Invacare Corporation
Q2 2021 Earnings Call Transcript

Published: 8 Aug 2021

[Operator:]

Good morning, ladies and gentlemen, and thank you for standing by. Welcome to the Invacare Second Quarter 2021 Conference Call and Webcast. After the management overview, we’ll open the call to questions. Investors and analysts interested in asking questions will need to dial in, as questions can not 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, August 5, 2021. I'll now turn the call over Lois Lee, Invacare's Director of Treasury, Investor Relations and Corporate Communications.

[Lois Lee:]

Thank you. Joining me on today's call from Invacare are Matt Monaghan, Chairman President and Chief Executive Officer; and Kathy Leneghan, Senior Vice President and Chief Financial Officer. Today we will be reviewing our second quarter 2021 financial 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 invacare.com/investorrelations. 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 slide and in our second quarter earnings release. For an explanation of 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 slides and in the related reconciliations in the slides in the earnings release posted on our website. I will now turn the call over to Matt Monaghan.

[Matt Monaghan:]

Thank you, Lois, and good morning. Starting on slide three, we entered the year with confidence that our second quarter would be a pivotal quarter, moving beyond the pandemic downturn and beginning to grow revenue. I'm pleased to announce that we achieved constant currency net sales growth of 7.8% with increases in all key product categories. Importantly, mobility and seating products rebounded strongly at constant currency net sales growth of nearly 18% in Europe and over 12% in North America. By region, net sales in both Europe and North America achieved significant growth as health care access improved in key markets and customers showed strong interest in new products. We continue to see increasing demand for all of our products, as evidenced by strong order intake, improved quote rates, and higher than normal backlog. As a result, in addition to strong sales in the second quarter, demand continues to support elevated order backlog. We ended the second quarter with $15 million of higher backlog than normal, similar to the level at the end of the first quarter. The continued higher backlog is expected to convert to sales over the next two quarters, as we work to fulfill higher demand on the growing supply chain disruption. On the cost side, we saw a good improvement in gross margin from favorable sales mix and the benefit of prior actions to optimize the business. These were more than offset by supply chain-related disruptions, as our factories endured more changeovers and shifting production plans to deal with intermittent parts shortages and shipments delay, which accounted for 80% of the margin decline. Higher material, freight and logistics costs offset by favorable sales mix accounted for the other 20%. Our operations team is very focused on improving efficiency in costs. We view the impact on gross margin is temporary and are taking actions to rectify this. Importantly, we expect gross margin to rebound through the remainder of the year. Turning to free cash flow. To support sales growth during the quarter, usage increased due to higher accounts receivable balances and elevated inventory levels, which Kathy will expand on later. We expect working capital to normalize by the end of the year, if cash is collected and inventory is converted to sales. Overall, second quarter results were largely in line with expectations with strong revenue growth, both year-over-year and sequentially in all major product lines and in Europe and North America. We're pleased with the progress we're making year-to-date and look forward to even stronger results in the second half. Turning to slide four. As the business environment and access to health care continue to improve, we remain well positioned to achieve our full year guidance. As a reminder, while the economy in many areas of the world continues to reopen, there are still pockets in both North America and Europe where access to our key customers and channels are still somewhat limited. As we experienced this quarter, we anticipate sales growth will continue in the back half of the year. Interest in recently launched products is helping us engage with customers to provide end users with even more capable devices. Early in the third quarter, we launched a new rear-wheel drive power wheelchair in North America the AVIVA STORM RX, which complements our full portfolio of best-in-class seating across all drive platforms. Our family of power wheelchairs allows end users to have the best in seating and complex control solutions and the best driving front, rear and or center-wheel drive share for the environment. In addition, in respiratory, our new P5 NXG stationary oxygen concentrator is now commercially available in the United States with plans to roll out globally in the coming months. As we focus on sales growth and meeting increased customer demand, we look forward to engaging our customers with new tools and our expanding IT platform, especially with more modern customer self-service features. At the same time, we're very focused on improving operating efficiency by reducing friction and removing costs from our business systems. While we expect the global supply challenges will persist in the near term, we're taking proactive measures to offset those such as investing in additional inventory, booking and planning freight further into the future to ensure timely receipt and delivery and more precisely planning manufacturing schedules to better match the anticipated arrival of component. As these mitigation efforts become more effective, we expect gross margin to expand significantly from second quarter results, which should enhance profitability. All things taken together, we remain confident in our ability to achieve our full year guidance as we continue to see strong demand across all product categories, convert our excess order backlog into sales, take actions to expand gross margin and leverage SG&A. All of these positive indicators support our conviction that Invacare is pivoting to a period of long-term growth. I'll now turn the call over to Kathy, who will provide a detailed financial summary.

