Invacare Corporation (IVC) Q3 2021 Earnings Call Transcript

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Invacare Corporation (IVC)
Q3 2021 Earnings Call
Oct 28, 2021, 8:30 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Good morning, ladies and gentlemen, and thank you for standing by. Welcome to the Invacare Third 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 cannot be submitted via the webcast. For the first part of the call, all phone lines have been placed on mute. This conference is being recorded Thursday, October 28, 2021. I will now turn the call over to Lois Lee, Invacare's Director of Treasury, Investor Relations and Corporate Communications. Thank you.

Lois Lee -- 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 Leneghan, Senior Vice President and Chief Financial Officer. Today we will be reviewing our third 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 global.invacare.com/investor-relations. Further information can be found on 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 are just 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 live and on our third quarter earnings release. For an explanation of the items discussed on today's calls that are considered to be non-GAAP financial information, such as constant currency net sales, constant currency SG&A, free cash flow and adjusted EBITDA please see the notes in the appendix of our webcast slide and in the related reconciliations in the slides, and in the earnings release posted on our website. I will now turn the call over to Matt.

Matt Monaghan -- Chief Executive Officer and Chairman of the Board

Thank you, Lois and good morning. Starting on slide three, I'm pleased to announce that we achieved constant currency net sales growth of 2.9% with increases in all key product categories despite continuing global supply chain challenges. Revenue growth was led by solid performance in Europe and Asia-Pacific and North America realized growth in mobility & seating and respiratory products appeared with strong new order intake, we continue to experience higher than typical backlog levels across all product categories compared to pre-pandemic levels, which is expected to drive sequential sales growth in the fourth quarter. As always, we're working diligently to maximize our throughput and improve our service levels to better support our customers' needs. Turning to gross profit, we've benefited from sales growth and favorable sales mix with higher gross profit on lower percentage of sales. Gross margin was impacted by previously disclosed changes to input costs ahead of offsetting price adjustments. We view these challenges as transitory and during the quarter we undertook actions to address them which I'll discuss more in detail in the next slide. To support existing levels of demand and expected sales growth, free cash flow usage increased as a result of greater investment in working capital, specifically inventory, which Kathy will discuss later. Overall, our third quarter sales results were in line with expectations with solid revenue growth year-over-year in all major product categories. Turning to slide four, we expect to finish the year on a strong note, while we anticipate global supply chain challenges to persist in the near-term, the disruptions are generally more predictable, and the actions we've taken should mitigate some of the remaining uncertainty.

In addition, our customers continue to demonstrate strong demand for our products even though access to healthcare has not fully rebounded from pre-pandemic levels. As mentioned previously, we're taking action to mitigate the supply chain challenges which impacted sales and gross margins. For example, we expanded our network of freight providers for more timely shipments, we found ways to improve staffing levels to increase throughput, and we have further increased inventory to mitigate supply chain uncertainties. In addition, we continue to adjust price and freight charges were applicable to offset the substantially higher material and logistics costs we continue to experience. Well still early in the fourth quarter, we're seeing positive signs that our actions should be effective. As we work through these near-term challenges, we're also marching forward with the next phase of our IT modernization Initiative in North America. I'm pleased to share that the program took a big step forward following the launch of our new e-commerce platform, which has features to enhance the customers experience and to improve the ease of doing business with Invacare. In 2022, we expect to launch the next phase in North America, which will focus on driving operational efficiencies, lowering costs and improving working capital management. Turning to sales, demand remains strong and we continue to see solid order rates in all regions and product categories. As we grow revenue, our order backlog has also continued to increase. In the third quarter, product availability in our targeted inventory strategy were key factors in driving strong sales growth in both Europe and Asia-Pacific. Specific material shortages, limited some of lifestyle product availability in North America balancing overall results. All things taken together, we expect fourth quarter will improve in all key metrics with sequential constant currency net sales growth, driving substantially higher profitability and free cash flow. We believe the progress we have made sets us up for a strong finish to the year and continued improvement in 2022. I'll now turn the call over to Kathy who will provide a detailed financial summary.

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

Thanks, Matt. Turning to slide six, reported net sales increased 5.8% and constant currency net sales increased 2.9% in line with our quarterly guidance, and driven by growth in all key product categories, sales growth was the result of continued strong order intake, and the conversion of a portion of the excess backlog from the second quarter of 2021. Gross profit increased $300,000 and benefited from net sales growth and favorable sales mix. However, gross profit as a percentage of sales declined 140 basis points. As previously discussed, gross margin continued to be impacted by global supply chain related challenges and labor shortages resulting in elevated manufacturing costs for the quarter. We expect many actions we have undertaken to mitigate these higher costs to become effective and benefit margins in the fourth quarter of '21. Constant currency SG&A expense decreased primarily related to lower employee related costs, including stock compensation expense. To drive profitability, we continue to align commercial expenses with net sales growth and monitor all discretionary spending. Operating loss excluding the goodwill impairment charge was $3.8 million, an improvement of $900,000 from the third quarter of 2020. This improvement was driven by sales growth and lower restructuring costs. In the third quarter of '21, the company recorded a one-time non-cash charge related to an impairment for Goodwill of $28.6 million. The company's reporting units for Goodwill assessment North America HMV, and the Institutional Products Group merged into one reporting unit as a result of changes to the operating structure of the North America business and the implementation of a new enterprise resource planning system at the end of the quarter. This change was considered a triggering event and required the company to perform an interim goodwill impairment test.

