UNITED STATES
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 June 30, 2006
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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
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(Exact name of registrant as specified in its charter)
Ohio 95-2680965
------------------------------- -------------------------------
(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) (Zip Code)
(440)329-6000
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(Registrant's telephone number, including area code)
(Former name, former address and former fiscal year, if changed since last
report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 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 whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act (Check
One).
Large accelerated filer X Accelerated filer Non-accelerated filer
----- ---- -----
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes No X
---- ----
As of August 4, 2006, the Company had 30,765,000 Common Shares and 1,111,565
Class B Common Shares outstanding.
INVACARE CORPORATION
INDEX
Part I. FINANCIAL INFORMATION: Page No.
------------------------------ --------
Item 1. Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets -
June 30, 2006 and December 31, 2005..........................3
Condensed Consolidated Statement of Earnings -
Three Months and Six Months Ended June 30, 2006 and 2005.....4
Condensed Consolidated Statement of Cash Flows -
Six Months Ended June 30, 2006 and 2005......................5
Notes to Condensed Consolidated Financial
Statements - June 30, 2006...................................6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations...............17
Item 3. Quantitative and Qualitative Disclosures About Market Risk...........29
Item 4. Controls and Procedures..............................................29
Part II. OTHER INFORMATION:
---------------------------
Item 1A. Risk Factors........................................................29
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds..........30
Item 4. Submission of Matters to a Vote of Security Holders..................30
Item 6. Exhibits.............................................................31
SIGNATURES....................................................................31
2
Part I. FINANCIAL INFORMATION
Item 1... Financial Statements
INVACARE CORPORATION AND SUBSIDIARIES
Condensed Consolidated Balance Sheets
June 30, December 31,
2006 2005
---- ----
(unaudited)
ASSETS (In thousands)
------
CURRENT ASSETS
..........Cash and cash equivalents $ 734 $25,624
..........Marketable securities 196 252
..........Trade receivables, net 277,186 287,955
..........Installment receivables, net 13,493 12,935
..........Inventories, net 189,494 176,925
..........Deferred income taxes 27,006 27,446
..........Other current assets 65,390 63,329
------- -------
.......... TOTAL CURRENT ASSETS 573,499 594,466
OTHER ASSETS 59,196 47,110
OTHER INTANGIBLES 110,718 108,117
PROPERTY AND EQUIPMENT, NET 175,554 176,206
GOODWILL 757,889 720,873
------- -------
.......... TOTAL ASSETS $1,676,856 $1,646,772
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
..........Accounts payable $148,393 $133,106
..........Accrued expenses 126,589 130,033
..........Accrued income taxes 7,861 13,340
..........Short-term debt and current maturities of long-term obligations 76,015 80,228
------- -------
.......... TOTAL CURRENT LIABILITIES 358,858 356,707
LONG-TERM DEBT 423,897 457,753
OTHER LONG-TERM OBLIGATIONS 88,461 79,624
SHAREHOLDERS' EQUITY
..........Preferred shares - -
..........Common shares 7,988 7,925
..........Class B common shares 278 278
..........Additional paid-in-capital 144,249 137,245
..........Retained earnings 607,390 598,025
..........Accumulated other comprehensive earnings 88,306 47,480
..........Treasury shares (42,571) (38,265)
------- -------
.......... TOTAL SHAREHOLDERS' EQUITY 805,640 752,688
------- -------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $1,676,856 $1,646,772
========== ==========
See notes to condensed consolidated financial statements.
3
INVACARE CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statement of Earnings - (unaudited)
Three Months Ended Six Months Ended
(In thousands except per share data) June 30, June 30,
2006 2005 2006 2005
----------------------------------------------------------------
Net sales $371,764 $396,267 $733,468 $767,211
Cost of products sold 265,728 282,983 525,629 544,083
------- ------- ------- -------
Gross profit 106,036 113,284 207,839 223,128
Selling, general and administrative expense 88,151 88,352 171,541 172,314
Charge related to restructuring activities 2,840 - 5,997 -
Interest expense 8,913 6,785 17,332 13,771
Interest income (716) (811) (1,316) (1,805)
------- ------- ------- -------
Earnings before Income Taxes 6,848 18,958 14,285 38,848
Income taxes 1,895 6,050 4,125 12,395
------- ------- ------- -------
NET EARNINGS $ 4,953 $ 12,908 $ 10,160 $ 26,453
======= ======= ======= =======
DIVIDENDS DECLARED PER
COMMON SHARE .0125 .0125 .0250 .0250
======= ======= ======= =======
Net Earnings per Share - Basic $ 0.16 $ 0.41 $ 0.32 $ 0.84
======= ======= ======= =======
Weighted Average Shares Outstanding - Basic 31,789 31,553 31,760 31,456
======= ======= ======= =======
Net Earnings per Share - Assuming Dilution $ 0.15 $ 0.40 $ 0.32 $ 0.81
======= ======= ======= =======
Weighted Average Shares Outstanding -
Assuming Dilution 32,113 32,530 32,155 32,533
======= ======= ======= =======
See notes to condensed consolidated financial statements.
4
INVACARE CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statement of Cash Flows - (unaudited)
Six Months Ended
June 30,
2006 2005
---- ----
OPERATING ACTIVITIES (In thousands)
Net earnings $ 10,160 $ 26,453
Adjustments to reconcile net earnings to
net cash provided by operating activities:
Depreciation and amortization 19,096 19,877
Provision for losses on trade and installment receivables 4,224 6,027
Provision for other deferred liabilities 4,286 1,390
Provision for deferred income taxes 1,790 4,559
Loss on disposals of property and equipment 558 320
Changes in operating assets and liabilities:
Trade receivables 3,591 (691)
Installment sales contracts, net (2,569) (3,687)
Inventories (9,632) (17,062)
Other current assets (992) 6,591
Accounts payable 6,239 (450)
Accrued expenses (10,909) (14,386)
Other deferred liabilities (1,029) 570
------- -------
NET CASH PROVIDED BY OPERATING ACTIVITIES 24,813 29,511
INVESTING ACTIVITIES
Purchases of property and equipment (9,789) (15,809)
Proceeds from sale of property and equipment 63 4,937
Other long term assets 62 (2)
Business acquisitions, net of cash acquired - (58,216)
Other (912) (3,237)
------- -------
NET CASH USED FOR INVESTING ACTIVITIES (10,576) (72,327)
FINANCING ACTIVITIES
Proceeds from revolving lines of credit, securitization facility and
long-term borrowings 430,840 295,695
Payments on revolving lines of credit, securitization facility and
long-term debt and capital lease obligations (468,507) (279,814)
Proceeds from exercise of stock options 1,835 1,202
Payment of dividends (795) (787)
------- -------
NET CASH (REQUIRED) PROVIDED BY FINANCING ACTIVITIES (36,627) 16,296
Effect of exchange rate changes on cash (2,500) 343
------- -------
Decrease in cash and cash equivalents (24,890) (26,177)
Cash and cash equivalents at beginning of period 25,624 32,567
------- -------
Cash and cash equivalents at end of period $ 734 $ 6,390
======= =======
See notes to condensed consolidated financial statements.
