Invacare Corporation (NYSE:IVC ) Q1 2022 Results Earnings Conference Call May 10, 2022 8:30 AM ET

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

Matthew Monaghan - President and Chief Executive Officer

Kathleen Leneghan - Senior Vice President and Chief Financial Officer

Brett Fishbin - KeyBanc Capital Markets

Peter Lukas - CGS Securities

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 first quarter 2022 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 in our SEC filings.

Before Matt begins, I'd like to note that during today's call, we may make forward-looking statements about the company that, by their nature, address matters that are uncertain. Actual future results may differ materially from those expressed in our statements today due to various uncertainties, and I refer you to the cautionary statement included on the second page of our webcast slides and in our first quarter earnings release. For an explanation of the items discussed in 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 and the earnings release posted on our website. I will now turn the call over to Matt Monaghan.

Thank you, Lois, and good morning. Beginning on Slide 3, we started 2022 with strong revenue growth, led by sales of mobility and seating as new high-value products gained traction with customers and as pandemic-related health care access continued to improve. We're encouraged by strong demand across all our product lines and regions and continued elevated backlog reflecting the strength of our portfolio. Our innovation engine, which didn't stop during COVID, has continued to produce new compelling products that drive strong demand. At the same time, and as noted in our fourth quarter '21 release, we anticipated temporary challenges would negatively impact gross margin in the first quarter. To address this, we've emphasized our more clinically valuable products and discontinued parts of our product ranges we can't support in the current environment. We've instituted price increases to offset higher costs, and we've taken steps to optimize value to our customers like aggregating orders and moving shipping locations. In addition, we expect to take further actions this year that will improve operating results. We anticipate the benefit of mix shift and pricing actions to be increasingly impactful in the sequential quarters. Overall, first quarter results were in line with our expectations, reflecting the seasonality of our business and the time lag of mitigating action.

Turning to Slide 4. After a deep strategic review of our current projects and processes and with the assistance of third-party experts, we've identified opportunities to improve our business to better serve our customers and to yield better results. These can be broadly classified in 2 core areas. First, as we announced last week, we've taken actions to streamline our operations and lower costs by simplifying the organization, especially leveraging technology to eliminate noncore administrative processes. Actions taken year-to-date through early May are expected to provide a benefit of approximately $6 million in 2022 and approximately $9 million on an annual run rate basis. Overall, once restructuring actions are completed, we anticipate a benefit of approximately $11 million in 2022 and at least $20 million of an annual run rate basis savings. This will be funded by restructuring costs of approximately $15 million to be incurred and paid in 2022. We have a strong track record of simplifying the organization while lowering costs to serve. As a result, SG&A expenses are expected to decline meaningfully in the second half of the year.

Second, turning to product mix. We're focusing on the parts of our product ranges with higher clinical value we can deliver more efficiently. This is expected to drive favorable sales mix, reduced complexity and lower cost, which is critical in the supply chain environment. Combined with pricing actions to offset higher costs, we expect a significant uplift in gross profit for the remainder of the year. The expected benefit across Europe and North America is approximately $21 million in 2022. Even through COVID, we continued launching new products with compelling clinical value in all product categories. These products have been well received by our customers and are expected to drive incremental sales growth. This will give us a strong foundation to narrow product line this year and still achieve solid sales results. We anticipate a net benefit of approximately $3 million for the remainder of the year.

In addition, further opportunities to simplify our organization are expected to reduce SG&A expense related to IT, administrative and other spending. We expect these actions will drive sequentially improving financial results enabling us to achieve full year guidance with higher adjusted EBITDA and free cash flow than the prior year. I'll now turn the call over to Kathy for a more detailed financial summary.

