Invacare Corporation
Q1 2019 Earnings Call Transcript

Published: 7 May 2019

[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 7, 2019. I will now turn the call over to Lois Lee, Invacare's Director of Treasury and Investor Relations.

[Lois Lee:]

Thank you, Lean. Joining me on today's call from Invacare are Matt Monahan, 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 the 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 presentations that we will be refer to during today's call at invacare.com/investorrelations. 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 the nature addressed matters that are uncertain. Actual future results may differ materially from those expressed in our statements today due to various uncertainties and I refer you to the cautionary statements included on the second page of our webcast slides and in our fourth quarter earnings release. For explanation 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&A, free cash flow, adjusted EBITDA and adjusted net loss. Please see the notes in the appendix of our webcast slides and in the related reconciliations in the earnings release posted on our website. I will now turn the call over to Matt Monaghan

[Matthew Monaghan:]

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 national competitive biddings 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 give us confidence we will be able to further optimize and streamline our costs 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 2018 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 or 36.5%, in spite of the anticipated declines in sales of respiratory product. Overall, while we recognize we have plenty of work ahead and need to deliver progressively stronger results we're encouraged by improved performance and believe our plan is progressing towards 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 achieved 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 Lifts, soft mattress and more beds in the lifestyles product category. In addition over the next few months, we will have significant new product introductions in mobility and seatings, which will accelerate profitable sales growth in 2019 and beyond. We also expect gross margin expansion as the European manual wheelchair production transfer become operationalized, as well as realizing the benefit of cost reduction actions taken in late 2018. In North America, our primary focus is to return the segment to profitability through sales growth, gross margin expansion and cost reductions. We're taking deliberate actions to achieve these goals and are well positioned 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 channels and infrastructure. Over the past few months, we launched a heavy duty TDX SP2 power wheelchair as a great bariatric wheelchair solution, which will expand the range of people we can serve. We expect sales is 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 introductions. In addition, near-term investments in systems technologies are expected to drive efficiencies, lower costs and improve 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 infrastructures 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, U.S. tariffs, and changes in CMS national competitive bidding progress. We've previously guided that the full year unmitigated impact of tariffs will be between $5 million and $7 million based on then current tariff rates. During the fourth quarter we took actions that successfully mitigated approximately $5 million of these costs, with additional supply chain actions still in process. In first quarter 2019, the negative impact of tariffs and related material costs increases were approximately $400,000. And we continue 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 in 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 a temporary, but significant decline in sales of respiratory products and to a lesser extent lifestyles product as a result of changes to national competitive bidding that went into effect on January 1st. As expected provider slowed purchases as they continue to assess the impact of this change on their business. In the interim, we have minimized productions as we sell through the inventory on hand until buying patterns normalize. And we are focused on some of 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 reductions. 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. Going forward, we anticipate improvement in our key metrics compared to the prior year, and progress towards both our short and long-term goals. With this foundation 2019 will be 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:]

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've 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 products. Excluding respiratory products constant currency net sales grew 3% on a consolidated basis. Gross margin as a percentage of net sales decreased 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 to $1.5 million. Both free cash flow and adjusted EBITDA reflect the benefit of lower operating loss. Turning to slide 10, during the first quarter reported net sales in Europe decrease 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 principally due to unfavorable foreign exchange, and unfavorable sales mix, partially offset by lower SG&A expenses, which reflect the benefit of the reduction in force actions taken in late 2018. The unfavorable impact from foreign currency translations was $700,000. 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 recorded primarily in lifestyle 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 costs 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 reductions. 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 inter segment [indiscernible] 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 significantly less than the first quarter 2019 as compared to the first quarter 2018. This was offset by lower accounts payable. For the full year 2019, we continue to expect free cash flow usage of less than $25 million. Total debt of $300 million excludes operating lease obligations of approximately $24 million that were capitalized on the balance sheet as a result of the adoption of the new lease 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 towards meeting our full year 2019 goals. We expect adjusted EBITDA 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 margins and realizing the benefit of cost reduction actions taken in late 2018. As a result, we continue to expect adjusted EBITDA 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 sight regarding continued improvement and transformation initiatives, and the trends we are seeing, we are progressing towards our 2019 goals. I will now turn the call back over to Matt.

