Invacare Corporation (NYSE:IVC) Q2 2022 Earnings Conference Call August 9, 2022 8:30 AM ET
Company Participants
Lois Lee – Director of Treasury, Investor Relations and Corporate Communications
Matt Monaghan – President and Chief Executive Officer
Kathy Leneghan – Senior Vice President and Chief Financial Officer
Conference Call Participants
Pete Lukas – CGS Securities
Brett Fishbin – KeyBanc
Operator
Good morning, ladies and gentlemen, and thank you for standing by. Welcome to the Invacare Second Quarter 2022 Conference Call and Webcast. After the management overview, we will open the call to questions. Investors and analysts interested in asking question 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 Tuesday, August 9, 2022.
I will now turn the call over to Lois Lee, Invacare’s Director of Treasury, Investor Relations and Corporate Communications.
Lois Lee
Thank you. Joining me on today’s call from Invacare are Matt Monaghan, Chairman, President and Chief Executive Officer; and Kathy Leneghan, Senior Vice President and Chief Financial Officer. Today, we will be reviewing our second quarter 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 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 adjust 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 second 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, 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 earnings release posted on our website.
I will now turn the call over to Matt Monaghan.
Matt Monaghan
Thank you, Lois, and good morning. Beginning on Slide 3, during the second quarter, we achieved sequential improvement in adjusted EBITDA as our strategic actions began to positively impact performance. In particular, the improved results were driven by lower SG&A expense and strong improvement in gross margin, due to increased pricing effectiveness and favorable product mix.
While input costs remain high, we’re seeing a greater impact from pricing actions as costs are somewhat less volatile. In addition, free cash flow turned positive, a significant improvement compared to both the prior year and sequentially. The improvement was driven by lower working capital as our cash conversion cycle improved, driven by improved cash collections and reduced inventory.
Looking at revenue for the quarter, we achieved sequential growth in mobility and seating products driven by increased adoption of our compelling product portfolio. As a testament to our culture and innovation, we’re proud to once again receive industry recognition in many categories for outstanding products and technology in our mobility and seating category.
Sales of lifestyle and respiratory products were impacted by continuing component and supply chain challenges, issues we are better positioned to address today and which I will discuss further momentarily. At the same time, we continue to experience elevated order backlog across all product categories and regions and see strong demand in mobility and seating and lifestyle products.
While backlog for respiratory products remains elevated, sales are anticipated to normalize in the next several quarters to pre-pandemic levels given less COVID-related demand for these products. The recent improvements in our business performance were pleased and secured additional capital after second quarter, which provides increased liquidity and flexibility.
We expect this strategic funding will enable us to more effectively work with our suppliers and find alternative solutions to short-term supply constraint, which will help us more quickly convert backlog customer orders to sales and accelerate transformative plans to drive long-term profitability. We anticipate the additional liquidity will also enhance our transformation plan to optimize product portfolio, physical footprint, lower operating costs, and improve operating leverage.
As we’re in the early stages of deploying additional capital, we look forward to providing updates in the coming quarters on how these actions are anticipated to drive profits and enhance shareholder value. Overall, we’re seeing favorable trends across the business, despite a challenging macroeconomic environment of cost and availability of inputs. While we have more work to do, we’re confident that we have the right tools, the right team, and the right balance sheet to drive sustainable long-term results.
I’ll now turn the call over to Kathy, who will provide a more detailed financial summary.
Kathy Leneghan
Thanks Matt. Turning to Slide 5, On a year-over-year basis, reported and constant currency net sales declined as continued supply chain challenges and component availability impacted our ability to efficiently serve our heightened demand. Gross margin was impacted by higher input costs intermittent product stoppages, due to supply chain challenges, and unfavorable foreign exchange, partially offset by the benefit of pricing actions.
Constant currency SG&A expense decreased primarily due to lower employment costs, partially offset by higher IT costs, classified as operating expenses as we temporarily pause any further ERP roll-out, similar to the first quarter of 2022. As a reminder, the cash cost of the IT modernization program remains unchanged.
Operating loss increased and adjusted EBITDA decreased due to lower gross profit from lower sales, higher restructuring costs, and IT expenses recorded as SG&A expense. As Matt noted, free cash flow turned positive for the quarter, an improvement of $27.3 million, driven by strong management of accounts receivable and inventory.
Turning to Slide 6, looking at our performance on a sequential basis, reported net sales decreased 6% and constant currency net sales decreased 3.2%. Growth in mobility and seating products was achieved in all regions driven by higher sales of powered mobility products.
