an agreement to amend the Company's $500,000,000
revolving credit agreement to among other things: (i) clarify the definition of
Adjusted EBITDA to exclude certain restructuring costs, (ii) amend the
definition of Total Debt to include lease receivable securitizations and exclude
trade receivable securitizations, and (iii) reduce the Total Debt to Adjusted
EBITDA ratio from 3.50 to 1.0, to 3.25 to 1.0 for the period commencing on
December 31, 2006 and continuing thereafter.
On September 30, 2005, the Company entered into a 364-day $100 million accounts
receivable securitization facility. The Receivables Purchase Agreement (the
"Receivables Agreement") , dated as of September 30, 2005, among Invacare
Receivables Corporation ("IRC"), as Seller, Invacare Corporation, as Servicer,
Park Avenue Receivables Company, LLC (the "Conduit"), the financial institutions
named therein and JPMorgan Chase Bank, N.A., as Agent, provides for, among other
things, the transfer from time to time by Invacare and certain of its
subsidiaries of ownership interests of certain domestic accounts receivable on a
revolving basis to the Conduit, an asset-backed issuer of commercial paper,
and/or the financial institutions named in the Receivables Agreement. Pursuant
to the Receivables Agreement, the Company and certain of its subsidiaries from
time to time may transfer accounts receivable to IRC, a special purpose entity
and subsidiary of Invacare. IRC then transfers interests in the receivables to
the Conduit and/or the financial institutions named in the Receivables Agreement
and receives funds from the Conduit and/or the financial institutions raised
through the issuance of commercial paper (in its own name) by the Conduit and/or
the financial institutions. In accordance with U.S. Generally Accepted
Accounting Principles, Invacare accounts for the transaction as a secured
borrowing. Borrowings under the facility are effectively repaid as receivables
are collected, with new borrowings created as additional receivables are sold.
Invacare received $75.5 million in funds pursuant to the securitization facility
on September 30, 2005 at an original borrowing rate of 4.1%, which was used to
reduce balances outstanding on Invacare's revolving credit facility. The debt is
reflected on the short-term debt and current maturities of long-term obligations
line of the condensed consolidated balance sheet at September 30, 2005.
Acquisitions - In the first nine months of 2005, Invacare Corporation acquired
the following businesses, which were individually immaterial, at a total cost of
$58,216,000, which was paid in cash:
o Australian Healthcare Equipment Pty Ltd, an Australian based company,
and manufacturer of beds, related furniture and pressure care products
for home care and non-acute institutional care.
o Altimate Medical, Inc., a U.S. company, and manufacturer of standing
frames and mobility aids for the rehabilitation market.
o Medical Support Systems Holdings Limited, a U.K. company, and
manufacturer of high quality, foam pressure-reducing products for the
healthcare market.
Goodwill recognized in these transactions amounted to approximately $33,039,000,
the majority of which is not expected to be deductible for tax purposes.
Goodwill of $12,864,000 was assigned to the European segment, $12,910,000 was
assigned to the North American segment and $7,265,000 was assigned to the
Asia/Pacific segment.
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On September 9, 2004 the Company acquired 100% of the shares of WP Domus GmbH
(Domus), a European-based holding company that manufactures several
complementary product lines to Invacare's product lines, including power add-on
products, bath lifts and walking aids, from WP Domus LLC. Domus has three
divisions: Alber, Aquatec and Dolomite. The acquisition allows the Company to
expand its product line and reach new markets. The final purchase price was
$226,806,000, including acquisition costs of $4,116,000, which was paid in cash.
During the third quarter, the Company finalized the purchase price allocation
related to the Domus acquisition and as a result recorded additional severance
and exit accruals ($6,987,000) and certain pre-acquisition liabilities for
warranty and product liability ($1,256,000) and legal and professional fees
associated with the transaction ($892,000) totaling $9,135,000, which increased
goodwill by the same amount.
In accordance with EITF Issue No. 95-3, "Recognition of Liabilities in
Connection with a Purchase Business Combination," the Company recorded accruals
for severance and exit costs for facility closures and contract terminations. A
progression of the accruals recorded in the purchase price allocation is as
follows (in thousands):
<table>
<caption>
Balance at Additional Balance at
12/31/04 Accruals Payments 9/30/05
------- ------- ------- -------
<s> <c> <c> <c> <c>
Facility closures, including
associated severance $ 604 $ 4,923 $ 939 $ 4,588
Sales agency terminations - 612 612 -
Exit of product lines - 1,452 - 1,452
------- ------- ------- -------
Total $ 604 $ 6,987 $ 1,551 $ 6,040
======= ======= ======= =======
</table>
The company anticipates all of the remaining reserves to be utilized in 2006.
Income Taxes - The Company had an effective tax rate of 31.9% for the three and
nine-month periods ended September 30, 2005 compared with 30.9% and 31.9% for
the same periods a year ago. The effective tax rate declined due to a change in
estimate in the mix of earnings and permanent deductions. The Company's
effective tax rate is lower than the U.S. federal statutory rate primarily due
to tax credits and earnings abroad being taxed at rates lower than the U.S.
federal statutory rate.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The following discussion and analysis should be read in conjunction with our
Condensed Consolidated Financial Statements and related notes thereto included
elsewhere in this Quarterly Report on Form 10-Q and in our Current Report on
Form 8-K as furnished to the Securities and Exchange Commission on October 27,
2005.
