Invacare Corporation

Good morning ladies and gentlemen and thank you for standing by. Welcome to the Invercare fourth quarter and full year 2021 conference call and webcast. After the management overview we will open 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 call is being recorded I will now turn the call over to Lois Lee, Invocare's Director of Treasury, Investor Relations, and Corporate Communications.

Thank you, Katie. Joining me on today's call from Invocare are Matt Monahan, Chairman, President, and Chief Executive Officer, and Kathy Linehan, Senior Vice President and Chief Financial Officer. Today, we will be reviewing our fourth quarter and full year 2021 financial results and providing investors with an update on our business. 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 that we will refer to during today's call at global.invacare.com slash investor dash relations. Further information can be found in our SEC filings. 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 statements included on the second page of our webcast slides and in our fourth quarter earnings release. For an explanation of those items considered to be non-GAAP financial information, it will be discussed on today's call, such as constant currency net sales, constant currency SG&A, free cash flow, adjusted EBITDA, and adjusted net loss. Please see the notes in the appendix of our webcast slides and in the related reconciliations in the earnings release posted on our website. I will now turn the call over to Matt Monahan.

Thank you, Lois, and good morning. Beginning on slide three, I'd like to thank our associates who continue to work diligently to navigate the challenges caused by the pandemic. Their continued dedication to our mission is inspiring. I'm proud of how the team finished the year, ending on a strong note in achieving constant currency net sales growth in the fourth quarter compared to prior year. Driving this improvement was mobility and seating products, which delivered a double-digit increase in reported net sales in the quarter, with particular strength in Europe. Shared with strong new order intake, excess backlogs remained higher than was typical before COVID. In addition, we realized the sequential improvement in gross margin and adjusted EBITDA, primarily from favorable product mix and the benefit of price adjustments to offset rising costs. Coupled with lower SG&A expense, sequential profitability and free cash flow improved materially. Overall, the fourth quarter improvement reflects strong demand and the result of effective actions. That said, to position Indicare for long-term success, we must continue to improve operating performance, optimize our portfolio for the current operating environment, and continue to improve working capital in the balance sheet. On slide four, we note some of the initiatives to help us pivot to a more profitable and competitive business model. To that end, we've already taken steps such as a combination of our Europe and Asia Pacific businesses under one leader, expected to create scale-based cost savings and synergy starting in 2022. This year, we expect sustained customer demand and persistent, now familiar, supply chain challenges. As a result, we expect to make business improvements, including optimizing our product line for efficiency in the current supply chain environment, shifting where and how we manufacture, assemble, and distribute products, especially considering freight and logistics trends that have emerged through COVID, aligning staff levels and how staff are organized to be streamlined and responsive, and improving working capital to enhance free cash flow and strengthen the balance sheet as a result of actions aligned to current supply chain conditions. While first quarter 2022 is expected to be our low point this year, following a typical seasonal pattern of lower sequential performance, we anticipate these actions will drive sequential quarterly improvements for the final three quarters of the year, with the majority of benefits expected to occur in the second half of the year. As a result, we anticipate improved full-year adjusted EBITDA with North America expected to return to profitability. We anticipate sequential quarterly revenue growth after the first quarter of 2022 and expect as part of the product portfolio review to see positive mix shift and better velocity as a result of selections that fit our operating model. Importantly, anticipated restructuring actions will drive improvements in gross margin, adjusted EBITDA, and free cash flow over the full year to create long-term shareholder value. After two years of external changes that have greatly impacted our business, we have a clearer view of new patterns likely to remain after COVID. These include changes in employment and labor availability, transportation routes, costs, and duration, higher material costs and scarcity, and longer supply times. In 2022, we plan to make fundamental changes for stability, customer engagement, and improve financial performance that will make us more competitive and be a better partner for our customers. I'll now turn the call over to Kathy, who will provide a detailed financial summary.