[Matthew Monaghan:]

Thanks, Kathy. We appreciate the continued support of our shareholders and our associates through this process with 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'll now take any questions. Lean?

[Operator:]

Thank you. [Operator Instructions] And we'll take our first question from Bob Labick with CJS Securities.

[Bob Labick:]

Good morning and congratulations on a nice start to the year.

[Matthew Monaghan:]

Hello, Bob. Good morning.

[Bob Labick:]

I wanted to start with the two things you need to do most obvious in your start to get into your calls are reducing SG&A which you've done a great job demonstrating already in Q1, and then growing seating in mobility. And you mentioned I believe you expect that to accelerate in the starting in Q2 maybe the back half of the year, can you talk a little bit more about the competitive dynamic in mobility and seating figure 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:]

Yes, thanks for the question. On mobility and seating, I think it's a combination of two or three things, one is continued time in market with the products we have and good customer relationships and I think there are some really good processes that our customers are developing to select the products that they chose to take through their offering and that normally gets worked out in first quarter and then I think with those products on formulary the balance of the year continues to grow on 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 through our products. So that's good for us to be in this good strong relationships and then the timing of markets actually will sell into their affiliate offices to make that work that's a big part of it. And 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 share that helps with remote diagnostics, the line extensions to that other things and the active manual space that make manual wheelchairs act like powered wheelchairs. And then beyond that a whole new line of products that'll 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 cushion that we'll see from now through 2019 and again in 2020.

[Bob Labick:]

Okay, great. Thank you. And then as it relates to the SG&A as I've 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 be able to achieve your goal of I think $25 million in savings in North America where you stand, what the kind of roadmap is there?

[Matthew Monaghan:]

Yes, there are sort of the 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's 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 customers self-service and many of the conveniences that all of us probably enjoy as consumers, which were lagging behind as a medical industrial enterprise. So those will the big enablers that allow us to bring together 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:]

And the kind of that is really going to be late 2019, but really into 2020.

[Bob Labick:]

Okay, great. And then lastly, I think you mentioned some new products in Europe, as well as is there any sense of the I guess ramp or when those should come on and obviously have the FX headwinds, but absent I think you have shown some strong growth there, how should we think about that going forward?

[Matthew Monaghan:]

Europe had some pretty strong seasonality, generally the first quarter is not a strong quarter in terms of growth over the prior year third quarter is typically very strong, fourth quarter is probably our second strongest and then second quarter is maybe ramps third. And those are the combination of government budgets, seasonality with Northern Hemisphere weather patterns that drive purchases of mobility and seating products and the purchasing of respiratory products ahead of our - which are flu seasonally those offset but 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 we'll continue to accelerate. What we haven't talked about in the call before probably is our work over the last three and half years to concentrate our engineering and product development teams which is centers of excellence who are now are doing a great job getting out products on time with the features and benefits that are desired in the marketplace at target cost that drive the financial return that allows reinvestments. And so from this point forward, we will have a very consistently cadence of product launches in Europe in all segment products in mobility and seating, powered manual and in lifestyle specialty. So 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:]

Okay super. Thank you very much.

[Matthew Monaghan:]

Thanks, Bob.

[Operator:]

And we will take our next question from Matthew Mishan with KeyBanc.

[Matthew Mishan:]

Great. Hi, Matt. Hi, Kathy, Lois.

[Matthew Monaghan:]

Good morning, Matt.

[Matthew Mishan:]

Good morning. Last quarter you discussed taken a look at your business segments and pretty much all your products across the board and on a go forward basis, where are you at with the process what kind of decision did you started to make?

