Invacare Corporation

Good morning, ladies and gentlemen, and thank you for standing by. Welcome to the Invercare second quarter 2022 conference call and webcast. After the management overview, we will open the call to questions. Investors and analysts interested in asking a question 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 Tuesday, August 9th, 2022. I will now turn the call over to Lois Lee, Invacare's Director of Treasury, Investor Relations and Corporate Communications.

Thank you. Joining me on today's call from Invacare are Matt Monaghan, Chairman, President and Chief Executive Officer, and Kathy Lenahan, Senior Vice President and Chief Financial Officer. Today we will be reviewing our second quarter 2022 financial results and providing investors with an update on our business 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.inricare.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 statement included on the second page of our webcast slides and in our second quarter earnings release. An explanation of the items discussed on today's call that are considered to be non-GAAP financial information, such as constant currency net sales, constant currency SG&A, free cash flow, and adjusted EBITDA, please see the notes in the appendix of our webcast slide and in the related reconciliations in the slides and earnings release posted on our website. I will now turn the call over to Matt Monahan.

Thank you, Louis, and good morning. Beginning on slide three, during the second quarter, we achieved sequential improvement in adjusted EBITDA as our strategic actions began to positively impact performance. In particular, the improved results were driven by lower STNA expense and strong improvement in gross margin due to increased pricing effectiveness and favorable product mix. While input costs remain high, we're seeing a greater impact from pricing actions as costs are somewhat less volatile. In addition, free cash flow turned positive, a significant improvement compared to both the prior year and sequentially. The improvement was driven by lower working capital as our cash conversion cycle improved, driven by improved cash collections and reduced inventory. Looking at revenue for the quarter, we achieved sequential growth in mobility and seating products driven by increased adoption of our compelling product portfolio. As a testament to our culture of innovation, we're proud to once again receive industry recognition in many categories for outstanding products and technology in our mobility and seating category. Sales of lifestyle and respiratory products were impacted by continuing component and supply chain challenges issues we are better positioned to address today and which I will discuss further momentarily. At the same time, we continue to experience elevated order backlog across all product categories and regions and see strong demand in mobility and feeding and lifestyles products. While backlog for respiratory products remains elevated, sales are anticipated to normalize in the next several quarters to pre-pandemic levels, giving less COVID-related demand for these products. Based on improvements in our business performance, we're pleased to have secured additional capital after second quarter, which provides increased liquidity and flexibility. We expect that strategic funding will enable us to more effectively work with our suppliers and find alternative solutions to short-term supply constraints, which will help us more quickly convert backlogged customer orders to sales and accelerate transformative plans to drive long-term profitability. We anticipate the additional liquidity will also enhance our transformation plans to optimize product portfolio, physical footprint, lower operating costs, and improve operating leverage. As we're in the early stages of deploying the additional capital, we look forward to providing updates in the coming quarters on how these actions are anticipated to drive profits and enhance shareholder value. Overall, we're seeing favorable trends across the business despite a challenging macroeconomic environment of cost and availability of inputs. While we have more work to do, we're confident that we have the right tools, the right team, and the right balance sheets to drive sustainable long-term results. I'll now turn the call over to Kathy, who will provide a more detailed financial summary.