Thanks, Matt. Turning to slide six, we finished 2021 with strong performance as both reported and constant currency net sales in the fourth quarter increased by 1%. Gross profit was unfavorable to the prior year as the benefit of pricing actions implemented during the quarter lagged the impact of higher material and freight costs. However, gross margin improved sequentially, driven by the benefit of pricing action and favorable product mix, partially offset by higher input costs. Importantly, operating income improved by $8.6 million and adjusted EBITDA increased by $3.6 million. driven by lower SG&A expense due to employment costs, including stock compensation. Free cash flow improved by $3.6 million, driven by lower working capital with continued elevated inventory levels higher than typical. Turning to slide seven, in Europe, fourth quarter reported and constant currency net sales increased 7.1% compared to the prior year. Sequentially, revenue growth of 8.7% was driven by increases in all key product categories as a result of the easing of healthcare restrictions and the benefit of pricing actions to offset higher input costs. Operating income more than doubled, improving by $9.3 million compared to the prior year as a result of gross profit improvement and reduced SG&A expense. Turning to slide eight, in North America, fourth quarter reported and constant currency net sales both declined by approximately 7%. Constant currency net sales growth of 4.3% in mobility and feeding products was more than offset by declines in lifestyle products. As a result of the inefficiencies and the controlled deployment of our latest ERP expansion in North America in the quarter, revenues were temporarily impacted. The system was fully operational by quarter end with further efficiencies expected. As the system matures and supports more customers, we expect to recognize benefits that will continue improving customer engagement and financial performance. Gross profit margin decreased as higher input costs, supply chain disruptions, and parts shortages led to unfavorable operating variances. In addition, we incurred higher operating costs to support the early activation of the latest ERP software. We realized a small benefit from pricing actions taken during the quarter, even though latent orders were fulfilled at previously quoted rates. Turning to slide nine, Asia Pacific fourth quarter reported and constant currency net sales decreased, with growth in respiratory products more than offset by declines in mobility and feeding products, largely due to freight delays for inbound finished goods. Operating loss for all other, which includes the Asia-Pacific business and unallocated corporate costs, increased compared to the prior year. This was due to lower profitability in the Asia-Pacific business, attributable to lower revenue, almost fully offset by lower SG&A expense related to employment and corporate stock compensation. Moving to slide 10, as of December 31st, 2021, the company had approximately $316 million of total debt and $84 million of cash on its balance sheet. In 2021, we took steps to improve our financial flexibility with the issuance of new convertible notes, which allowed us to retire nearly all of our 2022 convertible notes and extend the debt maturity to 2026. As always, we continue to look for ways to improve our financial results and to manage the balance sheet. In 2022, we expect to reduce working capital from the recent higher balances caused by COVID and our reaction to global supply chain disruptions. We are planning to have transformative restructuring investments, which we expect to fund throughout the year. And we may further optimize our balance sheet to support business needs. Turning to slide 11, in 2022, the company is taking strategic actions, which by the end of the year will position Invocare for durable long-term success. These actions include organizational and supply chain changes and a narrowing of the product portfolio for those items which no longer meet customer or business needs, driving improved profitability. As a result, the company anticipates full year 2022 adjusted EBITDA and free cash flows to improve compared to the prior year and the first quarter 2022 adjusted EBITDA to be negative with sequential quarterly improvements for the balance of the year as the expected profit improvement actions take effect. For clarity, the adjusted EBITDA guidance is based on 2021 actual performance, excluding the CARES Act benefit. In 2022, SG&A expense is expected to be higher in the first half of the year based on the timing of the restructuring action. Foreign exchange is also anticipated to be a headwind due to changes in foreign exchange rates compared to 2021. Finally, free cash flow is expected to be variable in the quarters, but in line with historic seasonality, especially in the first half as the company funds customer rebates earned from 2021. However, the company expects sequential improvement in free cash flow for the final three quarters of the year aligned with the expected improvement in adjusted EBITDA. I will now turn the call back over to Matt.

Thanks, Kathy. Turning to slide 12, we're figuratively standing on high ground, able to look back at the impacts to our business over the last two years and now look ahead to make reasonable assumptions about the foreseeable future. The world is certainly still dynamic, and business conditions will continue to change. We have enough perspective, though, to take some big steps that will make us more successful by the end of 2022. Our markets continue to be healthy. We appreciate all the change our customers and end users have dealt with, too. Thanks to all our associates in the broader community that support Indicare, we're looking forward to a bright future. We'll now take questions. Katie?

Thank you. If you'd like to ask a question, please press star followed by 1 on your telephone keypad. If you'd like to remove your question, please press star followed by 2. And when prepared to ask a question, please ensure your phone is unmuted locally. We take our first question from Bob Lubbock from CJS Securities. Please go ahead.

Good morning. Thanks for taking my questions. Hello, Bob. Hi. I wanted to start, you just discussed, you know, optimizing and narrowing the product portfolio. Maybe you could expand a little upon that. Maybe what segments and how much, you know, revenue might you walk away from? I'm assuming this means higher gross margins, you know, initially, but maybe lower gross profit initially and could enable lower SG&A down the road. So help me understand if that's right, but, you know, kind of what segments, how much revenue is this affecting and how should we look at it from a a modeling standpoint going forward.