[Kathy Leneghan:]

Thanks, Matt. Turning to slide six. Reported net sales increased 15.1%, with growth in all product categories and in all regions. Constant currency net sales increased 7.8%, driven by double-digit growth in both mobility and seating and respiratory products. We are pleased to have achieved strong sales growth, driven by new orders received during the quarter. And for mobility and seating, we are also seeing increased revenue from new products. Gross profit increased $4.2 million due to higher revenue and the benefit of favorable sales mix. As Matt mentioned, gross margin was significantly impacted by supply chain-related client disruptions and to a lesser extent higher freight and material costs. The company has taken and continues to implement various actions to reduce the impact on the business, including reduced work hours in certain locations, to align to the anticipated timing of the receipt of components and investing in increased inventory, much of which was received in the latter part of the second quarter. SG&A expenses returned to a more normalized level, and was higher than the prior year, as the second quarter 2020 benefited from reduced commercial expenses and discretionary spending, given the significant impact of the pandemic on the business. This year SG&A expense includes increased spending for sales marketing and commission programs to support and drive revenue growth. As sales strengthened, free cash flow was also impacted with higher levels of accounts receivable that we expect to be collected during the second half of the year. In addition, as previously disclosed, the company increased inventory levels to mitigate supply chain disruption and to prepare for the expected sequential sales growth in the latter half of the year. We anticipate this investment in inventory will convert to cash in the second half 2021 and enable us to achieve our free cash flow guidance. Turning to Slide 7. Reported net sales in all product lines improved year-over-year despite supply chain challenges, which limited the conversion of orders for shipments and resulted in excess order backlog of $15 million primarily in Europe. Mobility and seating products achieved constant currency net sales growth of 15% with strong growth in both Europe and North America, benefiting from the increased adoption of new products, introduced over the past 18 months. Constant currency net sales increased 2.9% for lifestyle products, even compared to a particularly strong Q2, 2020 that benefited from pandemic-related bed sales. Growth this quarter was led by higher sales of manual wheelchairs, hygiene products as well as health. Finally, growth in respiratory products was driven by continued strong demand in North America related to the pandemic. Turning to Slide 8. Europe constant currency net sales increased 7%, driven by an 18% growth in mobility and seating and over 6% increase in lifestyle products, partially offset by lower sales of respiratory products. Gross profit increased $5.7 million due to strong revenue growth and favorable sales mix, offset by supply chain-related plant disruptions and higher freight costs, resulting in flat gross margin. Driven by higher net sales, operating income increased by $2.8 million. Overall, we are encouraged by the improving health care access in key European markets, which helped drive our significant rebound in sales and profitability. Turning to Slide 9. North America achieved constant currency net sales growth of 10.1%, driven by increased revenues in all product categories. Mobility and seating products generating constant currency net sales growth of 12.6% and respiratory products grew by 24%. We achieved exceptionally strong growth in the quarter for mobility and seating products, benefiting from the increased adoption of new products. Gross profit declined $900,000, as favorable sales mix was more than offset by previous mentioned supply chain challenges, driving a 150 basis points decline in gross margin. Operating income decreased $3.2 million due to reduced gross profit and higher SG&A expense to support revenue growth. Turning to Slide 10. Constant currency net sales in the Asia Pac region, decreased 7.7% due to lower sales in lifestyle and mobility and seating products, partially offset by growth in respiratory products. While the Asia Pacific region continues to see strong demand, net sales growth was impacted by global shipping issues, which delayed the receipt of products. Operating loss increased by $1.8 million, primarily due to lower profitability in the Asia Pacific region, impacted by lower net sales, unfavorable gross margin and higher SG&A expense. Moving to Slide 11. As of June 30, 2021, the company had total debt of $322 million, excluding financing and operating lease obligations and $78 million of cash on the balance sheet. As a result of revenue growth the company had higher accounts receivables, which led to an increase of 7.4 days in sales outstanding as compared to the end of the first quarter of 2021, impacted by the timing of collections from revenue recognized in the quarter. In addition, the company had higher inventory levels to mitigate supply chain challenges and to prepare for the expected sales growth in the second half of the year. As discussed, we anticipate both metrics to normalize by the end of the year and drive positive free cash flow for the full year of 2021. Turning to Slide 12. Based on our visibility into the third quarter, we are reaffirming our full year guidance for 2021, consisting our constant currency net sales growth in the range of 47%, adjusted EBITDA of $45 million, and free cash flow of $5 million. Constant currency net sales are anticipated to increase sequentially, in the third and fourth quarters of 2021. Our outlook is supported by positive sales trends, such as strengthening order demand, mobility and seating product sales, which historically peak in the summer months, the conversion of excess backlog in the sales, increased adoption of new products, and the continuing reopening of key markets and channels. In addition, gross margin is expected to improve, driven by revenue growth, favorable sales mix and actions to resolve supply chain challenges at our plants. Over the next few quarters, we are taking steps to mitigate this impact where possible. As a result, improvements in adjusted EBITDA and free cash flow could accelerate for the second half of 2021. I will now turn the call back over to Matt.