Thanks, Matt. Turning to slide five, on a year-over-year basis, reported and constant currency net sales declined as continued supply chain challenges and component availability impacted our ability to efficiently serve our heightened demand. Gross margin was impacted by higher input costs, intermittent product stockages due to supply chain challenges, and unfavorable foreign exchange, partially offset by the benefit of pricing action. Constant currency SG&A expense decreased primarily due to lower employment costs, partially offset by higher IT costs, classified as operating expenses as we temporarily pause any further ERP rollout similar to the first quarter of 2022. As a reminder, the cash cost of the IT modernization program remains unchanged. Operating loss increased and adjusted EBITDA decreased due to lower gross profit from lower sales, higher restructuring costs, and IT expenses recorded as SG&A expense. As Matt noted, free cash flow turned positive for the quarter, an improvement of $27.3 million driven by strong management of accounts receivable and inventory. Turning to slide six, looking at our performance on a sequential basis, reported net sales decreased 6% and constant currency net sales decreased 3.2%. Growth in mobility and seating products was achieved in all regions, driven by higher sales of powered mobility products. Sales of respiratory and lifestyle products declined as a result of the aforementioned supply chain challenges, which limited the company's ability to fulfill orders and reduced the elevated order backlog. Despite softer sales, gross margin increased 160 basis points sequentially. driven by favorable pricing action. As previously noted, there is a lag between the impact of higher input costs and the effectiveness of pricing actions, and we anticipate sequential gross margin improvement as costs stabilize. Constant currency SG&A expense decreased sequentially due primarily to lower product liability costs, partially offset by higher stock compensation expense. Overall, our cost structure is expected to improve as we realize the benefit of previously announced actions to reduce SG&A expense, with the majority of the benefits starting in the second half of the year and into 2023. Operating loss and adjusted EBITDA improve driven by higher gross profit and lower SG&A. Free cash flow generation for the quarter was $0.1 million, an improvement of $30 million driven by reduced working capital, primarily the benefit of a shorter cash conversion cycle, favorably impacted by accounts receivable and inventory. Turning to slide seven, as Matt mentioned, we anticipate the additional liquidity to partially ease supply chain constraints by allowing the company to expedite key raw materials and components, onboard additional suppliers, and take internal actions to redesign products to mitigate supply constraints. For the second half of 22, adjusted EBITDA is anticipated to improve compared to the first half of the year, driven by gross profit improvement with the benefit of favorable product mix and price effectiveness, as well as lower operating expenses. As anticipated, demand for respiratory products is expected to lessen in the next several quarters, given less COVID-related demand. Given the ongoing supply chain challenges and increased inflationary pressures, the company has suspended its full year 2022 financial outlook. The company will provide updates in the coming quarters on the planned deployment of recently announced funding and on additional transformative actions as circumstances evolve. I will now turn the call back over to Matt.

Thanks, Kathy. We were pleased to see the beginning of positive trends, such as the sequential improvement in profitability, expanded gross margins, and lower operating expenses. While the second quarter was challenging in many ways, the underlying markets we served remained healthy and growing, and we continue to experience strong demand and elevated order backlog. As part of our overall plan to evolve the business, the additional liquidity and further planned actions are expected to improve near and long-term results and ultimately enhance shareholder value. Thank you for your continued support of Indicare and for taking time for this morning's call. We'll now take questions.

Thank you. If you would like to ask a question today, please press star followed by one on your telephone keypad. If you choose to withdraw your question, please press star followed by two. When preparing to ask your question, please ensure your phone is unmuted locally. And our first question today comes from Bob Lubbock of CDS Securities. Bob, please go ahead. Your line is open.

Yes. Hi. Good morning. It's Pete Lucas for Bob. I guess starting off with seating and mobility sales. Hi, how are you? In terms of seating and mobility sales, I guess it looks like the main driver there was powered mobility. Can you kind of discuss what's impacting sales the most? Is it access and sales and the outlook the most? Is it access to patients, market share, product lineup, and where's the focus to improve the revenue base there?

Yeah, I'd say a little bit of all of the above. The market continues to be really strong. Summer months are typically months where we have people getting out and want to ambulate out of doors. We're mostly a northern hemisphere business, so that's in the season. We have a great new rear-wheel drive power wheelchair that's doing really well in the marketplace. A lot of benefits for that drive style, and it's one of the newest products of that type in the market. So a lot of interest there.

And so looking at just North America, would you say that's probably the – would be the biggest driver in terms of product segments for North America?

Right now, yeah. A lot of interest in power mobility.

And then last one for me, in terms of the supply chain, if you could – you touched on in your remarks, I think you mentioned liquidity, helping with access to components. If you could just kind of maybe give us a little more detail on the biggest bottlenecks you're facing and kind of the goals to improve those?

You know, it kind of depends. Day to day, we really need 100% of the components available for a bill of material to ship products. I mean, that sounds obvious, but on any given day, supply chain challenges include things that are slightly delayed. So you can have all the inventory minus one part waiting around to finish a product. Sometimes our suppliers are having other kinds of challenges getting their own material. We can help in some cases alleviate that with liquidity by paying a small premium or paying for expedited freight to make that up where it makes sense. We try not to do that very often, but sometimes that's helpful. And we want to make sure that we're top of mind with our vendors in terms of working together to keep the supply chain moving, and this helps all of that. Okay. I think while costs for our inputs are high, not just the materials, but definitely labor and especially freight, we see less volatility right now. So prices remain elevated, and that helps us work with our customers and in the marketplace in general to balance out what the prices we need in the marketplace to cover these extraordinary costs are, and that makes for more normal operations. That's helping, too.