5
INVACARE CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated
Financial Statements
(Unaudited)
June 30, 2006
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.
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 June 30, 2006, the results of
its operations for the three months and six months ended June 30, 2006 and 2005,
respectively, and changes in its cash flows for the six months ended June 30,
2006 and 2005, respectively. Certain foreign subsidiaries, represented by the
European segment, are consolidated using a May 31 quarter-end in order to meet
filing deadlines. No material subsequent events have occurred related to the
European segment, which would require disclosure or adjustment to the Company's
financial statements. The results of operations for the three and six months
ended June 30, 2006, 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 June 30, 2006.
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 the Company's five primary product
lines, which include: 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.
6
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 described in the
summary of significant accounting policies for the Company's consolidated
financial statements. Intersegment sales and transfers are based on the costs to
manufacture plus a reasonable profit element. Therefore, intercompany profit or
loss on intersegment sales and transfers is not considered in evaluating segment
performance.
The information by segment is as follows (in thousands):
Three Months Ended Six Months Ended
June 30, June 30,
2006 2005 2006 2005
------- ------- ------- -------
Revenues from external customers
North America $250,106 $263,328 $500,081 $514,268
Europe 104,687 110,331 200,233 212,422
Asia/Pacific 16,971 22,608 33,154 40,521
------- ------- ------- -------
Consolidated $371,764 $396,267 $733,468 $767,211
======= ======= ======= =======
Intersegment Revenues
North America $11,804 $13,180 $25,889 $24,134
Europe 2,906 4,266 5,675 7,049
Asia/Pacific 9,256 9,228 17,282 18,249
------- ------- ------- -------
Consolidated $23,966 $26,674 $48,846 $49,432
======= ======= ======= =======
Charge related to restructuring before income
taxes
North America $ 2,034 $ - $ 4,865 $ -
Europe 1,100 - 1,438 -
Asia/Pacific 482 - 766 -
------- ------- ------- -------
Consolidated $ 3,616 $ - $ 7,069 $ -
======= ======= ======= =======
Earnings (loss) before income taxes
North America $ 8,589 $19,779 $17,759 $40,504
Europe 5,941 7,359 9,633 11,241
Asia/Pacific (1,967) (1,827) (3,365) (3,531)
All Other * (5,715) (6,353) (9,742) (9,366)
------- ------- ------- -------
Consolidated $ 6,848 $18,958 $14,285 $38,848
======= ======= ======= =======
* Consists of unallocated corporate selling, general and administrative costs
and intercompany profits, which do not meet the quantitative criteria for
determining reportable segments.
7
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.
Three Months Ended Six Months Ended
June 30, June 30,
2006 2005 2006 2005
------- ------- ------- -------
(In thousands, except per share data)
Basic
Average common shares outstanding 31,789 31,553 31,760 31,456
Net earnings $4,953 $12,908 $10,160 $26,453
Net earnings per common share $ .16 $ .41 $ .32 $ .84
Diluted
Average common shares outstanding 31,789 31,553 31,760 31,456
Stock options and awards 324 977 395 1,077
------- ------- ------- -------
Average common shares assuming dilution 32,113 32,530 32,155 32,533
Net earnings $ 4,953 $12,908 $10,160 $26,453
Net earnings per common share $ .15 $ .40 $ .32 $ .81
At June 30, 2006, 2,452,771 and 2,467,175 shares were excluded from the average
common shares assuming dilution for the three and six months ended June 30,
2006, respectively, as they were anti-dilutive. For the three and six months
ended June 30, 2006, the majority of the anti-dilutive shares were granted at an
exercise price of $41.87 which was higher than the average fair market value
prices of $28.80 and $30.46, respectively. At June 30, 2005, 400,812 and 50,023
shares were excluded from the average common shares assuming dilution for the
three and six months ended June 30, 2005, respectively, as they were
anti-dilutive. For the three and six months ended June 30, 2005, the majority of
the anti-dilutive shares were granted at exercise prices of $44.30 and $47.35,
respectively, which was higher than the average fair market value prices of
$44.01 and $45.05, 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. De Lage Landen Inc (DLL), a third party financing company, provides
the majority of the lease financing to Invacare's customers. The Company's
agreement with DLL provides for direct leasing between DLL and the Invacare
customer. The Company retains a limited recourse obligation ($44,504,000 at June
30, 2006) to DLL for events of default under the contracts (total balance
outstanding of $108,145,000 at June 30, 2006). 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.
8
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 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 also 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. 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, 2005 to June 30, 2006 was entirely the result of
currency translation.
All of the Company's other intangible assets have definite lives and are
amortized over their useful lives, except for $32,538,000 related to trademarks,
which have indefinite lives.
As of June 30, 2006 and December 31, 2005, other intangibles consisted of the
following (in thousands):
June 30, 2006 December 31, 2005
------------- -----------------
Historical Accumulated Historical Accumulated
Cost Amortization Cost Amortization
---------- ------------ ---------- ------------
Customer lists $67,831 $11,212 $64,218 $8,270
Trademarks 32,538 - 30,246 -
License agreements 8,105 6,100 7,564 5,821
Developed technology 6,658 710 6,260 487
Patents 12,695 3,274 12,414 2,690
Other 7,909 3,722 7,876 3,193
------- ------- ------- -------
$135,736 $25,018 $128,578 $20,461
======= ======= ======= =======
Amortization expense related to other intangibles was $4,559,000 in the first
half of 2006 and is estimated to be $8,912,000 in 2007, $8,487,000 in 2008,
$8,272,000 in 2009, $7,871,000 in 2010 and $7,638,000 in 2011.
Investment in Affiliated Company - FASB Interpretation No. 46, Consolidation of
Variable Interest Entities (FIN 46), 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 is 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 consolidates NeuroControl, a development stage company, which is
currently pursuing FDA approval to market a product focused on the treatment of
post-stroke shoulder pain in the United States. The Company owns a substantial
minority equity interest in NeuroControl and is its largest secured lender.
Certain of the Company's officers and directors (or their affiliates) have small
minority equity ownership positions in NeuroControl. Based on the provisions of
FIN 46 and the Company's analysis, the Company determined that it was the
primary beneficiary of this VIE as of January 1, 2005 due to the Company board
of directors' approval of additional funding in 2005. Accordingly, the Company
has consolidated this investment on a prospective basis since January 1, 2005
9
and recorded an intangible asset for patented technology of $7,003,000. The
other beneficial interest holders have no recourse against the Company.