[Matthew Monaghan:]

Yes, good question. And it's a reflection, so we wanted to make sure that we had a long-term robust plan after the third quarter tariff impact to make sure that we can still deliver the best outcome we could in the time frame of 2020 and that caused us to look very critically at the portfolio of products and businesses that we have and we undertook a lot of effort in fourth quarter and in first quarter internally and with the help of consultant to make sure we're looking at everything in the right way not blind to anything that we haven't evaluated before for improvement. Our objective is to make ensure 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-term on average if we get a 35% contribution margin and a 25% SG&A margin that means with 10% EBIT spread, which would work for us, some products are higher some products are lower, but that's sort of the rough math. What we did beginning in fourth quarter and even more actions 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 cost are in line with that math and we will continue to work this year specially on the G&A part of that. But 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 segment that we have with the portfolio narrowing that we've done and we will always continue to look at the right investments that we meet that equation work that have to have the ability to lead and share, that have to have an ability to get the right contribution margin and the cost of bringing those to market between selling and G&A 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 we 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 get easy to do business with a very cost effective as we like.

[Matthew Mishan:]

That's great. And then just a follow-up on the question around the acceleration in mobility and seating through the course of the year. My sense is that you guys annualized a contract win this past quarter and you've kind of seen as that contract progress you saw some good growth and then you saw a little bit of the deceleration, especially going into this quarter. But you do have a backlog and there is 90 to 120 days 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 one of your big three customers or have been added to the formulary.

[Matthew Monaghan:]

Yes, good question, you been long doing your homework to understand the market very well. So I guess to be agree on kind of the view on 2018, second quarter 2018 was really our big growth quarter, which was really the first quarter we were able to do open business post consent decree. Consent decree got resolved in July of 2017 we had new product in August of 2017 that got CMS approved in October 2017, which was evaluated for adoption by customers November to January and into beginning of 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, which we obviously haven't reported yet that looks back on the big growth year in the prior year and I think that pattern of first quarter selection, second through fourth quarter sell-through. It's probably going to persist as customers look at their annual purchasing volumes, rebate that they get with their various suppliers, and then they look to make changes in their formulary at the beginning of the year. So I think we're going to come out of the suppressed consent to create 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 giving them to differentiated values and respecting their customers and what they need to do to win and grow their businesses. And because of the portfolio of the technology we have in putting our products, we can do some unique things that our competitors can't do. We have very good competitors. So this competition, but I feel good about that. And 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:]

Okay. And then the last question, I'm going to jump out. You've previously given a run rate at Taylor Street. I think it bottomed out somewhere around $10 million a quarter. Could you just give us a sense of kind of where you're at now on Taylor Street over like maybe on an average trailing four quarters? And if there's still that fixed overhead absorption that you have to get pass as you kind of increase sales there?

[Matthew Monaghan:]

Yes, good question. So for a long time, during the consent decree, we reported the annual sales output of Taylor Street which was the consent decree facility into the U.S. market, not including with Taylor Street sent abroad. Folks may remember in June of 2015, we launched a really great power wheelchair platform called Rovi, R-o-v-i, which came to our markets from our motion concepts branch in Canada and in New York. And 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 component. It's kind of muddled, because we would have to add the Taylor Street components to some other business units. So I can only just roughly say that sales is greater than it was when it was just Taylor Street. And the overhead burden that we have, we continue to optimize. There's a huge physical footprint here in that area with the Taylor Street facility. But I think by now, there's very little of it that's fixed and encumbered or overly burdened that current output. Things are either well depreciated or scaled down to the size that we need for our current output. And now really all we do is change materials and direct labor as we ramp up capacity. I don't know Kathy, there's a different way to meet with that answer.

[Kathy Leneghan:]

No, I think that's true. The mobility and seating sales that we report in North America are more than just Taylor Street. And sub Taylor Street is a component of it, but to your point there's quite an under growth [indiscernible] there's growth in the custom manual side of the house that you should see in mobility and seating it's much more than Taylor Street. And I would say we have capacity in Taylor Street, so there's no additional investments that we would have to make once that volume comes along, which is managing that overhead structure.

