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Invacare Corp (NYSE:IVC)
Q2 2020 Earnings Call
Aug 6, 2020, 8:30 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good morning, ladies and gentlemen, thank you for standing by. Welcome to the Invacare Second Quarter 2012 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 is being recorded, Thursday, August 5, 2020.

I will now turn the call over to Lois Lee, Invacare's Director of Treasury and Investor Relations and Corporate Communications. Please go ahead.

Lois Lee -- Director of Treasury and Investor Relations and Corporate Communications

Thank you, Sarah. 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 2020 financial results, providing investors with an update on our transformation and our response to the COVID-19 pandemic. 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 statement 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 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, adjusted EBITDA and adjusted net loss, please see the notes in the appendix of our webcast slides and in the related reconciliations in the slides and the earnings release posted to our website.

I will now turn the call over to Matt Monaghan.

Matthew E. Monaghan -- Chairman, President and Chief Executive Officer

Thank you, Lois. Good morning to everyone. We'll begin on slide 3. First, I'd like to start today's call by expressing my gratitude for all our associates, who remain so committed keeping our workplace safe and productive in these uncertain times. As a company whose central focus is to make life's experiences possible, their hard work, creativity and dedication has been inspiring. Invacare's mission is built on the tenets of integrity leadership accountability and helping everyone be part of an inclusive culture around the world. We benefit as a company from the diversity of our team, differences of individuals, and the inspiring differences of people who rely on our products in their daily life.

We're pleased with our performance in the second quarter, achieving our 11th consecutive quarter of year-over-year improvement in adjusted EBITDA, as well as sequential improvement in adjusted EBITDA for the first quarter. We effectively shed costs, but managed cash to offset lower sales. During the quarter, we also overcame tremendous supply chain challenges, primarily related to our respiratory products, which limited our ability to meet the extremely high demand for these products, which are used for pandemic related care.

Turning to slide 4; we've established a strong track record of enhancing profitability. This quarter, delivering an 84% improvement in adjusted EBITDA. Profitability grew, as a result of stronger gross margin from favorable sales mix, cost savings from continuous improvement initiatives, and reduced SG&A expense. I'm pleased with our strong performance in this challenging environment, which highlights the value of changes, we continue to make.

On slide 5; we saw two distinct patterns driving demand, as a result of the pandemic. Beginning in late first quarter, we saw strong demand in our respiratory category for both stationary and portable oxygen concentrator. That elevated demand continues today. We had a smaller peak in demand for bed systems in our lifestyles category. At this point for the most part, that peak in bed demand has passed, the timing of the return to more normal sales rates and mix for these product groups are still to be determined, based on the course that the pandemic takes from here.

In Mobility and Seating, the good momentum we had in first quarter begin to slow in the early parts of second quarter, as public health restriction limited access to clinicians for custom fitting, which reduced sales. Looking ahead, we see encouraging signs that demand for Mobility and Seating products are starting to recover, as third quarter quote and order rates are improving over second quarter run rate.

In summary, we believe the second quarter will be the low point for sales in the year, as it coincided with the most restrictive phases of the global lockdown. Based on reasonable assumptions around the loosening of public health restriction, and when needing to access the healthcare facilities, we anticipate sales will begin to normalize over the next two to three quarters. We're confident that our diverse product portfolio, geographic coverage, continuous improvement initiatives and balance sheet will enable us to manage the business through the pandemic and accelerate our return to growth.

Turning to slide 6; second quarter results show that our transformation is working. Importantly, North America returns to profitability and generated $4.8 million in operating income in an unprecedentedly tough market. As a reminder, the North American segment has been undergoing in multiyear transformation, after the impact of national competitive bidding and sales restrictions related to the FDA Consent Decree, Craig, which combines with significantly reduced sales and profitability, starting nearly a decade ago.