Accounting for Stock-Based Compensation - Prior to the Company's adoption of
Statement of Financial Accounting Standard No. 123 (Revised 2004), Share Based
Payment ("SFAS 123R"), the Company accounted 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. Only compensation cost related to
restricted stock awards granted without cost was reflected in net income, as all
other options awarded were granted at exercise prices equal to the market value
of the underlying stock on the date of grant.
Effective January 1, 2006, the Company adopted SFAS 123R using the modified
prospective application method. Under the modified prospective method,
compensation cost was recognized for the six months ended June 30, 2006 for: 1)
all stock-based payments granted subsequent to January 1, 2006 based upon the
grant-date fair value calculated in accordance with SFAS 123R, and 2) all
stock-based payments granted prior to, but not vested as of, January 1, 2006
based upon grant-date fair value as calculated for previously presented pro
forma footnote disclosures in accordance with the original provisions of SFAS
No. 123, Accounting for Stock Based Compensation.
The amounts of stock-based compensation expense recognized were as follows (in
thousands):
Three Months Ended Six Months Ended
June 30, June 30,
2006 2005 2006 2005
----------------------------------------------------------
Stock-based compensation expense recognized as part of
selling, general and administrative expense $ 268 $ 223 $ 536 $ 435
The 2006 amounts above reflect compensation expense related to restricted stock
awards and nonqualified stock options awarded under the 2003 Performance Plan.
The 2005 amounts reflect compensation expense recognized for restricted stock
awards only, before SFAS 123R was adopted. Stock-based compensation is not
allocated to the business segments, but is reported as part of All Other as
shown in the Company's Business Segment Note to the Consolidated Financial
Statements.
Pursuant to the modified prospective application method, results for periods
prior to January 1, 2006 have not been restated to reflect the effects of
adopting SFAS 123R. The pro forma information below is presented for comparative
purposes, as required by SFAS No. 148, Accounting for Stock-Based Compensation -
Transition and Disclosure, an amendment of FASB Statement No. 123, to illustrate
the pro forma effect on net earnings and related earnings per share for the
periods ended June 30, 2005, as if the Company had applied the fair value
recognition provisions of SFAS No. 123 to stock-based compensation for that
period (in thousands):
10
Three Months Six Months
Ended Ended
June 30, 2005 June 30, 2005
------------- -------------
Net earnings, as reported $ 12,908 $ 26,453
Add: Stock-based compensation expense included in reported income, net of
tax ($78 and $152, respectively) 145 283
Deduct: Total stock-based compensation expense determined under fair
value-based method for all awards, net of tax ($684 and $1,337, respectively) (1,270) (2,484)
------- -------
Adjusted net earnings $ 11,783 $ 24,252
Net earnings per share:
Basic - as reported $ 0.41 $ 0.84
Basic - as adjusted for stock-based compensation expense $ 0.37 $ 0.77
Diluted - as reported $ 0.40 $ 0.81
Diluted - as adjusted for stock-based compensation expense $ 0.36 $ 0.75
Stock Incentive Plans - The 2003 Performance Plan (the "2003 Plan") allows the
Compensation, Management Development and Corporate Governance Committee of the
Board of Directors (the "Committee") to grant up to 3,800,000 Common Shares in
connection with incentive stock options, non-qualified stock options, stock
appreciation rights and stock awards (including the use of restricted stock),
which includes the addition of 1,800,000 Common Shares approved by the Company's
shareholders on May 25, 2006. The Committee has the authority to determine which
employees and directors will receive awards, the amount of the awards and the
other terms and conditions of the awards. During the first half of 2006 and
2005, the Committee granted 77,600 and 72,075 non-qualified stock options for a
term of ten years at the fair market value of the Company's Common Shares on the
date of grant under the 2003 Plan.
Restricted stock awards of 29,322 and 21,304 shares were granted in the first
half of 2006 and 2005, respectively, without cost to the recipients. Under the
terms of the restricted stock awards, all of the shares granted vest ratably
over the four years after the award date. Unearned restricted stock compensation
of $916,606 for the shares granted in the first half of 2006 and $1,016,200 for
the shares granted in the first half of 2005, determined as the market value of
the shares at the date of grant, is being amortized on a straight-line basis
over the vesting period. Compensation expense of $473,000 and $435,000 was
recognized in the first half of 2006 and 2005, respectively, related to
restricted stock awards granted since 2001. As of June 30, 2006, restricted
stock awards totaling 63,925 were not yet vested.
On December 21, 2005, the Board of Directors of Invacare Corporation, based on
the recommendation of the Committee, approved the acceleration of the vesting of
all of the Company's unvested stock options, which were then underwater. The
Board of Directors decided to approve the acceleration of the vesting of these
stock options primarily to partially offset certain reductions in other benefits
made by the Company and to provide additional incentive to those employees
critical to the Company's cost reduction efforts.
11
The decision, which was effective as of December 21, 2005, accelerated the
vesting for a total of 1,368,307 options on the Company's common shares;
including 646,100 shares underlying options held by the Company's named
executive officers. The stock options accelerated equated to 29% of the
Company's total outstanding stock options. Vesting was not accelerated for the
restricted awards granted under the Company's stock-based compensation plans and
no other modifications were made to the awards that were accelerated. The
exercise prices of the accelerated options, all of which were underwater, were
unchanged by the acceleration of the vesting schedules.
All of the Company's outstanding unvested options under plans which were
accelerated, had exercise prices ranging from $30.91 to $47.80 which were
greater than the Company's stock market price of $30.75 as of the effective date
of the acceleration.
Stock option activity during the six months ended June 30, 2006 was as follows:
Weighted Average
Exercise Price
--------------
Options outstanding at January 1, 2006 4,776,162 $31.57
Granted 77,600 31.46
Exercised (218,323) 24.96
Canceled (193,375) 35.78
------- -------
Options outstanding at June 30, 2006 4,442,064 $31.57
========= ======
Options price range at June 30, 2006 $16.03 to $47.80
Options exercisable at June 30, 2006 4,335,625
Options available for grant at June 30, 2006* 2,242,495
* Options available for grant as of June 30, 2006 reduced by net restricted
stock award activity of 159,339 and include 1,800,000 Common Shares
approved by the Company's shareholders on May 25, 2006.
The following table summarizes information about stock options outstanding at
June 30, 2006:
Options Outstanding Options Exercisable
------------------- -------------------
Number Weighted
Outstanding Average Remaining Weighted Average Number Exercisable Weighted Average
Exercise Prices At 6/30/06 Contractual Life Exercise Price At 6/30/06 Exercise Price
--------------- ---------- ---------------- -------------- ---------- --------------
$16.03 - $19.50 395,630 3.2 years $18.53 395,630 $18.53
$20.06 - $24.75 971,246 3.0 $23.53 947,259 $23.52
$25.13 - $29.85 668,508 2.9 $25.35 661,608 $25.31
$30.02 - $34.54 623,680 6.3 $32.66 552,730 $32.79
$36.10 - $39.67 685,512 6.8 $37.26 685,512 $37.26
$40.07 - $47.80 1,097,488 8.6 $43.01 1,092,886 $43.19
--------- --- ------ --------- ------
Total 4,442,064 5.4 $31.57 4,335,625 $31.65
========= =========
The stock options awarded provided a four-year vesting period whereby options
vest equally in each year. Options granted with graded vesting are accounted for
as single options.
