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Edited Transcript of HRC earnings conference call or presentation 28-Apr-17 12:30pm GMT

Thomson Reuters StreetEvents

Q2 2017 Hill-Rom Holdings Inc Earnings Call

BATESVILLE May 8, 2017 (Thomson StreetEvents) -- Edited Transcript of Hill-Rom Holdings Inc earnings conference call or presentation Friday, April 28, 2017 at 12:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* John J. Greisch

Hill-Rom Holdings, Inc. - CEO, President and Director

* Mary Kay Ladone

Hill-Rom Holdings, Inc. - VP of IR

* Steven J. Strobel

Hill-Rom Holdings, Inc. - CFO and SVP

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Conference Call Participants

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* David Ryan Lewis

Morgan Stanley, Research Division - MD

* Frederick A. Wise

Stifel, Nicolaus & Company, Incorporated, Research Division - MD

* John Hsu

* Matthew Charles Taylor

Barclays PLC, Research Division - Director

* Matthew Ian Mishan

KeyBanc Capital Markets Inc., Research Division - VP and Senior Equity Research Analyst

* Robert Adam Hopkins

BofA Merrill Lynch, Research Division - MD of Equity Research

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Presentation

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Operator [1]

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Good morning, and welcome to Hill-Rom's fiscal second quarter earnings conference call. (Operator Instructions) As a reminder, this call is being recorded by Hill-Rom and is copyrighted material. It cannot be recorded, rebroadcast or transmitted without Hill-Rom's written consent. If you have any objections, please disconnect at this time.

I would now like to turn the call over to Ms. Mary Kay Ladone, Vice President and Investor Relations at Hill-Rom. Ms. Ladone, you may begin.

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Mary Kay Ladone, Hill-Rom Holdings, Inc. - VP of IR [2]

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Good morning, everyone, and thanks for joining us for our fiscal second quarter 2017 earnings conference call. Joining me today are John Greisch, President and Chief Executive Officer of Hill-Rom; and Steve Strobel, Chief Financial Officer. Before we get started, I'd like to mention that in addition to the press release issued this morning, we have posted a supplemental presentation, which can be accessed on the Investor Relations page of our website at hill-rom.com under Events & Presentations.

So with that introduction, let me begin our prepared remarks this morning by reminding you that certain statements contained in this presentation are forward-looking statements rather than historical facts and are subject to risks and uncertainties that could cause actual results to differ materially from those described. Please refer to today's press release and our SEC filings for more detail concerning risk factors that could cause actual results to differ materially.

In addition, in today's call, non-GAAP financial measures will be used to help investors understand Hill-Rom's ongoing business performance. A reconciliation of the non-GAAP financial measures being discussed today to the comparable GAAP financial measures is included in our earnings release issued this morning and available as part of the presentation on our website.

Now I'd like to turn the call over to John.

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John J. Greisch, Hill-Rom Holdings, Inc. - CEO, President and Director [3]

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Thanks, Mary Kay. Good morning, everyone. Thanks for joining us today to discuss our second quarter financial results and outlook for the third quarter and full year. I will begin with some brief comments on our performance before turning the call over to Steve for additional details. After that, we will open the call for Q&A.

As you saw in our press release issued this morning, we exceeded guidance in the second quarter with accelerated revenue growth across our diversified portfolio and strong operational performance. Momentum in our core business, improving international growth trends, value from new product introductions and the recent acquisition of Mortara, were significant contributors to our second quarter results. We continue to successfully execute on key strategic priorities while enhancing outcomes and generating attractive returns for our shareholders.

Worldwide revenue of $679 million increased 8% on a constant currency basis, including Mortara revenue of approximately $13 million. Core revenue, which excludes Mortara as well as completed or potential divestitures advanced 7% on a constant currency basis and exceeded our guidance of growth in the 4% to 5% range.

Core growth acceleration is the result of several factors. First, we have established a strong foundation as we are now realizing benefits from our portfolio optimization and diversification efforts with solid growth across all 3 of our global businesses. Clearly, the value of our more diverse portfolio is yielding strong results.

Second, as expected, international performance contributed to our total revenue growth with core revenue advancing on a constant currency basis by 13% year-over-year and 10% sequentially, reflecting improvement in Europe, the Middle East and Latin America.

With strong execution from our international team and the organizational realignment largely behind us, we are making headway internationally despite continued economic challenges. We expect this positive momentum to continue for the remainder of the year.

