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Invacare Corporation (IVC) Q1 2019 Earnings Call Transcript

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Invacare Corporation (NYSE: IVC)
Q1 2019 Earnings Call
May 7, 2019, 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 first quarter 2019 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, phone lines have been placed on mute. This conference is being recorded Tuesday, May 7th, 2019.

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

Lois Lee -- Director of Treasury and Investor Relations 

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 first quarter 2019 financial results and providing investors with an update on our transformation.

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 that we will refer to during today's call at invacare.com/investorrelations. Further information can be found in our SEC filing.

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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 on our first quarter earnings release.

For an explanation of items considered to be non-GAAP financial information that will be discussed on today's call such as constant currency net sales, constant currency SG&As, free cash flow, adjusted EBITDA, and adjusted net loss, please see the notes in the appendix of our webcast slides and in a related reconciliations and earnings release posted on our website.

I will now turn the call over to Matt Monaghan.

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

Thank you, Lois. Good morning. We started 2019 with a focus on growing the business and delivering improved financial results. On slide four, I'm pleased to share with you some key performance metrics that illustrate our first quarter accomplishments.

Excluding respiratory products, where we expected softness as a result of changes to the national competitive bidding impacted by the expansion of bid areas to other providers, constant currency net sales grew 3% compared to the same period last year. At the same time, operating loss improved 13%, primarily attributable to cost reduction efforts including a significant reduction in SG&A. Our track record in past success gives us confidence we will be able to further optimize and streamline our cost structure as we continue to grow profitable sales and regain market share.

Free cash flow usage, which we previously guided would be similar to first quarter 2019 was favorable by $2.3 million or almost 9% due to reduced operating loss and lower capital expenditures. These actions and others led to an improvement in adjusted EBITDA of $400,000.00 or 36.5% in spite of the anticipated declines in sales of respiratory products. Overall, while we recognize we have plenty of work ahead and need to deliver progressively strong results, we're encouraged by improved performance and believe our plan is progressing toward our 2020 goals.

Turning to slide five, our enhanced transformation and growth plan, we continue to invest specifically in core areas in each geography that will drive the required financial results, market share gains, and optimize the use of capital. This is especially true in North America. In Europe, we achieve constant currency net sales growth consistent with our guidance, driven by strong performance in mobility and seating.

We have an extensive pipeline of new products, such as the recently launched stand assist patient lift, soft cloud mattress and bed in the lifestyles product category. In addition, over the next few months, we will have significant new product introductions in mobility and seating, which will accelerate profitable sales growth in 2019 and beyond. We also expect gross margin expansion as the European manual wheelchair production transfers become operationalized as well as realized the benefit of cost reduction action taken in 2018.

In North American, our primary focus is to return the segment to profitability through sales growth, gross margin expansion, and cost reduction. We're taking deliberate action to achieve these goals and to accelerate the business moving forward based on an extensive pipeline of new product introductions, good relationships with key customers, and continued investment in sales count and infrastructure.

Over the past few months, we launched our heavy-duty TDX XP2 power wheelchair as a great bariatric wheelchair solution, which will expand the range of people we can serve. We expect sales of mobility and seating products to grow at a low double-digit rate over the remainder of the year driven by typical seasonality and new product introduction.

In addition, near-term investments in systems technology are expected to drive efficiency, lower cost, and improved customer experience. The business we do in Asia Pacific region has good potential to expand beyond our core in Australia and New Zealand to Southeast Asia. The near-term focus in the region will be on building infrastructure that results in a more efficient, lower-cost distribution network with access to other regional markets. Finally, across all our business, we're taking actions that will reduce working capital and improve free cash flow.

Turning to slide six, as you'll recall in the third and fourth quarter 2018, we faced two external headwinds that impacted North America, US tariffs and changes in CMS national competitive bidding program. We had previously guided that the full year unmitigated impact of tariffs would be between $5 million and $7 million based on then current tariff rate.

During the fourth quarter, we took actions that successful mitigated approximately $5 million of these costs with additional supply chain actions still in process. In the first quarter of 2019, the negative impact of tariffs and related material cost increases were approximately $400,000.00 and we continued to identify opportunities to offset these costs.

Over the weekend, there was discussion about possible increases in tariffs from the current 10% rate to 25% and potentially more tariffs on another $300 billion or more of goods from China. Based on our success and quickly mitigating the previous round of tariffs, we are confident we can take actions to mitigate the impact of a substantial portion of future changes as they occur.

