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 March 31, 2006
-------------------------------------------------
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from to
-------------------------------------------------
Commission File Number 0-12938
---------------------------------------------------------
Invacare Corporation
--------------------------------------------------------------------------------
(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
--------------------------------------------------------------------------------
(Address of principal executive offices)
(440)329-6000
--------------------------------------------------------------------------------
(Registrant's telephone number, including area code
--------------------------------------------------------------------------------
(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 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 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 __
Indicated 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 May 4, 2006, the Company had 30,749,797 Common Shares and 1,111,965 Class
B Common Shares outstanding.
INVACARE CORPORATION
INDEX
Part I. FINANCIAL INFORMATION: Page No.
------------------------------ --------
Item 1. Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets -
March 31, 2006 and December 31, 2005.........................3
Condensed Consolidated Statement of Earnings -
Three Months Ended March 31, 2006 and 2005...................4
Condensed Consolidated Statement of Cash Flows -
Three Months Ended March 31, 2006 and 2005...................5
Notes to Condensed Consolidated Financial
Statements - March 31, 2006..................................6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations...............16
Item 3. Quantitative and Qualitative Disclosures About Market Risk...........27
Item 4. Controls and Procedures..............................................27
Part II. OTHER INFORMATION:
---------------------------
Item 1A. Risk Factors.........................................................27
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds..........27
Item 6. Exhibits.............................................................28
SIGNATURES....................................................................28
2
Part I. FINANCIAL INFORMATION
Item 1... Financial Statements
INVACARE CORPORATION AND SUBSIDIARIES
Condensed Consolidated Balance Sheets
March 31, December 31,
2006 2005
---- ----
(unaudited)
ASSETS (In thousands)
------
CURRENT ASSETS
..........Cash and cash equivalents $ 11,412 $25,624
..........Marketable securities 288 252
..........Trade receivables, net 284,504 287,955
..........Installment receivables, net 12,094 12,935
..........Inventories, net 181,007 176,925
..........Deferred income taxes 27,027 27,446
..........Other current assets 45,976 39,510
------- -------
.......... TOTAL CURRENT ASSETS 562,308 570,647
OTHER ASSETS 47,879 47,110
OTHER INTANGIBLES 106,541 108,117
PROPERTY AND EQUIPMENT, NET 172,676 176,206
GOODWILL 723,190 720,873
------- -------
.......... TOTAL ASSETS $1,612,594 $1,622,953
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
..........Accounts payable $130,582 $133,106
..........Accrued expenses 106,719 106,214
..........Accrued income taxes 11,339 13,340
..........Short-term debt and current maturities of long-term obligations 80,323 80,228
------- -------
.......... TOTAL CURRENT LIABILITIES 328,963 332,888
LONG-TERM DEBT 440,832 457,753
OTHER LONG-TERM OBLIGATIONS 83,153 79,624
SHAREHOLDERS' EQUITY
..........Preferred shares - -
..........Common shares 7,981 7,925
..........Class B common shares 278 278
..........Additional paid-in-capital 142,933 137,245
..........Retained earnings 602,835 598,025
..........Accumulated other comprehensive earnings 47,797 47,480
..........Treasury shares (42,178) (38,265)
------- -------
.......... TOTAL SHAREHOLDERS' EQUITY 759,646 752,688
------- -------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $1,612,594 $1,622,953
========== ==========
See notes to condensed consolidated financial statements.