[Matthew Mishan:]

Okay, thanks for that, Kathy. And appreciate you getting me on early in the call.

[Matthew Monaghan:]

Okay, thanks Matt.

[Operator:]

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

[Chris Cooley:]

Good morning. Thanks for taking the questions. And congratulations on a nice first quarter. Very good start to the year. I guess first for me if we could settle in a little bit on North America, I was very pleased to see 120 basis points 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 realize is a lower margin. And 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? We think about the canister business just trying to look at both the top line and also obviously the margin contribution there at the business and then how that transitions forward? Thanks, I've got that follow up afterwards. Thanks.

[Matthew Monaghan:]

We took notes on all those parts there.

[Chris Cooley:]

On five part question, right?

[Matthew Monaghan:]

Yes. I have to start up first IT team for doing such a great job to overcome these tariffs, which everybody knows came out of the blue after third quarter and it was great to see gross margin improve so soon after that happened. Kathy, why don't you take the first part of that and I can comment on the respiratory.

[Kathy Leneghan:]

Yes, so the 120 basis points improvement that you see in margin in North America, much of it is cost reduction initiatives that were implemented in the fourth quarter of last year, even into the first quarter of this year. And 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. And so 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 the infrastructure to be a minimal infrastructure to support the business that we have on a go forward basis. With that on the respiratory side of the house as well, while respiratory is a lower margin products, we focused on more of the higher profitability products within that product category. So focus more on 10-liter concentrators, the HomeFill product versus the highly commoditize 5-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:]

And I think maybe building on that the assignment 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. Because you remember, they were talking at the time and they're talking this last weekend about tariffs going up 2.5%. We said, we just - we have to be robust against that. And I think, 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 exercise some muscle to demonstrate how we can operate in that kind of regime, which I think will persist for another couple of years and achieve the [ph] same target.

[Chris Cooley:]

Super. That was a great effort to just really noted. I guess just quickly than for me at this point, you touched on this earlier, but the efforts to enhance the cadence of new products across the portfolio, not only in Europe, but also here in the states. Just kind of curious as you think about going forward, what type of contributions from both from the top-line, but also from a 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? And please feel free to correct me if I'm wrong 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:]

I guess, I'd say those are into 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 ever more integrated in how we create them 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 in design for a cost effective deployment around the world. So I would say those undertake why we think we'll get $37.5 million worth of incremental contribution from mobility and seating over the next couple of years. And I think that's the remarkable thing for me as we are still able to do it for something less than 1.8% of sales and R&D, which for medical device or industrial medical device companies remarkably productive. And that goes to I think how good our team is that's core competencies in developing really interesting products. That's good. When I look at the portfolio, now we will have interesting products coming out every quarter kind of perpetually. We've gotten through the wild wave why we doing some mobility and seating products. Now we're doing mobility and seating in respiratory and lifestyle products globally, all the time, and I think it's one of our strongest points. We have good competitors in each category and I think we have good new products and future products that will help us remain competitive. But then when you put them all together as a composite business, it's really remarkable.

[Chris Cooley:]

And if I could just squeeze one last one as well. Just when you look at the capital structure, thoughts obviously on, I guess the first tranche 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 the sufficient run rate both from a cash flow and from margin to make a better evaluation thereafter in this most recent proxy, you asked also potentially settling the equity, or partially an equity?

