Invacare Corporation

Good morning ladies and gentlemen and thank you for standing by. Welcome to the Invercare third quarter 2021 conference call and webcast. After the management overview, we'll be open to the call to questions. Investors and analysts interested in asking questions will need to dial in as questions cannot be submitted via the webcast. For the first part of the call, all phone lines have been placed on mute. This conference is being recorded Thursday, October 28th, 2021. I'll now turn the call over to Lewis Lee of Invacare's Director of Treasury Investor Relations and Corporate Communications. Thank you.

Thank you. Joining me on today's call from Invacare are Matt Monaghan, Chairman, President and Chief Executive Officer, and Kathy Monaghan, Senior Vice President and Chief Financial Officer. Today, we will be reviewing our third quarter 2021 finance results and providing investors with an update on our full year outlook. To help investors follow along, we have created slides to accompany this webcast. For those dialing in, you can find a link to our webcast slide presentation at global.invocare.com slash investor dash relations. Further information can be found on our SEC filing. Before Matt begins, I'd like to note that during today's call, we may make forward-looking statements about the company that by their nature address matters that are uncertain. Actual future results may differ materially from those expressed in our statements today due to various uncertainties, and I refer you to the cautionary statement included on the second page of our webcast slide and in our third quarter earnings release. For an explanation of the items discussed on today's calls that are considered to be non-GAAP financial information, such as constant currency net sales, constant currency SG&A, free cash flow, and adjusted interest costs, Please see the notes in the appendix of our webcast slide and in the related reconciliations in the slides and in the earnings release posted on our website. I will now turn the call over to Matt.

Thank you, Lois. Good morning. Starting on slide three, I'm pleased to announce that we achieved constant currency net sales growth of 2.9% with increases in all key product categories despite continuing global supply chain challenges. Revenue growth was led by solid performance in Europe and Asia Pacific, and North America realized growth in mobility and seating and respiratory products, Compared with strong new order intake, we continue to experience higher than typical backlog levels across all product categories compared to pre-pandemic levels, which is expected to drive sequential sales growth in the fourth quarter. As always, we're working diligently to maximize our throughput and improve our service levels to better support our customers' needs. Turning to gross profit, we benefited from sales growth and favorable sales mix with higher gross profit on lower percentage of sales, Gross margin was impacted by previously disclosed changes to input costs ahead of offsetting price adjustments. We view these challenges as transitory, and during the quarter, we undertook actions to address them, which I'll discuss more in detail on the next slide. To support existing levels of demand and expected sales growth, free cash flow usage increased as a result of greater investment in working capital, specifically inventory, which Kathy will discuss later. Overall, our sales results were in line with expectations, with solid revenue growth year over year in all major product categories. Turning to slide four, we expect to finish the year on a strong note. While we anticipate global supply chain challenges to persist in the near term, the disruptions are generally more predictable, and the actions we've taken should mitigate some of the remaining uncertainty. In addition, our customers continue to demonstrate strong demand for our products, even though access to healthcare has not fully rebounded from pre-pandemic levels. As mentioned previously, we're taking action to mitigate the supply chain challenges which impacted sales and gross margin. For example, we've expanded our network of freight providers for more timely shipment. We found ways to improve staffing levels to increase throughput, and we have further increased inventory to mitigate supply chain uncertainty. In addition, we continue to adjust price and freight charges where applicable to offset the substantially higher material and logistics costs we continue to experience. While still early in the fourth quarter, we're seeing positive signs that our actions should be effective. As we work through these near-term challenges, we are also marching forward with the next phase of our IT modernization initiative in North America. I'm pleased to share that the program took a big step forward following the launch of our new e-commerce platform, which has features to enhance customers' experience and to improve the ease of doing business with Indicare. In 2022, we expect to launch the next phase in North America, which will focus on driving operational efficiencies, lowering costs, and improving working capital management. Turning to sales. Demand remains strong, and we continue to see solid order rates in all regions and product categories. As we grow revenue, our order backlog has also continued to increase. In the third quarter, product availability and our targeted inventory strategy were key factors in driving strong sales growth in both Europe and Asia Pacific. Specific material shortages limited some of lifestyle product availability in North America, balancing overall results. All things taken together, we expect fourth quarter will improve in all key metrics with sequential constant currency net sales growth driving substantially higher profitability and free cash flow. We believe the progress we have made sets us up for a strong finish to the year and continued improvement in 2022. I'll now turn the call over to Kathy who will provide a detailed financial summary.