Sales of respiratory and lifestyle products declined as a result of the aforementioned supply chain challenges, which limited the company’s ability to fulfill orders and reduced the elevated order backlog. Despite softer sales, gross margin increased 160 basis points sequentially, driven by favorable pricing actions. As previously noted, there is a lag between the impact of higher input costs and the effectiveness of pricing actions and we anticipate sequential gross margin improvement as costs stabilize.
Constant currency SG&A expense decreased sequentially due primarily to lower product liability costs, partially offset by higher stock compensation expense. Overall, our cost structure is expected to improve as we realize the benefit of previously announced actions to reduce SG&A expense with the majority of the benefits starting in the second half of the year and into 2023.
Operating loss and adjusted EBITDA improved driven by higher gross profit and lower SG&A. Free cash flow generation for the quarter was $0.1 million, an improvement of $30 million, driven by reduced working capital, primarily the benefit of a shorter cash conversion cycle, favorably impacted by accounts receivable and inventory.
Turning to Slide 7, as Matt mentioned, we anticipate the additional liquidity to partially ease supply constraints by allowing the company to expedite key raw materials and components, onboard additional suppliers, and take internal actions to redesign products to mitigate supply constraints.
For the second half of 2022, adjusted EBITDA is anticipated to improve compared to the first half of the year, driven by gross profit improvement with the benefit of favorable product mix and price effectiveness, as well as lower operating expenses. As anticipated, demand for respiratory products is expected to lessen in the next several quarters, given less COVID-related demand.
Given the ongoing supply chain challenges and increased inflationary pressures, the company has suspended its full-year 2022 financial outlook. The company will provide updates in the coming quarters on the planned deployment of recently announced funding and on additional transformative actions as circumstances evolve.
I will now turn the call back over to Matt.
Matt Monaghan
Thanks, Kathy. We were pleased to see the beginning of positive trends such as the sequential improvement in profitability, expanded gross margins, and lower operating expenses. While the second quarter was challenging in many ways, the underlying markets we serve remain healthy and growing and we continue to experience strong demand in elevated order backlog.
As part of our overall plan to evolve the business, the additional liquidity and further planned actions are expected to improve near and long-term results and ultimately enhance shareholder value.
Thank you for your continued support of Invacare and for taking time for this morning’s call. We’ll now take questions.
Question-and-Answer Session
Operator
Thank you. [Operator Instructions] And our first question today comes from Bob Labick of CGS Securities. Bob, please go ahead. Your line is open.
PeteLukas
Yes. Hi, good morning. It’s Pete Lucas for Bob. I guess starting off with seating and mobility sales – hi, how are you? In terms of seating and mobility sales, I guess it looks like the main driver there was powered mobility. Can you kind of discuss what’s impacting sales the most? Is it access and sales and the outlook the most? Is it access to patients, market share, product line up and what can – where is the focus to improve the revenue base there?
Matt Monaghan
Yes, I’d say a little bit of all of the above, the market continues to be really strong summer months are typically months where we have people getting out and want to ambulate our out of doors for mostly our Northern Hemisphere business. So, that’s in the season. We have a great new rear wheel drive power wheelchair that’s doing really well in the market place, a lot of benefits for that drive style and it’s one of the newest products of that type in the market, so a lot of interest there.
Pete Lukas
And so, looking at just North America, would you say that’s probably the – would be biggest driver in terms of product segments for North America?
Matt Monaghan
Right now, yes. A lot of interest in powered mobility.
Pete Lukas
And then last one for me, in terms of the supply chain, if you could – you touched on in your remarks, I think you mentioned liquidity helping with access to components, if you could just kind of maybe give us a little more detail on the biggest bottleneck you’re facing and kind of the goals to improve those?
Matt Monaghan
It kind of depends, day-to-day we really need 100% of the components available for our build and material ship products. I mean that sounds obvious, but on any given day, supply chain challenges include things that are slightly delayed. So, you can have all the inventory minus one part waiting around to finish the product. Sometimes our suppliers are having other kinds of challenges getting their own material and we can help in some cases alleviate that with liquidity by paying a small premium or paying for expedited freight to make that up where it makes sense.
We try not to do that very often, but sometimes that’s helpful. And we want to make sure that we’re top of mind with our vendors in terms of working together to keep the supply chain moving and this helps all of that. So, I think while costs for our inputs are high, not just the materials, but definitely labor and especially freight, we see less volatility right now. So, prices remain elevated and that helps us work with our customers and in the marketplace in general to balance out what the prices we need in the marketplace to cover these extraordinary costs are and that makes for more normal operations that’s helping too.
Pete Lukas
Very helpful. Thanks.
Matt Monaghan
Okay. Thanks, Pete.
Operator
Thank you. [Operator Instructions] Our next question comes to Matthew Mishan of KeyBanc. Matthew, please go ahead. Your line is open.