12
The fair value of each option grant is estimated on the date of grant using the
Black-Scholes option-pricing model with the following weighted-average
assumptions:
2006 2005
---- ----
Expected dividend yield .67% .67%
Expected stock price volatility 26.7% 26.7%
Risk-free interest rate 4.38% 4.38%
Expected life (years) 5.6 5.6
The assumed expected life used is based on the Company's historical analysis of
option history. The expected volatility used is also based on actual historical
volatility, and expected dividend yield used is based on historical dividends as
the Company has no current intention of changing its dividend policy.
The weighted-average fair value of options granted during the first half of 2006
and 2005 was $12.41 for each period, respectively. The plans provide that shares
granted come from the Company's authorized but unissued Common Shares or
treasury shares. In addition, the Company's stock-based compensation plans allow
participants to exchange shares for withholding taxes, which results in the
Company acquiring treasury shares. The weighted-average remaining contractual
life of options outstanding at June 30, 2006 and 2005 was 5.4 years for both
periods, respectively. The total instrinsic value of stock awards exercised
during the six months ended June 30, 2006 and 2005 were $1,729,000 and
$6,481,000, respectively. As of June 30, 2006, all options outstanding and all
options exercisable had no intrinsic value as all options had exercisable prices
greater than the Company's closing stock price as of June 30, 2006. The exercise
of stock awards in the first half of 2006 and 2005 resulted in cash received by
the Company totaling $1,835,000 and $1,202,000 for each period, respectively and
tax benefits of $926,000 and $4,284,000, respectively.
As of June 30, 2006, there was $2,996,000 of total unrecognized compensation
cost from stock-based compensation arrangements granted under the plans, which
is related to non-vested shares, and includes $2,136,000 related to restricted
stock awards. The Company expects the compensation expense to be recognized over
a weighted-average period of approximately 2 years.
Prior to the adoption of SFAS 123R, the Company presented all tax benefit
deductions resulting from the exercise of stock options as a component of
operating cash flows in the Consolidated Statement of Cash Flows. In accordance
with SFAS 123R, tax benefits resulting from tax deductions in excess of the
compensation expense recognized for those options is classified as a component
of financing cash flows. The impact of this change was not material in the first
half of 2006.
13
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 half of 2006.
The following is a reconciliation of the changes in accrued warranty costs for
the reporting period (in thousands):
Balance as of January 1, 2006 $ 15,583
Warranties provided during the period 3,902
Settlements made during the period (4,717)
Changes in liability for pre-existing warranties during
the period, including expirations 259
------
Balance as of June 30, 2006 $ 15,027
======
Charge Related to Restructuring Activities - In the second half of 2005, the
Company initiated multi-year cost reduction plans which include: global
headcount reductions, transferring production to the Company's Chinese
manufacturing facilities, increased sourcing of products and components in Asia,
shifting resources from product development to manufacturing cost reduction
activities and product rationalization, and exiting facilities.
The restructuring was necessitated by the continued decline in reimbursement by
the U.S. government as well as similar reimbursement pressures abroad and
continued pricing pressures faced by the Company as a result of outsourcing by
competitors to lower cost locations.
To date, the Company has made substantial progress on its restructuring
activities, including exiting four facilities and eliminating approximately 450
positions through June 30, 2006, including 150 positions in the first half of
2006. Restructuring charges of $7,069,000 were incurred in the first six months
of 2006, of which $1,072,000 is recorded in cost of products sold as it relates
to inventory markdowns and the remaining charge amount is included on the Charge
Related to Restructuring Activities in the Condensed Consolidated Statement of
Earnings as part of operations. There have been no material changes in accrued
balances related to the charge, either as a result of revisions in the Company's
restructuring plan or changes in estimates, and the Company expects to utilize
the accruals recorded through June 30, 2006 during the next twelve months.
14
A progression of the accruals recorded as a result of the restructuring is as
follows by segment (in thousands):
Balance at Balance at
12/31/05 Accruals Payments 6/30/06
------- ------- ------- -------
North America
Severance $ 2,242 $ 3,406 $ (3,898) $ 1,750
Contract terminations 165 801 (894) 72
Product line discontinuance - 658 (658) -
------- ------- ------- -------
Total $ 2,407 $ 4,865 $ (5,450) $ 1,822
======= ======= ======= =======
Europe
Severance $ 799 $ 732 $ (1,343) $ 188
Product line discontinuance - 455 (455) -
Other - 251 (251) -
------- ------- ------- -------
Total $ 799 $ 1,438 $ (2,049) $ 188
======= ======= ======= =======
Asia/Pacific
------------
Severance $ 63 $ 252 $ (311) $ 4
Contract terminations - 239 (191) 48
Product line discontinuance - 269 (269) -
Other - 6 - 6
------- ------- ------- -------
Total $ 63 $ 766 $ (771) $ 58
======= ======= ======= =======
Consolidated
Severance $ 3,104 $ 4,390 $ (5,552) $ 1,942
Contract terminations 165 1,040 (1,085) 120
Product line discontinuance - 1,382 (1,382) -
Other - 257 (251) 6
------- ------- ------- -------
Total $ 3,269 $ 7,069 $ (8,270) $ 2,068
======= ======= ======= =======
Comprehensive Earnings (Loss) - Total comprehensive earnings were as follows (in
thousands):
Three Months Ended Six Months Ended
June 30, June 30,
2006 2005 2006 2005
------- ------- ------- -------
Net earnings (loss) $ 4,953 $12,908 $10,160 $26,453
Foreign currency translation gain (loss) 40,558 (35,759) 39,770 (39,084)
Unrealized gain (loss) on available for sale securities (60) (42) (38) 10
Current period unrealized gain (loss) on cash flow hedges 11 (4,910) 1,094 (4,337)
------- ------- ------- -------
Total comprehensive earnings (loss) $45,462 $(27,803) $50,986 $(16,958)
======= ======= ======= =======
Inventories - Inventories determined under the first in, first out method
consist of the following components (in thousands):
June 30, December 31,
2006 2005
------- -------
Raw materials $ 58,884 $59,888
Work in process 21,221 16,700
Finished goods 109,389 100,337
------- -------
$189,494 $176,925
======= =======
15
Property and Equipment - Property and equipment consist of the following (in
thousands):
June 30, December 31,
2006 2005
------- -------
Machinery and equipment $263,944 $252,545
Land, buildings and improvements 88,348 84,031
Furniture and fixtures 27,224 28,788
Leasehold improvements 15,238 15,194
------- -------
394,754 380,558
Less allowance for depreciation (219,200) (204,352)
------- -------
$175,554 $176,206
======= =======
Financing Arrangements - On April 27, 2006, the Company consummated a new Senior
Notes offering for $150 million at a fixed rate of 6.15% due April 27, 2016. The
proceeds were used to reduce debt outstanding under the Company's $500 million
revolving credit facility.