Thanks, Matt. Turning to slide six, reported net sales increased 5.8% and constant currency net sales increased 2.9%. in line with our and driven by growth in all key product categories. Sales growth was the result of continued strong order intake and the conversion of a portion of the excess backlog from the second quarter of 2021. Gross profit increased $300,000 and benefited from net sales growth and favorable sales mix. However, gross profit as a percentage of sales declined 140 basis points. As previously discussed, gross margin continued to be impacted by global supply chain related challenges and labor shortages, resulting in elevated manufacturing costs for the quarter. We expect the many actions we have undertaken to mitigate these higher costs to become effective and benefit margins in the fourth quarter of 21. Constant currency SG&A expense decreased, primarily related to lower employee related costs, including stock compensation expense. To drive profitability, we continue to align commercial expenses with net sales growth and monitor all discretionary spending. Operating loss, excluding the goodwill impairment charge, was $3.8 million, an improvement of $900,000 from the third quarter of 2020. This improvement was driven by sales growth and lower restructuring costs. In the third quarter of 21, the company recorded a one-time non-cash charge related to an impairment for Goodwill of $28.6 million. The company's reporting units for Goodwill Assessment, North America HME, and the Institutional Products Group merged into one reporting unit as a result of changes to the operating structure of the North America business and the implementation of a new enterprise resource planning system at the end of the quarter. This change was considered a triggering event and required the company to perform an interim goodwill impairment test. Adjusted EBITDA was $18.1 million, an increase of $8.3 million, primarily attributable to $10.1 million of CARES Act benefit, and net sales growth partially offset by higher supply chain costs. Excluding the CARES Act benefit, adjusted EBITDA for the third quarter was $8 million. Note that the CARES Act benefit was and is not considered in the company's full year 2021 guidance for adjusted EBITDA. Free cash flow usage for the quarter reflects an investment in working capital, including $10.1 million of additional inventory as compared to the second quarter of 21. As previously disclosed, the company increased inventory levels to mitigate supply chain disruptions and to prepare for expected sequential sales growth in the fourth quarter. We anticipate that inventory levels and accounts receivable will remain elevated at year-end and convert to cash over the next few quarters. Turning to slide seven, reported net sales in all key product lines improved despite supply chain challenges, which continued to limit the conversion of orders to revenue. We see strong demand in all product categories and in all regions, which resulted in excess order backlog that was higher than typical compared to pre-pandemic levels and similar to the end of the second quarter. We are working diligently to reduce the excess backlog and return our service levels back to more normal lead times. On a consolidated basis, constant currency net sales of lifestyle products grew 5.2%, driven by exceptionally strong sales of manual wheelchairs and hygiene products in Europe. Mobility and seating products also achieved constant currency net sales growth in North America and Asia Pacific. In addition, we continue to see elevated demand for respiratory products globally related to the pandemic. Turning to slide eight, Europe constant currency net sales increased 4.5%, driven by more than 17% growth in lifestyle products as a result of heightened demand for products that were readily available, demonstrating the importance of our targeted inventory strategy. While respiratory demand remains strong, fulfilling that demand has been hindered by the availability of components to complete orders. Gross profit increased $3.2 million and gross margin increased 20 basis points, driven by net sales growth and favorable product mix, partially offset by higher freight costs and supply chain disruptions. As Matt mentioned, we have taken actions to mitigate the impact of these additional costs and expect to see benefits starting in the fourth quarter. Operating income benefited from SG&A leverage and increased by $2 million, driven by higher gross profit from revenue growth. Turning to slide nine, North America constant currency net sales decreased slightly, a 7% increase in mobility and seating, and an over 6% increase in respiratory products, was more than offset by lower sales of lifestyle products. Higher sales of mobility and seating products was driven by power wheelchairs and power add-on products. The lifestyle product category was impacted by supply chain issues, limiting the availability of materials and components, in particular for beds. In addition, access to institutional and government customers remained limited compared to pre-pandemic levels. That said, overall, we continue to see increased capacity in all products and strong order intake. Gross profit declined by $2.8 million and gross margin declined 80 basis points due to unfavorable operating variances as a result of supply chain challenges, partially offset by favorable product mix. Operating loss of $1.5 million was impacted by reduced gross profit and higher SG&A expense, the latter of which came primarily as a result of spending supporting revenue growth. As noted, the goodwill impairment charge previously discussed is not included in the operating results for North America. Turning to slide 10, constant currency net sales in the Asia-Pacific region increased 17%, driven by significantly higher sales of respiratory products and an over 15% increase in mobility and feeding products. Sales rebounded in the Asia-Pacific region as a result of receiving products delayed from the second quarter, which has been impacted by global shipping issues. Operating loss improved by $2.2 million, driven primarily by lower corporate SG&A expense, including reduced stock compensation expense. This was partially offset by lower profitability in the Asia-Pacific region, impacted by higher material and freight costs, as well as higher SG&A expense. Moving to slide 11. As of September 30, 2021, the company had a total debt of $318 million, excluding financing and operating lease obligations, and $74 million of cash on the balance sheet. Lower cash balances are primarily related to higher levels of working capital, which we anticipate will remain elevated through the end of the year. As part of the company's strategy to mitigate supply chain challenges and to prepare for expected sales growth, The company added $10.1 million of incremental inventory in the quarter, which is expected to convert to cash over the next few quarters. In the third quarter of 2021, the company received forgiveness of its CARES Act debt obligation of $10.1 million of principal and accrued interest. Turning to slide 12, we are reaffirming our full year guidance for 2021 consisting of constant currency net sales growth in the range of minus 1% to positive 2%. adjusted EBITDA in the range of $30 to $37 million, and free cash flow usage in the range of $10 to $20 million. As previously mentioned, full-year adjusted EBITDA guidance does not include the CARES Act benefit recognized in the third quarter. For the fourth quarter, the company anticipates sequential improvement in constant currency net sales growth driven by continued strong order intake and the conversion of a portion of its elevated backlog into revenue. We expect the actions we have taken to support sales growth and manage near-term supply chain challenges will drive sales growth, favorable sales mix, and expand gross margin. As a result, adjusted EBITDA and free cash flow are expected to improve materially. I will now turn the call back over to Matt.