[Matt Monaghan:]

Thanks, Kathy. Turning to Slide 13. I want to first thank all of our associates, who put in extraordinary efforts to support our customers as we all recover from the impact of pandemic. As we enter the second half of the year, I'm incredibly excited about the positive trends in our favor, which bodes well for a strong finish for the year. We anticipate the continued easing of health care restrictions, combined with strong demand, favorable sales mix and the fulfillment of excess backlog will drive robust revenue growth and profitability. As seen in previous years, Invacare has a long history of generating a substantial majority of its adjusted EBITDA in the second half of the year and this year is expected to be similar. Taken together, we have continued confidence in our ability to meet our 2021 goals and to remain focused on executing our long-term growth strategy. Thank you for your continued support of Invacare and for taking time for this morning's call. We'll now take questions.

[Operator:]

Thank you, very much, sir. We'll now move to our first question over the phone, which comes from Bob Labick from CJS Securities. Please go ahead.

[Bob Labick:]

Good morning.

[Matt Monaghan:]

Hey, Bob

[Bob Labick:]

Hi. So very nice quarter. And obviously, we're encouraged by the continued outlook. And I just wanted to start with North America and mobility and seating. There was a strong sequential pickup in sales of $31 million in the quarter. And I just wanted to ask, how much of that is a snap back from the weaker Q1, or is the kind of $31 million quarterly run rate a new level that you can grow off of? How should we think about that big swing from quarter-to-quarter?

[Matt Monaghan:]

Yes. I think we're looking at the general recovery of the market and continue the overall organic growth of the business based on new products I think we grow from Europe in mobility and seating Bob.

[Bob Labick:]

That's fantastic. Yes. And I guess I'd ask the same question as it relates to respiratory. And I think you mentioned that your new product has now launched. Was that in the sales in the quarter, or is that benefit going forward? How should we think about the new respiratory products in the sales level of respiratory?

[Matt Monaghan:]

Yes that's going to be benefit going forward. It is available for sale but it's just getting started now. So no effect of that in the second quarter. At some point we'll see a muting of respiratory sales, as pandemic demand wiggles at some point that will be expected to happen, lifestyle should continue to go forward and grow. We still have opportunities to grow in lifestyle. I was really pleased with lifestyle's growth in the quarter I think we all were with the strong second quarter last year. And we still grew on top of that this year and we're still more opening long-term care facilities and other forms of growth we expect. So I think a good outlook for really all our segments.

[Bob Labick:]

Okay. Super. And then obviously there's an expected lift in the second half of EBITDA as you discussed. And I think Kathy just said, sequential sales growth, which is certainly seasonal and normal on the European side. And I guess it sounds like there could be even sequential growth in North America as well. So maybe you can talk us through how much of the incremental EBITDA growth in the back half is from sales growth? And how much is from incremental cost reductions, or help us just think through those kind of levers.

[Matt Monaghan:]

Yes, we've had good product and customer mix coming into second quarter, which we think will continue. Sales growth will have a lot of leverage going forward so that will improve gross margin. Other things we're doing to convert materials and labor into sustainable products should improve gross margin by reducing variances. And these – the inefficiencies in our factories from the daily shifting of production plans based on supply chain changes every day and what parts have been received on time or a little delayed should be further mitigated as we get into the other teams getting increasingly good at planning for that or dealing with that. And I think those are the few things really. Sales growth with good margin which gives us leverage to continue to start. I think probably a different – probably a little different by product or plan or region, which generally both of those will be strong contributors.

[Kathy Leneghan:]

Yes. It really is the sales growth that we would see in Q3, Q4 that we're anticipating. And then obviously the improvement in the supply chain efficiencies, should help us in the second half of the year as well.