Lastly, we are creating value with new products, which contributed several points of growth to our top line. We are pleased with the initial adoption of these products like the Connex Spot Monitor, Spot Vision Screener, RetinaVue and Integrated Table Motion.

Our financial performance this quarter also reflects continued execution on our margin expansion initiatives, disciplined cost management resulting in SG&A leverage and continued investment in R&D to support future growth.

With strong revenue and adjusted operating margin expansion of 110 basis points, we delivered adjusted earnings of $0.88 per diluted share, an increase of 24% versus the prior year. As mentioned in the press release, adjusted earnings include a $0.06 tax benefit related to stock-based compensation, which we expect to reinvest in our business over the remainder of the year.

We also announced this morning that we are raising our full year revenue and earnings guidance, which now includes Mortara and reflects our confidence in our ability to drive sustainable revenue growth and margin expansion in the second half of the year.

Before turning the call over to Steve, I'd like to take a moment to highlight recent progress in expanding our capabilities, capitalizing on new product introductions and partnering with customers to enhance outcomes for patients and their caregivers.

As you may recall, a key element of our strategy is to diversify our portfolio and enhance performance with sustainable and profitable growth through M&A initiatives. To that end, in the quarter, we were pleased to complete the acquisition of Mortara, a leader in diagnostic cardiology and patient monitoring technology.

This strategic transaction expands Hill-Rom's diagnostic cardiology franchise and complements and enhances Welch-Allyn's presence in vital signs monitoring. The transaction has compelling financial benefits as it accelerates revenue growth, is accretive to adjusted gross and operating margin and is expected to generate approximately $10 million in annualized cost synergies over the next 2 years. Our integration efforts are underway, and we look forward to successfully incorporating Mortara into our Front Line Care business.

In addition, we continue to invest in R&D and develop innovative product and service solutions to drive accelerated future growth. We are pleased with the elevated pace of new product launches as our R&D pipeline continues to deliver clear value for both caregivers and patients around the world.

For example, during the second quarter, we launched the TruSystem 3000 Mobile Operating Table, which enhances our surgical portfolio by providing a cost-effective, reliable and flexible operating table for international markets.

In addition, we expanded our Patient Support Systems portfolio with the international launch of the new Hill-Rom 900 Accella bed system for higher acuity, intensive and acute care settings. This product offers caregivers a number of features that make caring for patients easier and safer and enhances patient outcomes by supporting early mobilization.

Lastly, we will soon introduce a new innovation in respiratory care with the recent 510(k) approval of the Monarch Airway Clearance System. The Monarch System provides high-frequency chest wall oscillation therapy in a mobile vest with a customizable, personalized fit allowing a patient to be active and productive while receiving therapy.

We're also capitalizing on a number of new products that have been introduced over the last year or 2. We continue to be excited about the Welch Allyn RetinaVue imager, a breakthrough handheld technology for primary care settings, which makes diabetic retinopathy screenings simple and affordable.

In addition to providing enhanced care for diabetic patients, this screening allows -- also provides Hill-Rom with an ongoing recurring revenue stream. Since the product was launched last year, physicians have screened nearly 90,000 patients and have identified more than 13,000 patients with potential vision complications, thereby improving patient outcomes through early detection and treatment.

With Integrated Table Motion for the da Vinci XI surgical system, we achieved a record number of placements this quarter, which again contributed to the strong momentum in our Surgical Solutions business. The surgical system and table seamlessly integrate, allowing surgeons and anesthesiologists to make a comprehensive range of table adjustments easily and efficiently during surgery.

We also continue to leverage our strong brand equity and Hill-Rom's acute care relationships with Welch Allyn's differentiated vital signs portfolio including the Connex Spot Monitor, an easy-to-use vital signs monitor that provides comprehensive and accurate blood pressure measurement, pulse oximetry and temperature using a single device, which improves patient satisfaction and delivers enhanced connectivity to the EMR.

So to summarize, we continue to be pleased with our team's execution against our strategic priorities that will position us well for future success. We'll continue to focus on enhancing our portfolio, delivering solid financial performance, advancing innovative solutions with continued investment in R&D and pursuing business development initiatives that deliver enhanced returns in the near and long term.

With that, let me turn the call over to Steve.