Kathy, turning to slide 13, we're pleased that our third quarter results reflect constant currency net sales growth. We anticipate the actions we have taken will enable us to finish the year on a strong note and instill confidence that we will achieve our full year guidance. Looking further ahead, I'm confident that the durable benefits from our recent actions allow us to drive sustainable, profitable growth in 2022 and beyond. Thank you for your continued support of InvoCare and for taking time for this morning's call. We'll now take questions.

Thank you. If you would like to ask a question, please press start followed by one in the telephone keypad. And if you change your mind, please press start followed by two and unmute locally. Thank you. Our first question comes in from Bob Labic of White Plain from CJJS Securities. Your line is open, please go ahead.

Good morning. Thanks for taking my questions.

Good morning, Bob. Hi.

I wanted to start with North American mobility and seating. Obviously, some nice growth year over year, but still down versus kind of 2019 levels. I wanted to get a sense, where do you think the market is versus 2019? And, you know, you guys have a whole new lineup out there since the last few years. So, What does it take to kind of win share and grow North American seeding and mobility over prior levels looking ahead?

I think the market, Bob, is still working its way back to normalcy to pre-pandemic levels. We're not quite there yet. I think new products are driving a lot of interest in sales and growth for us. I think it's going to take us a little bit longer to get there than we had originally anticipated just based on health care access and the way the market's going. But it's very, very steady interest and increased demand. And we like the way the new products are being received in the market.