3
INVACARE CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statement of Earnings - (unaudited)
Three Months Ended
(In thousands except per share data) March 31,
2006 2005
------- -------
Net sales $361,704 $370,944
Cost of products sold 259,901 261,100
------- -------
Gross profit 101,803 109,844
Selling, general and administrative expense 83,390 83,962
Charge related to restructuring activities 3,157 -
Interest expense 8,419 6,986
Interest income (600) (994)
------- -------
Earnings before income taxes 7,437 19,890
Income taxes 2,230 6,345
------- -------
NET EARNINGS $ 5,207 $ 13,545
======= =======
DIVIDENDS DECLARED PER
COMMON SHARE 0.0125 0.0125
======= =======
Net Earnings per Share - Basic $ 0.16 $ 0.43
======= =======
Weighted Average Shares Outstanding - Basic 31,731 31,359
======= =======
Net Earnings per Share - Assuming Dilution $ 0.16 $ 0.42
======= =======
Weighted Average Shares Outstanding -
Assuming Dilution 32,190 32,534
======= =======
See notes to condensed consolidated financial statements.
4
INVACARE CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statement of Cash Flows - (unaudited)
Three Months Ended
March 31,
2006 2005
------- -------
OPERATING ACTIVITIES (In thousands)
Net earnings $ 5,207 $ 13,545
Adjustments to reconcile net earnings to
net cash provided (used) by operating activities:
Depreciation and amortization 9,813 10,132
Provision for losses on trade and installment receivables 1,794 1,696
Provision for other deferred liabilities 1,222 569
Provision for deferred income taxes 667 3,183
Loss on property and equipment sales/disposals 269 21
Changes in operating assets and liabilities:
Trade receivables 2,440 5,398
Installment sales contracts, net (253) (1,785)
Inventories (4,985) (14,988)
Other current assets 4,201 1,911
Accounts payable (2,091) (11,322)
Accrued expenses (9,854) (11,945)
Other deferred liabilities 99 111
------- -------
NET CASH PROVIDED (USED) BY OPERATING
ACTIVITIES 8,529 (3,474)
INVESTING ACTIVITIES
Purchases of property and equipment (5,009) (9,007)
Proceeds from sale of property and equipment 33 100
Other long term assets (523) 289
Business acquisitions, net of cash acquired - (9,252)
Other (159) (1,641)
------- -------
NET CASH USED FOR INVESTING ACTIVITIES (5,658) (19,511)
FINANCING ACTIVITIES
Proceeds from revolving lines of credit, securitization facility and
long-term borrowings 145,155 138,634
Payments on revolving lines of credit, long-term debt
and capital lease obligations (162,007) (130,490)
Proceeds from exercise of stock options 1,343 (243)
Payment of dividends (397) (387)
------- -------
NET CASH (REQUIRED) PROVIDED BY FINANCING
ACTIVITIES (15,906) 7,514
Effect of exchange rate changes on cash (1,177) (336)
------- -------
Decrease in cash and cash equivalents (14,212) (15,807)
Cash and cash equivalents at beginning of period 25,624 32,567
------- -------
Cash and cash equivalents at end of period $ 11,412 $ 16,760
======= =======
See notes to condensed consolidated financial statements.
5
INVACARE CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated
Financial Statements
(Unaudited)
March 31, 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 March 31, 2006, the results
of its operations for the three months ended March 31, 2006 and 2005,
respectively, and changes in its cash flows for the three months ended March 31,
2006 and 2005, respectively. Certain foreign subsidiaries, represented by the
European segment, are consolidated using a February 28 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 months
ended March 31, 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 March 31, 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 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 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
6
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
March 31,
2006 2005
-------- --------
Revenues from external customers
North America $249,975 $250,940
Europe 95,546 102,091
Asia/Pacific 16,183 17,913
-------- --------
Consolidated $361,704 $370,944
======== ========
Intersegment Revenues
North America $14,085 $10,954
Europe 2,769 2,783
Asia/Pacific 8,026 9,021
-------- --------
Consolidated $24,880 $22,758
======== ========
Earnings (loss) before income taxes
North America $9,170 $20,725
Europe 3,692 3,882
Asia/Pacific (1,398) (1,704)
All Other * (4,027) (3,013)
-------- --------
Consolidated $7,437 $19,890
======== ========
* Consists of unallocated corporate selling, general and administrative costs
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.