In terms of our business optimization plans, we continue to make good progress on our IT modernization program in North America and plant consolidation in Germany, both of which are expected to drive significant cost savings in 2021.

As new products are key drivers of sales growth, it's important to have a vibrant R&D pipeline, and we do. I'm proud of the team staying on track to develop and launch innovative new products at the same pace, in keeping to the pre-pandemic schedule, which highlights our R&D strength. Over the past few quarters, we have launched three major power wheelchairs, all of which have achieved steady growth in their short time in the market. This quarter, we launched another. The MPS Mini Maxx wheelchair with standing capabilities for small drivers, which is eligible for full reimbursement within the U.S. Group-III category. Our Adaptive Switch Labs division, which produces sophisticated alternative controls for wheelchair drivers with highly unique need, launched a great new head array. And in July, in North America, we launched the SMOOV one, a terrific power add-on for manual wheelchairs, which has already achieved great success in Europe. All these products, as well as a very full pipeline of innovation in all categories will continue to support growth, wherever people need durable healthcare solution.

During the pandemic, our team has found creative ways to support our customers and to drive sales, by leveraging telepresence technology. The LiNX wheelchair control system helps us perform contactless wheelchair delivery, and our Assurance program offers a fit guarantee, giving customers the confidence to choose Invacare power wheelchairs, when clinical visits are restricted. In Europe, we upgraded our online presence by launching a digital catalog, a Product Visualizer and a new website. These are just a few of the ways our commercial team has maintained high customer engagement, while complying with safe public health measures.

I am proud of the continued progress we've made on our transformation, and of our ability to execute under challenging circumstances, a well-developed skill over the past many years. Our powerful innovation culture is enabling adaptation and growth.

I'll now turn the call over to Kathy.

Kathleen P. Leneghan -- Senior Vice President and Chief Financial Officer

Thanks Matt. Turning to slide 8; reported net sales decreased 16.8% and constant currency net sales decreased 12.9%, primarily driven by growth in respiratory and more than offset by declines in Mobility and Seating and non-bed lifestyle products. Gross profit increased 130 basis points to 28.9%, primarily due to favorable product mix and lower material and freight costs, partially offset by unfavorable foreign exchange.

Constant currency SG&A decreased 13.2% or $8.8 million, driven by reduced employment costs and lower commercial expenses. Lower employment costs included the benefit of reduced work hours and furloughs enabled by government-based programs, to mitigate the impact of the pandemic. Operating loss improved by $2.3 million, driven by reduced SG&A expenses, partially offset by lower net sales and higher restructuring costs. Adjusted EBITDA was $6.6 million, up nearly 84% driven by reduced SG&A expense and improved gross profit as a percentage of sales. The company's free cash flow usage was $1.9 million, an increase of $2.1 million, due to higher capital expenditures.

Turning to slide 9; as Matt discussed, consolidated net sales declined due to public health restrictions that limited access to healthcare professionals and elective care, with the greatest impact on Mobility and Seating. While Mobility and Seating net sales declined, the company expects sequential growth as quotes and orders in the third quarter have been higher than the run rate achieved in the second quarter of 2020.

Within the lifestyles product category, higher sales of pandemic related bed systems sold in the home care market, were offset by lower sales of other lifestyle products as a result of limited access to healthcare institutions, including long-term care facility.

In respiratory, the company realized higher demand for both stationary and portable oxygen concentrators, with sales limited by global supply chain challenges which dampened manufacturing capacity. The company expects elevated demand for respiratory products to continue through the third quarter, as possible declines from COVID-19 infections lessen.

Turning to slide 10; during the second quarter, net sales were negatively impacted by strict quarantine measures in the company's key European markets, primarily, the U.K., France and Germany. As a result, reported net sales in Europe decreased 24%, and constant currency net sales decreased 20.7%, driven by declines in sales in Mobility and Seating and non-bed lifestyle product.