Thanks, Matt. Turning to Slide 6 on our consolidated results. Reported net sales increased 2.4% and demand trends remained strong. Constant currency net sales increased 6.4% led by Europe with 11% growth as a result of double-digit increases in sales of lifestyle and mobility and seating products. North America achieved nearly 12% growth in mobility and seating products, primarily attributable to power wheelchairs. For respiratory products, we saw similarly strong demand but continued supply chain disruptions delayed quarterly sales due to the availability of components. Gross profit as a percentage of net sales declined as the benefit of price increases was more than offset by higher input costs, including material and freight costs as well as unfavorable variances. I would remind you that these inflationary costs were largely absent in the first quarter of last year.

For example, container costs for products shipped from Asia to the U.S. in the first quarter of last year were approximately $8,000 for a 40-foot container. That same shipment in the first quarter this year was $20,000 or 2.5x the cost. Similarly, the price of steel is more than 2x the price we paid in the first quarter of last year and is a significant input cost for products like beds, lifts and wheelchairs. These macroeconomic issues are not unique to Invacare. Due to the essential nature of our products and critical equipment we provide, the market is supporting price increases to mitigate higher input costs, which have been implemented not only by us, but also our competitors. In addition, we anticipate favorable sales mix emphasizing products that provide higher clinical value, which support higher selling prices as we progress during the year. While gross profit reflected higher average selling prices, the benefit was muted by the fulfillment of orders and backlog at old pricing and the timing of the effectiveness with customer contracts. We expect the actions we have undertaken to become increasingly more effective as the year progresses and positively impact margins.

At the same time, issues of a more temporary nature also impacted margins during the quarter. As previously guided during our fourth quarter 2021 release, Omicron related absenteeism, coupled with the lack of available components led to operational inefficiencies. In addition, we saw unfavorable product mix as we continue to optimize our product portfolio and sell off low-margin inventory. Constant currency SG&A expense increased primarily due to IT costs classified as operating expenses as we temporarily paused any further ERP rollout with consideration of the restructuring and strategic actions to be implemented by the company. Previously, these costs would have been classified as capital expenditures. We anticipate higher levels of SG&A expense will continue through the second quarter of 2022 related to this classification change. Importantly, the cash cost of the IT modernization program remains unchanged.

As Matt mentioned, our cost structure is expected to decrease as we realize the benefit of strategic actions, which are anticipated to reduce SG&A expense going forward, especially for the second half of the year. For example, in North America, more than 40% of our SAP orders are now processed automatically as customers enter orders directly via e-commerce tools available in the system. In addition, a large portion of quotes and orders if received by e-mail or fax can now be automatically uploaded to the system. This has significantly reduced the amount of manual intervention and reduces our costs to serve while improving the customer experience. Early feedback from customers and associates has been favorable, and we expect additional efficiencies as they become more familiar with the enhanced tools at their disposal.

Operating loss and adjusted EBITDA were both lower due to decreased gross profit and higher SG&A expense. We also recognized restructuring charges of $3.8 million in the quarter. The restructuring actions taken in the first quarter are expected to generate annual run rate savings of $3 million, with approximately $2 million to be realized over the remainder of the year. Free cash flow usage for the quarter was $29.8 million, primarily to fund the operating loss and the payment of customer rebates and accounts payable. This was in line with historic seasonality as the company generally consumes cash in the first half of the year and generates cash in the second half of the year. We expect this trend to continue and be amplified as we realize the benefit of effective pricing and restructuring actions to improve the profitability and free cash flow along with the benefit of working capital converting to cash in the remainder of the year. As guided, we expect free cash flow to improve sequentially throughout 2022.

Turning to Slide 7. We are reaffirming our full year guidance with improvement in both adjusted EBITDA excluding the benefit of the CARES Act loan forgiveness in 2021 and free cash flow compared to the prior year. In addition, we anticipate sequential improvement in both key metrics in the last 3 quarters of the year, as effective pricing offsets higher costs and favorable product mix with the benefit of restructuring actions are realized. Reported net sales for the year are anticipated to be flat to down 1% to 2% compared to last year as we continue to optimize the product portfolio, partially offset by the introduction of new products and the benefit of pricing actions. I will now turn the call over to Matt.