Three Months Ended
March 31,
2006 2005
-------- --------
(In thousands, except
per share data)
Basic
Average common shares outstanding 31,731 31,359
Net earnings $5,207 $13,545
Net earnings per common share $ 0.16 $ 0.43
Diluted
Average common shares outstanding 31,731 31,359
Stock options and awards 459 1,175
-------- --------
Average common shares assuming dilution 32,190 32,534
Net earnings $5,207 $13,545
Net earnings per common share $ 0.16 $ 0.42
7
At March 31, 2006 and 2005, 2,336,431 and 37,645 shares were excluded from the
average common shares assuming dilution, as they were anti-dilutive. In 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 price of $32.13 for
2006. In 2005, the majority of the anti-dilutive shares were granted at an
exercise price of $47.01, which was higher than the average fair market value
price of $46.11 for 2005.
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 agreement provides for direct leasing between DLL and the
Invacare customer. The Company retains a limited recourse obligation
($44,943,000 at March 31, 2006) to DLL for events of default under the contracts
(total balance outstanding of $108,448,000 at March 31, 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.
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 March 31, 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 $30,510,000 related to trademarks,
which have indefinite lives.
8
As of March 31, 2006 and December 31, 2005, other intangibles consisted of the
following (in thousands):
March 31, 2006 December 31, 2005
-------------- -----------------
Historical Accumulated Historical Accumulated
Cost Amortization Cost Amortization
---------- ------------ ---------- ------------
Customer lists $64,584 $9,699 $64,218 $8,270
Trademarks 30,510 - 30,246 -
License agreements 7,578 5,954 7,564 5,821
Developed technology 6,304 597 6,260 487
Patents 12,418 2,980 12,414 2,690
Other 7,855 3,478 7,876 3,193
------- ------- ------- -------
$129,249 $22,708 $128,578 $20,461
======== ======= ======== =======
Amortization expense related to other intangibles was $2,248,000 in the first
quarter of 2006 and is estimated to be $8,925,000 in 2007, $8,649,000 in 2008,
$8,213,000 in 2009, $7,962,000 in 2010 and $7,715,000 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
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 three months ended March 31, 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
9
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
March 31,
2006 2005
---- ----
Stock-based compensation expense recognized as part of
Selling, general and administrative expense $ 268 $ 213
The 2006 amount above reflects compensation expense related to restricted stock
awards and nonqualified stock options awarded under the 2003 Performance Plan.
The 2005 amount reflects 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 period ended March 31, 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):
Three Months Ended
March 31, 2005
--------------
Net earnings, as reported $ 13,545
Add: Stock-based compensation expense included
in reported income, net of tax ($75) 138
Deduct: Total stock-based compensation expense
determined under fair value-based method (1,214)
for all awards, net of tax ($653)
-------
Adjusted net earnings $ 12,469
Net earnings per share:
Basic - as reported $ 0.43
Basic - as adjusted for stock-based compensation expense $ 0.40
Diluted - as reported $ 0.42
Diluted - as adjusted for stock-based compensation expense $ 0.38
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 2,000,000 Common Shares in
connection with incentive stock options, non-qualified stock options, stock
appreciation rights and stock awards (including the use of restricted stock).
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 quarter of 2006 and 2005, the Committee granted
10
68,700 and 51,900 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
quarter 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 quarter of 2006 and $1,016,200
for the shares granted in the first quarter 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 $229,000 and $213,000 was
recognized in the first quarters of 2006 and 2005, respectively, related to
restricted stock awards granted since 2001. As of March 31, 2006, restricted
stock awards totaling 88,150 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
for 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 the recent reductions in other
benefits made by the Company and to provide additional incentive to those
employees critical to the Company's current 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 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 the 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 three months ended March 31, 2006 was as
follows:
Weighted Average
Exercise Price
----------------
Options outstanding at January 1, 2006 4,776,162 $31.57
Granted 68,700 31.66
Exercised (196,987) 24.94
Canceled (144,203) 38.77
--------- ------
Options outstanding at March 31, 2006 4,503,672 $31.61
========= ======
Options price range at March 31, 2006 $16.03 to
$47.80
Options exercisable at March 31, 2006 4,395,270
Options available for grant at March 31, 2006* 432,520
* Options available for grant as of March 31, 2006 reduced by net restricted
stock award activity of 159,339.