Gross profit decreased 90 basis points, driven by unfavorable product mix. Operating income decreased $3.3 million, due to reduced gross profit from the lower net sales and unfavorable foreign exchange, partially offset by reduced SG&A expenses and a gain recognized on the sale of a German facility. Lower SG&A expenses included the benefit of furloughs, and reduced work hours implemented at a majority of the European locations.

Moving to slide 11, the company was not as impactful -- I'm sorry the pandemic was not as impactful in North America, as compared to Europe, as the U.S. was never fully shut down. Reported net sales decreased 3.3% and constant currency net sales decreased 3%, with growth in respiratory products more than offset by declines in Mobility and Seating and non-bed lifestyle products.

Within Mobility and Seating, higher value power mobility products were resilient, only experiencing a slight decline of 1%. The North America segment realized a favorable mix shift for its higher acuity products, as end users with more severe needs continue to access healthcare, while less urgent elective care was more often delayed.

Gross profit increased 230 basis points or $2.4 million, driven by favorable product mix and lower operational cost, including reduced material and freight costs as a result of previous transformation initiatives. The North America segment returned to profitability, with operating income of $4.8 million, an improvement of $6.1 million driven primarily by lower SG&A expenses primarily in employment costs and the benefit of reduced operational costs.

Turning to slide 12; All Other, which comprises the sales in the Asia-Pacific region, increased by 8.1% on a constant currency basis, driven by higher sales of lifestyle and Mobility and Seating products. Operating loss increased by $300,000, driven by higher corporate SG&A expense, primarily related to equity compensation, partially offset by improved operating income in the Asia-Pacific business, attributable to lower SG&A expense.

Moving to slide 13; as of June 30, 2020, the company had total debt of $319 million, excluding operating lease obligations of $15.9 million, capitalized on the balance sheet. At the end of the quarter, the company had approximately $104 million of cash on its balance sheet. The increase was primarily the result of cash borrowed on the company's credit facilities, proceeds from the sale of dynamic controls, and government loan programs, partially offset by cash used to fund operations and cash paid to expense a portion of the convertible debt. In the second quarter, the company extended the maturity of a significant portion of the 2021 convertible note, and a portion of the 2022 convertible notes, to new maturity date of November '24, with terms substantially similar to the existing 2024 notes. We are very pleased to have executed this transaction during a turbulent market.

On slide 14, we are reintroducing new full-year guidance for 2020. Based on the loosening of public health restrictions and renewed access to healthcare facilities, the company anticipates reported net sales in the range of $810 million to $840 million. Adjusted EBITDA, similar to the prior year in the range of $20 million to $30 million, and free cash flow usage, in line with the prior year in the range of $7 million to $10 million. This guidance assumes consolidated net sales to improve sequentially, staying below the prior year. Due to the more stringent quarantine programs in the company's key markets in Europe, net sales are expected to recover slowly, staying below the prior year in the range of mid-teen declines.

In North America, net sales are expected to be below the prior year, in the range of low single digit declines. Adjusted EBITDA is expected to improve sequentially and for the full year, achieve results similar to 2019, despite lower net sales due to the pandemic.

I will now turn the call back over to Matt.

Matthew E. Monaghan -- Chairman, President and Chief Executive Officer

Thanks Kathy. It was a good quarter in tough times. We acted decisively to ensure the safety of our associates and customers, while protecting our business against the near-term impact of the pandemic. This resulted in continued improvement in profitability, and a significant achievement in these unprecedented times. As I look further out, I'm confident that the actions we've taken to improve our competitiveness, reduce our cost structure, and strengthen our balance sheet, has set the foundation for long-term profitable growth. It was the direct result of the many quarters of hard work that enabled our team to deliver a strong result this quarter, and we plan to unlock additional value for years to come.

Thanks for your continued support of Invacare and for taking time for this morning's call. We'll now take questions.

Questions and Answers:

Operator

[Operator Instructions]. We'll go ahead and take our first question from Bob Labick with CJS Securities.