[Matthew Monaghan:]

Good question, Chris. We always think about our balance sheet to make sure we're using capital appropriately on a transactional basis for working capital, and then cash on hand or cash balance for that eventuality or for paying these two tranches of debt. Our best tool to facilitate good refinancing is having solid EBITDA, which is the basis of normally commercial lending facilities. And that's why it's so important for us not only to make our commitment to the company's owners the shareholders and delivering EBITDA, so that we have the commercially reasonable refinancing tranche to be in stock. So the $20 million EBITDA target which we're very committed to hitting this year is an important lead point for that which then leads us to that other targets the 85 to 105 for next year adjusted EBITDA that should put us in the zone of relatively normal discussions with lenders to refinance that. On the proxy, thanks for bringing that up. We took out the convertible debt instruments because of our market cap and share prices decline. We were constrained 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 settling some combination of shares in cash, should those converts the exercisable in the $16 plus range.

[Chris Cooley:]

Understood, thanks. Appreciate the time.

[Matthew Monaghan:]

Thanks Chris.

[Operator:]

And we'll take our next question from Mike Madison with Needham and Company.

[Mike Madison:]

Hi, thanks for taking my questions. I guess, I just wanted to start with the respiratory business. So the slide said that you're going to reevaluate all businesses from market leadership and profitability doesn't seem like you're going to get to either of those in the respiratory business. So why wouldn't you just exit that business completely?

[Matthew Monaghan:]

That's a good question. We want to make sure that our business leaders internally that oversee these various segments and product portfolios are asking that. So I think as Kathy mentioned, as an answer to a previous question, we are definitely shifting our focus in our internal portfolio to make sure we continue to have a solid offerings in the 5-meter 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 and we continue to have leading features, functionality in our product. And then in the middle is 10-meter in the HomeFill, which continue to have enhancement opportunities. So I think if our shareholders can see the results of a 35% nominal contribution margin and enough - low enough SG&A to get the 10% spreads. That's a pretty good use of capital now. We always look at how to optimize our use of capital. I think 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 510(Okay) to enhancements to those products. And we think we have good alignment with customers on what they want in a product that serves their customers well, so we should be able to grow those. It is a challenging market in total. But there are some real product categories in there that we know did well, I think we can still be a leader. And if we can generate that kind of EBITDA, and that's good returns for shareholders as we make our targets for this year and next year in refinancing. But we'll keep looking at it. You should hold us accountable to demonstrating that we are leading in share and delivering that kind of contribution.

[Mike Madison:]

Okay, thanks. And then, the respiratory business, I mean, it wasn't just down significantly in North America. It was down a lot in Europe as well, though it was up in Asia. But, I mean, how much of this is really because of this reimbursement change are they ended the contracts and open it up to all comers versus the move to POCs in this market. Because it seems like there's more going on than just the reimbursement changes, I guess.

[Matthew Monaghan:]

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 found ways to not keep our facilities full and still increase profit and you would see that in the results we've turned in it's really remarkable to do as well as we've been doing, despite the really significant downturn in sales. So 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 has been a tremendous amount I would say feeding frenzy around battery powered portable oxygen concentrators, which are a great modality. But I think as we get into the - I don't know if it's exactly the third or fourth year of this bolus of deployment. I think providers are realizing that once the warranty ends, these things are 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 HomeFill portable oxygen concentrator system, which is roughly the same cost of purchase for the last three or four times as long with very little service costs along the way. So I think what we're going to see as a settling out in the marketplace of a more reasonable balance of the modalities that DME providers are using to get reimbursement and serve their clients well, and we're really well positioned to have that balance. We great 5-liter, great 10-liter, we have this unique HomeFill that still has patented technology that makes it different. And we have a really great portal oxygen concentrator that's still is leading in terms of connectivity of features, and everything. So when we look at the marketplace, and if we see a reason to hang with our customers and continue to provide this whole portfolio and then internally optimize our costs, and we still deliver improved results to shareholders despite this [technical difficulty] world economy.

[Mike Madison:]

Okay. And then just one on the tariffs. So, let's assume that the tariffs increased to 25% Friday night. That - where would you stand with being able to mitigate that from a timing standpoint? I mean, 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? And is there a risk that there's some kind of timing issue that it still hits your second quarter results as you take steps to offset it?