As discussed last quarter, we anticipated the temporary but significant decline in sales of respiratory products and to a lesser extent, lifestyle products as a result of changes to national competitive bidding that went into effect on January 1st. As expected, providers slowed purchasers as they continued to assess the impact of this change on their business.

In the interim, we have minimized production as we sell through the inventory on hand until buying patterns normalize. And we have focused on selling the more valuable differentiated products within the portfolio. There have been no further updates on the next round of competitive bidding that goes into effect in 2021 but we do not anticipate any significant changes that would negatively impact our business.

Turning to slide seven, you can see the milestones of what we've accomplished so far and our plans for 2019 and beyond. In 2018, we returned the company to positive adjusted EBITDA by taking actions to optimize sales, mitigate external headwinds, and continue cost reduction. While this quarter was in line with expectations, we understand that to achieve our long-term goal, we need to accelerate growth and continue driving enhanced profitability. That said, we're encouraged by our progress to date.

Moving forward, we anticipate improvement in our key metrics compared to the prior year and progress toward both our short and long-term goals. With this foundation, 2019 will be an inflection point in the company's turnaround. As a result, we remain committed to achieving our near-term adjusted EBITDA target of at least $20 million by the end of 2019 as well as our long-term goal of $85 million to $105 million in adjusted run rate EBITDA by year end 2020.

I'll now turn the call over to Kathy Leneghan to discuss the performance of the segments and additional financial results for the first quarter.

Kathy Leneghan -- Senior Vice President and Chief Financial Officer

Thanks, Matt. Before we get into the numbers, I wanted to highlight a few changes in our segment reporting beginning in the first quarter 2019. As a result of the company's continued transformation, we have revised our segment reporting to more accurately reflect how the businesses are managed and how performance is assessed.

As a result, the former North America HME and IPG segments are being unified into a single operating segment called North America. Additionally, the former Asia Pacific segment is now being reported as part of all other as the Asia Pacific businesses individually and collectively do not meet the SEC requirements to be disclosed as a reportable segment. Segment results for 2018 have been revised to be comparable to 2019.

Turning to slide nine, reported net sales decreased 5.8% and constant currency net sales decreased 1.4% as growth in mobility and seating and lifestyle products was more than offset by expected declines in respiratory product. Excluding respiratory products, constant currency net sales grew 3% on a consolidated basis. Gross margin as a percentage of net sales deceased 50 basis points to 27.5%, driven by unfavorable sales mix in Europe, foreign exchange, primarily offset by increased gross margin in North America.

Constant currency SG&A improved by $3.7 million or 5.2%, driven by cost reductions implemented in 2018. Operating loss improved by $700,000 to $4.5 million, primarily related to reduced SG&A expense, partially offset by lower gross profit. GAAP loss per share was $0.42 as compared to $0.43 last year and adjusted net loss per share was $0.32 as compared to $0.35.

Free cash flow usage improved $2.3 million to a usage of $24.4 million. Adjusted EBITDA improved by $400,000.00 to $1.5 million. Both free cash flow and adjusted EBTIDA reflect the benefit of lower operating loss.

Turning to slide ten, during the first quarter, reported net sales in Europe decreased 4.9% compared to the same period last year. Constant currency net sales increased 1.9%, driven by a 5.6% increase in mobility and seating products and a 2% increase in lifestyle products. Operating income decreased $800,000.00, principally due to unfavorable foreign exchange and unfavorable sales mix, partially offset by lower SG&A expenses, which reflect a benefit of the reduction in forced actions taken in late 2018. The unfavorable impact from foreign currency translation was $700,000.00.

Moving to slide 11 -- as previously discussed, sales in North America reflect a combination of the former North America HME and IPG segments. With IPG sales being reported primarily in lifestyles and a small portion in respiratory. North America constant currency net sales decreased 8.5% year over year, significantly impacted by reduced respiratory sales of $7.7 million or close to 35%, which we anticipated as a result of CMS changes.

Gross margin increased 120 basis points despite the negative impact of tariffs and related material cost increases of approximately $400,000. Operating loss improved by $2.1 million or 33% due to improved gross margins and reduced SG&A expenses, both the result of cost reduction.

Turning to slide 12, sales in the all other segment are comprised entirely of the Asia Pacific region. Constant currency net sales increased 19.9% year over year, driven by increased sales in all product categories with particular strength in mobility and seating. Operating loss related to the all other segment includes Asia Pacific operating profit offset by unallocated corporate SG&A and intersegment elimination. The increase in the operating loss of $400,000 was driven by higher warranty costs in Asia Pacific.