Brett Fishbin
Hey, guys. This is Brett Fishbin on today for Matt. Thank you for taking the questions. Starting off, I was hoping you guys could provide a little more color around the strategic funding you released in July, specifically maybe just touching on some of the key consideration factors as you went through the process? And then like why this was the best outcome and decision for Invacare?
Matt Monaghan
Yes, good question, Brett. We continue to manage operations and the balance sheet and the whole business in total as we look at the opportunities to make investments to restructure the business and organize ourselves in a way that will deliver efficient operations in the supply chain environment. Our ability to do that sooner than later is going to yield better results, and [better NPV] [ph]. So, we wanted to do that.
We also needed to bring some flexibility to operations to keep the supply chain going and to convert this demand. We continue to have really great interest from customers and our products in all categories and regions and we needed to take some steps to make sure that that’s converting from backlog orders to sold orders, as quickly as possible. And given the uncertainty in the debt markets and other factors, we conducted a process that ended with that result, which is good liquidity that’s going to help the business here.
Brett Fishbin
Appreciate that color. And then just moving to some of the near-term trends you’re seeing around revenue and margins, just thinking about pricing and some of the benefits and net benefits you may be seeing from that. I think last call you described pricing as generally offsetting some of the product discontinuations you’ve made. Is this still like a decent way to look at it and like the overall benefit to growth or is there like a different way that we should be thinking about it at this point?
Matt Monaghan
Yes, two different things here, we should disentangle. So, we’re eliminating some products that are just too difficult to produce to procure parts for during the supply chain challenge and we’re migrating those to a narrower selection of products that still offer the same clinical benefit. So, think of, an example, instead of 23 colors, we’re down to fewer than 23 colors because that’s an idea of what’s easier. And that’s a big part of what we’re doing in the supply chain.
Brett Fishbin
All right. And then just like following up, on the benefit from pricing. Maybe if you could just provide like a little more color on how much of a tailwind it’s been, like how much it’s been able to offset some of the increased costs you’re seeing? Just any more detail on that.
Matt Monaghan
Yes. Sorry, so [indiscernible] for a second. The other part of the answer was pricing is an offsetting product discontinuation. Pricing is really helping us try to keep up with increased input costs. And as you might remember from first quarter, we had about a 410 basis point of gross margin [gap] [ph] increase because cost to us were increasing faster than prices to our customers. And this last quarter, we’re about 160 basis points better in closing that gap to do that.
So, we’re working with our customers as equitably as possible to pass-through costs that we just can’t defray in any other way. So that’s pricing related to costs and then we have revenue from substituted products where our continuing products offsetting lost revenue from what we’re not producing at this time.
Kathy Leneghan
The other item I would just highlight is that sequentially we did see an improvement in the margin. And that primarily is related to the effectiveness of pricing as we continue through the year, we spoke about on our previous call. In Q1, we would have fulfilled orders that would have been at old pricing, that would have existed in the backlog. And so, we are seeing a more effective pricing regimen in the second quarter, which is helping to offset the higher cost base that we have as well.
Brett Fishbin
All right. Very clear. Thank you for that detail. And then last question from me. I think you mentioned on the call that the ERP implementation remains temporarily paused. So, just wondering if you could provide an update on where it’s stands and when you may be able to resume that initiative? Thank you for taking the questions.
Matt Monaghan
Sure. Thanks, Brett. So, in North America, we’ve got our updated ERP system on the front-end of nearly all of the business, some of the highly configured products we paused before doing. We’ve got a fair amount of reorganization to do and where our facilities are and where certain products are made and we wanted to pause on investing in the current footprint, which would only be redone based on how the footprint is revised. And we think that’ll take a couple of quarters to resolve.
And then once we have that template, created in North America that will be deployed globally. Again, I think as Kathy mentioned in her remarks, the contract we have with our systems integrator has a fixed monthly fee. The difference for us is whether that is capitalized during the development phase and subsequently depreciated over the life of the product or it’s all expensed within the period. The cash cost in any given period is always the same.
Brett Fishbin
All right. Thanks again for taking the questions.
Matt Monaghan
All right. Thanks, Brett.
Operator
Thank you. We currently have no further questions. So, I’ll hand the call back over to Matt Monaghan for any closing remarks.
Matt Monaghan
Okay. Thanks [Nadia] [ph] and thanks everybody for taking your time this morning. Kathy, Lois, and I are available for any follow-up questions, which you can coordinate through Lois Lee with contact information on our website, www.invacare.com., under Investor Relations. Thanks very much.
Operator
Thank you. This will conclude today’s call. Thank you all for joining. You may now disconnect your lines.
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