OUTLOOK
Uncertainty still remains regarding the resolution of Medicare reimbursement for
power wheelchairs in particular, and equipment in general. The implementation of
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new codes for power wheelchairs scheduled for the beginning of 2006 has been
postponed to a date later in 2006. The impact is hard to determine regarding the
newly effective regulations requiring physician documentation of medical
necessity along with face-to-face exams for a power wheelchair prescription; and
those regulations may be delayed until April 2006. Additionally, the Senate
Finance Committee's proposal to cut $900 million from durable home medical
equipment spending over five years is a new development that will restrain
growth if passed by Congress.
In addition, the Company continues to review its global manufacturing and
distribution strategy and develop a multi-year plan beginning in 2006 to exit a
number of manufacturing and distribution locations, which is expected to result
in additional annualized pre-tax savings of up to $21 million. These plans would
lead to pre-tax restructuring charges over the next two years estimated at $22
million. While plans are not complete, the Company currently believes that the
financial benefits from the restructuring in any one year will minimize the net
income impact from the charge incurred in that year.
For the full year 2005, in light of the continuing reimbursement pressures, the
Company is lowering guidance for earnings per share to a range of $1.76 to $1.89
and net sales growth to a range of 11% to 12%. The earnings per share guidance
includes the impact of the $6.8 million to $7.8 million restructuring charge on
a pre-tax basis for the third and fourth quarters, or $0.14 to $0.16 per share
after tax. Previous guidance included in the Company's Form 10-Q for the second
quarter of 2005 had anticipated a net sales increase of between 14% and 15% and
earnings per share of between $2.14 and $2.30, including the impact of
restructuring costs of $0.06 to $0.10 per share after tax. The new guidance
anticipates foreign currency and acquisitions to account for 10% of the net
sales increase. Excluding the impact of foreign currency and acquisitions, the
net sales increase is now expected to be between 1% and 2%. The Company
anticipates operating cash flows of between $90 million and $100 million and net
purchases of property plant and equipment of approximately $35 million, in line
with previous guidance included in the Company's Form 10-Q for the second
quarter of 2005.
For the fourth quarter, the Company expects a net sales increase of between 2%
and 4% and earnings per share of between $0.47 and $0.60, which includes the
impact of the $4 million to $5 million fourth quarter restructuring charge on a
pre-tax basis, or $0.08 to $0.10 per share after tax. The 13 cent range for
earnings per share is primarily due to uncertainty surrounding reimbursement,
weakness in the national accounts business, and inefficiencies resulting from
the October implementation of a new Oracle(R) enterprise resource planning
system in the Company's North American home care business. This guidance
anticipates foreign currency and acquisitions to account for 2% of the net sales
increase. Excluding the impact of foreign currency and acquisitions, the net
sales increase would be between zero and 2%.
RESULTS OF OPERATIONS
NET SALES
Net sales for the three months ended September 30, 2005 were $395,270,000,
compared to $349,507,000 for the same period a year ago, representing a 13%
increase. Foreign currency translation did not materially impact the net sales
increase while acquisitions accounted for 12% of the net sales increase for the
quarter. For the nine months ended September 30, 2005, net sales increased 15%
to $1,162,481,000, compared to $1,010,138,000 for the same period a year ago.
Foreign currency translation and acquisitions accounted for 1% and 11% of the
net sales increase for the first nine months, respectively. Excluding the impact
of foreign currency and acquisitions, the net sales growth of 1% for the quarter
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and 2% for the first nine months of the year was driven primarily by volume
increases in all three business segments.
North American Operations
North American net sales increased 4% for the quarter to $260,871,000 as
compared $251,457,000 for the same period a year ago with foreign currency
accounting for 1% of the net sales increase and acquisitions contributing an
additional 2%. For the first nine months, net sales increased 5% to $776,665,000
as compared $737,780,000 for the same period a year ago, with foreign currency
accounting for 1% of the net sales increase and acquisitions contributing an
additional 2%. These sales consist of Rehab (power wheelchairs, custom manual
wheelchairs, personal mobility and seating and positioning), Standard (manual
wheelchairs, personal care, home care beds, low air loss therapy and patient
transport), Continuing Care (beds and furniture), Respiratory (oxygen
concentrators, aerosol therapy, sleep, homefill and associated respiratory) and
Distributed (ostomy, incontinence, diabetic, wound care and other medical
supplies) products.
The increase for the quarter was principally due to net sales increases in Rehab
products (14%), Distributed products (7%) and Continuing Care products (2%),
which were partially offset by declines in Respiratory products (13%) and
Standard products (2%). Acquisitions accounted for 14% of the Continuing Care
product net sales increase.
The Respiratory net sales decline in the quarter was due to slow purchases from
national accounts for the HomeFill(TM) oxygen system product line and oxygen
concentrators, which was partially offset by double-digit growth with local and
regional providers for the HomeFill(TM) product. The net sales decline
experienced in Standard products for the quarter was the result of increasing
unit volumes, which were more than offset by lower pricing implemented in the
second half of 2004 and a significant slow down in purchases by a national
account. Invacare Continuing Care Group sales, without acquisitions, declined by
12% due to weakness in nursing home-related bed sales.