Peter Lukas -- CJS Securities -- Analyst

Hi. [Technical Issues] here for Bob. Good morning. Good morning, Matt.

Matthew E. Monaghan -- Chairman, President and Chief Executive Officer

Oh hey, Peter. You cut out there for a second. Could you start the question over?

Peter Lukas -- CJS Securities -- Analyst

Sure. Just had a question on gross margins, just where you see the opportunity over the next 12 months, maybe by region; specifically how much room do you have in North America? And part two, if you could also just talk about cost savings by region, and where you see the opportunities?

Matthew E. Monaghan -- Chairman, President and Chief Executive Officer

Yeah. Good questions Peter. There are a couple of things we're doing in general and then can Kathy can comment also. Interesting consequence of the pandemic was that people who really needed healthcare, that weren't seeking elective are optional care, still access healthcare and those kind of more complex cases need more complex equipment, which tends to be a little bit higher margin for us. So we had gross margin expansion during the pandemic, really globally, as a consequence of the pandemic. Not clear when that's going to resolve, based on how the pandemic progresses from here. And in addition, our new products generally provide more valuable clinical use to end-users and customers. So there is some mix to that gross margin that's going to persist, and of course if its received at all due to a more normal mix, we're still going to be continuing to work to offset that with cost reductions, which are part of our long-term plan. So I don't know that I can really guide you too precisely on where gross margin is going to go, but we wanted to set a marker out there that said, that during the pandemic, some of that advancement in gross margin percent wasn't only due to the ongoing cost reductions or a little bit of favorability, as a result product mix in the pandemic. And I would say based on that, it's relatively hard to predict the difference between North America and Europe.

Now we've previously indicated the value of our German plant consolidation in Europe, which I think Kathy, is still slated to be...

Kathleen P. Leneghan -- Senior Vice President and Chief Financial Officer

About $5 million.

Matthew E. Monaghan -- Chairman, President and Chief Executive Officer

$5 million, which we announced maybe five quarters ago, roughly. That's on track pretty much to the day, in terms of implementation. So we should see that really hit the P&L at the very end of this year and definitely all of 2021, is what we're looking for. The IT improvements that will drive overall profitability in North America will be in place for 2021, and that's both revenue synergies, which we hadn't predicted too well, well should be much easier to do business with, with Amazon like conveniences that we've all become accustomed to as consumers, and then lots of tools for productivity inside the company. So that's really what's in play for 2021 and probably beyond today's detailed guidance. Does that help you, Peter?

Peter Lukas -- CJS Securities -- Analyst

Yeah, great thanks. And just one more from me, any update on the -- for recipe on the new product launch in terms of timing or expectations?

Matthew E. Monaghan -- Chairman, President and Chief Executive Officer

Great expectations with a fantastic new product coming out in third quarter. We will be debuting that here pretty shortly. It has progressed surprisingly well in the pandemic, with so many people working remotely. I think everyone around the world is figuring out new ways to do work and one of the questions was, how did innovation progress? When you normally have people congregating around prototypes, then fiddling with parts, then collaborating on design, and despite being entirely remote during this period, we've had no change in the respiratory product launch timeline or the launch timeline of any of our products. I mean, great accolades to the team for figuring out new ways to be innovative. They have been fantastic.

Peter Lukas -- CJS Securities -- Analyst

Very helpful, thank you. And congrats again on the quarter.

Matthew E. Monaghan -- Chairman, President and Chief Executive Officer

Thanks Peter.

Operator

We'll take our next question from Ross Osborn with Stephens.

Ross Osborn -- Stephens Inc. -- Analyst

Good morning. This is Ross on for Chris. Congrats on a great quarter.

Kathleen P. Leneghan -- Senior Vice President and Chief Financial Officer

Good morning.