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Steven J. Strobel, Hill-Rom Holdings, Inc. - CFO and SVP [4]

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Thanks, John, and good morning, everyone. As mentioned in the press release, we reported GAAP earnings of $0.51 per diluted share in the second quarter compared to $0.33 in the prior year. Adjustments to reported earnings primarily include intangible asset amortization, acquisition integration and other special charges not reflective of ongoing performance. On an adjusted basis, earnings of $0.88 per share increased 24%, exceeding our guidance of $0.77 to $0.79 per diluted share.

This performance reflects strong revenue growth, disciplined cost management, continued margin expansion and a tax benefit of approximately $0.06 per diluted share related to stock-based compensation. The Mortara acquisition, which closed mid-quarter, was immaterial to adjusted earnings per diluted share.

Now let me briefly walk through the P&L before turning to our financial outlook for the third quarter and fiscal year 2017.

Starting with revenue. For our fiscal second quarter, revenue of $679 million grew 7% and includes 13% -- $13 million of revenue from Mortara. On a constant currency basis, revenue increased 8%. Domestic revenue increased 6%, while international revenue grew -- growth rebounded after several challenging quarters and advanced 14%.

Core revenue growth was 7% on a constant currency basis and exceeded our guidance of 4% to 5% growth. As a reminder, core revenue excludes the impact of businesses that we divested or may divest in both the current and prior year. It also excludes revenue from Mortara.

Before moving on, keep in mind that as I discuss each business segment, I will address revenue growth on a constant currency basis only, which we believe provides investors the best assessment of underlying operational performance.

Starting with Patient Support Systems. Second quarter revenue on a global basis of $363 million increased 4%. On a core basis, Patient Support Systems revenue increased 6%. We were very pleased to see accelerated international revenue growth of 9% versus a decline of 11% in the first quarter.

We achieved solid growth across all regions except Asia Pacific, where we continued to face some difficult comparisons to the prior year. Domestic revenue in Patient Support Systems business grew 2%, with U.S. core revenue increasing 4% driven by mid-single-digit growth of our bed systems. This growth was partially offset by a decline in rental revenue.

Now moving to Front Line Care. Global revenue for the quarter was $211 million and increased 15%. Excluding Mortara, Front Line Care grew as expected to 7%. This performance can be attributed to gains in our thermometry business and vital signs portfolio, the contribution from new products and accelerated international growth across all regions as we are leveraging Hill-Rom's international channel and expertise.

Lastly, the Surgical Solutions business delivered a strong quarter, with revenue of $105 million, an increase of 12%. Growth was driven by continued strength of our surgical positioning products and the Integrated Table Motion system. Growth was well balanced geographically, with U.S. revenue up 13% and international revenue up 12%, driven by double-digit growth in Europe, Latin America and the Middle East.

Now turning to the rest of the P&L. Adjusted gross margin in the quarter improved sequentially by 50 basis points to 48%. Compared to last year, adjusted gross margin expanded 10 basis points supported by our continued focus on portfolio diversification and ongoing benefits from cost and sourcing efficiencies.

Favorable mix and improved international margins were partially offset by lower margins in our rental and Surgical Solutions business. R&D spending of $35 million increased 3% versus the prior year. And as a percentage of revenue, the ratio of 5.2% is consistent with our long-term objectives.

Adjusted SG&A of $189 million increased 4%. Disciplined cost management more than offset investments in our international infrastructure, expansion of our U.S. specialty sales force, new product launches and the addition of Mortara. This resulted in an SG&A ratio of 27.8% of revenue, an improvement of 80 basis points versus last year.

As a result, adjusted operating profit for the quarter totaled $102 million. Given strong revenue growth, continued gross margin expansion and SG&A leverage, adjusted operating margin improved 110 basis points over last year to 15%. This is our seventh consecutive quarter of triple-digit basis point operating margin expansion.

Other expense of $22 million was slightly higher than last year, as interest related to the Mortara financing was partially offset by savings generated from the refinancing of our credit facilities late last year. The adjusted tax rate was 26.1% compared to 28.9% in the prior year. As previously mentioned, our tax rate benefited by the change in accounting for stock-based compensation.

So rounding out the P&L, on the strength of robust revenue growth, continued focus on margin expansion and the tax benefit, adjusted earnings advanced 24% to $0.88 per diluted share.

Turning to cash flow. On a year-to-date basis, cash flow from operations of $126 million improved $39 million versus the prior year, while capital expenditures totaled $47 million. Free cash flow year-to-date of $79 million almost doubled versus last year, and we've returned $53 million to shareholders through dividends and a $30 million share repurchase.