Acquisitions - In the first six months of 2006, the Company made no
acquisitions. 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 Company recorded accruals of
$5,954,000 in accordance with EITF Issue No. 95-3, Recognition of Liabilities in
Connection with a Purchase Business Combination, of which $3,813,000 is
outstanding as of June 30, 2006.
A progression of the accruals balances for the quarter is as follows (in
thousands):
Balance at Additional Balance at
12/31/05 Accruals Adjustments Payments 6/30/06
-------- -------- ----------- -------- -------
Severance $ 3,049 $ - $ 117 $ (287) $ 2,879
Sales agency terminations - - - - -
Exit of product lines 897 - 37 - 934
------- ------- ------- ------- -------
Total $ 3,946 $ - $ 154 $ (287) $ 3,813
======= ======= ======= ======= =======
Adjustments above represent the impact of currency translation. The Company
anticipates all of the remaining reserves to be utilized in 2006.
Income Taxes - The Company had an effective tax rate of 28.9% for the six month
period ended June 30, 2006 compared with 31.9% for the same period 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.
16
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 July 27,
2006.
OUTLOOK
Reimbursement uncertainties continue to affect the core North American rehab,
respiratory and standard businesses. The power wheelchair market is likely to
remain under pressure until the Centers for Medicare and Medicaid ("CMS")
defines the reimbursement levels for the 64 new codes announced in early June.
This uncertainty has particularly impacted Medicare power wheelchair sales and
will likely continue to pressure results for the remainder of 2006. Uncertainty
also remains in determining the level of reimbursement for durable medical
equipment, oxygen, and oxygen equipment servicing as part of the Deficit
Reduction Act passed earlier in the year, as well as the questions surrounding
transfer of title for both durable and oxygen equipment. This significant and
continuing uncertainty surrounding oxygen reimbursement has negatively impacted
HomeFill sales in particular.
On July 27, 2006, CMS issued proposed guidelines to be effective January 1,
2007, which would increase HomeFill reimbursement by $12 per month and decrease
by $21 per month reimbursement for home delivery by cylinders. This is a
significant change from the current modality neutral reimbursement and appears
to favor HomeFill. The industry will carefully analyze the proposal and provide
comments to CMS during the comment period, which ends September 25, 2006.
As a result of these conditions, the Company has lowered its full year earnings
per share guidance to between $1.45 and $1.65, excluding restructuring charges,
versus $2.00 to $2.10 previously. The net sales increase is expected to be
between 0% and negative 2%. This new guidance excludes any impact from foreign
currency and acquisitions.
This earnings per share range includes the impact from the stock option
accounting Statement of Financial Accounting Standards No. 123 (Revised 2004),
Share Based Payment ("SFAS 123R") issued by the Financial Accounting Standards
Board. The impact of SFAS 123R on earnings per share for 2006 is estimated to be
$0.05.
The Company anticipates operating cash flows of between $70 million and $85
million and net purchases of property plant and equipment of approximately $30
million, down from previous guidance in which operating cash flows were
anticipated to be between $102 million and $112 million and net purchases of
property plant and equipment was approximated to be $32 million.
The Company anticipates that third quarter sales will strengthen sequentially,
but the regulatory overhang will probably prevent a restoration of organic
growth as it is believed that the challenges from Medicare reimbursement will
continue to negatively impact performance and will remain for the foreseeable
future. As a result of these market realities, cost reduction remains the
Company's top priority.
17
As such, the Company will continue to execute on the following previously
communicated initiatives, which are expected to improve second half performance:
>> Shifting substantial resources from product development to manufacturing
cost reduction activities, engineered product cost reductions and product
rationalization.
>> Manufacturing cost reduction activities including headcount reductions.
>> Transferring additional manufacturing to China and increasing the Asian
sourcing of products.
>> Continuing to cost reduce the design and engineering of our products to
address the reimbursement and pricing realities.
Despite continued soft sales in the United States, the Company expects to see
significant benefits in the second half of 2006 from these on-going initiatives
and from normal seasonal increases in international businesses, scheduled new
product introductions and a return to more conventional fourth quarter sales
volume from the abnormally low 2005 level that was principally attributable to
the implementation of a new enterprise resource planning system.
In addition, the Company is progressing on its global manufacturing and
distribution strategy to exit a number of manufacturing and distribution
locations and reduce costs by $30 million annually by 2008.
RESULTS OF OPERATIONS
NET SALES
Net sales for the three months ended June 30, 2006 were $371,764,000, compared
to $396,267,000 for the same period a year ago, representing a 6% decrease.
Acquisitions added one percentage point to the net sales for the quarter, which
was offset by a one percentage point decrease resulting from foreign currency
translation. For the six months ended June 30, 2006, net sales decreased 4% to
$733,468,000, compared to $767,211,000 for the same period a year ago.
Acquisitions contributed one percentage point to net sales, while foreign
currency translation resulted in a decrease of two percentage points.
Excluding the impact of foreign currency and acquisitions, the net sales decline
in the second quarter and first half was negatively impacted by Medicare
reimbursement policies, the details of which have not been fully clarified, that
have been most disruptive to the power wheelchair and oxygen markets. In
addition, significant uncertainty amongst customers concerning the possible
outcomes from the CMS relative to reimbursement levels continues to constrain
growth.
North American Operations
North American net sales decreased 5% for the quarter to $250,106,000 as
compared to $263,328,000 for the same period a year ago with foreign currency
and acquisitions each contributing one percentage point. For the first half, net
sales decreased 3% to $500,081,000 as compared $514,268,000 for the same period
a year ago, with foreign currency and acquisitions each contributing one
percentage point. 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.
18
The decrease for the quarter was principally due to net sales decreases in
Respiratory products (22%), Standard products (5%) and Rehab products (3%),
which were partially offset by net sales increases in Continuing Care products
(11%).
The Respiratory products net sales decline for the quarter was largely due to
slower demand in the HomeFillTM oxygen system product line. In addition to
significantly reduced purchases versus last year by national providers, sales to
small providers and independents declined 9% in the quarter. Our proprietary
technology continues to build share in the ambulatory oxygen market, but
providers have slowed purchases of HomeFill until they have a clearer view of
future oxygen reimbursement levels. Uncertainty surrounding the provisions of
the Deficit Reduction Act, including the 36-month capped rental period, transfer
of title, and ongoing equipment service levels continues to impact the oxygen
market.