Yeah, maybe Kathy and I can both answer that. I mean, from a high-level perspective, it's not whole segments. It's really looking at the vast variety that is offered in all of our segments practically around the world and just looking at the challenges that come from having that vast array of options and features in the supply chain environment. You know, the easy hypothetical example is If you have 23 colors of everything, maybe 22 or 12 or something else is easier. When you multiply that by sizes and all sorts of features and all our custom and semi-custom products, that's one of the things that's caused our working capital to balloon so much, especially on inventory. and uh and not be able to deal with the challenges of the current supply chain environment as effectively as we'd like to so that's a big thing it effectively makes us a better service provider to customers lowers working capital and increases the velocity of things moving through our facilities with effectively no change uh to what customers are able to to get from us i mean maybe hypothetically going from 23 colors to 20 colors somebody loses out on on some fringe variety, but essentially it's tightening up that offering, the breadth of the offering.

I would add to that, Bob, from a modeling perspective, while revenue would decline because of the actions that we would take with product elimination or discontinuation, the offset for that would be the pricing actions that we would put in place. Our revenue, you know, could be flat, maybe down slightly. There would be puts and takes on both pricing as well as the discontinuation.

Okay, got it. And then you discussed, you know, incremental and additional, you know, transformative restructuring. Can you talk about the overall scope and size and what geographies? Will this be, you know, eliminating some manufacturing facilities or how should we think about the cost reductions and where will they be coming?

Yeah, again, maybe a two-party answer, Kathy, too. If you imagine the map that we operate in our network of sales offices, manufacturing facilities, service centers, and distribution locations, that map was created pre-COVID, pre-current constraints of supply, current routes of trade, which are not at all what they were two years ago or even longer ago. So the fundamental principles this year are looking at how does inventory move most easily. It's different ports of entry, different nodes in our distribution network where we accumulate inventory so we're close to customers and can be really effective in avoiding lanes of passage that are either unpredictable or too expensive or not always available. And as Kathy mentioned in the prepared slides, Remarks, you know, an easy example is to talk about Asia Pacific where, you know, when you're going to certain smaller countries that we serve, there are just points in the calendar lately where a bookable seat rate is not easily available. We've got to revise how we operate our physical infrastructure in this reality and go forward. And when we do that and look at narrowing the product portfolio so that that variety flows smoothly in the current conditions, then the recipe is successful.

And so now we're in the process to, you know, finalize actions related to, you know, restructuring. And as we solidify those, you know, obviously there will be costs that the company will incur as we go through 2022, but we're expecting the benefits to start being very visible in the second half of the year.

Well, and I think, you know, the other way to answer that, Bob, is that they're in the plan. We see those internally as making 2022 as effective as reported today with our outlook.

Okay, great. And then last one for me. I'll jump back in queue. Could you give us an update on the competitive environment? Obviously, a lot of the, you know, the headwinds – vast majority of the headwinds you face are not unique to Invacare, right? This is supply chains, raw materials, and everything else. How are volumes trending, and how is the industry overall doing? How is your share trending, I guess, would be the question. How is the industry overall kind of handling these same impacts and headwinds?

Well, I think nobody likes inflation, but I guess what's common is it more or less affects everyone relatively equally. Now, maybe if one company in any industry is manufacturing in a location that's better or worse relative to freight or labor availability or cost than another, then there can be some arbitrage there. But I would say Generally, the markets that we serve, healthcare access is recovering. Maybe long-term care facilities aren't fully back to pre-COVID census, but there's general access everywhere. And I think our customers and the suppliers who we compete with to exchange value in this industry are relatively working well together. I think everyone's more or less in the same situation, trying to deal with a very dynamic environment. And probably the most dynamism we have right now is just cost and availability of components and freight, and that's really for everyone.

Got it. Okay, great. I'll jump back in queue. Thank you. Thanks, Bob.

We take our next question from Matthew Meechan from KeyBank. Please go ahead.

Hey, good morning, guys, and thank you for taking the questions. I just want to start off with when Q Sales um, sequentially down. How should we think about them compared to kind of one Q 21 last year? Um, because there's a big delta between where those were last year in the first quarter and where you ended the fourth quarter.