Finally, let me conclude my comments this morning by providing our third quarter and updated full year 2017 financial outlook, which includes the impact of Mortara.

For the year, we now expect reported revenue growth of 3.5% to 4%. Given current rates, we estimate a negative impact from foreign currency of approximately 1 percentage point. So revenue on a constant currency basis is expected to increase 4.5% to 5%, and this includes revenue from Mortara of approximately $70 million. We expect core revenue, which excludes Mortara and the impact of completed and potential divestitures from both periods, to increase 3.5% to 4% on a constant currency basis.

Now by business segment. For Patient Support Systems, we continue to project low single-digit revenue growth on a constant currency basis in line with our year-to-date performance. For Front Line Care, we expect -- we continue to expect mid-single-digit constant currency growth for the base business and, as previously mentioned, approximately $70 million in revenue for Mortara. Lastly, we continue to expect mid-single-digit growth on a constant currency basis for our Surgical Solutions business.

From a profitability standpoint, we expect adjusted gross margin to be approximately 49%; R&D spending of approximately 5% of sales; adjusted SG&A of approximately 27.5% of sales; interest expense of approximately $92 million, which is an increase from our previous guidance due to the Mortara financing; a projected tax rate of approximately 29% to 29.5%; and finally, we expect approximately 67 million shares outstanding for the year.

To summarize, this guidance translates into adjusted earnings of $3.82 to $3.88 per diluted share, reflecting growth of approximately 13% to 15%. This represents an increase from our previous guidance range of $3.74 to $3.82 per share.

From a cash flow perspective, we continue to project 2017 operating cash flow of $330 million to $340 million and capital expenditures of approximately $120 million to $130 million.

For the third quarter 2017, including Mortara revenue of approximately $30 million, we expect reported revenue growth of 5% to 6%. On a constant currency basis, we expect revenue to increase 6% to 7%. And our core revenue is expected to increase 4% to 5% on a constant currency basis. Finally, for the third quarter, we expect adjusted earnings of $0.89 to $0.91 per diluted share, reflecting growth of 10% to 12%.

And with that, I'll turn the call back over to John for closing comments.

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John J. Greisch, Hill-Rom Holdings, Inc. - CEO, President and Director [5]

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Thanks, Steve. In closing, we are pleased with accelerated revenue growth across our core business, improved international performance and continued focus on margin expansion, which allowed us to deliver strong adjusted earnings growth in the second quarter.

As a result, we are raising our full year guidance. Our improved outlook reflects the benefit of Mortara, accelerated investments behind several of our key strategic growth initiatives and a conservative view on U.S. capital spending given uncertainties surrounding health care reform.

While we continue to closely monitor the health care landscape, our Hill-Rom team remains committed to diversifying the portfolio, leveraging our strong global brands and geographic footprint, and launching new innovations to enhance growth and profitability in the years ahead.

While we are very pleased with our performance and execution, we remain focused on the growth and margin opportunities ahead of us as we deliver on our mission and create long-term value for patients, customers and shareholders. We look forward to updating you on our continued progress.

With that, operator, let's open the call for Q&A.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from the line of David Lewis from Morgan Stanley.

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David Ryan Lewis, Morgan Stanley, Research Division - MD [2]

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John, I want to start with you and then talk about revenue trends and then move on to earnings and maybe reconcile some of the numbers there. But John, I just want a square performance and guidance year-to-date. The way we see it is, you kind of combined first half results to sort of low single-digit performance then you have an acceleration in the back half of the year to 4% to 5% or better, which is sort of basically the way you described the year in the initial guidance. So I guess the question is, is the year playing out largely as expected? And can you talk about the sustainability of momentum in key U.S. franchises and international markets? And then I had a quick follow-up.

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John J. Greisch, Hill-Rom Holdings, Inc. - CEO, President and Director [3]