11
The following table summarizes information about stock options outstanding at
March 31, 2006:
Options Outstanding Options Exercisable
------------------------------------------------------ --------------------------------------
Weighted
Number Average Weighted Number Weighted
Outstanding Remaining Average Exercisable Average
Exercise Prices At 3/31/06 Contractual Life Exercise Price At 3/31/06 Exercise Price
--------------- ---------- ---------------- -------------- ---------- --------------
$16.03 - $19.50 399,605 3.4 years $18.53 399,605 $18.53
$20.06 - $24.75 977,396 3.2 $23.52 953,409 $23.52
$25.13 - $29.85 675,001 3.1 $25.31 675,001 $25.31
$30.02 - $34.54 633,807 6.5 $32.65 564,857 $32.78
$36.10 - $39.67 693,637 7.0 $37.26 693,637 $37.26
$40.07 - $47.80 1,124,226 8.9 $43.19 1,108,761 $43.19
--------- --- ------ --------- ------
Total 4,503,672 5.7 $31.61 4,395,270 $31.66
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.
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 quarters 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 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 March
31, 2006 and 2005 was 5.7 years for both periods, respectively. The total
instrinsic value of stock awards exercised during the three months ended March
31, 2006 and 2005 were $1,578,000 and $4,173,000, respectively. As of March 31,
2006, the intrinsic value of all options outstanding was $2,477,000, while the
intrinsic value of all options exercisable was $2,637,000. The exercise of stock
awards in the first quarter of 2006 and 2005 resulted in cash received by the
Company totaling $1,529,000 and $1,526,000 for each period, respectively and tax
benefits of $559,000 and $2,237,000, respectively.
As of March 31, 2006, there was $3,212,000 of total unrecognized compensation
cost from stock-based compensation arrangements granted under the plans, which
is related to non-vested shares, and includes $2,379,000 related to restricted
stock awards. The Company expects the compensation expense to be recognized over
a weighted-average period of approximately 2 years.
12
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
quarter of 2006.
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 quarter 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 1,856
Settlements made during the period (2,574)
Changes in liability for pre-existing warranties during
the period, including expirations 133
-------
Balance as of March 31, 2006 $ 14,998
=======
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 400
positions through March 31, 2006, including 100 positions in the first quarter
of 2006. Restructuring charges of $3,453,000 were incurred in the first quarter
of 2006, of which $296,000 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. The restructuring charges included charges of
$2,831,000 in North America, $338,000 in Europe and $284,000 in Asia/Pacific. Of
the total charge incurred to date, $1,691,000; $718,000 and $212,000 remains
unpaid as of March 31, 2006 for each of the segments respectively. There have
been no material changes in accrued balances related to the charge, either as a
result of revisions in the plan or changes in estimates, and the Company expects
to utilize the accruals recorded through March 31, 2006 during 2006.
13
A progression of the accruals recorded as a result of the restructuring is as
follows (in thousands):
Balance at Balance at
12/31/05 Accruals Payments 3/31/06
---------- -------- -------- ----------
Severance $ 3,104 $ 2,102 $ 2,674 $ 2,532
Contract terminations 165 739 904 -
Product line discontinuance - 606 606 -
Other 83 6 - 89
------ ------ ------ ------
Total $ 3,352 $ 3,453 $ 4,184 $ 2,621
====== ====== ====== ======
The severance incurred in the period resulted from the reduction of 100
positions. Additional severance will be incurred for the remaining reduction of
200 more positions in 2006 and another 300 positions thereafter.