David Wright Got it. Okay, great. And then, obviously, you know, you discussed the gross margin was impacted in the quarter by supply chain, you know, materials and labor. And I guess trying to get a sense of if you reported, you know, call it 27 percent gross margin this quarter, Given the new product lineup that you have, you know, better margin products, et cetera, absent these headwinds, where do you think the gross margin, you know, for this kind of sales would be? Where is that kind of budgeted? I'm trying to get a sense of, you know, where you are in your progression of gross margin growth, absent obviously all the noise that's out there.

Yeah, that may be something Kathy and I will have to join the answer here. You know, I think right now, We're trying to be very surgical about adjustments to price and surcharges or whatever to offset very specific changes in material costs or labor or freight so that we're competitive and fair with our customer partners. There's always a little bit of lag in where we incur costs, and then we have to kind of apply those to any price changes that we need to have going forward, and there's always a little bit of delay for that happening. And that's why margin is going to lag a little bit to the extent that prices, sorry, our costs are changing at a rapid rate. But I don't know, Kathy, if you have a way to estimate an answer for Bob or Ian.

Yeah, when you take a look at the gross margin, you know, obviously in the quarter we were down versus last year about 140 basis points. The majority of that, the vast majority of that are the higher cost inputs on the material side of the house and the freight costs. The actions that we've taken, including pricing actions and surcharges, we did not see a benefit of that in the third quarter, just given the timing of notification to the customers for that to come through. So from that perspective, we haven't seen that benefit. The actions that we've taken, we believe, will mitigate costs as we go forward, but that'll be a benefit that we'll see in the fourth quarter that is baked into the guidance for the fourth quarter to see a ramp up in

margins with that benefit of pricing actions that we haven't seen in the third quarter got it okay great and then last one for me i'll jump back in queue and talk about it a little bit here uh the price increases i think you put in place in september first and there's you know a little lag to go through there how have they been received and have your competitors um you know raise prices yet because obviously they're facing the same headwinds that you are uh but you know the timing could be different. So maybe talk about how the price has been received and the competitive dynamic of pricing right now in the industries that you serve.

Yeah, I think nobody loves a price increase, but I think when our customers and in the marketplace around the world, people look at it, it's everywhere. It's in the market that we serve and it's outside the market that we serve. So I think it's understandable. It's up to us to be judicious in how we're doing that, and it kind of differs by product and market, and in some cases contracts which only permit price adjustments under certain circumstances. But we think generally the entire marketplace is absorbing the consequences of labor costs and availability, freight, and material, and I think it's so far pretty competitive.

Got it. Okay. Thanks very much. Okay. Good to talk to you, Bob.

Our next question comes in from Matt Mission of KeyBank. Matt, your line is open. Please go ahead with your question. Thank you.

Hey, guys. This is Brett Fishpin on today for Matt. Thanks very much for taking the questions. Starting off, just hoping you could provide a little bit more color on where you're seeing strength in the backlog, maybe from a geographic or product area standpoint. And then, you know, characterizing your level of confidence that strength can help drive the sequential sales improvement currently implied in the 4Q guidance.

Yeah, I'd almost go the other way. I'm not sure where we are seeing any weakness in demand, Brett. Respiratory continues to be very strong for us. I think, as we've talked about previously, the consequence of the pandemic is still driving a lot of long-term demand for oxygen concentration. Lifestyles, we have new products in the major markets and demand, although We still don't see long-term care facilities back at pre-pandemic levels of occupancy or openness. We still see strong demand at Lifestyles. The only challenge we had this quarter was a little bit of difficulty during the quarter getting steel for some of our bed products. So that dampened Lifestyles results in North America, but otherwise demand's good. And then mobility and seating continues to be strong everywhere. Great new product lineup and continuing build back of the overall market demand. But I think it's good everywhere, product and geography. And I think I guess the second part of your question about, you know, confidence driving sequential growth, you know, level of backlog is the result of the math of how much new order, what's the rate of new order entry and what's the rate of filling orders and output. And it's great to see strong increased demand reflected in the backlog while we're still growing revenue, which means higher output. So more input even beyond the higher level of output we're getting. So we're feeling pretty good about the way the future looks.