The 14% net sales increase in the quarter for the rehab products line was due
primarily to stronger sales of consumer power wheelchairs, which were up 30% for
the quarter versus last year's third quarter. Despite the improvement versus an
unusually weak sales quarter last year, the Company does not anticipate that the
third quarter performance is an indication of an improved environment for
consumer power wheelchairs in the United States. Consumer power wheelchair
revenues for the nine-month period were down 3% compared to prior year.
The increase for the first nine months was principally due to net sales
increases in Respiratory products (10%), Continuing Care products (15%) and
Distributed products (7%) and Rehab products (2%), which were partially offset
by declines in Standard products (3%). Acquisitions accounted for 15% of the
Continuing Care product net sales increase and positively impacted Rehab product
net sales by 1%.
European Operations
European net sales increased 40% for the quarter to $111,909,000 as compared to
$79,889,000 for the same period a year ago with acquisitions and foreign
currency translation accounting for a 43% increase and a 4% decrease in the net
sales, respectively. European net sales for the first nine months increased 44%
to $324,331,000 as compared to $224,633,000 for the same period a year ago with
acquisitions and foreign currency translation accounted for 41% and 2% of the
net sales increase, respectively. The sales increase for the quarter and first
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<page>
nine months, excluding foreign currency and acquisitions, was primarily due to
improved performance in all regions, excluding Germany.
Asia/Pacific Operations
The Company's Asia/Pacific operations consist of Invacare Australia and
Australian Healthcare Equipment, which manufacture, import and distribute the
entire range of Invacare products; Dynamic Controls, a New Zealand manufacturer
of electronic operating components used in power wheelchairs and scooters; and
Invacare New Zealand, a manufacturer of wheelchairs and beds and a distributor
of a wide range of home medical equipment.
Asia/Pacific net sales increased 24% in the third quarter to $22,490,000 from
$18,161,000 in the third quarter of last year and increased 29% for the first
nine months of the year to $61,485,000 from $47,725,000 for the same period a
year ago. For the quarter, acquisitions accounted for 16% of the net sales
increase, while foreign currency translation contributed an additional 1%. For
the first nine months of the year, acquisitions accounted for 16% of the net
sales increase, while foreign currency translation contributed an additional 7%.
The resulting 7% net sales increase for the quarter and 6% net sales increase
for the first nine months of the year, excluding foreign currency and
acquisitions, was largely due to volume increases in all locations.
GROSS PROFIT
Gross profit as a percentage of net sales for the three and nine-month periods
ended September 30, 2005 was 30.0% and 29.4%, respectively, compared to 30.4%
and 29.9%, respectively, in the same periods last year. The decline for both
periods is primarily due to significant increases in freight costs, largely due
to fuel surcharges driven by the high price of oil, and price reductions on
standard products in North America, which started in July of last year and thus
negatively impact the gross margin comparison to the first nine months of last
year. The increase in freight costs was partially offset by freight auctions and
modifications to the company's freight policy, which were implemented in the
third quarter of this year.
For the first nine months of the year, North American margins as a percentage of
net sales declined to 29.0% compared with 30.6% in the same period last year
principally as a result of the above-referenced increase in freight costs and
decrease in pricing, especially in the Standard products category. In Europe,
gross margin improved year to date by 2.4 percentage points, primarily due to
the higher gross margins achieved by Domus, which the Company acquired in
September 2004. Gross margin in Asia/Pacific improved year to date by .3
percentage points, largely due to margin improvement in the Australian business
due to more favorable product mix.
SELLING, GENERAL AND ADMINISTRATIVE
Selling, general and administrative expense as a percentage of net sales for the
three and nine months ended September 30, 2005 was 21.7% and 22.2%, compared to
20.4% and 21.4% for the same periods a year ago. The dollar increases were
$14,679,000 and $42,009,000, or 20.6% and 19.4%, respectively for the quarter
and first nine months of the year. Acquisitions increased these expenses by
$12,585,000 in the quarter and $35,061,000 in the first nine months of the year,
while foreign currency translation increased these expenses by $180,000 in the
quarter and $4,105,000 in the first nine months of the year compared to the same
periods a year ago. Excluding the impact of foreign currency translation and
16
<page>
acquisitions, selling, general and administrative expense increased $1,914,000
or 2.7% for the quarter and $2,843,000 or 1.3% for the first nine months of the
year compared to the same periods a year ago, primarily due to higher
distribution and commission costs due to higher sales volumes and increases in
sales and marketing spending.
North American selling, general and administrative cost increased $5,393,000 or
10.9% for the quarter and $9,686,000 or 6.4% in the first nine months of the
year compared to the same periods a year ago. Acquisitions accounted for 2.8%
and 2.3% of the increase in each period, respectively, while foreign currency
translation accounted for less than 1% in both periods. The additional
distribution, commission and sales and marketing costs, incurred on a
consolidated basis noted above, were primarily related to North America.
European selling, general and administrative cost increased $7,108,000 or 36.4%
for the quarter and $25,183,000 or 43.2% for the first nine months of the year
compared to the same periods a year ago. For the quarter, acquisitions caused
SG&A expense to increase by $10,690,000 or 54.8% while foreign currency
translation decreased SG&A expense by $153,000 or 0.8%. For the first nine
months of 2005, acquisition and foreign currency translation increased SG&A
expense by $30,075,000 or 51.6%, and $2,448,000 or 4.2%, respectively. The
decrease in spending for the quarter and year to date, excluding acquisition and
foreign currency translation, was primarily attributable to efforts to bring
spending in line with lower than planned sales.