With additional actions in 2006, the Company anticipates recognizing additional
charges of $4,314,000 and approximately $8 million for the year pre-tax. In
addition, the Company continues to further refine its global manufacturing and
distribution strategy. Execution of these cost reduction actions has begun.
Comprehensive Earnings - Total comprehensive earnings were as follows (in
thousands):
Three Months Ended
March 31,
2006 2005
------ ------
Net earnings $ 5,207 $13,545
Foreign currency translation loss (788) (3,325)
Unrealized gain on available for sale securities 22 52
Current period unrealized gain on cash flow hedges 1,083 573
------ ------
Total comprehensive earnings $ 5,524 $10,845
====== ======
Inventories - Inventories determined under the first in, first out method
consist of the following components (in thousands):
March 31, December 31,
2006 2005
------- -------
Raw materials $ 56,262 $59,888
Work in process 20,336 16,700
Finished goods 104,409 100,337
------- -------
$181,007 $176,925
======= =======
14
Property and Equipment - Property and equipment consist of the following (in
thousands):
March 31, December 31,
2006 2005
------- -------
Machinery and equipment $255,561 $252,545
Land, buildings and improvements 84,471 84,031
Furniture and fixtures 26,966 28,788
Leasehold improvements 14,908 15,194
------- -------
381,906 380,558
Less allowance for depreciation (209,230) (204,352)
------- -------
$172,676 $176,206
======== ========
Financing Arrangements - On March 31, 2006, the Company and the other parties to
its $500 million Credit Agreement dated as of January 12, 2005, entered into
certain amendments to the Agreement which among other things: (i) amended the
definitions of Adjusted EBITDA and EBIT under the Credit Agreement to clarify
the treatment of restructuring costs under the Credit Agreement, and (ii)
amended the definition of Consolidated Interest Expense under the Credit
Agreement to exclude any interest accrued under any Trade Receivables
Securitization Transaction permitted pursuant to Section 5.2(n) of the Credit
Agreement.
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 quarter 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 $3,946,000 is
outstanding as of March 31, 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 3/31/06
-------- -------- ----------- -------- -------
Severance $ 3,049 $ - $ (94) $ - $ 2,955
Sales agency terminations - - - - -
Exit of product lines 897 - (28) - 869
------- ------- ------- ------- -------
Total $ 3,946 $ - $ (122) $ - $ 3,824
======= ======= ======= ======= =======
Adjustments above represent the impact of currency translation. The Company
anticipates all of the remaining reserves to be utilized in 2006.
15
Income Taxes - The Company had an effective tax rate of 30.0% for the three
month period ended March 31, 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.
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 April 27,
2006.
OUTLOOK
Reimbursement uncertainties continue to negatively impact the core North
American businesses. The Centers for Medicare and Medicaid Services (CMS) has
recently released new guidelines on power wheelchair eligibility, effective June
5, 2006. The guidelines affirm the need for face-to-face physician examinations,
with required documentation provided by the physician to equipment providers
within 45 days thereafter. However, there is still uncertainty regarding CMS'
finalization of new reimbursement codes and a determination of reimbursement
levels. Separately, there is no further progress in determining the level of
reimbursement for ongoing service of oxygen products as part of the recently
enacted 36 month capped rental period. Adding to the uncertainty is the
suggestion that President Bush's 2007 budget proposal will address possible
further reductions in the capped rental period for oxygen therapy.
As a result of these reimbursement issues, along with increasing volumes of
low-cost Asian product, the Company is reducing its estimated net sales increase
for 2006 to between 1% and 3% from its prior guidance of an increase between 4%
and 6%. The new net sales guidance excludes any impact from foreign currency and
acquisitions. The Company is reaffirming its earlier earnings per share guidance
of between $2.00 and $2.10, excluding restructuring charges and the impact of
any new acquisitions in 2006. The second quarter results are expected to be
somewhat improved sequentially over the first quarter with the bulk of the
improvement in the second half of the year as a result of the following
variables (listed from highest to lowest in impact):
>> Manufacturing cost reduction activities including headcount
reductions, transferring production to China, and engineered product
cost reductions.