Very helpful. Thanks.

Okay. Thank you.

Thank you. And as a reminder, if you would like to ask a question today, please press star followed by one on your telephone keypads now. And our next question comes from Matthew Mission of KeyBank. Matthew, please go ahead. Your line is open.

Hey, guys. This is Brett Fishman on today for Matt. Thank you for taking the questions. Starting off, I was just hoping you guys could provide a little more color around the strategic funding you raised in July, specifically maybe just touching on some of the key consideration factors as you went through the process and then, like, why this was the best outcome and decision for InvoCare.

Yeah, good question, Brett. You know, we continue to manage operations and the balance sheet and the whole business in total as we look at the opportunities to make investments to We structure the business and organize ourselves in a way that will deliver efficient operations in the supply chain environment. Our ability to do that sooner than later is going to yield better results, better NPV. So we wanted to do that. We also needed to bring some flexibility to operations to keep the supply chain going and to convert this demand. We continue to have really great interest from customers in our products in all categories and regions. and we needed to take some steps to make sure that that's converting from backlog orders to sold orders as quickly as possible. And given the uncertainty in the debt markets and other factors, we conducted a process that ended with that result, which is good liquidity that's going to help the business here.

I appreciate that, caller. And then just moving to some of the near-term trends you're seeing around revenue and margin, just thinking about pricing and some of the benefits and net benefits you may be seeing from that, I think last call you described pricing as generally offsetting some of the product discontinuations you've made. Is this still a decent way to look at it and the overall benefit to growth, or is there a different way that you should be thinking about it at this point?

Yeah, two different – things we should disentangle. So we're eliminating some products that are just too difficult to produce to procure parts for during the supply chain challenge, and we're migrating those to a narrower selection of products that still offer the same clinical benefit. So think of an example, instead of 23 colors, we're down to fewer than 23 colors, because that's an idea of what's easier. And that's a big part of what we're doing in the supply chain.

All right, and then just following up on the benefit from pricing, maybe if you could just provide a little more color on how much of a tailwind it's been, like how much it's been able to offset some of the increased costs you're seeing, just any more detail on that.

Yeah, sorry to cut out there for a second. The other part of the answer was – pricing isn't offsetting product discontinuations. Pricing is really helping us try to keep up with increased input costs. And as you might remember from first quarter, we had about a 410 basis point of gross margin gap increase because costs to us were increasing faster than prices to our customers. And this last quarter, we're about 160 basis points better in closing that gap to do that. So we're working with our customers as equitably as possible to pass-through cost that we just can't defray in any other way. So that's pricing related to cost. And then we have revenue from substituted products or our continuing products offsetting lost revenue from what we're not producing at this time.

The other item I would just highlight is that sequentially we did see an improvement in the margin. And that primarily is related to the effectiveness of pricing as we continue through the year. We spoke about on our previous call in Q1, we would have fulfilled orders that would have been at old pricing that would have existed in the backlog. And so we are seeing a more effective pricing regimen in the second quarter, which is helping to offset the higher cost base that we have as well.

All right, very, very clear. Thank you for that detail. And then last question from me. I think you mentioned on the call that the ERP implementation remains temporarily paused. I'm just wondering if you could provide an update on where it stands and when you may be able to resume that initiative. Thank you for taking the questions.

Sure. Thanks, Brett. So in North America, we've got our updated ERP system on the front end of nearly all of the business. Some of the highly configured products we paused before dealing with. We've got a fair amount of reorganization to do and where our facilities are and where certain products are made. And we wanted to pause on investing in the current footprint, which would only be redone based on how the footprint is revised. And we think that'll take a couple of quarters to resolve. And then once we have that template created in North America, that'll be deployed globally. Again, I think as Kathy mentioned in her remarks, The contract we have with our systems integrator has a fixed monthly fee. The difference for us is whether that is capitalized during the development phase and subsequently depreciated over the life of the product or it's all expensed within the period. The cash cost in any given period is always the same.

All right, thanks again for taking the questions. All right, thanks, Fred.

Thank you. We currently have no further questions, so I'll hand the call back over to Matt Monahan for any closing remarks.

Okay. Thanks, Nadia. And thanks, everybody, for taking your time this morning. Kathy, Lois, and I are available for any follow-up questions that you can coordinate through Lois Lee. Please contact information on our website, www.indicator.com, on investor relations. Thanks very much.

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