The decline in net sales of Standard products for the quarter was due to
particular weakness in sales of manual wheelchairs and patient aids, such as
canes, walkers and bath aids, due to low-cost Asian imports negatively impacting
volumes. However, Standard product revenues improved sequentially over first
quarter by 3% as a result of pricing and product line adjustments, which have
been facilitated by the acceleration of Asian sourcing.
Rehab product net sales decline was due primarily to continued Medicare power
wheelchair eligibility pressures and Medicaid related reimbursement pressures.
Sales of consumer power wheelchairs were down 7% and continued to be acutely
impacted by these reimbursement issues.
The Continuing Care products sales increase for the quarter was due to increased
unit volumes.
European Operations
European net sales decreased 5% for the quarter to $104,687,000 as compared to
$110,331,000 for the same period a year ago, with foreign currency accounting
for four percentage points of the net sales decrease, while acquisitions
contributed one percentage point for the quarter. European net sales for the
first six months decreased 6% to $200,233,000 as compared to $212,422,000 for
the same period a year ago, with foreign currency accounting for seven
percentage points of the net sales decrease, while acquisitions contributed two
percentage points for the six-month period. Reimbursement challenges continue to
impact our German business in the Invacare wheelchair product lines, which was
partially offset by strong performance in a number of other countries.
Asia/Pacific Operations
The Company's Asia/Pacific operations consist of Invacare Australia, which
imports and distributes the Invacare range of products and manufactures and
distributes the Rollerchair range of custom power wheelchairs and Pro Med lifts,
DecPac ramps and Australian Healthcare Equipment beds, furniture and pressure
care products; Dynamic Controls, a New Zealand manufacturer of electronic
operating components used in power wheelchairs and scooters; Invacare New
Zealand, a manufacturer of wheelchairs and beds and a distributor of a wide
range of home medical equipment; and Invacare Asia Sales, which imports and
distributes home medical equipment to the Asia markets.
19
Asia/Pacific net sales decreased 25% in the quarter to $16,971,000 from
$22,608,000 in the second quarter of 2005 and decreased 18% year to date to
$33,154,000 from $40,521,000 for the same period a year ago. For the quarter,
foreign currency accounted for six percentage points of the net sales decline,
while acquisitions did not impact results for the quarter. For the first half of
the year, foreign currency translation contributed seven percentage points to
the decrease while acquisitions contributed one percentage point for the
six-month period. Performance in this region continues to be negatively impacted
by U.S. reimbursement uncertainty in the consumer power wheelchair market,
resulting in decreased sales of microprocessor controllers by our Dynamic
Controls subsidiary.
GROSS PROFIT
Gross profit as a percentage of net sales for the three and six-month periods
ended June 30, 2006 were 28.5% and 28.3%, respectively, compared to 28.6% and
29.1%, respectively, in the same periods last year. However, gross margin
improved by .4 percentage points in the second quarter compared to the first
quarter of 2006 as a result of cost reduction initiatives. Margins continue to
be negatively impacted by lower volumes, high freight costs and a change in
sales mix toward lower margin products.
For the first six months, North American margins as a percentage of net sales
declined to 26.9% compared with 28.4% in the same period last year principally
due to reduced volumes of higher margin product, largely as a result of
government reimbursement uncertainties primarily in Rehab and Respiratory
products and to a lesser extent by pricing reductions in Standard products. In
Europe, gross margin as a percentage of net sales improved year to date by .1 of
a percentage point due to continued cost reduction activities. Gross margin, as
a percentage of net sales in Asia/Pacific, increased year to date by 1.2
percentage points, largely due to cost reduction activities.
SELLING, GENERAL AND ADMINISTRATIVE
Selling, general and administrative ("SG&A") expense as a percentage of net
sales for the three and six months ended June 30, 2006 was 23.7% and 23.4%,
respectively, compared to 22.3% and 22.5%, respectively, for the same periods a
year ago. The dollar decreases were $201,000 and $773,000, or .2% and .4%,
respectively, for the quarter and first half of the year. Acquisitions increased
these expenses by $892,000 in the quarter and $2,408,000 in the first half,
while foreign currency translation decreased these expenses by $1,369,000 in the
quarter and $4,232,000 in the first half compared to the same periods a year
ago. Excluding the impact of foreign currency translation and acquisitions,
selling, general and administrative expense increased 0.3% for the quarter and
0.6% compared to the same period a year ago.
North American SG&A cost increased $1,448,000, or 2.6%, for the quarter and
$4,179,000, or 3.9%, in the first half compared to the same periods a year ago.
Acquisitions accounted for 1.3% and 1.6% of the increase in each period,
respectively, while foreign currency translation accounted for approximately
0.7% and 0.6% of the increase in each period, respectively.
European SG&A cost decreased $1,126,000, or 4.0%, for the quarter and $3,898,000
or 6.9% for the first half compared to the same periods a year ago. For the
quarter, acquisitions increased SG&A expense by $195,000 or .7%, and foreign
currency translation decreased SG&A by $1,329,000 or 4.7%, respectively. For the
first half of 2006, acquisitions increased SG&A expense by $594,000 or 1.0%, and
foreign currency translation decreased SG&A by $4,176,000 or 7.3%, respectively.
20
Asia/Pacific SG&A cost decreased $523,000, or 10.6%, for the quarter and
$1,054,000, or 11.5%, in the first half of the year compared to the same periods
a year ago. For the quarter, foreign currency translation decreased SG&A expense
by $426,000, or 8.6%, while acquisitions had no impact. For the first half of
2006, acquisitions increased SG&A expense by $158,000, or 1.7%, and foreign
currency translation decreased SG&A by $686,000, or 7.5%, respectively.
CHARGE RELATED TO RESTRUCTURING ACTIVITIES
On July 28, 2005, the Company announced cost reductions and profit improvement
actions, which included: reducing global headcount, 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, reducing general
expenses, and exiting four facilities.
The restructuring was necessitated by the continued decline in reimbursement by
the U.S. government as well as similar reimbursement pressures abroad and
continued pricing pressures faced by the Company as a result of outsourcing by
competitors to lower cost locations.
To date, the Company has made substantial progress on its restructuring
activities, including exiting four facilities and eliminating approximately 450
positions through June 30, 2006, including 150 positions in the first half of
2006. Restructuring charges of $3,616,000 and $7,069,000 were incurred in the
three and six month periods ending June 30, 2006, of which $776,000 and
$1,072,000, respectively, is recorded in cost of products sold as it relates to
inventory markdowns and the remaining charge amount is included on the Charge
Related to Restructuring Activities in the Condensed Consolidated Statement of
Earnings as part of operations.