All right, great. And then I was just wondering if you could walk us through how you're thinking about some of the moving pieces around free cash flow into the fourth quarter and what you would need to see there to achieve the full year guidance of 10 to 20 million of usage.

Yeah, Kathy, you want to give an answer to that?

I will. So for the fourth quarter, you know, we've obviously anticipated a significant in EBITDA from Q3 to Q4. The EBITDA driver is revenue growth, revenue growth not only from coming in the door, but also to reduce the backlog that we do have on hand. We have a significant amount of inventory on our balance sheet as of the end of September. And so we do believe that that will convert to revenue and then to cash in the fourth quarter. So we would anticipate to see a reduction in working capital coming into the fourth quarter. So it really is, you know, the two drivers from a cash flow perspective are the uptick in EBITDA driven by revenue. We are anticipating margin improvement primarily due to the pricing actions that we've taken in the third quarter that will come through from an EBITDA perspective. And then really it's the working capital to be able to convert that inventory into revenue and then into cash. We do still anticipate that we will have higher levels of inventory on the balance sheets. at the end of 21 versus 20, but there should be a significant amount which will turn in the fourth quarter into revenue.

All right. Appreciate that detail very much. And then last one from me, just looking bigger picture, As some of these macro headwinds are hopefully beginning to subside, what type of visibility do you guys now have into some of the potential longer-term targets around EBITDA, whether it's a run rate or an annual number, or a sustainable revenue growth target, and the timeline of when you might be able to provide those to investors? Thank you very much for taking the questions.

Sure, Brett. You know, I think the secret to that's going to be when changes become more predictable, which I think it's already starting to happen. 2021 has been a year of, I would say, accelerating changes through the summertime, maybe fall. We'll see what happens to freight heading into late January, early February. Chinese New Year's typically a constraint point for over-ocean shipping. But I think as soon as we see the rate of change of input costs stabilizing and including labor availability, we'll be able to project something longer term. We've gotten into a little bit of a tradition of talking more long range when we come out with fourth quarter earnings. So we'll take a look at it at that time early 2022. Appreciate the questions today.

The next question on the line comes from Mike Matson of Neaton. Mike, your line is open. Please go ahead. Thank you.

Hi, this is Joseph on from Mike. Appreciate taking our questions. I guess the first one, morning, morning, around employee retention. I guess what steps have you guys taken to improve that rate and how confident are you that that turnover rate will decline in the future?

Yeah, we have a great team of associates, and I think this is the era of everybody's got to be the best employer that they can be because employees do have choices. So we're a great competitive race, good work environment, benefits, a pathway forward to expand what people do in the company, no matter what their line of work or expertise is, and it depends kind of locally. what those dynamics are like, but we're really excited about our access to labor. We have looked at it everywhere we are to make sure that we are competitive in those local markets. And I like the way that our local teams are addressing those. It's a whole constituency between, you know, all those factors that I've mentioned. So I think we've got a path forward to do this, but it's a very dynamic workplace right now. And we're going to have to continue to be competitive all the time.

okay that's that's helpful um and then maybe could you guys possibly quantify the order backlog that you currently have in the guidance yeah in our remarks we've said that it is as a similar level as what we saw at the end of the second quarter and so while we continue to see strong demand that backlog level is roughly about the same. And that number at the end of Q2 was about $15 million. Again, that's a number that's higher than our normal pre-pandemic backlog that we would have seen and obviously influenced by just the availability of components to be able to ship and fulfill those orders.

Sure. Okay. That's helpful. That's all from me. Appreciate it. OK. All right. Thanks, Jensen.

As a reminder, if you would like to ask a question, please press star followed by 1 in your telephone keypad. And then if you change your mind, please press star followed by 2. We currently have no further questions registered on the line, so I'll hand back to the management team.

OK, thank you. Thanks, everybody, for tuning in this morning. Kathy, Lois, and I are available for any follow-up questions that you can coordinate to Lois Lee. Thanks very much. Have a good day.

Thank you very much for joining today. You may now disconnect your lines.