Asia/Pacific selling, general and administrative cost increased $2,178,000 or
90.9% for the quarter and $7,140,000 or 119.5% in the first nine months of the
year compared to the same periods a year ago. For the quarter, acquisitions and
foreign currency translation increased SG&A expense by $535,000 or 22.3%, and
$10,000 or .4%, respectively. For the first nine months of the year, acquisition
and foreign currency translation increased SG&A expense by $1,537,000 or 25.7%,
and $698,000 or 11.7%, respectively. The increase in spending, excluding
acquisition and foreign currency translation, was primarily attributable to
additional systems costs related to an Enterprise Resource Planning (ERP)
implementation and foreign currency transactions.
CHARGE RELATED TO RESTRUCTURING ACTIVITIES
On July 28, 2005, the Company announced cost reductions and profit improvement
actions, which included the following:
>> reducing global headcount by 230 personnel,
>> outsourcing improvements utilizing the Company's China manufacturing
capability and third parties,
>> shifting substantial resources from product development to
manufacturing cost reduction activities and product rationalization,
>> reducing freight exposure through freight auctions and changing the
freight policy,
>> general expense reductions, and
>> exiting four facilities.
To date, the Company has made substantial progress on its restructuring
activities, including exiting four facilities and eliminating approximately 170
positions through September 30, 2005, which resulted in restructuring charges of
$2,760,000, principally for severance, of which $2,200,000 was incurred in North
America, $300,000 in Asia/Pacific and $260,000 in Europe. With additional
17
<page>
actions, the Company anticipates recognizing an additional $4,000,000 to
$5,000,000 ($2,725,000 to $3,405,000 after tax or $0.08 to $0.10 per diluted
share) in the fourth quarter. The actions in the third and fourth quarter are
expected to result in annualized pre-tax savings of at least $25 million as
Invacare enters 2006.
In addition, the Company continues to review its global manufacturing and
distribution strategy and develop a multi-year plan beginning in 2006 to exit a
number of manufacturing and distribution locations, which is expected to result
in additional annualized pre-tax savings of up to $21 million. These plans would
lead to pre-tax restructuring charges over the next two years estimated at $22
million. While plans are not complete, the Company currently believes that the
financial benefits from the restructuring in any one year will minimize the net
income impact from the charge incurred in that year.
INTEREST
Interest expense increased by $4,395,000 and $13,112,000 for the third quarter
and first nine months of 2005, respectively, compared to the same periods last
year, primarily due to increased borrowings for acquisitions and higher average
borrowing rates. Interest income decreased $899,000 and $1,368,000 for the third
quarter and first nine months of 2005, respectively, compared to the same
periods last year, primarily due to extended financing terms provided to our
customers.
INCOME TAXES
The Company had an effective tax rate of 31.9% for the three and nine-month
periods ended September 30, 2005 compared with 30.9% and 31.9% for the same
periods a year ago. The effective tax rate declined due to a change in estimate
in the mix of earnings and permanent deductions. The Company's effective tax
rate is lower than the U.S. federal statutory rate primarily due to tax credits
and earnings abroad being taxed at rates lower than the U.S. federal statutory
rate.
LIQUIDITY AND CAPITAL RESOURCES
The Company's reported level of debt decreased by $23,888,000 from December 31,
2004 to $526,148,000 at September 30, 2005 as cash generated from operations was
used to pay down debt. The Company continues to maintain an adequate liquidity
position to fund its working capital and capital requirements through its bank
lines of credit and working capital management.
On September 29, 2005, the Company and the other parties to its Note Purchase
Agreements dated as of February 27, 1998 and October 1, 2003, entered into
certain amendments to those agreements that, among other things: (i) required
the Company to at all times maintain at least a $350,000,000 revolving credit
facility, (ii) amended the maximum permitted amount of debt, and (iii) amended
certain defined terms, including the definition of "Consolidated Total Assets"
and "Debt." In addition, the amendment to the 1998 Purchase Agreement changed
certain covenants of the Company relating to incurrence of debt, liens and asset
sales. In addition, on August 12, 2005, the Company entered into an agreement to
amend the Company's $500,000,000 revolving credit agreement to among other
things: (i) clarify the definition of Adjusted EBITDA to exclude certain
restructuring costs, (ii) amend the definition of Total Debt to include lease
receivable securitizations and exclude trade receivable securitizations, and
(iii) reduce the Total Debt to Adjusted EBITDA ratio from 3.50 to 1.0, to 3.25
to 1.0 for the period commencing on December 31, 2006 and continuing thereafter.
18
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On September 30, 2005, the Company entered into a 364-day $100 million accounts
receivable securitization facility. The Receivables Purchase Agreement (the
"Receivables Agreement") , dated as of September 30, 2005, among Invacare
Receivables Corporation ("IRC"), as Seller, Invacare Corporation, as Servicer,
Park Avenue Receivables Company, LLC (the "Conduit"), the financial institutions
named therein and JPMorgan Chase Bank, N.A., as Agent, provides for, among other
things, the transfer from time to time by Invacare and certain of its
subsidiaries of ownership interests of certain domestic accounts receivable on a
revolving basis to the Conduit, an asset-backed issuer of commercial paper,
and/or the financial institutions named in the Receivables Agreement. Pursuant
to the Receivables Agreement, the Company and certain of its subsidiaries from
time to time may transfer accounts receivable to IRC, a special purpose entity
and subsidiary of Invacare. IRC then transfers interests in the receivables to
the Conduit and/or the financial institutions named in the Receivables Agreement
and receives funds from the Conduit and/or the financial institutions raised
through the issuance of commercial paper (in its own name) by the Conduit and/or
the financial institutions. In accordance with U.S. Generally Accepted
Accounting Principles, Invacare accounts for the transaction as a secured
borrowing. Borrowings under the facility are effectively repaid as receivables
are collected, with new borrowings created as additional receivables are sold.