Yeah. So Matt, you know, normally the first quarter is our lowest quarter from a revenue perspective. we would anticipate the same seasonality that we would normally see in a year, so that the first quarter would be the lowest. We would have, obviously, benefits from pricing actions that have been taken. But as Matt mentioned earlier on this call, we also will see a drop because of product elimination or product discontinuation. That will impact Q1 probably more towards Q2, but there would be some impact on that as well. But Q1 would naturally be our lowest quarter for revenues, and we expect that same seasonality in 2022.

It sounds like if you take the moving pieces somewhere similar to where the first quarter of 21 was last year. Is that a fair characterization? That could be a reasonable assumption. And then can you talk a little more about the ERP implementation and how that impacted sales in the fourth quarter and kind of where are you now with it?

Yeah, the ERP implementation, the next wave of it, really brought online availability of customers to order and have orders fulfilled for non-custom configured products. Started in October, and as any company would do starting up, there's the kind of normal throttling of, orders and output so you can check all the technicalities, make sure invoicing is right and shipments are right and things like that. And that took two or three weeks to make sure that we were ramping up the velocity appropriately. Kind of a light October, normal November, and a little bit higher December output, but December output wasn't enough to offset the first couple of weeks of throttle output in October as we were going live. So that was really impactful. All the functionality is online now and through what's working. So we expect efficiencies to grow from here. Already have more customers using the system than the previous system. So we're encouraged by that. And I think a lot of new functionality is helping customers interact with us more easily.

And I thought what the bright spot in the fourth quarter for me was the profitability in Europe. Can you just help me understand that? You know, what drove that, and how much of that is typical seasonality versus some of the actions that you kind of implemented to improve that? Yeah, Kathy can take us through that.

Yeah, so definitely, you know, we had nice profitability in the fourth quarter. A portion of that are, you know, sustained SG&A cost savings that had been implemented previously, and we've seen the benefit of that. in the financial results. We also had nice growth, growth both sequentially as well as year over year. Markets seem to open more in relation when you compare it to 2020. So because of the additional volume as well, there were manufacturing efficiencies within the operations side of the house, which definitely impacted and improved their margins versus historically where we were at earlier in the year as well. They continue to be challenged by supply chains. just like the rest of the businesses as well, but definitely a nice improvement in the fourth quarter and really driven by the revenue growth as well as expanding the margin, but nice cost savings that have been implemented previously that we can now see coming through the SG&A.

Okay. And then any update on the FDA warning letter, and did that have any impact on the quarter or on guidance?

Typical update, you know, very clear observations that need to get the kind of corrective action internally. We're very clear on what those actions are. We've submitted our normal monthly updates to FDA. We take all those very seriously. We think we know what we need to do to correct those, and I would say normal course of those corrections underway. No other impact beyond just the focus on making those changes. Okay.

And then just lastly, the accounts payable balance. Um, I look back and there has been some, some, some, uh, variability as you move from three Q to four Q in, in, in that historically, but is there anything, is there anything you want to call out around accounts payable and how, and how you're managing that given, given the supply chain and how you expect that to reverse out, um, into, uh, into next year?

Yeah, maybe we both answer that, you know, as, as, uh, we've transitioned into the COVID period and transportation costs have gone, you know, for example, crossing an ocean in four or five weeks to 17 weeks by the time a container's gotten out of a port. It's easy to imagine that working capital stretches out inventory payables and not so much on the receivable side, but clearly terms have needed to lengthen out that follow the physical flow of inventory in the total days to convert inventory into cash on the backend. So I think that's, kind of the normal cycle as we improve velocity, narrow our selection of products that helps us make inventory move through the system more swiftly in 2022, we would expect those things to improve. I don't know, Kathy, we should add to that.

Yeah, no, I think that's spot on. It really is a relation of the transit time and the receipt of inventory is significantly lengthened. I'm just matching up those payment terms without those delays. but we would anticipate the APB balance is going to continue to come down as we come into 2022. Okay.

And you guys still think you can improve free cash flow year over year with the accounts payable coming down?

Yeah, we do. Yeah, go ahead, Kathy.

No, I was just going to say we have a significant investment in inventory in our balance sheet that needs to turn to cash, but no, still with the improvement in free cash flow.

Excellent. Thank you for taking the questions. Thanks, Matt.

As a reminder, to ask a question, that is star followed by 1 on your telephone keypad now. We currently have no further questions, so I'll hand it back to our speaker team.

Yeah, thank you, Katie, and thanks to everyone for taking time for the call this morning. I hope you have a good day. Happy to follow up by contacting Lois Leen.

Thank you all for joining. This now concludes today's call. Please disconnect your lines.