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Sure, David. I'll touch on a few things there. You're right. Year-to-date, our core revenue is up about 3%. The first quarter was tougher for the reasons that we went through last quarter. Most notably, international was negative and Welch Allyn came off of a tough comp from Q1 in fiscal '16. Are we playing out along the lines of what we expected? I think Q2 was a little stronger than what we expected. We guided to a 4% to 5% core growth. We achieved 7%. We saw really strong performance across the board. The biggest swing factors from Q1 to Q2 as well as relative to our guidance were really in our international market. We posted low double-digit growth internationally. It's a first strong quarter of growth in international for several years. And as you heard in my comments, we expect that to continue -- momentum to continue here in the second half of the year. Other momentum across the portfolio, surgical had a great quarter with low double-digit growth. Front Line Care was up about 7 points, and that was with a flattish Respiratory Care business. So Welch Allyn was ahead of that number, so slightly ahead of where we expected. And the new product introductions across the portfolio are taking hold nicely. Our outlook for the second half of the year remains largely consistent with what we projected 3 months ago at 4% to 5% core currency growth -- core growth in constant currency terms, with reasonably consistent growth rates across the portfolio from what you saw here in the second quarter. As I mentioned in my comments, we're keeping our eye on U.S. CapEx, but low single-digit growth for PSS is what we expect to deliver for the year and no major changes. So reasonably well in line with expectations, a bit stronger here in Q2, which we're thrilled with. Up and down the P&L, I think we delivered what we said we're going to do and then some and feel confident in the second half of the year as well.

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David Ryan Lewis, Morgan Stanley, Research Division - MD [4]

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Okay, John, very clear. And then just kind of a similar question on earnings. You beat by $0.10 then you get Mortara only raising by $0.08. So how much of this is kind of prudent conservatism midyear? Where are these 3Q investments being directed? And can you help us think about Mortara accretion in '17 and, more importantly, 2018?

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John J. Greisch, Hill-Rom Holdings, Inc. - CEO, President and Director [5]

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Yes, I'll take the first crack at that and then -- and Steve can clean it up. As you said, we beat the high end of our guidance by about $0.09. $0.06 of that was the stock comp accounting change, which we've chosen to reinvest really behind some of the new product introductions. Largely, RetinaVue, which we're seeing good traction on and with accelerated investments on The Street, we think we can accelerate the revenue growth even further. Our new med-surg product is coming out later this year and we're going to put some muscle behind that. And then you saw the 510(k) approval for our mobile respiratory product, Monarch, which we announced earlier this week. Those, plus continuing to invest in international, where we're really beginning to see the benefits of our diverse portfolio and focus put on our higher-growth, higher-margin products. That benefit is really kicking in now. And I said that last quarter, and we clearly delivered and even overdelivered on that. Turnaround performance internationally; I feel great about what's happening outside the United States. So we've chosen to reinvest that into those growth areas. So you look at the operational improvement in Q2 of, call it, $0.03 -- $0.03 to $0.04 plus the Mortara accretion, that drove the guidance lift for the full year.

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Steven J. Strobel, Hill-Rom Holdings, Inc. - CFO and SVP [6]

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Yes, David. You look at the midpoint to midpoint, we're going up about $0.07. So as John said, after we reinvest behind our growth initiatives through the operational improvement from the second quarter and some modest accretion from Mortara.

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David Ryan Lewis, Morgan Stanley, Research Division - MD [7]

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And then, could you help us think about 2018? I want to make sure The Street is sort of reconciled and understands sort of net accretion and financing costs, and then get kind of the right number in '18 before we get to the guide.

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John J. Greisch, Hill-Rom Holdings, Inc. - CEO, President and Director [8]

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Yes, I'd rather not talk specifically about '18, David. I'll share what we shared at the time we announced it. We expect EBITDA of roughly $25 million in year 1 for Mortara. And again, their business was about $115 million in revenue growing roughly 4% a year. Once we get fully integrated with our regions, like we've done with Welch Allyn and Trumpf, we're certainly hopeful we're going to accelerate that. And then we get $10 million of synergies over the next 2 years on top of that with the financing costs offsetting that. So I'd rather save the specifics till we get into '18 guidance. But hopefully, that gives you a framework for piecing that together.

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Steven J. Strobel, Hill-Rom Holdings, Inc. - CFO and SVP [9]

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Yes. I think that -- I think the message is not a lot has changed from when we discussed the Mortara kind of financial profile when we purchased them and closed in February.

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Operator [10]

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Bob Hopkins of Bank of America is on the line with a question.

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Robert Adam Hopkins, BofA Merrill Lynch, Research Division - MD of Equity Research [11]

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So a couple of things. Just to -- first of all, just to finish that thought. You gave us plenty of numbers there to do the math. But could you just be specific in terms of the EPS contribution from Mortara in this fiscal year?

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John J. Greisch, Hill-Rom Holdings, Inc. - CEO, President and Director [12]

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In this fiscal year, Bob, should be a couple pennies. And it was immaterial, as we said, in the quarter.