Ross Osborn -- Stephens Inc. -- Analyst

Matt, in your prepared remarks, you noted that order rates for Mobility and Seating hasn't elevated globally in 3Q versus the 2Q. Can you provide some more detail by region? I believe you said Europe sales as a whole are expected to be down in mid-teens and North America are expected to be down low-single digits. So if you could write any more color on how Mobility and Seating kind of fits into that overall geographic trends, that would be great?

Matthew E. Monaghan -- Chairman, President and Chief Executive Officer

Yeah, we'll give some amount of color. It turns out that maybe predictably or understandably, its different by country. Different countries have different social circumstances and different public responses to the pandemic, which have absolutely affected access to healthcare, and therefore, sales of our products, it turns out to be different by country. If we start with Europe, there are certain places, of course, you'd imagine Italy and Spain had a very early downturn as they nearly closed their economy. Germany and France were kind of in the middle. I would say in terms of getting after early, shutting down their economies in access to things like elective care and have started to improve. And the U.K., surprisingly has had quite a significant impact, maybe latest in the -- in lessening of public health restrictions in the recovery of their economy.

And at the other end of the spectrum, the Nordic markets continued kind of quite unchanged, and principally that was because the way our part of healthcare is delivered and the Nordics tend to be very separate from where people get acute care. So if someone needs one of our products in Sweden or Norway, let's say, they are going to go to a very different physical location to get those products, and someone with COVID might go to get care, and therefore the public is generally not as concerned about going to get a wheelchair from Invacare, for fear of being exposed to people with COVID. So a whole spectrum of change. I think what's important for us has been, to see enough signals in the return of mobility to say it's not just a statistical aberration in the short term, we want to see a consistent pattern of a monster [Phonetic] month, that quotes and order rates are improving in across Europe in total, we do see that, well, as I explained its different by country by country.

And then in North America seen same kind of thing, we probably look at states a little bit, but I'd indicate we don't have particular exposure to any one state, when you kind of look at the composite, and we're more than a month into improved quoting order rates in North America, which gives us confidence to sign up for the sequential growth and the two to three quarter recovery that Kathy mentioned in her remarks. Does that help?

Ross Osborn -- Stephens Inc. -- Analyst

Okay, thank you for the additional color there. And then just one more, and on respiratory, does the company's full-year guidance assume that demand remains elevated throughout the rest of the year, and then should we expect 2Q to have then, the kind of peak in sales there, given where the pandemic is? And then just lastly, how have the supply chain issues kind of progressed, with regards to respiratory? Thank you.

Matthew E. Monaghan -- Chairman, President and Chief Executive Officer

Yeah. Good questions. Calling the peak is really calling the pandemic, which is hard for us to do. But we've been really pleased that customers around the world have trusted us with their urgent demand for respiratory products, both in stationary and portable devices to help their clients or patients with COVID symptoms and that continues now very high for those products, and we expect it to continue, I think the questions we're all going to ask internally and externally are, as the pandemic continues to rise in incident rates in major economies and predominantly we are a Northern Hemisphere company in terms of revenue, As we get into winter months, there is some likelihood that that incident rate continues to be elevated, which we believe would lead us to have elevated demand for oxygen concentrators of all varieties. So there is a potential, obviously you can can't call for when the pandemic is going to go better than other people, but there is a chance that this is going to continue for some time and for now, we see no abatement in that elevated demand.

In terms of supply chain issues, when we started in the second quarter to fulfil this demand, we had challenges getting components from our global suppliers and they're all over the world. They are across Europe, the states in the United States and in Asia Pacific and we -- if we had a component in Italy, you could imagine how hard it was to get our component in March and April, and that's been resolved. But as we got into April and May, there were certain states on lockdown where our industrial looking components weren't coming from businesses deemed essential and those businesses had to close or figure out other ways to operate. So it cost us more to keep those vendors open, and we had to make special arrangements, to make sure that those components could get to us, and during the entire pandemic, probably every company that produces a product and the world knows that logistics cost and logistics availability has become very problematic.