Thanks, Kathy. Before we conclude today, I'd like to thank our associates who worked so hard to ensure we continue to make progress and serve our customers. Despite many challenges in the past few years, we delivered vital health care solutions by being flexible and reactive to the ever-changing environment. In 2022, we're taking actions to reset how we work to address persistent market conditions more easily. As the year progresses, we look forward to providing updates on other transformative changes expected to generate profitable growth in 2022 and beyond. Overall, we remain confident these actions will drive durable results and greater shareholder value.

Thank you for your continued support and for taking time for this morning's call. We'll now take questions. Nadia?

[Operator Instructions] And our first question today comes from Matthew Mishan of KeyBanc.

This is Brett Fishbin on today for Matt. Starting off, I know you touched on it a little bit in the remarks, but just given there's 2 different components of the restructuring programs you've announced. Can you just lay out clearly when do you expect to realize the expected savings through 2022 and into 2023, just for our modeling purposes?

Kathy, why don't you help with the precision on timing? Brett, the actions have started, so obviously, things that we've announced in the 8-K that revealed year-to-date actions will anniversary through practically all of this year and then you can roughly do the math on what's left to achieve this year and see how it goes into the first quarter of 2022. Actions will continue through fourth quarter based on the tools that we evolve that will allow us to be more efficient and to operate with lower cost. But Kathy, can bring a little precision to that for you.

Yes. So for the actions that we've already implemented and announced, we would see a very small benefit in Q2. The majority of the benefit would be in Q3 and Q4, just given timing of notification to employees and when those employees would cease working for the company. Actions were taken both in Europe as well as in North America. The benefits are seeing quicker in North America versus Europe, just given timing of notification periods. So primarily, and as we've spoken about previously, the majority of the restructuring savings that would be announced this year, we would see in the second half of the year, and that's what's going to drive reduced SG&A structure as well as improvement in the margins for the second half of the year.

All right. I appreciate that color. And then just thinking about some of the elevated costs you're seeing around the supply chain with freight and materials. Have you started to see any level of improvement there in April and early May? Or is it still kind of status quo versus the first quarter?

The more important improvement for us, honestly, is the volatility. If prices are elevated but stable, then we and our customers and markets generally can absorb those kind of changes. What was really tough in 2021 and the first quarter of 2022, it's been just a rate of change. I think it's slowed down a little. We've even seen some temporary improvements in cost, I think, more before the invasion of Ukraine and after where things like steel and diesel fuel have gone back up. But 2022 looks a little more predictable. We've talked to our suppliers. We can see a little bit further out on availability and cost and that helps us work meaningfully with customers to deal with the issues that higher costs affect everyone. So that feels better more about volatility than the actual specific price of things.

All right. And then lastly for me. Just thinking about the free cash flow dynamics I think you alluded to improved profitability as one of the key drivers there. But just thinking about some of the other moving pieces, is there anything you would call out that gives you confidence in hitting the directional guidance of improvements year-over-year, maybe with a specific lens around some of the working capital moving pieces.

Maybe Kathy can join me here on a joint answer. I think you'd see results of improved AR as we get into the year and finish up the implementation early in the year of SAP in North America for the functionality that we deployed. We've got new tools that are helping with planning in our sales inventory operations process for material management, and we're seeing results of inventory that are looking favorable and those tools and the lower volatility with suppliers is giving us part of the confidence for working capital this year. Kathy, what would you add?

Yes. I think the key is we have a season -- we do have a very seasonal free cash flow. We do anticipate that free cash flow will improve sequentially for the last 3 quarters of the year. That is driven by the improvement in the profitability, but also an improvement in working capital, primarily inventory. We still have a significant investment of inventory in our balance sheet, and we do anticipate that a portion of that will turn to cash in the year.