Moving to slide 13 -- free cash flow usage improved $2.3 million to $24.4 million and in line with previous guidance, primarily related to reduced operating loss and lower capital expenditures. While inventory purchases were significant less in the first quarter 2019 as compared to the first quarter 2018, this was offset by lower accounts payable. For the full year 2019, we continued to expect free cash flow usage of less than $25 million.

Total debt of $300 million excludes operating these obligations of approximately $24 million that were capitalized on the balance sheet as a result of the adoptions of the new accounting standard effective January 1, 2019. The company continues to have full borrowing capacity available under its credit facility. The company believes that a return to positive adjusted EBITDA driven by operational performance and its balance sheet will support the company's transformation plans and enable the company to address future debt maturities.

On slide 15, we continue to make progress toward meeting our full year 2019 goal. We expect adjusted EBTIDA to accelerate in the second half of the year due to typical seasonality of sales, the completion of the European production transfers, supply chain initiatives to expand gross margin, and realizing the benefit of cost reduction actions taken in late 2018. As a result, we continue to expect adjusted EBTIDA of at least $20 million in 2019.

First quarter, free cash flow usage was in line with guidance and improved compared to last year. We expect sequential quarterly improvement during 2019 as we reduce operating loss and manage working capital including significant reductions in inventory levels, while following typical seasonality. For the full year, we expect free cash flow usage to be less than $25 million.

Based on our line of site regarding continued improvement and transformation initiatives and the trends we are seeing, we are progressing toward our 2019 goal. I will now turn the call back over to Matt.

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

Thanks, Kathy. We appreciate the continue support of our shareholders and our associates through this process. We had a solid start to the year. We have a long-term strategy to rebuild this business, deliver shareholder value, and be a sustainable leader in the markets we serve. Thank you for taking the time on the call this morning. We will now take any questions.

Questions and Answers:

Operator

Thank you. If you'd like to ask a question, please signal by pressing *1 on your telephone keypad. If you're using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. Again, please press *1 to ask a question. We'll take our first question from Bob Labick with CJS Securities.

Bob Labick -- CJS Securities -- Analyst

Good morning and congratulations on a nice start to the year. I wanted to start with the two things you need to do most obvious in your chart to get to your goals are reducing SG&A, which you've done a great job demonstrating in Q1 and then growing seating and mobility. You mentioned, I believe, you expect that accelerate starting in Q2, maybe in the back half of the year. Can you talk a little bit more about the competitive dynamic and mobility in seating, particularly in North America and what you see ahead to give you confidence you can return that area to growth after a generally flat Q1?

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

Yeah. Thanks for the question. On mobility and seating, I think it's a combination of two or three things. One is continued time and market with the products we have and good customer relationships. I think there are some really good prophecies that our customers are developing to select the products they choose to take through their offering and that normally gets worked out in the first quarter and then I think with those products on formulary, the balance of the year continues to grow in that platform.

So, we can demonstrate our alignment to those customers who are seeking really great things for their end user customers and we can deliver differentiated solutions to our products. So, that's good for us to be in those good strong relationships and then the time in market to actually go sell into their affiliate offices to make that work, that's a big part of it.

Then the second part is just this product pipeline that we have which we have been bringing into the global marketplace in mobility and seating, starting with the world's first connected chair that helps with remote diagnostics, the line extensions of that, other things, manual sprays that make manual wheelchairs act like power wheelchairs.

Then beyond that, a whole new line of products that will be coming out over the foreseeable future that will keep that portfolio really vital, interesting for our customers to consider, interesting for their end user patients to get into using and a good gross margin for us to grow. So, I think those are the ingredients and the crescendo that we'll see from now until 2019 and again in 2020.

Bob Labick -- CJS Securities -- Analyst

Okay. Great. Thank you. Then as it relates to the SG&A, as I mentioned, excellent progress in Q1, can you talk a little bit about what you've been doing internally, any new hires, things like that, and what behind the scenes you need to do to be able to achieve your goal of $25 million in savings in North America, where you stand, what the roadmap is there?

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

Yeah. There are sort of in normal sorts of optimizing processes that we expect to continue doing that will result in lower cost but really importantly, over the next 18 months will be some infrastructure investments that fit within our normal capex and operating expense budget that will allow us to be easier to do business with and more cost effective as an operating business. Things in phone system and IT technology that allow customer self-service and many convinces that all of us probably enjoy as consumers, which we're lagging behind as a medical industrial enterprise.

So, those will be the big enablers that allow us to bring together the various subsidiaries of our company and be really simple to do business with globally, lower cost, better customer delight. We expect some share gains as a result of that and the ability to improve SG&A.