I think by now, it's less, but it takes a 100% of components to still make a product, and while we maybe had problems with lots of components early, we still have a few missing things that we're dealing with every day or every week. It's certainly much more manageable than it was, but there are still things that are prohibiting us from meeting the elevated demand as immediately as we like. We're still working. We got a great team working on it. We got a small army of people every day that try to put out the fire that's come in for the day, and the results are very evident. We could have easily turned in a hero for respiratory, given the amount of problems that we had that was not a windfall that we had such good results in respiratory this quarter. So hats off to the team.

Ross Osborn -- Stephens Inc. -- Analyst

Thank you.

Matthew E. Monaghan -- Chairman, President and Chief Executive Officer

Thank Ross.

Operator

We'll take our next question from Mike Matson with Needham.

David Saxon -- Needham -- Analyst

Yeah, hi, good morning. This is David Saxon on for Mike. Thanks for taking the questions.

Matthew E. Monaghan -- Chairman, President and Chief Executive Officer

Hi David.

David Saxon -- Needham -- Analyst

Just a few -- yeah hi, just a few this morning, just on the cost reduction initiatives, when you think about them, are there any that are more durable that could allow you to become a leaner company after the pandemic? And then, can you quantify the benefit of some temporary cost reductions to EBITDA?

Matthew E. Monaghan -- Chairman, President and Chief Executive Officer

Yeah, in terms of durable cost reductions, its interesting, so certainly everybody has found new ways to be productive. Whether if -- we go down the P&L, whether its salespeople that work from home, that are more productive, because they're spending less wheelchair time, we're certainly going to try to make that more durable, and we think we've found more useful ways to engage with customers that are more convenient for customers, are delightful for customers, that should persist. Certainly we're not spending money on airfare like we had and maybe other forms of physically getting together to do training and customer engagement and end user kinds of activities will persist.

On the supply chain side, we continue to work against the 2018 tariffs, and those things are very durable improvements and quarter-by-quarter we keep eliminating the final remaining dollars that should improve gross margin. And as we look at other supply chain solutions that allow us to continue to produce during this period, we're probably going to find some gross margin enhancements that work better for us and everybody has been stretched a little bit in the time and you're exactly right, we've got to find ways to [Indecipherable] most or all of that sticks.

Now some of the cost reductions are activity based. So as volume went down in some of our products, like we talked about Seating and Mobility, we've reduced the variable costs and some of those variable costs will come back, as volume increases. Some of those costs are fixed in nature. You might have cost to the facility that gets spread over, whether the facility is working at 80% or 100%, so what we're going to try to do is, manage how much those netback. And then in SG&A, of course, if selling costs go down, when sales go down, commission payments are lower, and there's a lot of G&A activities, that activity based accounting, customer reviews, invoicing, collections, things like that, which will start to come up, but we found a lot of productive ways to make those activities occur with fewer people.

So you're right to observe, that there is a likelihood that those [Indecipherable] could be durable and incremental what we had planned. We just don't have a way right now to predict how much favorable those are, and what we're going to do for the next two to three quarters as sales recover, is try to manage to keep those down, as the pressure of elevated activity in sales comes back, which is going to try to increase it. So our goal for the next two to three quarters is to keep margin and profitability as close to the theme, as we've had.

And maybe Kathy can talk about the programs that have helped us maintain this profitability around the world?

Kathleen P. Leneghan -- Senior Vice President and Chief Financial Officer

Yeah, primarily in Europe, many of the governments offered assistance to companies, so we were able to take advantage of lower reduced work hours for our employees, as the volume came down in Q2, as well as furloughs. So that was a benefit to the P&L from a from a European perspective of roughly $2 million in the quarter. As Matt has mentioned, as the business comes back though, some of those costs will be added back, as people come back on board, with the increased volume that we have seen in Q3. So obviously, that was a temporary benefit that we saw in Q2. But a good benefit as we were making our way through the pandemic, and coming out of that with higher volume in Q3. That probably is the most significant I would have to say, because as you can see from the North America performance, we actually had nice volume on the respiratory side of the house. We have nice volume on the power mobility side of the house, and so while we did ramp down some costs on the North America side, it wasn't as prevalent as the European business, which you can see, all the European sales were down roughly about 20% in the quarter.