[Bob Labick:]

Right, okay. Super. And then last one for me, I'll get back in queue. Many companies or most companies are suffering from labor constraints. I'm just wondering how that has impacted you in the first half? And how you see that playing out if there's any relief for better labor markets ahead, or how you're looking at that and how that plays into your outlook?

[Matt Monaghan:]

Yes. It's definitely been a challenge for us in all our major plant locations for various reasons. We've seen some improvement at the end of second quarter, beginning of third quarter. I think some unemployment benefits may have changed I think as the labor market gets past the summer months and people get into the fall, we do expect some change. But honestly, it's a good chance for employers like Invacare to show that they are great long-term employers and it's not a job-shop gig market for us. We look forward to offering people a great long-term engaged career opportunity at all levels. So we think we'll have lessening impact of labor over time.

[Bob Labick:]

Super. All right. Thanks very much.

[Matt Monaghan:]

Yes. Good to talk you, Bob.

[Bob Labick:]

Thank you.

[Operator:]

Thank you very much. We will now move on to our next question over the phone, which comes from Mike Matson from Needham & Co. Please go ahead.

[Unidentified Analyst:]

Hi, guys. This is Joseph on for Mike. I guess first off, if you guys can maybe comment on the free cash flow guidance. How confident are you in it? And do you expect any working capital increases to reverse in the second half?

[Matt Monaghan:]

I'll make a start with an answer and then Kathy can chime in a different view. We've consumed quite a bit of cash in terms of inventory. Second quarter real positive results in terms of sales obviously, which increased accounts receivable $20 million, which we'll expect to return to cash in third quarter, a little bit more incremental inventory to help us with our supply chain. The math works out I think pretty clearly, we've got to generate a lot of cash which we expect to be – we expect to grow with a lot of good working capital actions underway. But Kathy, can you give a more detailed answer?

[Kathy Leneghan:]

Yes. I think that we mentioned at the end of the second quarter, we had increased accounts receivable from sales growth in Q2 of roughly $20 million based on our average DSOs that should turn to cash into Q3 as well. We have invested in inventory. We've spoken about that on previous calls. Historically, we do invest in inventory in the first half of the year but we also invested in additional inventory given the supply chain challenges. We would anticipate a reduction in inventory, probably more so in the fourth quarter at the year-end than the third quarter of the year. But clearly cash flow should benefit from improvements in the AR balances as well as the inventory balances as we progress for the remainder of the year.

[Unidentified Analyst:]

Okay. Okay. Great. You guys have already mentioned the increase in inventory. Does this necessarily mean you're out of the woods with regarding the supply chain issues? And is there a risk that like new component shortages because of the capacity in the second half? And then maybe touching on some recent news we've heard from other companies reporting concerning the semiconductor shortage and their ability to push out products. Is this going to affect your guidance supply at all? Thanks.

[Matt Monaghan:]

Sure. So I think we expect the inventory -- sorry, supply chain to improve only in the sense that it stabilizes and this continues to be disruptive. So what's difficult for us is this disruptions are less predictive, but we're pretty good at predicting where the disruptions are in our supply chain team and a lot of people supporting our operations. They're doing a fantastic job dealing with the reality that we predict will persist through probably April or May next year. But that's okay, because of the incremental inventory to take us through the heavy sales growth period that we have typically now in the second and third quarter with warm weather months where we especially have a lot of mobility and seating products and getting ready for the end of the year. That's a great program. So I think that will be okay. We see new shortages in the second half. We see new shortages every day, but we end up resolving them within a few days, and then there's the next kind of thing that happens and it's a new way of working. As far as semiconductor shortages, we have like everyone challenges with active and passive electronic components, but nothing in the order that you read about in the automobile industry or something, which has a heavy impact for long durations on big product families for us. It's just another component that we view in the short-term. So it shouldn't be any big impact relative to semiconductors.

[Unidentified Analyst:]

Okay. Great. That's super helpful. And then maybe if I could just leave in one more. Concerning long-term organic revenue growth at this point. You guys feel confident that you can sustain low to mid single-digit growth in 2022 and beyond that?

[Matt Monaghan:]

Well, we really haven't gotten to long-term guidance, but I'd say the market certainly supports that kind of growth. We have great products that allow us to engage with sales teams and customers a lot of interest with customers. We're doing things to get friction out of our interactions with customers with new IT systems and customer self-service. So we definitely think we can support that or above market growth rates of revenue in the long-term, but I don't take that as specific guidance yet. We'll be out with specific guidance I think around the end of the year.