Adjusted EBITDA was $18.1 million, an increase of $8.3 million primarily attributable to $10.1 million of CARES Act benefit, and net sales growth partially offset by higher supply chain costs. Excluding the CARES Act benefits, adjusted EBITDA for the third quarter was $8 million. Note that the CARES Act benefit was and is not considered in the company's full-year 2021 guidance for adjusted EBITDA. Free cash flow usage for the quarter reflects an investment in working capital, including $10.1 million of additional inventory as compared to the second quarter of '21. As previously disclosed, the company increased inventory levels to mitigate supply chain disruptions and to prepare for expected sequential sales growth in the fourth quarter. We anticipate that inventory levels and accounts receivable will remain elevated at year-end and convert to cash over the next few quarters. Turning to slide seven, reported net sales in all key product lines improved despite supply chain challenges, which continued to limit the conversion of orders to revenue. We continue to see strong demand in all product categories and in all regions, which resulted in excess order backlog that was higher than typical compared to pre-pandemic levels and similar to the end of the second quarter. We're working diligently to reduce the excess backlog and return our service levels back to more normal lead times. On a consolidated basis, constant currency net sales of Lifestyle products grew 5.2% driven by exceptionally strong sales of manual wheelchairs and hygiene products in Europe. Mobility & seating products also achieved constant currency net sales growth in North America and Asia Pacific. In addition, we continue to see elevated demand for respiratory products globally related to the pandemic. Turning to slide eight, Europe constant currency net sales increased 4.5% driven by more than 17% growth in lifestyle products as a result of heightened demand for products that were readily available, demonstrating the importance of our targeted inventory strategy. While respiratory demand remained strong, fulfilling that demand has been hindered by the availability of components to complete orders.

Gross profit increased $3.2 million, and gross margin increased 20 basis points driven by net sales growth and favorable product mix partially offset by higher freight costs and supply chain disruptions. As Matt mentioned, we have taken actions to mitigate the impact of these additional costs and expect to see benefits starting in the fourth quarter. Operating income benefited from SG&A leverage and increased by $2 million, driven by higher gross profit from revenue growth. Turning to slide nine, North America constant currency net sales decreased slightly, a 7% increase in mobility & seating and an over 6% increase in respiratory products was more than offset by lower sales of lifestyle products. Higher sales of mobility & seating products was driven by power wheelchairs and power add-on products. The lifestyle product category was impacted by supply chain issues limiting the availability of materials and components in particular for bed. In addition, access to institutional and government customers' remains limited compared to pre-pandemic level. That said, overall, we continue to see increased customer interest in all products and strong order intake. Gross profits declined by $2.8 million and gross margin declined 80 basis points due to unfavorable operating variances as a result of supply chain challenges, partially offset by favorable product mix. Operating loss of $1.5 million was impacted by reduced gross profit and higher SG&A expense, the latter of which came primarily as a result of spending supporting revenue growth. As noted the goodwill impairment charge previously discussed is not included in the operating results for North America.

Turning to slide 10, constant currency net sales in the Asia Pacific region increased 17%, driven by significantly higher sales of respiratory products, and an over 15% increase in mobility & seating products. Sales rebounded in the Asia Pacific region as a result of receiving products delayed from the second quarter, which had been impacted by global shipping issues. Operating loss improved by $2.2 million, driven primarily by lower corporate SG&A expense, including reduced stock compensation expense. This was partially offset by lower profitability in the Asia Pacific region impacted by higher material and freight costs as well as higher SG&A expense. Moving to slide 11, as of September 30, 2021, the company had total debt of $318 million, excluding financing and operating lease obligations, and $74 million of cash on the balance sheet. Lower cash balances are primarily related to higher levels of working capital, which we anticipate will remain elevated through the end of the year. As part of the company's strategy to mitigate supply chain challenges and to prepare for expected sales growth, the company added $10.1 million of incremental inventory in the quarter, which is expected to convert to cash over the next few quarters. In the third quarter of 2021, the company received forgiveness of its CARES Act that obligation of $10.1 million of principal and accrued interest. Turning to slide 12, we are reaffirming our full-year guidance for 2021 consisting of constant currency net sales growth in the range of minus 1% to positive 2%. Adjusted EBITDA in the range of $30 million to $37 million, and free cash flow usage in the range of $10 million to $20 million. As previously mentioned, full-year adjusted EBITDA guidance does not include the CARES Act benefit recognized in the third quarter. For the fourth quarter, the company anticipates sequential improvement and constant currency net sales growth driven by continued strong order intake and the conversion of a portion of its elevated backlog into revenues. We expect the actions we have taken to support sales growth and manage near-term supply chain challenges will drive sales growth, favorable sales mix and expand gross margin. As a result, adjusted EBITDA and free cash flow are expected to improve materially. I will now turn the call back over to Matt.

