Invacare Corporation (NYSE:IVC) Q3 2022 Earnings Conference Call November 8, 2022 8:30 AM ET
Company Participants
Lois Lee – Director of Treasury, Investor Relations and Corporate Communications
Geoffrey Purtill – Interim President and Chief Executive Officer
Kathy Leneghan – Senior Vice President and Chief Financial Officer
Conference Call Participants
Peter Lukas – CJS Securities
Operator
Good morning, ladies and gentlemen, and thank you for standing by. Welcome to the Invacare Third Quarter 2022 Conference Call and Webcast. [Operator Instructions] This conference is being recorded, Tuesday, November 8, 2022.
I will now hand over to Lois Lee, Invacare’s Director of Treasury and Investor Relations.
Lois Lee
Thank you. Joining me on today’s call from Invacare are Geoff Purtill, Interim President and Chief Executive Officer; and Kathy Leneghan, Senior Vice President and Chief Financial Officer.
Today, we will be reviewing our third quarter 2022 financial results and providing investors with an update on our business outlook. To help investors follow along, we have created slides to accompany this webcast. For those dialing in, you can find a link to our webcast slide presentation at global.Invacare.com/investor-relations. Further information can be found in our SEC filings.
Before Geoff 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 third quarter earnings release.
For an explanation of the items discussed on today’s call that are considered to be non-GAAP financial information, such as constant currency net sales, constant currency SG&A expense, 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 to our Web site.
I will now turn the call over to Geoff Purtill.
Geoffrey Purtill
Thank you, Lois, and good morning, everyone. Before we begin, I’d like to say how pleased I am to be here this morning. While I’m new to the CEO role, I have been with Invacare for over 12 years in various roles of increasing responsibilities, and I am very familiar with our products, customers and the markets.
I have enjoyed traveling around the organization and meeting as many associates as possible, and I want to thank them for all of their hard work. I wholeheartedly believe that Invacare has a central role to play in improving the quality of life for our end users by providing home health care solutions that make life’s experiences as possible.
Just over 2 months ago, I was named Interim President and CEO. Since then, the company has acted on various strategic initiatives to strengthen the business and return to profitability. I’m excited about the many opportunities ahead to further optimize the business performance.
As you can see on Slide 3, in late July and early October, we increased our financial flexibility by securing $85 million of additional financing, a portion of which was used to unlock the supply chain. As Kathy will explain in more detail later, Third quarter revenues were impacted by supply chain challenges and component shortages due to supplier delivery holds which have since improved.
Early in the fourth quarter, we have already seen the benefit of this additional liquidity and expect to deliver sequential growth in our key metrics for the full quarter. We continue to work hard to regain the confidence of our customers and the trust of our vendors as we navigate through these challenges.
Turning to our transformation plan. We have spent the better part of the year taking a hard look at every aspect of our business, leaving no stone unturned as we position Invacare for the future. After carefully evaluating our strategic options and core revenue streams, we have determined that the lifestyle and mobility and seating product categories, which have experienced 30% more open orders since the end of last year, are core to improving Invacare’s growth and profitability.
As a result, we are discontinuing production of respiratory products by the end of the year. We will continue to support the respiratory parts and services needs of our customers and honor our respiratory-related warranty and regulatory obligations. As previously guided, sales of respiratory products are anticipated to decline further given excess supply in the market and lower COVID-related demand. Combined with higher input costs and inflationary pressures, respiratory products no longer meet our minimum profitability targets.
Turning to our Board. We have added three new directors who have deep expertise in business turnarounds. We look forward to working closely with our full Board as we continue to navigate through our transformation. In summary, we are committed to taking necessary and decisive action to accelerate the execution of our multifaceted strategic plan and increase shareholder value. We have made great progress in just a few months’ time as the actions we have taken so far are already driving sequential revenue and profitability improvements in early fourth quarter.
Turning to Slide 4. As I mentioned earlier, we are updating our strategic priorities to focus our resources on those categories which have the highest potential. Our core product categories of lifestyle and mobility and seating continued to experience strong demand and orders. These products serve a growing market with favorable demographics and reduces the complexity of the supply chain overall. Our fully refreshed line of award-winning products are driving great customer interest and deliver important end user benefits.
We anticipate that by streamlining operations to focus on our core categories, we will improve product mix, expand gross margin, reduce our cost to serve and ultimately drive higher profitability and increase shareholder value.