The restructuring charge for the quarter included charges of $2,034,000 in North
America, which were incurred principally for severance; $1,100,000 in Europe
primarily related to product line discontinuations and severance; and $482,000
in Asia/Pacific mostly related to product line discontinuations. Restructuring
charges for the first half included charges of $4,865,000 in North America,
which were incurred principally for severance; $1,438,000 in Europe primarily
related to product line discontinuations and severance; and $766,000 in
Asia/Pacific related to product line discontinuations, severance and contract
terminations.
With additional actions to be undertaken during the remainder of 2006, the
Company anticipates recognizing restructuring charges of approximately
$10,000,000 for the year pre-tax, which includes the incurrence of additional
severance charges for the reduction of 150 more positions in 2006. In addition,
the Company continues to further refine its global manufacturing and
distribution strategy, which is expected to result in additional annualized
pre-tax savings of up to $30 million annually by 2008 once all plans have been
executed. These plans would lead to cumulative pre-tax restructuring charges
estimated at $42 million. The Company expects a global reduction of at least 600
positions and to exit a number of its manufacturing operations worldwide.
21
INTEREST
Interest expense increased $2,128,000 and $3,561,000 for the second quarter and
first half of 2006, respectively, compared to the same periods last year,
primarily due to higher average borrowing rates. Interest income for the second
quarter and first half of 2006 decreased $95,000 and $489,000, 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 27.7% for the three-month period and
28.9% for the six-month period ended June 30, 2006, compared with 31.9% for each
of 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 $38,069,000 from December 31,
2005 to $499,912,000 at June 30, 2006, as cash generated from operations and
cash made available due to better cash management 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.
As of June 30, 2006, the Company had approximately $416,901,000 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 June 30, 2006, 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 $20,418,000 as of June 30, 2006.
On April 27, 2006, the Company consummated a new Senior Notes offering for
$150,000,000 at 6.15% due April 27, 2016. The proceeds were used to reduce debt
outstanding under the Company's revolving credit facility and increased the
Company's fixed rate as a percentage of total debt outstanding.
CAPITAL EXPENDITURES
The Company had no individually material capital expenditure commitments
outstanding as of June 30, 2006. The Company estimates that capital investments
for 2006 will approximate $30,000,000 as compared to $31,517,000 in 2005. 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.
22
CASH FLOWS
Cash flows provided by operating activities were $24,813,000 for the first half
of 2006 compared to $29,511,000 in the first half of 2005. The decrease in
operating cash flows for the first half of 2006 compared to the same period a
year ago was primarily the result of lower earnings offset by the result of
better working capital management as payables, accruals and inventories were
less of a drain on cash.
Cash used for investing activities was $10,576,000 for the first half of 2006
compared to $72,327,000 in the first half of 2005. The decrease in cash used for
investing is the result of no acquisitions being completed in the first half of
2006 compared to the first half of 2005 and reduced purchases of property and
equipment in the first half of 2006 compared to the first half of 2005.
Cash required by financing activities was $36,627,000 for the first half of 2006
compared to cash provided of $16,296,000 in the first half of 2005. Financing
activities for the first half of 2006 were impacted by a decrease in the
Company's net long-term borrowings as 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 half of 2006, the Company generated free cash flow of
$20,334,000 compared to free cash flow of $18,639,000 in the first half of 2005.
The increase was primarily attributable to lower purchases of property, plant &
equipment and better working capital management as accounts payable, accruals
and inventories were less of a drain on cash partially offset by lower earnings.
Free cash flow is a non-GAAP financial measure that is comprised of net cash
provided by operating activities, excluding net cash impact related to
restructuring activities, less net purchases of property and equipment, net of
proceeds from sales 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, for example, acquisitions). The non-GAAP
financial measure is reconciled to the GAAP measure as follows (in thousands):
Six Months Ended June 30,
2006 2005
------- -------
Net cash provided by operating activities $ 24,813 $29,511
Net cash impact related to restructuring activities 5,247 -
Less: Purchases of property and equipment - net (9,726) (10,872)
------- -------
Free Cash Flow $ 20,334 $18,639
======= =======
DIVIDEND POLICY
On May 25, 2006, the Company's Board of Directors declared a quarterly cash
dividend of $0.0125 per Common Share to shareholders of record as of July 3,
2006, which was paid on July 14, 2006. At the current rate, the cash dividend
will amount to $0.05 per Common Share on an annual basis.
23
CRITICAL ACCOUNTING POLICIES
The Consolidated Financial Statements included in the report include accounts of
the Company, all majority-owned subsidiaries and a variable interest entity for
which the Company is the primary beneficiary. 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.
Revenue Recognition
-------------------
Invacare's revenues are recognized when products are shipped to unaffiliated
customers. The SEC'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 (GAAP) to selected revenue recognition
issues. The Company has concluded that its revenue recognition policy is
appropriate and in accordance with GAAP 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. DLL, a third
party financing Company, provides the majority of the 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.
24
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 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 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 determined for
manufacturing inventories 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 continues 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
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 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. 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
completed the required initial analysis of goodwill as of January 1, 2002 as
well as the annual impairment tests in the fourth quarter of each subsequent
year, including 2005. The results of these analyses indicated no impairment of
goodwill. Interest rates have a significant impact upon the discounted cash flow
methodology utilized in our annual impairment testing. Increasing interest rates
decrease the fair value estimates used in our testing.
25
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 or the limits of the
Company's per country foreign liability limits as applicable. 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
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 from the date of sale to the
customer by warranties against defects in material and workmanship for various
periods depending on the product. 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 included in this report for a reconciliation
of the changes in the warranty accrual.
Accounting for Stock-Based Compensation
---------------------------------------
Prior to January 1, 2006, the Company accounted 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. Effective January 1, 2006, the
Company adopted SFAS 123R using the modified prospective application method.
Under the modified prospective method, compensation cost was recognized for the
six months ended June 30, 2006 for: 1) all stock-based payments granted
subsequent to January 1, 2006 based upon the grant-date fair value calculated in
accordance with SFAS 123R, and 2) all stock-based payments granted prior to, but
not vested as of, January 1, 2006 based upon grant-date fair value previously
calculated for previously presented pro forma footnote disclosures in accordance
with the original provisions of SFAS No. 123, Accounting for Stock Based
Compensation. Results for periods prior to January 1, 2006 have not been
restated.
26
On December 21, 2005, the Board of Directors of Invacare Corporation, based on
the recommendation of the Compensation, Management Development and Corporate
Governance Committee (the "Committee"), approved the acceleration of the vesting
for substantially all of the Company's unvested stock options, which were then
underwater. The Board of Directors decided to approve the acceleration of the
vesting of the these stock options primarily to partially offset certain
reductions in other benefits made by the Company and to provide additional
incentive to those employees critical to the Company's cost reduction efforts.