Invacare received $75.5 million in funds pursuant to the securitization facility
on September 30, 2005 at an original borrowing rate of 4.1%, which was used to
reduce balances outstanding on Invacare's revolving credit facility. The debt is
reflected on the short-term debt and current maturities of long-term obligations
line of the condensed consolidated balance sheet at September 30, 2005.
As of September 30, 2005, the Company had approximately $247,546,000 available
under its lines of credit, excluding debt covenant restrictions. The Company's
borrowing arrangements contain covenants, with respect to maximum amount of
debt, minimum loan commitments, interest coverage, net worth, dividend payments,
working capital, and funded debt to capitalization, as defined in the Company's
bank agreements and agreement with its note holders. As of September 30, 2005,
the Company was in compliance with all covenant requirements. Under the most
restrictive covenant of the Company's borrowing arrangements, the Company has
the capacity to borrow up to an additional $133,544,000 as of September 30,
2005.
CAPITAL EXPENDITURES
The Company had no individually material capital expenditure commitments
outstanding as of September 30, 2005. The Company estimates that capital
investments for 2005 could approximate up to $35,000,000 as compared to
$41,400,000 in 2004. The Company believes that its balances of cash and cash
equivalents, together with funds generated from operations and existing
borrowing facilities will be sufficient to meet its operating cash requirements
and to fund required capital expenditures for the foreseeable future.
CASH FLOWS
Cash flows provided by operating activities were $62,513,000 for the first nine
months of 2005 compared to $75,180,000 in the first nine months of 2004. The
decrease in operating cash flows for the first nine months of 2005 compared to
the same period a year ago was largely due to lower earnings, and higher
inventory levels. Inventory levels increased primarily due to building product
for anticipated increases in sales growth that did not materialize, primarily in
North America. In addition, with increased shipments from the Far East, the
Company had more products in transit than in previous years.
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<page>
Cash used for investing activities was $80,468,000 for the first nine months of
2005 compared to $297,219,000 in the first nine months of 2004. The decrease in
cash used for investing is attributable to the higher level of acquisitions
incurred in the first nine months of 2004 compared to the first nine months of
2005. In addition, cash used for investing activities benefited by $4,633,000
from the sale of a manufacturing facility no longer used by the Company and
reduced capital expenditures.
Cash required by financing activities was $11,918,000 for the first nine months
of 2005 compared to cash provided of $209,176,000 in the first nine months of
2004. Financing activities for the first nine months of 2005 were impacted by an
decrease in the Company's net long-term borrowings of $13,258,000 as more
operating cash flows were used to decrease borrowings compared to the same
period a year ago in which the Company's borrowings increased as a result of
acquisitions.
The effect of foreign currency translation and acquisitions may result in
amounts being shown for cash flows in the Condensed Consolidated Statement of
Cash Flows that are different from the changes reflected in the respective
balance sheet captions.
During the first nine months of 2005, the Company generated free cash flow of
$42,583,000 compared to free cash flow of $46,256,000 in the first nine months
of 2004. The decrease was primarily attributable to lower earnings and higher
inventory levels as explained above. Free cash flow is a non-GAAP financial
measure that is comprised of net cash provided by operating activities less net
purchases of property and equipment. Management believes that this financial
measure provides meaningful information for evaluating the overall financial
performance of the Company and its ability to repay debt or make future
investments (including acquisitions, etc.). The non-GAAP financial measure is
reconciled to the GAAP measure as follows (in thousands):
Nine Months Ended
September 30,
2005 2004
------- -------
Net cash provided by operating activities $62,513 $75,180
Less: Purchases of property and equipment - net (19,930) (28,924)
------- -------
Free Cash Flow $42,583 $ 46,256
====== ======
DIVIDEND POLICY
On September 8, 2005, the Company's Board of Directors declared a quarterly cash
dividend of $0.0125 per Common Share to shareholders of record as of October 1,
2005, which was paid on October 14, 2005. At the current rate, the cash dividend
will amount to $0.05 per Common Share on an annual basis.
CRITICAL ACCOUNTING POLICIES
The consolidated financial statements include accounts of the Company and all
majority-owned subsidiaries. The preparation of financial statements in
conformity with accounting principles generally accepted in the United States
requires management to make estimates and assumptions in certain circumstances
that affect amounts reported in the accompanying consolidated financial
statements and related footnotes. In preparing these financial statements,
management has made its best estimates and judgments of certain amounts included
in the financial statements, giving due consideration to materiality. However,
application of these accounting policies involves the exercise of judgment and
use of assumptions as to future uncertainties and, as a result, actual results
could differ from these estimates.