Kathy Leneghan -- Senior Vice President and Chief Financial Officer

And the benefit of that is really going to be late in '19 but really into 2020.

Bob Labick -- CJS Securities -- Analyst

Okay. Great. Lastly, I think you mentioned some new products in Europe as well. Is there any sense of the ramp or when those should come on? Obviously, you have the FX headwinds, but absent that, I think you've shown some strong growth there. How should we think about that going forward?

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

Europe had some pretty strong seasonality. Generally, the first quarter is not a strong quarter in terms of growth over prior. Third quarter is typically very strong. Fourth quarter is probably our second strongest and then second quarter maybe ranks third. Those are a combination of government budget, seasonality with Northern Hemisphere weather patterns that drive purchases of mobility and seating products and the purchasing of respiratory products ahead of a weaker flu season. Those all stack up to give us that very predictable quarterly season pattern.

We have a really strong portfolio of products that have been coming out in Europe and will continue to accelerate. What we haven't talked about on the call before probably is our work over the last three and a half years to concentrate our engineering and product development teams into centers of excellence who by now are doing a great job getting out products on time with the features and benefits that are desired in the marketplace that target costs that drive financial return that allows reinvestment.

So, from this point forward, we will have a very consistent cadence of product launches in Europe in all segments in mobility and seating, powered and manual, and in lifestyles, especially. That will help drive growth in Europe. I think a lot of those products then will flow from Europe elsewhere in the world.

Bob Labick -- CJS Securities -- Analyst

Okay. Super. Thank you very much.

Operator

We'll take our next question from Matthew Mishan from KeyBanc.

Matthew Mishan -- KeyBanc Capital Markets -- Analyst

Great. Hi, Matt. Hi, Kathy and Lois. Last quarter, you discussed taking a look at your business segments and all your products across the board on a go-forward basis. Where are you at with that process? What kind of decisions did you start to make?

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

Good question and good recollection. We wanted to make sure that we had a long-term robust plan after the third quarter tariff impact to make sure we could still deliver the best outcome we could in the timeframe of 2020. That caused us to look very quickly at the portfolio of products and businesses that we had. We undertook a lot of effort in the fourth quarter and in the first quarter internally and with the help of consultants to make sure that we're looking at everything in the right way, not blind to anything that we hadn't evaluated before for improvement.

Our objective is to make sure that anything we go forward with can be market-leading, market share-gaining, and acceptable profit level. Our general math, which we've been discussing for a long time is on average if we get a 35% contribution margin and a 25% SG&A margin, that leaves us a 10% EBIT spread, which would work for us. Some products are higher. Some products are lower. That's sort of the rough math.

What we did beginning in fourth quarter and even more in first quarter were to focus more on the products that drive that kind of margin to simplify how we're selling so that our selling costs are in line with that math and we will continue to work this year especially on the G&A part of that. Again, with the infrastructure investments that I mentioned to the last question, which will allow us to get the 35-25-10 math to work out.

We like the segments that we have with the portfolio narrowing that we've done and we will always continue to look at the right investments that make that equation work. They have to have the ability to lead and share. They have to have the ability to get the right contribution margin and the cost of bringing those to market between selling and G&A. You can't get in the way of that 10% EBITDA spread.

So, I think we feel pretty confident about what we've done to make that happen and just start seeing that materialize even more through 2019 and into the first quarter of 2020 by the time we get all the infrastructure things done so that we're easy to do business with and very cost-effective as we like.

Matthew Mishan -- KeyBanc Capital Markets -- Analyst

That's great. Then just a follow-up on the question around the acceleration in mobility and seating through the course of the year. My sense is you guys annualized a contract win this past quarter and you've kind of seen, as that contract progressed, you saw some good growth and then you saw a little bit of deceleration, especially going into this quarter. But you do have a backlog and there is 90-120-day lead time with this business.

What is the backlog saying right now that would give us confidence that you can accelerate this business to low double-digits through the course of the year and have you been awarded any new contracts from any of your big three customers or been added to a formulary?

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

Good question. You've been doing your homework to understand the market very well. I guess to agree on the view of 2018, the second quarter of 2018 was really our big growth quarter, which was really the first quarter, we were able to open business post-consent decree. Consent decree got resolved July of 2017. We had new products in August of '17 that got CMS approval in October '17, which was evaluated for adoption by customers in November to January into 2018.

By the time those decisions were made and our customer sales teams were notified, the real effect came into second quarter 2018. So, we're heading into a quarter now that looks back on a big growth year in the prior year. I think that pattern of first quarter selection, second, third, fourth quarter sell through is probably going to persist as customers look at their annual purchasing volumes, rebates that they get with their suppliers and then they look to make changes in their formulary at the beginning of the year.