[Operator Instructions] And our next question comes from Bob Labick of CGS Securities.

It's Pete Lukas for Bob. Just to start with a 2-part question. One, if you could discuss in a little bit more detail North American pricing and volume in Q1 and your assumptions for the year. And then in terms of pricing, can you kind of discuss how that works? Are reimbursement rates going up? Or do you take price and that comes out of pocket?

Kathy, why don't you take the first part of that?

Yes. So we've given guidance for the consolidated company in regards to revenues. We do anticipate for the year that revenues would be down 1% to 2%. That does include the benefit of pricing actions that are being taken in Europe as well as in North America. And it would be offset by the product discontinuations that we would have to eliminate products that no longer meet a certain threshold or profile. That same concept would be true in North America as well, probably more so on the discontinuation side of the house. But we would anticipate on a consolidated basis, as I mentioned, that revenues would be down roughly 1% to 2% on a reported basis.

And then reimbursement levels, depending on the country and the product category have shown some flexibility in the United States. There's been some moderate or minor uplift continue to account for inflation. We have certain agreements in place around the world with customers that give us a pricing adjustment based on a basket of factors. Otherwise, it's absorbed in the marketplace generally. Some customers don't get direct reimbursement for a product. They'll put the product in a fleet, which gets reused over a long period of time where in the care, durability, [use per day] and total cost and then the reimbursement that they get is for a monthly rental fee or something like that for the product, so it is more indirect.

Great. And just sticking with pricing. How much pricing do you need to get parity on products? And how often do the prices get set and how often do you see changes in the -- in reimbursement?

Well, you can see the level of margin compression we've had this quarter and we've reported in the past few quarters, and that's really just the simple mechanism of the lag between when we see higher input costs. And when we're able to translate that into price changes to our customers, that's normally a 90-ish day process depends on a lot of local differences. So you would imagine that we need to do enough in pricing to offset those costs in addition to the actions we take to be more efficient and cost effective in how we convert materials to finished goods for our customers, so that's the basic equation. I think we've seen very constructive dialogue with customers and reimbursement agencies on how this all works. No one is immune from the cost increases that we're seeing, steel, diesel, plastics, transportation of all forms. And so it's just a matter of remaining competitive.

And I think the Invacare advantage is we can normally demonstrate pretty conclusively that total cost of ownership is lower when someone buys an Invacare product and puts in their fleet because they're more reliable and tend to last longer with less refurbishment or less unreimbursed service over time. So that's the value equation that continues to hold strong for our company and allows us to be engaged with customers to keep growing the business. In addition, we continue to roll out new products that meet a margin profile. They're designed to go through the supply chain, the modern supply chain more effectively and they have really compelling value exchange in the clinical setting. So that's the equation here.

Great. And just one more, if I could. In terms of the product portfolio changes that you've made, can you maybe give us a few examples of some of the bigger changes that are impacting margins and revenues?

We are typically looking at each range in their clinical range of value. So in beds, we have more and less valuable products, which also have more and less price for customers. They do more and fewer things for customers in a clinical way. But if you took a bed, for example, on average, a low end bed or a high end bed has roughly the same amount of steel in it. So when the price of steel doubles or triples, you have a different problem to solve by passing that on in a low-value bed or a high-value bed, which might have 10x the price in the marketplace. So it's an easier opportunity for us to talk to customers about making those adjustments at the high end. And those are in every product category. We have simple and complex beds, simple and complex saving aids, simple and complex respiratory products and mobility and seating solutions and our sales team and clinicians and everyone are really working naturally in concert to align to the higher value things that can be delivered in the market in these inflationary times.

[Operator Instructions] We currently have no further questions. I'll hand the call back over to Matt Monaghan for any closing remarks.

Okay. Thank you, Nadia, and thanks, everyone, for your time on the call this morning. Kathy, Lois and I are available for any follow-up questions, which you can coordinate through Lois Lee. Have a good day.