[Matthew Monaghan:]

Yes, 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 the gap in what we haven't mitigated which was $400,000 in the quarter. But then go up by something like 2.5 time reflecting the 10% to 25% tariff increase. However, that GAAP already includes some products, like in the steel and aluminum categories that are already at 25%. So that GAAP isn't entirely going to be escalated. So I think if you said $400,000 is a $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 really would take actions to reduce that even further.

[Kathy Leneghan:]

And while that would be the maximum to your point, the unmitigated portion primarily relates to many of the product that's already added 25% rate.

[Mike Madison:]

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

[Kathy Leneghan:]

On the growth on the sale 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 discrete charge related to warranty that impacted the results, a one-time charge related to warranty not related to the sales growth that we saw in the Asia-Pac distribution business.

[Mike Madison:]

Okay, great. Thanks a lot.

[Matthew Monaghan:]

Okay, thanks Mike.

[Operator:]

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

[Jim Sidoti:]

Good morning. Can you hear me?

[Matthew Monaghan:]

I can, Jim. Good morning. Thanks for calling.

[Jim Sidoti:]

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:]

The sum of quarters two, three, and four will be zero from here for our guidance. That doesn't mean that every quarter will be zero, but to sum of the remainder of the year at least.

[Kathy Leneghan:]

Historically, Q2 is a usage quarter, and then we get better in Q3 and Q4. So 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:]

Okay. And I think on the last call, you hoped or indicated that you might see a pickup in respiratory sales in the back half of this year or is that still the case or do you no longer think that will happen?

[Matthew Monaghan:]

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

[Jim Sidoti:]

All right. And one last one from me, if you look at the says 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 to grow to single digit sales growth, low single digit sales growth in 2019 and 2020, does that mean you expect growth both the year or just the combined years?

[Matthew Monaghan:]

Both years. We expect sales up, it might not be exactly the same every season or every quarter we do have seasonality in Europe for sure. Just a little different in North America and then overall for the company, but we expect growth overall both year.

[Jim Sidoti:]

So despite the fact sales declined in…

[Kathy Leneghan:]

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

[Jim Sidoti:]

Right. So respiratory I mean, it looks like it was about $19 million this quarter do you think that's the bottom or do you think that continues to decline?

[Matthew Monaghan:]

We attribute this to the external shift in national competitive bidding in the metropolitan areas and in fact the external impact and there are no other external impacts we should be get the bottom of that looking for it to stabilize and grow, if those markets that allow and fleets get older and need to be replenished again specially heading into the winter flu season. So I don't think it was down from here I think it's just to assume the assets would have placed to service customer nationally in the winter and if the winter is the peak use of those kind of things then our customers collectively, all of our customers and our competitive customers will have that fleet that can get into Labor Day let's say at least. And then when more people come really into the market and the fleet of products are then were it there will need to be more replenishment. So I think if you look at the macro side of that I'd say it's probably at the bottom in terms of demand.

[Jim Sidoti:]

Okay, very good.

[Kathy Leneghan:]

The decline we saw in the first quarter is consistent with the declines in the percentage that we saw in Q3 as well as Q4. And so our plan assumes that that same decline continues through the remainder of 2019.

[Matthew Monaghan:]

Yes, we kind of look at it sequentially on a rate basis.

[Jim Sidoti:]

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

[Matthew Monaghan:]

It should be, everything else grows and Asia-Pac, Europe everything in North America except respiratory and respiratory is sort of the CBD [ph] until the market comes back and then all the pieces should be working together. And in the meantime in that being excuse for profitability as you can see what we've done to drive gross margin up despite that sales decline.

[Jim Sidoti:]

All right, thank you.

[Matthew Monaghan:]

Thanks, Jim.

[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:]

Okay, thank you Lean. And thanks to everybody your time and attention in today's call. Kathy, Lois and I are available for any follow up questions. Hope you have a good day. Thank you.

[Operator:]

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