I think we're going to come out of the suppressed consent decree kind of selling and we're going to be more exposed now to something that's like an emerging form of seasonality in the North America seating and mobility market. I feel really good about our relationships with all our key customers.

We are absolutely focused on making them successful by getting them differentiated values and respecting their customers and what they need to do to win and growth their businesses. Because of the portfolio of the technology we have and put in our products, we can do some unique things that our competitors can't do. We have very good customers, but I feel good about that. I think as we look into the quote bank and the order bank going forward, we do see this seasonality emerging that leads us to believe we're on the right path for the growth objectives we have.

Matthew Mishan -- KeyBanc Capital Markets -- Analyst

Then the last question and then I'm going to jump out -- you've previously given a run rate at Taylor Street. I think it bottomed out some more around like $10 million a quarter. Could you just give us a sense of where you're at now on Taylor Street, maybe trailing four quarters and if there's still that fixed overhead absorption that you have to get past as you increase sales there.

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

Good question. For a long time during the consent decree, we reported that annual sales output of Taylor Street, which was the consent decree facility, into the US market, not including what Taylor Street sent abroad. Folks may remember in June of 2015, we launched a really great power wheelchair platform called Rovi, which came to our Motion Concepts branch in Canada and in New York. That went into the North American market serving some of the same needs that Taylor Street had previously met.

We don't report the Taylor Street anymore and it's kind of muddled because we would have to add the Taylor Street components to some other business units. I can only just roughly say that sales is greater than it was when it was just Taylor Street. The overhead burdens we have we continue to optimize. There's a huge physical footprint here in Elyria with the Taylor Street facility.

But I think by now, there's very little of it that's fixed and encumbered or overly burdens current output. Things are either well-depreciated or scaled down to the size that we need to our current output. Now, all we do is change materials and direct labor as we ramp up.

Kathy Leneghan -- Senior Vice President and Chief Financial Officer

I think that's true. The mobility and seating sales we report in North America are more than just Taylor Street. So, Taylor Street is a component of it, but to your point, there's growth on the Rovi side of the house. There's growth in the custom manual side of the house that you'd see in mobility and seating much more than Taylor Street. I would say we have capacity on Taylor Street. There are no additional investments that we would have to make once that buy-in comes along. We're just managing that overhead structure.

Matthew Mishan -- KeyBanc Capital Markets -- Analyst

Thanks a lot, Kathy. Lois, I appreciate you getting me on earlier in the call.

Operator

We'll take our next question from Chris Cooley with Stephens.

Chris Cooley -- Stephens, Inc. -- Managing Director

Good morning. Thanks for taking the questions. Congratulants on a nice first quarter, good way to start the year. First for me, if we could consider a little bit on North America, I was very pleased to see the 120-basis point step-up in gross margin. I was hoping you could maybe help us parse that a little bit from change in the product mix and also help us think about cost reduction initiatives in terms of what were the primary contributing factors there to helping you get that step up in gross despite the decline in respiratory, which I realized was a lower margin.

Maybe within that same context, could you maybe help us quantify the dollar impact of the rationalization that you undertook during the quarter on the respiratory side. When we think about the cannister business, just trying to look at both the topline and obviously, the margin contribution there and then how that transitions forward. Thanks.

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

I have to give a shout-out to our supply chain team for doing such a great job to overcome these tariffs, which everybody knows came out of the blue after third quarter. It was great to see gross margin improve so soon after that happened. Kathy, why don't you take the first part of that?

Kathy Leneghan -- Senior Vice President and Chief Financial Officer

Yeah. So, the 120-basis point improvement that you see in margin in North America, much of it is cost reduction initiatives that were implemented in the fourth quarter last year or even into the first quarter of this year. A good example of that would be on the respiratory side of the house. We had a line of sight that we thought the respiratory business would be down year over year and we guided to that.

As a result of that, we shrunk our infrastructure that we had supporting that business and that enabled us, even though respiratory is a lower margin product, that did give us some upside on the margin side of the house because we were able to shrink that infrastructure to be a minimal infrastructure to support the business we have on a go forward basis.

With that on the respiratory side of the house as well, while respiratory is a lower-margin product, we focused on more of the higher profitability products within that product category and we focused more on 10-liter concentrators, the home fill product versus the highly commoditized five-liter concentrators. So, as well, there would be some product mix in there as well, but it really is more from the cost reduction side of the house and looking at the infrastructure to support the business that we have in the view going forward.