20
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Revenue Recognition
Invacare's revenues are recognized when products are shipped to unaffiliated
customers. The Securities and Exchange Commission's Staff Accounting Bulletin
(SAB) No. 101, "Revenue Recognition," as updated by SAB No. 104, provides
guidance on the application of generally accepted accounting principles to
selected revenue recognition issues. The Company has concluded that its revenue
recognition policy is appropriate and in accordance with generally accepted
accounting principles and SAB No. 101.
Sales are only made to customers with whom the Company believes collection is
reasonably assured based upon a credit analysis, which may include obtaining a
credit application, a signed security agreement, personal guarantee and/or a
cross corporate guarantee depending on the credit history of the customer.
Credit lines are established for new customers after an evaluation of their
credit report and/or other relevant financial information. Existing credit lines
are regularly reviewed and adjusted with consideration given to any outstanding
past due amounts.
The Company offers discounts and rebates, which are accounted for as reductions
to revenue in the period in which the sale is recognized. Discounts offered
include: cash discounts for prompt payment, base and trade discounts based on
contract level for specific classes of customers. Volume discounts and rebates
are given based on large purchases and the achievement of certain sales volumes.
Product returns are accounted for as a reduction to reported sales with
estimates recorded for anticipated returns at the time of sale. The Company does
not sell any goods on consignment.
Distributed products sold by the Company are accounted for in accordance with
EITF 99-19 Reporting Revenue Gross as a Principal versus Net as an Agent. The
Company records distributed product sales gross as a principal since the Company
takes title to the products and has the risks of loss for collections, delivery
and returns.
Product sales that give rise to installment receivables are recorded at the time
of sale when the risks and rewards of ownership are transferred. In December
2000, the Company entered into an agreement with DLL, a third party financing
company, to provide the majority of future lease financing to Invacare
customers. As such, interest income is recognized based on the terms of the
installment agreements. Installment accounts are monitored and if a customer
defaults on payments, interest income is no longer recognized. All installment
accounts are accounted for using the same methodology, regardless of duration of
the installment agreements.
Allowance for Uncollectible Accounts Receivable
Accounts receivable are reduced by an allowance for amounts that may become
uncollectible in the future. Substantially all of the Company's receivables are
due from health care/medical equipment dealers and long term care facilities
located throughout the United States, Australia, Canada, New Zealand, Asia and
Europe. A significant portion of products sold to dealers, both foreign and
domestic, is ultimately funded through government reimbursement programs such as
Medicare and Medicaid. In addition, the Company has seen a significant shift in
reimbursement to customers from managed care entities. As a consequence, changes
in these programs can have an adverse impact on dealer liquidity and
profitability. The estimated allowance for uncollectible amounts is based
primarily on management's evaluation of the financial condition of the customer.
In addition, as a result of the third party financing arrangement with DLL,
management monitors the collection status of these contracts in accordance with
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the Company's limited recourse obligations and provides amounts necessary for
estimated losses in the allowance for doubtful accounts.
Inventories and Related Allowance for Obsolete and Excess Inventory
Inventories are stated at the lower of cost or market with cost principally
determined for domestic manufacturing inventories by the last-in, first-out
(LIFO) method and for non-domestic inventories and domestic finished products
purchased for resale by the first-in, first-out (FIFO) method.
Inventories have been reduced by an allowance for excess and obsolete
inventories. The estimated allowance is based on management's review of
inventories on hand compared to estimated future usage and sales. A provision
for excess and obsolete inventory is recorded as needed based upon the
discontinuation of products, redesigning of existing products, new product
introductions, market changes and safety issues. Both raw materials and finished
goods are reserved for on the balance sheet.
In general, we review inventory turns as an indicator of obsolescence or slow
moving product as well as the impact of new product introductions. Depending on
the situation, the individual item may be partially or fully reserved for. No
inventory that was reserved for has been sold at prices above their new cost
basis. The Company continued to increase its overseas sourcing efforts, increase
its emphasis on the development and introduction of new products, and decrease
the cycle time to bring new product offerings to market. These initiatives are
potential sources of inventory obsolescence for both raw material and finished
goods.
Goodwill, Intangible and Other Long-Lived Assets
Property, equipment, intangibles and certain other long-lived assets are
amortized over their useful lives. Useful lives are based on management's
estimates of the period that the assets will generate revenue. As a result of
the adoption of Statement of Financial Accounting Standard (SFAS) No. 142,
Goodwill and Other Intangible Assets in 2002, goodwill and intangible assets
deemed to have indefinite lives are subject to annual impairment tests in
accordance with the Statement. Furthermore, goodwill and other long-lived assets
are reviewed for impairment whenever events or changes in circumstances indicate
that the carrying amount of an asset may not be recoverable. The Company
completes its annual impairment tests in the fourth quarter of each year and the
results of these analyses have historically indicated no impairment of goodwill.
Product Liability
The Company's captive insurance company, Invatection Insurance Co., currently
has a policy year that runs from September 1 to August 31 and insures annual
policy losses of $10,000,000 per occurrence and $11,000,000 in the aggregate of
the Company's North American product liability exposure. The Company also has
additional layers of external insurance coverage insuring up to $100,000,000 in
annual aggregate losses arising from individual claims anywhere in the world
that exceed the captive insurance company policy limits. There can be no
assurance that Invacare's current insurance levels will continue to be adequate
or available at affordable rates.