>> Normal seasonal increase in International businesses in the second
half of the year.
>> Continued soft sales in the U.S. adjusted for scheduled new product
introductions and normal fourth quarter 2006 revenues as compared to
the abnormally low fourth quarter 2005 revenues due to the enterprise
resource planning (ERP) implementation.
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.
16
The Company anticipates operating cash flows of between $102 million and $112
million and net purchases of property plant and equipment of approximately $32
million, in line with previous guidance.
The Company expects the challenges from Medicare reimbursement and further
pricing pressures from low-cost Asian imports to continue and accordingly is
focused on cost reduction as its top priority, including:
>> Execution of the previously communicated multi-year plan to reduce
global manufacturing and distribution costs by $30 million annually by
2008.
>> Transferring additional manufacturing to China and increasing the
Asian sourcing of products. The Company expects the total cost of
products coming from Asia to approximate $200 million in 2006 versus
2005 levels of approximately $140 million. The Company continues to
achieve approximately 20% savings from these transfers.
>> Continue to cost reduce the design and engineering of the Company's
products to address the reimbursement and pricing realities.
RESULTS OF OPERATIONS
NET SALES
Net sales for the three months ended March 31, 2006 were $361,704,000, compared
to $370,944,000 for the same period a year ago, representing a 2% decrease.
Acquisitions added two percentage points to the net sales for the quarter and
this was offset by a two percentage point decrease resulting from foreign
currency translation. Excluding the impact of foreign currency translation and
acquisitions, the net sales decline was driven primarily by Medicare
reimbursement pressures and uncertainties, continuing price reductions driven by
low-cost Asian product, and to the residual impact of the fourth quarter ERP
implementation that adversely affected high-margin products such as custom power
and custom manual wheelchairs.
North American Operations
North American net sales decreased by less than one percent for the quarter to
$249,975,000 as compared $250,940,000 for the same period a year ago with
foreign currency accounting for a 1% increase and acquisitions contributing an
additional 1%. 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 decrease for the quarter was principally due to net sales decreases in
Standard products (7%) and Respiratory products (5%), which were partially
offset by increases in Rehab products (5%), Distributed products (4%) and
Continuing Care products (3%).
The Standard products net sales decline in the quarter was due to a particular
weakness in manual wheelchairs and patient aids (canes, walkers, crutches)
primarily due to continuing low-cost Asian imports driving further price
reductions.
17
The Respiratory net sales decline in the quarter was due to a decline in the
HomeFillTM oxygen system product line, which offset strong sales of oxygen
concentrators. The HomeFillTM decline was attributable to significantly reduced
purchases from National Providers in this year's first quarter versus last year,
which offset increased sales of 3% to small providers and independents. Recently
announced reimbursement changes and further proposed changes in President Bush's
fiscal 2007 budget have created uncertainty and negatively impacted the Homefill
revenues by causing providers to reduce capital investment in this new
technology.
Rehab product sales adjusted for acquisitions declined less than one percent.
Rehab equipment revenues, adjusted for acquisitions declined 2% as the result of
Medicare eligibility issues and related reimbursement pressures. Sales of
consumer power wheelchairs were down 1% versus last year's first quarter.
Customer power wheelchairs and custom manual wheelchairs were down 6% and 8%,
respectively, as we continued to rebuild the order pipeline adversely impacted
by the ERP implementation in the fourth quarter.
European Operations
European net sales decreased 6% for the quarter to $95,546,000 as compared to
$102,091,000 for the same period a year ago with acquisitions and foreign
currency translation accounting for a 3% increase and a 9% decrease in the net
sales, respectively. The Company continues to experience some weakness in our
German business in the Invacare wheelchair product lines due to reimbursement
pressures, but saw 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.