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

I think building on that, the sentiment that we took coming out of the third quarter tariffs was really, we had to shed any optimism in the plan and really eliminate any costs that would prevent us from getting to the same or similar result despite tariffs potentially going up. Remember, they were talking at the time. They were talking last weekend about tariffs going up 2.5%. We have to robust against that. It caused us to focus a little harder on getting costs out, which we did pretty swiftly and that's benefiting us now. We also exercised some muscle to demonstrate how we can operate in that kind of regime, which I think will persist for another couple of years. We'll see targets.

Chris Cooley -- Stephens, Inc. -- Managing Director

Super. That was a great effort there. I guess quickly then for me, you touched on this earlier, the efforts to enhance the cadence of new products across the portfolio not only in Europe, but also here in the states.

I'm just kind of curious as you think about going forward, what type of contributions from the top line but also from margin perspective do you think we should start to assume once we get to more of a normalized rate, I'm assuming more in the second half of 2020 and into 2021 -- please feel free to correct me on the timing -- but from that new product, is that something that we should think about as just helping you maintain or does that help drive incremental not only absolute growth but also margin?

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

I'd say those who answer the overall support of the $12.5 million of incremental contribution in Europe from profitable sales growth and the $25 million of incremental contribution we expect in North America from profitable sales growth and as we come out with these new products, we're evermore integrated in how we create the internally and how we deploy them through a supply chain that's incredibly more efficient than we've done in the past, which will also increase gross margin per sale.

So, we should have more sales because we have new and very interesting products to garner customer interest and as we sell them, they'll be more efficient and design for a cost-effective deployment around the world. I would say those underpin why we think we'll get $37.5 million worth of incremental contribution for mobility over the next couple of years. I think the remarkable thing for me if we are still able to do it for nothing less than 1.8% of sales in R&D, which for a medical device or industrial medical device comes to be remarkably productive and echoes to how good our team is at core competencies and developing really interesting products.

When I look at the portfolio now, we will have interesting products coming out every quarter kind of perpetually. We've gotten through the bow wave of we were doing some mobility and seating products, now we're doing mobility in seating and respiratory and lifestyles products globally all the time. I think it's one of our strongest points. We have been competitors in each category and I think we have good new products and future products that will help us remain competitive. Then when you put them all together as a composite business, it's really remarkable.

Chris Cooley -- Stephens, Inc. -- Managing Director

If I could just squeeze one last one in as well, when you look at the capital structure, thoughts obviously on the first or the two converts. Is that something that you feel like you'll be in a position to more thoroughly evaluate as you're in the second half of the year or is that something that as you enter 2020 you think you'll have sufficient run rate from cash flow and from margin to make a better evaluation there in this most recent proxy. You ask to also potentially settle inequity or partial inequity.

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

Good question, Chris. We always think about our balance sheet to make sure we're using capital perfectly on a transactional basis for working capital and on a cash on hand or cash balance for that eventuality for paying these two trenches of debt. Our best tool to facilitate a good refinancing is having solid EBITDA, which is the basis of commercial normally, commercial lending facilities. That's why it's so important for us not only to make our commitment to the company's owners and shareholders in delivering EBITDA, but so that we have these commercial reasonable refinancing terms that we inspect.

So, the $20 million EBITDA target which we are very committed to hitting this year is an important weight point for that, which then leads us to that other target, the $85 million to $105 million for next year, adjusted EBTIDA that should put us in the zone of normal discussions with lenders to refinance that.

On the proxy, thanks for bringing that up. When we took out the convertible debt instruments, because of our market cap and share price at the time, we were concerned to only be able to take those debt issuances being able to settle in cash and we think it's important for shareholders to allow management to have the flexibility to settle in some combination of shares and cash should those converts be exercisable in the $16.00+ range.

Chris Cooley -- Stephens, Inc. -- Managing Director

Understood. Thanks. Appreciate the time.

Operator

And we'll take our next question from Mike Matson with Needham & Company.

Mike Matson -- Needham & Company -- Analyst

Thanks for taking my questions. I guess I wanted to start with the respiratory business. The slide said that you're going to reevaluate all businesses for market leadership and profitability. It doesn't seem like you're going to get to either of those in the respiratory business. Why wouldn't you exit that business completely?

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

That's a good question. We want to make sure our business leaders internally that oversee these various segments and product portfolios are asking that. I think as Kathy mentioned, we are definitely shifting our focus in our internal portfolio to make sure we continue to have solid offerings in the five-liter category, which is the mainstay of our customers. I think there are a lot of dynamic things going on in the battery-powered portable segment.