Product liability reserves are recorded for individual claims based upon
historical experience, industry expertise and indications from a third-party
actuary. Additional reserves, in excess of the specific individual case
reserves, are provided for incurred but not reported claims based upon
third-party actuarial valuations at the time such valuations are conducted.
Historical claims experience and other assumptions are taken into consideration
by the third-party actuary to estimate the ultimate reserves. For example, the
actuarial analysis assumes that historical loss experience is an indicator of
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future experience, the distribution of exposures by geographic area and nature
of operations for ongoing operations is expected to be very similar to
historical operations with no dramatic changes and that the government indices
used to trend losses and exposures are appropriate. Estimates made are adjusted
on a regular basis and can be impacted by actual loss awards or settlements on
claims. While actuarial analysis is used to help determine adequate reserves,
the Company is responsible for the determination and recording of adequate
reserves in accordance with accepted loss reserving standards and practices.
Warranty
Generally, the Company's products are covered by warranties against defects in
material and workmanship for periods of up to six years from the date of sale to
the customer. Certain components carry a lifetime warranty. A provision for
estimated warranty cost is recorded at the time of sale based upon actual
experience. The Company continuously assesses the adequacy of its product
warranty accrual and makes adjustments as needed. Historical analysis is
primarily used to determine the Company's warranty reserves. Claims history is
reviewed and provisions are adjusted as needed. However, the Company does
consider other events, such as a product recall, which could warrant additional
warranty reserve provision. No material adjustments to warranty reserves were
necessary in the current year. See Warranty Costs in the Notes to the
Consolidated Financial Statements for a reconciliation of the changes in the
warranty accrual.
Accounting for Stock-Based Compensation
The Company accounts for options under its stock-based compensation plans using
the intrinsic value method proscribed in Accounting Principles Board Opinion
(APBO) No. 25, Accounting for Stock Issued to Employees, and related
Interpretations. The majority of the options awarded have been granted at
exercise prices equal to the market value of the underlying stock on the date of
grant; thus, no compensation cost has been reflected in the Consolidated
Statement of Earnings for these options. In addition, restricted stock awards
have been granted without cost to the recipients and are being expensed on a
straight-line basis over the vesting periods.
In December 2002, the Financial Accounting Standards Board (FASB) issued SFAS
No. 148, Accounting for Stock-Based Compensation-Transition and Disclosure. This
statement provides guidance for those companies wishing to voluntarily change to
the fair value based method of accounting for stock-based compensation. The
statement also amends the disclosure requirements of SFAS No. 123. While
Invacare continues to utilize the disclosure-only provisions of SFAS No. 123,
the Company has modified its disclosures to comply with the new statement. See
Accounting for Stock-Based Compensation in the Notes to the Consolidated
Financial Statements.
Income Taxes
As part of the process of preparing its financial statements, the Company is
required to estimate income taxes in various jurisdictions. The process requires
estimating the Company's current tax exposure, including assessing the risks
associated with tax audits, as well as estimating temporary differences due to
the different treatment of items for tax and accounting policies. The temporary
differences are reported as deferred tax assets and or liabilities. The Company
also must estimate the likelihood that its deferred tax assets will be recovered
from future taxable income and whether or not valuation allowances should be
established. In the event that actual results differ from its estimates, the
Company's provision for income taxes could be materially impacted.
The Company does not believe that there is a substantial likelihood that
materially different amounts would be reported related to its critical
accounting policies.
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RECENTLY ADOPTED ACCOUNTING POLICIES
In January 2003, the FASB issued Interpretation No. 46, Consolidation of
Variable Interest Entities ("FIN 46"), which was revised in December 2003 and,
which among other things, deferred the implementation date of FIN 46 until
periods after March 15, 2004. This interpretation requires consolidation of an
entity if the company is subject to a majority of the risk of loss from the
variable interest entity's ("VIE") activities or entitled to receive a majority
of the entity's residual returns, or both. A company that consolidates a VIE is
known as the primary beneficiary of that entity.
The Company has an investment in NeuroControl, a development stage company,
which is currently pursuing FDA approval to market in the United States a
product focused on the treatment of post-stroke shoulder pain. The amount of net
advances and investment recorded on the Company's books was approximately
$3,000,000 at December 31, 2004. Certain of the Company's officers and directors
(or their affiliates) have minority equity ownership positions in NeuroControl.
Subsequent to December 31, 2004, the Company's board of directors approved an
additional investment by the Company in NeuroControl. Accordingly, the Company
has consolidated this investment prospectively beginning with the quarter ended
March 31, 2005, as the Company is now deemed the primary beneficiary of this VIE
based on the provisions of FIN 46. The other beneficial interest holders have no
recourse against the Company.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In December 2004, FASB issued Statement of Financial Accounting Standards
("SFAS") No. 123 (Revised 2004), Share-Based Payment ("SFAS 123R"), which
requires companies to expense stock options and other share-based payments. SFAS
123R supersedes SFAS No. 123, which permitted either expensing stock options or
providing pro forma disclosure. In April 2005, the SEC announced that the
adoption of SFAS 123R would be delayed. The provisions of SFAS 123R, which will
become effective with respect to the Company on January 1, 2006, apply to all
awards granted, modified, cancelled or repurchased after January 1, 2006 as well
as the unvested portion of prior awards. The Company will adopt the standard as
of the effective date and estimates that the impact to the Company's reported
results will likely result in greater expense than is reflected in the pro forma
results shown in the Company's note regarding Accounting for Stock-Based
Compensation in the Notes to its Consolidated Financial Statements due in part
to the clarification in the new standard regarding the treatment of options
granted to those who are retiree eligible at the date of grant.
QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
The Company is exposed to market risk through various financial instruments,
including fixed rate and floating rate debt instruments. The Company uses
interest rate swap agreements and treasury locks to mitigate its current and
future exposure to interest rate fluctuations. Based on the Company's September
30, 2005 debt levels, a 1.0% change in interest rates would impact interest
expense by approximately $5,106,000 over the next twelve months. Additionally,
the Company operates internationally and as a result is exposed to foreign
currency fluctuations. Specifically, the exposure includes inter Company loans
and third party sales or payments. In an attempt to reduce this exposure, the
Company utilizes foreign currency forward contracts. The Company does not
believe that any potential loss related to these financial instruments would
have a material adverse effect on the Company's financial condition or results
of operations.
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FORWARD-LOOKING STATEMENTS
This Form 10-Q contains forward-looking statements within the meaning of the
"Safe Harbor" provisions of the Private Securities Litigation Reform Act of
1995. Terms such as "will," "should," "plan," "intend," "expect," "continue,"
"forecast", "believe," "anticipate" and "seek," as well as similar comments, are
forward-looking in nature. Actual results and events may differ significantly
from those expressed or anticipated as a result of risks and uncertainties which
include, but are not limited to, the following: pricing pressures, the success
of the Company's ongoing efforts to reduce costs, increasing raw material costs,
the consolidations of health care customers and competitors, government
reimbursement issues (including those that affect the sales of and margins on
product, along with the viability of customers) both at the federal and state
level, the successful implementation of the Company's enterprise resource
planning system, the ability to design, manufacture, distribute and achieve
market acceptance of new products with higher functionality and lower costs, the
effect of offering customers competitive financing terms, Invacare's ability to
successfully identify, acquire and integrate strategic acquisition candidates,
the difficulties in managing and operating businesses in many different foreign
jurisdictions (including the recent Domus acquisition), the timely completion of
facility consolidations, the vagaries of any litigation or regulatory
investigations that the Company may be or become involved in at any time
(including the previously-disclosed litigation with Respironics), the
difficulties in acquiring and maintaining a proprietary intellectual property
ownership position, the overall economic, market and industry growth conditions
(including the impact that acts of terrorism may have on such growth
conditions), foreign currency and interest rate risks, Invacare's ability to
improve financing terms and reduce working capital, as well as the risks
described from time to time in Invacare's reports as filed with the Securities
and Exchange Commission. We undertake no obligation to review or update these
forward-looking statements or other information contained herein.
Item 3. Quantitative and Qualitative Disclosure of Market Risk.
The information called for by this item is provided under the same caption under
Item 2 - Management's Discussion and Analysis of Financial Condition and Results
of Operations.
Item 4. Controls and Procedures.
As of September 30, 2005, an evaluation was performed, under the supervision and
with the participation of the Company's management, including the CEO and CFO,
of the effectiveness of the design and operation of the Company's disclosure
controls and procedures. Based on that evaluation, the Company's management,
including the CEO and CFO, concluded that the Company's disclosure controls and
procedures were effective as of September 30, 2005 in ensuring that information
required to be disclosed by the Company in the reports it files and submits
under the Exchange Act is recorded, processed, summarized and reported, within
the time periods specified in the Commission's rules and forms. There were no
changes in the Company's internal control over financial reporting that occurred
during the Company's most recent fiscal quarter that have materially affected,
or are reasonably likely to materially affect, the Company's internal control
over financial reporting.
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Part II. OTHER INFORMATION
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds (c) The
following table presents information with respect to repurchases of common
shares made by the Company during the three months ended September 30, 2005. All
of the repurchased shares were surrendered to the Company by employees for tax
withholding purposes in conjunction with the vesting of restricted shares held
by the employees under the Company's 2003 Performance Plan.
<table>
<caption>
Total Number of Shares Maximum Number
Total Number of Purchased as Part of of Shares That May Yet
Shares Publicly Announced Be Purchased Under
Period Purchased Plans or Programs the Plans or Programs
------ --------------- ---------------------- -----------------------
<s> <c> <c> <c> <c>
7/1/2005-7/31/05 (1) 160 $ 39.36 - $
8/1/2005-8/31/05 - - - -
9/1/2005-9/30/05 - - - -
----- ----- ----- -----
Total 160 $ 39.36 - $ -
===== ===== ===== =====
</table>
(1) Represents common shares surrendered to the Company for tax
withholding purposes in conjunction with the vesting of restricted
shares under the Company's 2003 Performance Plan.
Item 6. Exhibits.
Exhibits:
Official Exhibit No.
--------------------
31.1 Certification of the Chief Executive Officer pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002 (filed
herewith).
31.2 Certification of the Chief Financial Officer pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002 (filed
herewith).
32.1 Certification of the Chief Executive Officer pursuant
to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002
(furnished herewith).
32.2 Certification of the Chief Financial Officer pursuant
to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002
(furnished herewith).
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
INVACARE CORPORATION
By:/s/ Gregory C. Thompson
-----------------------------------------
Gregory C. Thompson
Chief Financial Officer
(Principal Financial and Accounting Officer)
Date: November 8, 2005