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Robert Adam Hopkins, BofA Merrill Lynch, Research Division - MD of Equity Research [13]

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Okay. So on to my questions. First, congrats especially on the OUS performance. We've been waiting to see that for a while and it's great to see it come through. A couple questions I wanted to ask and just starting on revenues. First, just to sort of check these boxes. In the performance this particular quarter on the revenue side, was there kind of anything onetime about these results? And then also on the revenue side, you mentioned U.S. capital trends a couple times. Are U.S. capital trends stable right now? Or are you seeing signs of softening?

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John J. Greisch, Hill-Rom Holdings, Inc. - CEO, President and Director [14]

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Yes, there is nothing unusual in the quarter, Bob. It really was -- particularly internationally, and you haven't been alone waiting for the turnaround, but I can assure you. But our team led by Carlos Alonso, they've now been in place for a little bit over a year. We've gotten the realignment of the organization behind us as I mentioned in my comments. And the focus on the higher-growth, higher-margin products across the world, we're beginning to see the benefits of that. And it's really exciting to see that because, as you all know, that's been the biggest drag on our overall performance for the last several years. So nothing unusual in the quarter at all. U.S. capital environment. The delay of the legislation -- repeal and replace, whatever's going to happen, it's probably introduced a little more caution among customers, more on small deferrable spending from what we can see as opposed to larger strategic projects. But I wouldn't say there's been any major change in the environment. I think as we look forward to the rest of the year, whatever short-term disruption there may be, if the delay continues and uncertainty grows, we think with some of the new products we're bringing out, we're hopeful we're going to be able to accelerate some replacement demand, particularly in our capital products with our new med-surg beds as we go into Q4 and 2018. And if you look at our U.S. capital revenue, that was up. Steve mentioned the bed systems were up mid-single digits. Our U.S. capital was up about 7% here in Q2. So pretty strong performance for the first half of the year here. But the longer the uncertainty goes, an issue, but so far, I think, no major change in environment.

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Robert Adam Hopkins, BofA Merrill Lynch, Research Division - MD of Equity Research [15]

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Okay. And then just one quick last one. Can you just highlight, in the near term, what are the most important new product launches for you guys? And then also, Steve, for you, just I was wondering if you could break down the increase in the EPS guidance for the year. And I think you said obviously $0.02 of it is Mortara. But I ask the question because you said that the benefit from the tax rate this quarter is being offset by extra spending, so $0.02 comes from Mortara. What's the -- is the other increasing guidance, the other $0.01 is just coming from the better revenue growth trends and the raising guidance there? That's all I have.

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Steven J. Strobel, Hill-Rom Holdings, Inc. - CFO and SVP [16]

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I'll -- let me take that one, first. Yes, I think, what we said was in the second quarter, our beat in the second quarter was operational and tax. And I think we're flowing through to the full year guidance some of that operational improvement plus Mortara accretion and then spending back the benefit from the tax change. Does that make sense?

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Robert Adam Hopkins, BofA Merrill Lynch, Research Division - MD of Equity Research [17]

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Yes.

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John J. Greisch, Hill-Rom Holdings, Inc. - CEO, President and Director [18]

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In terms of new products, Bob, a couple comments. Internationally, I commented on a new operating room table, the TruSystem 3000. And then we've got a new bed frame, the Hill-Rom 900 Accella, which is an advanced featured med-surg bed for our international markets. We're really excited about both of those products. Domestically, the 2 biggies to come are the Monarch vest system, the mobile vest system for our respiratory care patients, which we're launching as we speak following the 510(k) approval. And then our new med-surg product will come out later this year. And as I mentioned, I am confident as that product is in the market, I expect just as we did with our ICU launch a few years ago to see accelerated demand and accelerated replacement cycles. The only other 2 I've mentioned because they're having the impact that we expected, RetinaVue and Integrated Table Motion. I think that when we launched Integrated Table Motion, we commented that that's going to be a 1 point accretive to our growth rate new product launch, and we're tracking right in line with that expectation. And RetinaVue isn't quite at that level yet, but it's getting there quickly and that's one where we're going to put a lot more investment behind as we go through the rest of '17 and into '18.

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Operator [19]

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Matt Taylor of Barclays is on the line with a question.

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Matthew Charles Taylor, Barclays PLC, Research Division - Director [20]

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And I guess the first question I have was I wanted to know, did you give the order growth and the backlog numbers? Or could you give us that? I didn't see that anywhere in the materials that were released.