We continue to have leading features and functionality in our product. Then in the middle is the ten-liter and the home fill, which continue to have enhancement opportunities. If our shareholders can see the results of a 35% nominal contribution margin and a low enough SG&A to get this 10% spread, that's a pretty good use of capital now. We always look at how to optimize our use of capital.

Right now, that is our best plan going forward. We have taken a really critical look at that business during the reimbursement dynamics that have caused for us a sales downturn and it's enabled us to look at it differently in ways that will drive longer-term profit out of those products. We continue to submit for enhancements to those products and we think we have good alignment with our customers on what they want and a product that serves their customers well.

It is a challenging market in total, but there are some real product categories in there that we know uniquely well where we can still be a leader and if we can generate that kind of EBTIDA, then that's good return for shareholders if we make our targets for this year and next year. We'll keep looking at it. You should hold us accountable to make sure that we are leading and sharing and delivering that kind of contribution.

Mike Matson -- Needham & Company -- Analyst

Okay. Thanks. The respiratory business, it wasn't just down significantly in North America. It was down a lot in Europe as well. How much of this is really because of this reimbursement change where they ended the contracts and opened it up to all comers versus the move to POCs in this market? It seems like there's more going on than just the reimbursement changes, I guess.

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

I think different companies that we compete with are treating the change in the marketplace differently. We've taken the outlook to maintain good customer relationships as they go through this transformation and we've found ways to not keep our facilities full and still increase profit. You would see that in the results. It's remarkable to do as well as we've been doing despite the really significant downturn in sales. That's caused us to take a lot of smart actions that will benefit as well currently and in the long-term.

I think what customers are experiencing now in the marketplace is the need for a better balance in the portfolio. There's been a tremendous amount, a feeding frenzy around battery powered portable action concentrators, which are a great modality, but I think as we get into the third or fourth year of this bullous of deployment, I think providers are realizing that once the warranty ends, these things are a pretty expensive way to deploy ambulatory oxygen for a very fixed reimbursement when it's under a reimbursed consumer compared to other modalities like our home fill portable oxygen concentrator system, which is roughly the same cost to purchase but will last three or four times as long with very little service cost along the way.

I think what we're going to see is a settling out in the marketplace of a more reasonable balance of the modalities that providers are using to get reimbursement and serve their clients well and we're really well-positioned to have that balance. We have great 5-liter, great 10-liter. We have this unique home fill that still has patented technology that makes it different. We have a really great portable oxygen concentrator that still is leading in terms of connectivity and features and everything.

When we look at the marketplace, I think we see a reason to hang with our customers and continue to provide them this whole portfolio and then internally optimize our costs and we still deliver improved results to shareholders despite what's swirled in the economy.

Mike Matson -- Needham & Company -- Analyst

Okay. Just one on the tariffs -- let's assume the tariffs increase to 25% Friday night. Where would you stand with being able to mitigate that from a timing standpoint? I guess you've already mitigated the existing tariffs. So, if they're on the same items, a lot of that would already be mitigated or would you have to take additional steps? Is there a risk there's some kind of timing issue that it still hits your results as you take steps to offset it?

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

Yeah. I think if that happens Friday night, maybe by Sunday, we'll get past the frustration of such an asymmetric foreign economic policy. The actions that we have taken to mitigate the previous tariffs should be in effect, as you said, as a gap in what we haven't mitigated, which was $400,000 in the quarter, but then go up by something like 2.5 times, reflecting the 10% to 25% tariff increase.

However, that gap already includes some product like in the steel and aluminum categories that are already at 25%. So, that gap isn't entirely going to be escalated. I think if you said $400,000 is $1.6 million in the year and you multiply that by 2.5 times, that's sort of the maximum it could be, but we'd take actions to reduce that even further.

Kathy Leneghan -- Senior Vice President and Chief Financial Officer

While that would be the maximum, to your point, the unmitigated portion primarily relates to many of the products that are already at 25%, right?

Mike Matson -- Needham & Company -- Analyst

Thanks. Just on all other Asia Pacific category, you saw really strong growth there. So, I guess first, were there any kind of one-off stocking orders in the quarter? I'm a little surprised to see such strong growth but then see the operating income still down year over year.

Kathy Leneghan -- Senior Vice President and Chief Financial Officer

The growth on the sales side of the house was really in all product categories, so, nothing unusual going through there on the operating loss side of the house. There was a discreet charge related to warranty that impacted the results of a one-time charge related to warranty and that related to the sales growth that we found in the Asia Pac distribution businesses.

Mike Matson -- Needham & Company -- Analyst

Okay. Great.