The decision, which was effective as of December 21, 2005, accelerated the
vesting for a total of 1,368,307 options on the Company's common shares;
including 646,100 shares underlying options held by the Company's named
executive officers. The stock options accelerated equated to 29% of the
Company's total outstanding stock options. Vesting was not accelerated for the
restricted awards granted under the Company's stock-based compensation plans and
no other modifications were made to the awards that were accelerated. The
exercise prices of the accelerated options, all of which were underwater, were
unchanged by the acceleration of the vesting schedules.
All of the Company's outstanding unvested options under its stock-based
compensation plans which were accelerated, had exercise prices ranging from
$30.91 to $47.80 which were greater than the Company's stock market price of
$30.75 as of the effective date of the acceleration.
Upon adoption of SFAS 123R, the Company did not make any other modifications to
the terms of any previously granted options. However, the terms of new awards
granted have been modified so that the vesting periods are deemed to be
substantive for those who may be retiree eligible. No changes were made
regarding the valuation methodologies or assumptions used to determine the fair
value of options granted and the Company continues to use a Black-Scholes
valuation model. As of June 30, 2006, there was $2,996,000 of total unrecognized
compensation cost from stock-based compensation arrangements granted under the
plans, which is related to non-vested shares, and includes $2,136,000 related to
restricted stock awards. The Company expects the compensation expense to be
recognized over a weighted-average period of approximately 2 years. The impact
on earnings per share for 2006 is estimated to be $0.05.
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 was reflected in the Consolidated Statement of Earnings for these
options prior to January 1, 2006. However, restricted stock awards granted
without cost to the recipients were and continue to be expensed on a
straight-line basis over the vesting periods.
27
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.
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In June 2006, the Financial Accounting Standards Board (FASB) issued FASB
Interpretation No. 48, Accounting for Uncertainty in Income Taxes, an
interpretation of FASB Statement No. 109 ("FIN 48"). FIN 48 prescribes
recognition and measurement of a tax position taken or expected to be taken in a
tax return as well as guidance regarding derecognition, classification, interest
and penalties, accounting in interim periods, disclosure, and transition. FIN 48
is effective for fiscal years beginning after December 15, 2006, thus January 1,
2007 for Invacare. The Company will adopt the standard as of the effective date
and is currently analyzing the requirements and thus is unable to estimate the
impact to the Company's reported results at this time.
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 to mitigate its current and future exposure to
interest rate fluctuations. Based on the Company's June 30, 2006 debt levels, a
1.0% change in interest rates would impact interest expense by approximately
$2,882,000 over the next twelve months. Additionally, the Company operates
internationally and as a result is exposed to foreign currency fluctuations.
Specifically, the exposure includes intercompany loans and third party sales or
payments. In an attempt to reduce this exposure, foreign currency forward
contracts are utilized. 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.
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
budgetary and reimbursement issues at both the federal and state level
(including those that affect the sales of and margins on product, along with the
viability of customers), the ongoing implementation of the Company's North
American enterprise resource planning system, the ability to develop and sell
28
new products with higher functionality and lower costs, the effect of offering
customers competitive financing terms, the ability to successfully identify,
acquire and integrate strategic acquisition candidates, the difficulties in
managing and operating businesses in many different foreign jurisdictions, the
orderly completion of facility consolidations, the vagaries of any litigation or
regulatory investigations that the Company may be or become involved in at any
time, the difficulties in acquiring and maintaining a proprietary intellectual
property ownership position, the overall economic, market and industry 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 June 30, 2006, an evaluation was performed, under the supervision and with
the participation of the Company's management, including the Chief Executive
Officer and Chief Financial Officer, of the effectiveness of the design and
operation of the Company's disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-159e)). Based on that evaluation, the
Company's management, including the Chief Executive Officer and Chief Financial
Officer, concluded that the Company's disclosure controls and procedures were
effective as of June 30, 2006, in ensuring that information required to be
disclosed by the Company in the reports it files and submits under the Exchange
Act is (1) recorded, processed, summarized and reported, within the time periods
specified in the Commission's rules and forms and (2) accumulated and
communicated to the Company's management, including the Chief Executive Officer
and the Chief Financial Officer, as appropriate to allow for timely decisions
regarding required disclosure. 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.
Part II. OTHER INFORMATION
Item 1A. Risk Factors
In addition to the other information set forth in this report, you should
carefully consider the risk factors disclosed in Item 1A of the Company's Annual
Report on Form 10-K for the fiscal year ended December 31, 2005.
29
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 June 30, 2006.
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.
Total Number Average Total Number of Shares Maximum Number
of Price Purchased as Part of of Shares That May Yet
Shares Paid Publicly Announced Be Purchased Under
Period Purchased Per Share Plans or Programs the Plans or Programs
--------------------- ----------- --------- ---------------------- ---------------------
4/1/2006-4/30/2006 - - - -
5/1/2006-5/31/2006 (1) 7,449 $ 30.40 - -
6/1/2006-6/30/2006 (1) 2,485 $ 28.19 - -
------ ------ ------ ------
Total 9,934 $ 29.85 - $ -
====== ====== ====== ======
(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 4. Submission of Matters to a Vote of Security Holders
On May 25, 2006, the Company held its 2006 Annual Meeting of Shareholders to act
on proposals to: 1) elect three directors to the class whose three-year term
will expire in 2009, 2) approve and adopt an amendment to increase the shares
reserved for issuance under the Invacare Corporation 2003 Performance Plan, and
3) ratify the appointment of Ernst & Young LLP as our independent auditors for
our 2006 fiscal year.
James C. Boland, Gerald B. Blouch and William M. Weber were each re-elected for
a three-year term of office expiring in 2009 with 36,324,372, 36,878,046 and
36,094,688 affirmative votes and 3,572,015, 3,018,341 and 3,801,699 votes
withheld, respectively.
Michael F. Delaney, C. Martin Harris, M.D., Bernadine P. Healy, M.D., A. Malachi
Mixon, III, John R. Kasich, Dan T. Moore, III and Joseph B. Richey, II are
directors with continuing terms.
The proposal to approve and adopt an amendment to increase the shares reserved
for issuance under the Invacare Corporation 2003 Performance Plan received
24,999,682 affirmative votes, 10,939,282 negative votes and 1,606,139 abstained
votes.
The proposal to ratify the appointment of Ernst & Young LLP as the Company's
independent auditors for its 2006 fiscal year received 39,612,580 affirmative
votes, 177,399 negative votes and 106,410 abstained votes.
30
Item 6. Exhibits.
Exhibits:
Official Exhibit No.
31.1 Chief Executive Officer Rule 13a-14(a)/15d-14(a)
Certification (filed herewith).
31.1 Chief Financial Officer Rule 13a-14(a)/15d-14(a)
Certification (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).
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: August 8, 2006