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John J. Greisch, Hill-Rom Holdings, Inc. - CEO, President and Director [21]

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Matt, as that business has become a smaller and smaller part of the portfolio, we've elected not to disclose those more for competitive reasons. Nobody else in that space has given out the specific numbers that we have been giving out. And given the declining importance of our U.S. bed business, we've elected for competitive reasons to not report those numbers anymore. I think with the product sales and service and rental breakdown and GBU break down, hopefully, you guys get enough detail behind the product categories we've got without really breaching any competitive disclosures that we don't need to give. And with U.S. capital revenue up 7% here in Q2, that should give you a pretty good flavor of how that business performed.

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Matthew Charles Taylor, Barclays PLC, Research Division - Director [22]

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Okay, great. And then, I guess, I just wanted to understand, philosophically, how you're thinking about kind of the upside that you're getting from the growth here because you did get significant upside on the quarter and sort of chose to reinvest some of that rather than just drop it all through. You haven't given an update on your kind of longer plan in a while, but you're clearly sort of ahead of pace. And I'm just wondering, as we move forward, as you see better growth in the core business and from some of these acquisitions, are you going to choose to reinvest some of that or drop it through? And how do you think about that?

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John J. Greisch, Hill-Rom Holdings, Inc. - CEO, President and Director [23]

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Yes, it's a really good question. Let me take it in a couple doses, if I may. So why reinvest the unanticipated tax accounting change benefit? We've got some pretty exciting growth opportunities in front of us, and we've been balancing the investments in those opportunities with delivering strong double-digit earnings growth which we've committed to 2.5 years ago or 1.5 years ago now. So given the opportunity to reinvest and accelerate some of the demand behind the growth products, we chose to do that. Obviously, the biggest challenge we've been dealing with has been top line revenue growth. And I think the more muscle we can put behind the growth opportunities we have, the better. And hence, the decision to do that behind the year as I mentioned. RetinaVue, next-gen med-surg, Monarch and international specifically. And still, by the way, deliver double-digit earnings growth here in the second half of the year and Q3 double-digit growth if you look at our guidance. So we're committed to delivering on the LRP goals that we set out in September '15. You're right, we're probably ahead of that. As Steve mentioned, we had 7 quarters in a row of triple-digit operating margin improvement. That's a performance we're incredibly proud of and committed to continue driving operating margin expansion, while at the same time, the goal that has been maybe a little more elusive has been top line revenue growth, which is why we're putting some more investment behind the opportunities that are in front of us and driving growth in international markets at the same time. So we'll come out later this year with a refresh of our LRP goals for the coming 3 years, but certainly committed and right in line with what we laid out nearly 2 years ago now.

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Operator [24]

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Our next question comes from the line of Rick Wise of Stifel.

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Frederick A. Wise, Stifel, Nicolaus & Company, Incorporated, Research Division - MD [25]

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Let me start off with gross margin. Obviously, you raised guidance for revenues and EPS, but your gross margin guidance is basically at the same place. And just help me think through it. I mean, you clearly have ongoing cost reduction initiatives and maybe you can talk about that. You said yourself, we're seeing an accelerated pace of new product launches. If my understanding is correct, Mortara has an above current rate -- maybe I'm wrong -- gross margin relative to Hill-Rom. What am I not understanding about gross margin? And maybe just help us think through that outlook a little more carefully.

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John J. Greisch, Hill-Rom Holdings, Inc. - CEO, President and Director [26]

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Yes. Let me comment on what happened with Q2 in our quick outlook, Rick, and then Steve can follow up. So Q2, our margin was up 10 basis points. We had a couple of down arrows in the margin -- in our gross margin. Our rental margins, as you saw, were down. We've got a relatively low-margin third-party equipment rental business which not only has been purposely shrinking in revenue, but the margins are increasingly under pressure. It's probably our lowest-margin business that what we have today. So that hurt us somewhat here in the second quarter. And then we had some supply chain costs relative to one of our plant closures that were a bit of a surprise. We were able to absorb it and still deliver an above-expectation quarter, but that hit our margins here temporarily in Q2. If you look ahead, we've got some significant acceleration in the second half of the year, consistent with last year. And I think our full year guidance and gross margin was up 90 bps or so over last year at 49%. So the only blemish on the quarter, to be honest with you, is the 2 things I just mentioned, which are temporary in nature. And I think the full year commitment of 90 basis points to 49% is pretty much in line with -- is exactly in line with what we said 3 months ago and I think on track for all the reasons that you just mentioned.