[Unidentified Analyst:]

Sure. Thank you, guys. Much appreciate it.

[Matt Monaghan:]

Okay. Thanks, Joseph.

[Operator:]

We'll now move on to our next question on the phone which comes from Matthew Mishan from KeyBanc. Please go ahead. Your line is open.

[Brett Fishbin:]

Hey, guys. This is Brett Fishbin on today for Matt. Thanks so much for taking the question. I just wanted to follow-up on margins. On margins you mentioned the 80% on the gross margin side was attributable to the supply chain disruption. So I just wanted to get a little bit of a sense, what's assumed in your guidance around the continued impact into the second half, how much of these disruptions can offset those factors? And then just as a follow-up, what's a reasonable gross margin range to assume for the second half that can enable you to achieve the full year EBITDA guidance?

[Matt Monaghan:]

Thank you. I don't know if Kathy will give specific guidance on gross margin, we can work towards that answer. A big thing we've got to work on in the factories is seen with even just a little bit more visibility with the day-to-day receipt of products and components are going to be, so that our operations can start the day with the staffing for the planned production for the day. There was a great article in the Wall Street Journal maybe a month ago that talked about a company in a different industry that's doing probably what a lot of industrial companies are. Instead of starting the day with the plan that you've had for a long time, you start the day with an operations plan based on the parts that have been received or are available that day. It's really kind of a backward way of producing, which a lot of companies and lots of industries are doing to make success happen these days. So for us it's getting just a little bit more visibility and a little bit more inventory like we purchased, so that we can get back to more normal orderly production planning and production execution day-to-day. That's going to be a big driver to reduce operating variances that were the big impact on gross margins this quarter. What we'll see as maybe was previously answered the balance of the year with strong sales growth is going to give us good leverage in operations, plus backing off on variances with better planning and continued good mix with new products and customer engagements with the right products and the right margin mix going through our factories, which will be the recipe for the balance of the year. We continue to expect component and commodity prices to be kind of in the neighborhood where they are now so we don't expect a lot of change there. You see those being stabilized. I think that leads us to the end of the year plan that builds up the guidance. I don't know Kathy if you want to add to that?

[Kathy Leneghan:]

Yes. The reference to the 80% really is in relation to the increased cost that we saw that we do believe are temporary in nature in just managing the efficiency of our operations given the timing of one inventory in the supply chain would arrive at our various locations. And so we're very focused and reducing that negative impact for the second half of the year, and we should see an improvement over where we were in the second quarter. But to the Matt's point, obviously, with revenue growth will come leverage of our cost structure and as well growth in the mobility and seating inside of the house, we should see favorable sales mix in the second half of the year as well.

[Brett Fishbin:]

All right. I appreciate that. And then one more for me. Can you just provide a little bit more color on how much of the expected revenue growth this year is being driven by new product launches? And following up, are there any sort of products you call out as meaningful contributors should we see growth in your mid-term outlook?

[Matt Monaghan:]

Tough to say. We do have a good proportion of revenue that is with new products. We don't call that out specifically a bit different by country and market based on what products are launching in countries, and how reimbursement is very different for every market, which highlights certain products over others. I would say, we're looking forward to the respiratory product helping boost the respiratory sales since the pandemic demand wanes over time, that will happen at some point, in fact not too much of that yet. We have a very deep product line in mobility and seating with power add-ons that are doing really well. New power wheelchairs recently launched power wheelchairs that have great features and manual wheelchairs our mobility and seating segment. We've seen great customers engagement globally all those products are rolling out globally. On the lifestyles products, we have a huge catalog of new products. Too numerous to mention and they're specific by market, but we think generally our lifestyles products should continue to have good growth. So when you look at really every product category is going to be sustained by new product development and launches that have occurred in the last 18 months, and we have a sustained pipeline that have stayed at 2% of sales growth with R&D over an incredibly productive R&D team and we'll keep that going.

[Brett Fishbin:]

Right. Appreciate it. Thank you.

[Matt Monaghan:]

Brett, thank you.

[Operator:]

Just to confirm, there are no further questions queued over the phone at this time. So I would like to turn the call back over to our speakers and hosts for any additional closing remarks.

[Matt Monaghan:]

Yes. Thank you Simon, and thanks to everyone who tuned in this morning for our call and Q&A. Kathy, Lois and I are available for any follow-up questions, which Lois would be happy to coordinate. Thanks and have a good day.

[Operator:]

Thank you very much to all speakers. Ladies and gentlemen, this does conclude today's call. Thank you very much for your participation. You may now disconnect.