Asia/Pacific net sales decreased 10% in the quarter to $16,183,000 from
$17,913,000 in the same period last year. Foreign currency accounted for seven
percentage points of the net sales decline, while acquisitions contributed two
percentage points for the quarter. 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.
GROSS PROFIT
Gross profit as a percentage of net sales for the three-month period ended March
31, 2006 was 28.1% compared to 29.6% in the same period last year. The decline
for the period is primarily due to a change in sales mix towards lower margin
products, continued price reductions on standard products in North America, and
increases in freight costs, largely due to fuel surcharges driven by the high
price of oil, compared to the first three 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 2005.
In Europe, gross margin improved as a percentage of net sales by 1.7 percentage
18
points compared to the first quarter of last year, primarily due to lower
freight and R&D costs and continued cost reductions, while gross margin in
Asia/Pacific declined by .4 percentage points for the same period due to
unfavorable product mix.
SELLING, GENERAL AND ADMINISTRATIVE
Selling, general and administrative (SG&A) expense as a percentage of net sales
for the three months ended March 31, 2006 was 23.1% compared to 22.6% in the
same period a year ago. The dollar decrease was $572,000 or less than one
percent for the quarter. Acquisitions increased these expenses by $1,516,000 in
the quarter, while foreign currency translation decreased these expenses by
$2,472,000 in the quarter. Excluding the impact of foreign currency translation
and acquisitions, selling, general and administrative expense increased $384,000
or less than one percent for the quarter compared to the same period a year ago,
primarily due to higher administrative costs.
North American SG&A cost increased $2,926,000 or 5.7% for the quarter compared
to the same period a year ago. Acquisitions accounted for 1.9% of the increase
while foreign currency translation accounted for less than 1% of the increase.
European SG&A cost decreased $2,772,000 or 9.6% for the quarter compared to the
same period a year ago. For the quarter, acquisitions caused SG&A expense to
increase by $399,000 or 1.4% while foreign currency translation decreased SG&A
expense by $2,492,000 or 8.7%. The decrease in spending for the quarter,
excluding acquisition and foreign currency translation, was primarily
attributable to efforts to bring spending in line with lower than planned sales.
Asia/Pacific SG&A cost decreased $726,000 or 17.4% for the first quarter of the
year compared to the same period a year ago. Foreign currency translation
decreased SG&A expense by $224,000 or 5.4% while acquisitions added $158,000 or
3.8% in increased expenses. The decrease in spending, excluding acquisition and
foreign currency translation, was primarily attributable to foreign currency
transactions.
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, 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 400
positions through March 31, 2006, including 100 positions in the first quarter
of 2006. Restructuring charges of $3,453,000 were incurred in the first quarter
of 2006, of which $296,000 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. The restructuring charge for the quarter
included charges of $2,831,000 in North America, $338,000 in Europe and $284,000
in Asia/Pacific. Of the total charge incurred to date, $1,691,000; $718,000 and
$212,000 remains unpaid as of March 31, 2006 for North America, Europe and
Asia/Pacific, respectively. There have been no material changes in accrued
balances related to the charge, either as a result of revisions in the plan or
19
changes in estimates, and the Company expects to utilize the accruals
outstanding at March 31, 2006 during 2006.
With additional actions, the Company anticipates recognizing an additional
charge of approximately $4-5 million for the remaining quarters of 2006. For
2006, the Company anticipates recognizing restructuring charges of approximately
$8 million for the year pre-tax. These actions are expected to result in
annualized pre-tax savings of at least $8 million. 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 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.
INTEREST
Interest expense increased by $1,433,000 for first three months of 2006,
compared to the same period last year, primarily due to higher average borrowing
rates. Interest income decreased $394,000 for the first 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 30.0% for the three-month period ended
March 31, 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.