David Saxon -- Needham -- Analyst

Great, that's helpful. And then when you're thinking about your portfolio, are there any other opportunities, more to Dynamic Controls, that might help you manage the balance sheet? And then I had just one last follow-up?

Matthew E. Monaghan -- Chairman, President and Chief Executive Officer

Now on the balance sheet, I think we're pretty comfortable with the balance sheet now getting us through the pandemic, getting us through obligations that are forecasted over the forecasted period. So really no indications there. Anything I would say differently. We're very comfortable with the actions that we took, to get us to this point. Second quarter was a tough market to do equity debt deals, and we executed, I think pretty nicely on behalf of shareholders to move some of that debt out to 2024 at a very good price premium. So that was really good. I think we're fine for now. I don't know if Kathy, any comments there?

Kathleen P. Leneghan -- Senior Vice President and Chief Financial Officer

Yeah, no, I think we're very happy with the portfolio that we have. We've seen nice improvement in the margins related to each of the three main product categories. There is no discrete business similar to like PCL that you'd say, you you'd want to monetize. I think we're very happy with the portfolio that we have right now.

David Saxon -- Needham -- Analyst

Okay. And then lastly, just on the gross margins, I mean during the quarter it was above what we were modelling, so just wondering if you can comment on kind of how we should think about the third and fourth quarters. Thanks so much.

Kathleen P. Leneghan -- Senior Vice President and Chief Financial Officer

Yeah, so -- you're absolutely right, when we gave guidance at the end of the first quarter, we had anticipated that margins would decline in Q2. And what we actually saw in Q2, was a move to higher value products, higher end power wheelchairs, higher end beds for the COVID, higher end respiratory product as well. So that was a pleasant surprise. I mean, we were happy to see that. As the business continues to rebound in Q3 and Q4, we're anticipating that the product mix will come down slightly, just given less acuity products that we are going to sell into Q3 and Q4. And so because of that, we would anticipate an unfavorable product mix, that would hit margins in Q3 and Q4. Not significant, but it would be down versus the benefit that we would have seen in Q2.

We also saw nice improvement year-over-year in material costs related to tariffs, so it was a portion of that, as well as freight costs, and we would assume that that would continue for Q3 and Q4 as well, to offset that product mix. So we're anticipating that margins will be down slightly, not significantly. There will be puts and takes to it. But overall, should be down primarily, just because of the mix and the mix of the product line within the business.

David Saxon -- Needham -- Analyst

Great, thanks for taking my questions.

Kathleen P. Leneghan -- Senior Vice President and Chief Financial Officer

No problem.

Matthew E. Monaghan -- Chairman, President and Chief Executive Officer

Thanks, David.

Operator

We'll take our next question from Matt Mishan with KeyBanc.

Brett Fishbin -- KeyBanc -- Analyst

Hey guys, this is Brett Fishbin on for Matt. Thanks very much for taking the questions. Just wanted to start off by following up on some of the dynamics in Europe. We were a little bit surprised by how different the revenue performance was there compared to in the U.S.? I was just wondering if you could provide some more detail on what the biggest differences were between the two regions in 2Q, if there were any beyond just the timing and the magnitude of the shutdowns? And then how we should be thinking about the European recovery into 2021, in context of an overall return to pre-COVID sales levels?