Operator

We'll take our next question from Jim Sidoti with Sidoti & Company.

Jim Sidoti -- Sidoti & Company -- Analyst

Good morning. So, based on the cash flow usage in the quarter and the guidance for the year, it seems like you're expecting to be pretty much cash flow neutral for the remainder of the year, is that accurate?

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

The sum of quarters two, three, and four will be zero for our guidance. That doesn't mean that every quarter will be zero.

Kathy Leneghan -- Senior Vice President and Chief Financial Officer

Historically, Q2 is a usage quarter and then we get better in Q3 and Q4. We would assume that same seasonality that you would have seen last year as well, but each quarter should be better than the previous quarter.

Jim Sidoti -- Sidoti & Company -- Analyst

I think on the last call, you indicated you might see a pickup in respiratory sales in the back-half of this year. Is that still the case? Do you no longer think that will happen?

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

It's an estimate at this point. We've certainly put a robust plan together that assumes it does not grow externally. That's good. We wanted to underpin our story without a lot of optimism, but it's typical for the markets to begin incremental purchases late August or around labor day in the US getting ready for the winter flu season. We assume there's some chance of acceleration at that point, but we don't need it to get to our plan.

Jim Sidoti -- Sidoti & Company -- Analyst

Last one for me -- you look at the outlook section of the 10-Q you filed last night, you said in order to achieve the earnings and free cash flow targets, you expect low-single-digit sales growth in 2019 and 2020. Does that mean you expect growth both years or just the combined years?

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

Both years. We expect sales growth. It might not be the same every season or every quarter because you do have seasonality in Europe for sure. It's a little different in North American and then overall for the company, but we expect growth overall.

Jim Sidoti -- Sidoti & Company -- Analyst

So, despite the fact sales declined...

Kathy Leneghan -- Senior Vice President and Chief Financial Officer

On the European side of the house, we're anticipating sales growth on the European side of the house. We're anticipating sales growth on the mobility and seating side of the house from a North America perspective, but in 2019, that will be offset by respiratory decline.

Jim Sidoti -- Sidoti & Company -- Analyst

Right. Respiratory, it looks like it was about $19 million this quarter. You think that's the bottom or that continues to decline?

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

We attribute this to this external shift in national competitive bidding in the metropolitan areas. If that's the external impact and there are no other external impacts, we should be at the bottom of that looking forward to stabilizing growth as those markets settle out as fleets get older and need to be replenished again, especially heading into the winter flu season. So, I don't think it goes down from here.

I think if you assume the assets were in place to serve customers nationally in the winter and the winter is the peak use of those kinds of things, then our customers, all of our customers and competitors' customers will have that fleet that can get in through labor day and then when more people come in the market, then the products are more aged, there will need to be more replenishment. So, I think if you look at the macros like that, I would say it's probably at the bottom in terms of demand.

Kathy Leneghan -- Senior Vice President and Chief Financial Officer

The decline we saw in the first quarter is consistent with the declines of the percentage that we saw in Q3 as well as Q4. Our plan assumes that's in decline and continues for the remainder of 2019.

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

We look at it sequentially on a rate basis.

Jim Sidoti -- Sidoti & Company -- Analyst

Okay. But the message I think you're trying to give is even with the weak sales in respiratory because of the strength in Europe and a pickup in mobility, you think overall, sales will be up in low-single digits by the end of the year?

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

Should be. Everything else growths -- Asia Pac, Europe, everything in North America except respiratory. Respiratory is this TBD until the market comes back. Then all the pieces should be working together. In the meantime, we're not letting that be an excuse for profitability, as you can see what we've done to drive gross margin up despite that sales decline.

Jim Sidoti -- Sidoti & Company -- Analyst

Thank you.

Operator

And there are no further questions at this time. I would like to turn the conference back over to Matt Monaghan for any additional or closing remarks.

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

Thank you. Thanks, everybody for the time and attention on today's call. Kathy, Lois, and I are available for any follow-up questions. We hope you have a good day. Thank you.

Operator

That does conclude today's conference. Thank you for your participation. You may now disconnect.

Duration: 51 minutes

Call participants:

Lois Lee -- Director of Treasury and Investor Relations 

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

Kathy Leneghan -- Senior Vice President and Chief Financial Officer

Bob Labick -- CJS Securities -- Analyst

Matthew Mishan -- KeyBanc Capital Markets -- Analyst

Chris Cooley -- Stephens, Inc. -- Managing Director

Mike Matson -- Needham & Company -- Analyst

Jim Sidoti -- Sidoti & Company -- Analyst

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