I will now turn the call over to Kathy, who will provide a more detailed financial summary.
Kathy Leneghan
Thanks, Geoff. Turning to Slide 6. Consolidated reported net sales declined across all main product categories, primarily due to supply chain challenges, including component shortages, which limited our ability to manufacture products and fulfill existing orders within the quarter. These issues have substantially improved so far in the fourth quarter.
In addition, as approximately 60% of our revenues are earned outside of the U.S., reported net sales were significantly impacted by unfavorable foreign exchange, given the strength of the U.S. dollar. In Europe, more than half of the decline in reported net sales was due to unfavorable foreign exchange, with the remainder due to the aforementioned challenges.
Year-to-date, Europe has achieved modest constant currency net sales growth despite the third quarter anomaly. In North America, revenues declined in all product categories, but most significantly in respiratory products, as anticipated.
Turning to our core products. Open orders for lifestyle and mobility & seating products were $80.5 million at the end of the third quarter as compared to $60.5 million at the end of last year. Open orders remain elevated due to global component shortages, primarily electronic components and other key input materials; supply chain challenges; and supplier delivery holds.
Gross margin decreased due to higher input costs, intermittent production stoppages due to supply chain challenges and component shortages and unfavorable foreign exchange, partially offset by the benefits of pricing actions. Notably, margins were impacted by 510 basis points from the write-down of $8.7 million of inventory and purchase obligations related to the decision to discontinue production of respiratory products, as Geoff previously mentioned.
Constant currency SG&A expense increased primarily due to higher IT costs classified as operating expenses as we paused any further ERP rollout, similar to the first half of 2022, partially offset by lower employment costs. As a reminder, the cash cost of the IT modernization program remains unchanged.
Operating loss increased and adjusted EBITDA decreased due primarily to lower sales, inventory and purchase obligation write-downs related to the discontinuation of the respiratory product line and unfavorable foreign exchange. As anticipated, the company utilized a portion of the proceeds from the financing transactions to help unlock the supply chain and accelerate its transformation initiatives.
We expect to see a sequential improvement in adjusted EBITDA as we begin to convert open orders more efficiently into sales. While the third quarter was challenging, the underlying markets we serve remain healthy and growing, and we continue to experience strong demand and orders for our lifestyle and mobility & seating product category.
Turning to Slide 7. Looking at our performance on a sequential basis. Reported net sales decreased 9.8% with declines in all product categories due to the previously mentioned supply chain challenges and unfavorable foreign exchange of 3%. Early in the fourth quarter thus far, we have seen the flow of incoming materials improve as proceeds from the incremental financing were used to unlock the supply chain.
Constant currency SG&A expense decreased $3.3 million sequentially, driven by lower employment costs. Overall, our cost structure is expected to improve as we realize the benefits of previously announced actions to reduce SG&A expense, with further actions to be enacted.
Operating loss increased and adjusted EBITDA decreased due to lower gross profit from lower revenues, with operating loss also impacted by the write-down of inventory and purchase obligations related to the discontinuation of the production of respiratory products. Free cash flow usage for the quarter was $20.5 million to fund the operating loss and reduce accounts payable.
Turning to Slide 8. Early in the fourth quarter, we have begun to see the favorable trends which bode well for the remainder of the year. As a result of our incremental financing, we have seen improved access to key materials and components.
On a consolidated basis, the company expects to see sequential constant currency net sales growth in the fourth quarter. Adjusted EBITDA is also anticipated to improve sequentially, driven by revenue growth, higher gross profit attributable to the increased effectiveness of pricing actions, improved operational efficiency and restructuring benefits, partially offset by unfavorable foreign exchange.
Through the first 2 months of its fourth quarter, Europe is on pace to deliver sequential constant currency net sales improvement and positive adjusted EBITDA for the quarter. The company anticipates it will incur additional restructuring charges for North America in the fourth quarter as it focuses on improving the profitability of this segment for the long-term. We believe that transformation initiatives we have already executed, in addition to future actions, will support continued improvement in our financial performance.
I will now turn the call back over to Geoff.