Matt Monaghan -- Chief Executive Officer and Chairman of the Board

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

Questions and Answers:

Operator

Thank you. [Operator Instructions] Our first question comes in from Bob Labick from CJS Securities. Your line is open. Please go ahead.

Bob Labick -- CJS Securities -- Analyst

Good morning. Thanks for taking my questions.

Matt Monaghan -- Chief Executive Officer and Chairman of the Board

Hi, Bob.

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

Good morning, Bob.

Bob Labick -- CJS Securities -- Analyst

Hi. Wanted to start with the North American mobility & seating obviously some nice growth year-over-year, but still down versus kind of 2019 levels. Wanted to get a sense, where do you think the market is versus 2019? And you guys have a whole new lineup and out there since over the last few years, so what does it take to kind of win share and grow North American seating and mobility over prior levels looking ahead?

Matt Monaghan -- Chief Executive Officer and Chairman of the Board

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

Bob Labick -- CJS Securities -- Analyst

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

Matt Monaghan -- Chief Executive Officer and Chairman of the Board

Yes, that may be something, Kathy, and I'll have to join the answer here, you know, I think right now, we're trying to be very surgical about adjustments to price and surcharges that are whatever to offset very specific changes in material costs or labor or freight, so that we're competitive and fair with our customer partners. And there is always a little bit of lag and where we incur costs, then we have to kind of apply those to any price changes that we need to have going forward. And there's always a little bit of delay for that happening. And that's why margin is going to lag a little bit to the extended prices-sorry, our costs are changing at a rapid rate. And, Kathy, if you have a way to estimate an answer for Bob into that differently.

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

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

Bob Labick -- CJS Securities -- Analyst

Got it. Okay, great. And then last one for me, I'll jump back in queue. And talk about it a little bit here. The price increases I think you put in place in September 1st, and there's a little lag to go through there. How have they been received and have your competitors raise prices yet? Because obviously, they're facing the same headwinds that you are. But the timing could be different. So maybe talk about how the price has been received and the competitive dynamic of pricing right now in the industries that you serve?

Matt Monaghan -- Chief Executive Officer and Chairman of the Board

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

Bob Labick -- CJS Securities -- Analyst

Got it. Okay. Thanks very much.

Matt Monaghan -- Chief Executive Officer and Chairman of the Board

Okay, good to talk about.

Operator

Our next question comes in from Matt Mishan of KeyBanc. Matt your line is open. Please go ahead with your question. Thank you.

Matt Mishan -- KeyBanc -- Analyst

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

Matt Monaghan -- Chief Executive Officer and Chairman of the Board

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

Matt Mishan -- KeyBanc -- Analyst

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

Matt Monaghan -- Chief Executive Officer and Chairman of the Board

Yes, Kathy, you want to give answer to that?

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

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

Matt Mishan -- KeyBanc -- Analyst

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

Matt Monaghan -- Chief Executive Officer and Chairman of the Board

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

Operator

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

Unidentified Participant

Hi, this is Joseph on for Mike. Appreciate taking our questions. I guess the first one.

Matt Monaghan -- Chief Executive Officer and Chairman of the Board

Good morning.

Unidentified Participant

Morning, morning. Around employee retention? How I guess-what steps have you guys taken to improve that rate? And how confident are you that that turnover rate will decline in the future?

Matt Monaghan -- Chief Executive Officer and Chairman of the Board

Yes, we have a great team of associates. And I think this is the era of everybody's got to be the best employer that they can be, because employees do have choices. So we try to offer great competitive rates, good work environment, benefits of pathway forward to expand what people do in the company, no matter what their line of work or expertise isn't. It depends on kind of locally, what those dynamics are like. But we're really excited about our access to labor. We have looked at it everywhere we are to make sure that we are competitive in those local markets. And I like the way that our local teams are addressing those. It's a whole constituency between all those factors that I've mentioned. So I think we've got a path forward to do this. But it's a very dynamic workplace right now. And we're going to have to continue to be competitive all the time.

Unidentified Participant

Okay. That's helpful. And then maybe, could you guys possibly quantify the order backlog that you currently have?

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

In the guidance, I think it will be in our remarks suite that it is as a similar level as what we saw at the end of the second quarter, until while we continue to see strong demand on that backlog level is roughly about the same. And that number at the end of Q3 was about $15 million. Again, that's the number that's higher than our normal pre-pandemic backlog that we would have seen. And obviously influenced by just component the availability of components to be able to ship and fulfill those orders.

Unidentified Participant

Sure, OK. That's helpful. That's all from me. Appreciate it.

Matt Monaghan -- Chief Executive Officer and Chairman of the Board

Okay. All right. Thanks, Joseph.

Operator

[Operator Instructions]. We currently have no further questions registered on the line. So I'll hand back to the management team.

Matt Monaghan -- Chief Executive Officer and Chairman of the Board

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

Operator

[Operator Closing Remarks]

Duration: 30 minutes

Call participants:

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

Matt Monaghan -- Chief Executive Officer and Chairman of the Board

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

Bob Labick -- CJS Securities -- Analyst

Matt Mishan -- KeyBanc -- Analyst

Unidentified Participant

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