LIQUIDITY AND CAPITAL RESOURCES
The Company's reported level of debt decreased by $16,826,000 from December 31,
2005 to $521,155,000 at March 31, 2006, 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 March 31, 2006, the Company and the other parties to its $500 million Credit
Agreement dated as of January 12, 2005, entered into certain amendments to the
Agreement which among other things: (i) amended the definitions of Adjusted
EBITDA and EBIT under the Credit Agreement to clarify the treatment of
restructuring costs under the Credit Agreement, and (ii) amended the definition
of Consolidated Interest Expense under the Credit Agreement to exclude any
interest accrued under any Trade Receivables Securitization Transaction
permitted pursuant to Section 5.2(n) of the Credit Agreement.
As of March 31, 2006, the Company had approximately $251,141,000 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 March 31, 2006, the
20
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 $35,400,000 as of March 31, 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 debt to approximately 40% of the total debt outstanding.
CAPITAL EXPENDITURES
The Company had no individually material capital expenditure commitments
outstanding as of March 31, 2006. The Company estimates that capital investments
for 2006 could approximate up to $32,000,000 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.
CASH FLOWS
Cash flows provided by operating activities were $8,529,000 for the first three
months of 2006 compared to cash used by operating activities of $3,474,000 in
the first three months of 2005. The increase in operating cash flows for the
first quarter of 2006 compared to the same period a year ago was primarily the
result of better working capital management as inventory levels were lower,
while payables and accruals were less of a drain on cash.
Cash used for investing activities was $5,658,000 for the first three months of
2006 compared to $19,511,000 in the first three months of 2005. The decrease in
cash used for investing is attributable to the higher level of acquisitions
incurred in the first quarter of 2005 compared to the first quarter of 2006 and
reduced purchases of property and equipment in the first quarter of 2006
compared to the first quarter of 2005.
Cash required by financing activities was $15,906,000 for the first three months
of 2006 compared to cash provided of $7,514,000 in the first three months of
2005. Financing activities for the first quarter of 2006 were impacted by a
decrease in the Company's net long-term borrowings of $16,852,000 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 quarter of 2006, the Company generated free cash flow of
$3,553,000 compared to negative free cash flow of $12,381,000 in the first
quarter of 2005. The increase was primarily attributable to reduced inventory
levels and close management of payments to vendors. 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
21
future investments (including acquisitions, etc.). The non-GAAP financial
measure is reconciled to the GAAP measure as follows (in thousands):
Three Months Ended
March 31,
2006 2005
------- -------
Net cash provided (used) by operating activities $ 8,529 $(3,474)
Less: Purchases of property and equipment - net (4,976) (8,907)
------- -------
Free Cash Flow $ 3,553 $(12,381)
======= =======
DIVIDEND POLICY
On February 9, 2006, the Company's Board of Directors declared a quarterly cash
dividend of $0.0125 per Common Share to shareholders of record as of April 3,
2006, which was paid on April 11, 2006. 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 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.
22
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.
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 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
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
23
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 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 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.
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
24
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
three months ended March 31, 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.
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 the recent
reductions in other benefits made by the Company and to provide additional
incentive to those employees critical to the Company's current 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 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 the 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 March 31, 2006, there was $1,750,000 of total
unrecognized compensation cost from stock-based compensation arrangements
granted under the plans, which is related to non-vested shares, and includes
$917,000 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 have granted
without cost to the recipients were and continue to be expensed on a
straight-line basis over the vesting periods.
25
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.
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 March 31, 2006 debt levels, a
1.0% change in interest rates would impact interest expense by approximately
$4,500,000 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
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.
26
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 March 31, 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 March 31, 2006, 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.
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 this fiscal year ended December 31, 2005.
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 March 31, 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
--------------------- ----------- --------- ---------------------- ---------------------
1/1/2006-1/31/2006 (1) 687 $ 31.65 - $ -
2/1/2006-2/28/2006 (1) 12,778 $ 33.38 - -
3/1/2006-3/31/2006 - - - -
------ ------ ------ ------
Total 13,465 $ 33.29 - $ -
====== ====== ====== ======
(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.
27
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: May 9, 2006
28