Geoffrey Purtill
Thanks, Kathy. Turning to Slide 9. The company has identified additional opportunities to drive growth and improved profitability in 2023 and beyond. As we have demonstrated with the respiratory announcement, we are not afraid to make tough decisions, and we will continue to implement various actions over the next two quarters to strengthen the long-term health of the business. These actions may include product line rationalization, footprint optimization, supply chain simplification, organization rightsizing and liquidity enhancements.
By continuing to evolve and capitalize on the company’s strengths and opportunities, we believe Invacare can return to an industry leadership position. We look forward to announcing further transformation actions as they finalize. Thank you for your continued support of Invacare and for taking time for this morning’s call.
We will now take questions.
Question-and-Answer Session
Operator
[Operator Instructions] Our first question is from Bob Labick from CJS. Please go ahead.
Peter Lukas
Hi. Good morning. It’s Pete Lukas for Bob. As you look out to taking further actions, how can we think about Europe and the rest of the world? Is that something that could be separated? Asking because it seems like that alone is worth more than the enterprise value of the company. And as you look at that, do you see buyers for that business out there? Are there people that would be valuable to? Just kind of how are you thinking about that?
Kathy Leneghan
Yes, Pete, thanks for the question. And so obviously, I think we’ve spoken previously, the European business and the North America business are — there are some overlaps between the two businesses, but they are pretty separate from their perspective. Obviously, there are many different players in the European market in our space as well, and so there could be the potential for interest in that particular business. But we are very happy with the European business. Q3 was pretty much an anomaly from the revenue side of the house, but we see line of sight as we look into Q4 for stronger revenues, stronger profitability. It’s a very healthy business for the company, and we continue to make improvements on not only on the European side of the house, but for the company on a global basis.
Peter Lukas
Helpful. Thanks. And then, Geoff, I guess, just with a fresh set of eyes, in terms of the U.S. seating & mobility, it just has had a really tough time growing post-consent decree. And this actually seems like it has shrunk a little bit despite the new product cycle. Just wondering why — what you see the main issues being, and kind of how you see those improving going forward.
Geoffrey Purtill
Yes. Thanks, Pete. Look, I think the mobility & seating channel is one where reimbursement is pretty key. And in some ways, we’ve struggled a little bit to meet those needs adequately with some of the supply chain challenges we’ve had. But we do see good synergy. This is one area where a global portfolio is very helpful. At the moment, we don’t have that, and that’s an area that we would look to work towards so that we have a more cost effective and more efficient product range that meets the needs of the reimbursement, but also our end users. So we do see some opportunity for growth there.
Peter Lukas
And then I guess lastly, sticking with the supply chain. You say it seems to be improving a bit in Q4. Is that something that you feel, with the liquidity that you have now, can kind of finally put behind you? It just seems that you guys have been losing share across all product lines. I’m just wondering if that’s just mainly the supply chain, or is it something competitors are doing differently?
Geoffrey Purtill
I think that’s an interesting question, Pete. I guess, if the expectation is or the — if you think we are losing share, then the competitors are doing something different. But I’d say the supply chain issues are consistent across all competitors. Some people are experiencing them in different ways. But what we do see is commodity pricing in general, not in every area, but commodity pricing in general, looking like it will stay pretty much the same in ’23 versus ’22. We do see freight coming down, which should be a benefit to everyone and certainly to us. But we are a broad portfolio across multiple countries, and that comes with some complexity that some of our competitors don’t have. So that’s something that we need to address in our portfolio as we go forward. But I’d say, in the supply chain in general, freight seems to be coming down, but other costs seem to be about the same. And of course, I don’t have a crystal ball, so I don’t know what other things might happen in the marketplace over the next year or so.
Kathy Leneghan
But I would agree, Geoff. I don’t think the supply chain challenges are unique to the company. And while we are seeing some commodity costs come down, electronics still continue to be a challenge for the company and for our competitors to be able to access those components to be able to complete units to customers.
Peter Lukas
Appreciate it. Very helpful. Thanks. I will jump back into the queue.
Geoffrey Purtill
Thanks, Pete.
Kathy Leneghan
Thank you.
Operator
[Operator Instructions] We have no further questions on the call, so I will hand the floor back to the team at Invacare.
Geoffrey Purtill
Thanks, Sebastian. Thank you for your time this morning. Kathy, Lois and I are available for any follow-up questions, which you can coordinate through Lois Lee. Have a great day.
Operator
This concludes today’s conference call. Thank you all very much for joining. You may now disconnect your lines.
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