Matthew E. Monaghan -- Chairman, President and Chief Executive Officer

Yeah, good questions. Pretty straightforward answer. The European -- let's call European governments from the member states, were pretty organized in their response to the pandemic. And the results that we see in terms of less human catastrophe, was because they were more hermetically sealed, they took more cohesive actions, their actions were more complete across their economies. And the benefit to humans was, tougher economies, especially in Italy, Spain -- or let's say Iberia, Germany, France, then United Kingdom. And those are major markets for us. Certainly, Germany, France, United Kingdom, they are all important to us. But those three in particular were severely shut down, which was probably a wise thing to do and affected our sales. But the benefit of that sudden shutdown is public health issues, and say the more you do that upfront, the more smoothly your economies should be able to recover, because you get beyond the consequences of the pandemic. But we expect that European markets will come back in an orderly fashion. Deeper down for a shorter period of time and more quickly back, is probably what we would forecast.

Kathleen P. Leneghan -- Senior Vice President and Chief Financial Officer

The only other thing I was going to add is that, the European business has a pretty significant scooter business, that will be part of Mobility and Seating, that is more of a seasonal business and so obviously, the season is probably Q2 and Q3. So that also would have been an impact that you would have seen for Europe, that's not in the U.S., because we really don't sell scooters in the U.S.

Brett Fishbin -- KeyBanc -- Analyst

All right, thanks for that color. And then moving to the balance sheet, we noticed a fairly material step up in inventory. Just wondering in order of magnitude, if that was more of a reflection of building inventory in areas where demand is expected to be stronger, or if it's more related to areas that have been a little bit slower, and may have built up during the quarter?

Matthew E. Monaghan -- Chairman, President and Chief Executive Officer

More the latter. In areas like respiratory or beds, where demand has been strong, the inventory turned quite quickly, and so that's not the consequence. It's really about a relatively long supply chain; because we had so many customized products which need a large variety of components to be ready for order and assembly, we couldn't turn that off as quickly as orders came down. But the good news is, having that inventory, and it's good inventory for good products that we expect to be part of the recovery of the company, will allow us to readily fulfil demand as it comes back and hopefully be -- and especially a good provider to our customers around the world, with great responsiveness, as a result. So we expect to liquidate that over the recovery period should be fine.

Brett Fishbin -- KeyBanc -- Analyst

And then just last quick one from me. Can you just provide the FX assumptions you're using for the remainder of 2020 in the guidance, just given how fast it has been moving recently?

Kathleen P. Leneghan -- Senior Vice President and Chief Financial Officer

Yeah. Our modelling has utilized the rates that were in effect at the end of Q2 of '20. So that's what we've modelled the second half of the year at, assuming those rates. Roughly like the euro would be at like a $1.10, that's roughly where we would be at. [Multiple Speakers] the euro and the GBP. Yeah.

Brett Fishbin -- KeyBanc -- Analyst

All right. Got it. Thank you so much.

Kathleen P. Leneghan -- Senior Vice President and Chief Financial Officer

Thank you.

Matthew E. Monaghan -- Chairman, President and Chief Executive Officer

All right, thank you.

Operator

It appears there are no further questions at this time. Ms. Lee, I'd like to hand the conference back to you for any additional or closing remarks?

Matthew E. Monaghan -- Chairman, President and Chief Executive Officer

Okay Sam. Thanks everyone for their time this morning. Kathy, Lois and I are available for any follow-up questions, which you can coordinate through Luis Lee. Have a good day. Thanks.

Operator

[Operator Closing Remarks].

Duration: 38 minutes

Call participants:

Lois Lee -- Director of Treasury and Investor Relations and Corporate Communications

Matthew E. Monaghan -- Chairman, President and Chief Executive Officer

Kathleen P. Leneghan -- Senior Vice President and Chief Financial Officer

Peter Lukas -- CJS Securities -- Analyst

Ross Osborn -- Stephens Inc. -- Analyst

David Saxon -- Needham -- Analyst

Brett Fishbin -- KeyBanc -- Analyst

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