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Steven J. Strobel, Hill-Rom Holdings, Inc. - CFO and SVP [27]

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And Rick, I would just add that the progression over the quarters of our gross margin this year will mimic in large respect kind of our overall progression from prior years as the third and fourth quarter margins with additional volume and additional leverage and our manufacturing footprint improves quarter-over-quarter.

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Frederick A. Wise, Stifel, Nicolaus & Company, Incorporated, Research Division - MD [28]

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Great. And just to make sure I understand, John and Steve, the plant closing that's done, that's over, and no longer a drag in the second half and beyond. And supplier issue, is that resolved? Or just to follow that up.

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John J. Greisch, Hill-Rom Holdings, Inc. - CEO, President and Director [29]

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Yes, sorry. It wasn't a supplier issue. I probably mumbled through supply chain issue. So it was a plant closure.

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Frederick A. Wise, Stifel, Nicolaus & Company, Incorporated, Research Division - MD [30]

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I see.

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John J. Greisch, Hill-Rom Holdings, Inc. - CEO, President and Director [31]

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Yes. And as Steve said, second half, we expect to see good acceleration both on the gross line and the operating margin line also. I think second half operating margin is going to be up 300 basis points plus compared to the first half of the year.

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Frederick A. Wise, Stifel, Nicolaus & Company, Incorporated, Research Division - MD [32]

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Great. And the rental revenue is down in the U.S. Again, I wanted to make sure, is that tied to what you're talking about here?

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John J. Greisch, Hill-Rom Holdings, Inc. - CEO, President and Director [33]

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That's the biggest reason, absolutely. Yes, the third party where we rent infusion pumps, ventilators for on-demand purposes, not a great profit business for us. So that's been declining consistently here over the last several quarters as we try to optimize the portfolio.

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Frederick A. Wise, Stifel, Nicolaus & Company, Incorporated, Research Division - MD [34]

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Yes, 2 last ones for me. One, Steve, you mentioned that interest expense is a bit higher than you've guided. It's a bit higher than we would have modeled post Mortara. Maybe you help us understand that. Maybe, John, just one last bigger picture for you, the Bard-Becton combination, just your thoughts on that and the consolidation in the industry. And just how that ties in or not or accentuates or gives you opportunities relative to your own M&A initiatives and you can update us on your thinking there.

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Steven J. Strobel, Hill-Rom Holdings, Inc. - CFO and SVP [35]

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Hey Rick, first on the interest expense. I think that's -- there's nothing tricky in it with the bonds that we issued, the 5% coupon bonds added over the -- from February 14 on through the remainder of this year added to our prior guidance gets us to the 92. So we can walk you through it in more detail if you need to, but it's really nothing more mysterious than that.

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John J. Greisch, Hill-Rom Holdings, Inc. - CEO, President and Director [36]

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Yes, Rick, on the Bard-Becton deal, I'd rather not comment on that specifically. But consolidation within our customer base within the device industry, we've been part of that in a smaller way than Bard-Becton or Medtronic, Covidien or some of the other ones. But that's exactly what we've been pursuing on our own the last few years, and I think it's going to continue. And as aggressive as we have been with using our balance sheet others are following suit, obviously, but we're going to continue to do that as the opportunities avail themselves and as our financial flexibility allows us to do so. So I think the customer consolidation is the starting point for some of what we're seeing across the med tech world and I think it's going to continue and we plan to be part of it and aggressively continue to look for opportunities to strengthen our company just as we've done the last couple of years.

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Operator [37]

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Our next question comes from the line of Matt Mishan from KeyBanc.

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Matthew Ian Mishan, KeyBanc Capital Markets Inc., Research Division - VP and Senior Equity Research Analyst [38]

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John, could you give us an update on where you're at with the remaining divestitures? And also, could you help us understand -- I know you have the divestitures that you've been excluding from core growth but you've also had like business like you talked about like the equipment rental business that you've been optimizing. Could you give us a sense of what that headwind's been and when those are likely to be done as well?

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John J. Greisch, Hill-Rom Holdings, Inc. - CEO, President and Director [39]

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Yes. So on the $75 million of divestitures, $75 million of 2016 revenue, just to remind everybody, half of that was pretty much out of the portfolio by early fiscal '17. The remaining half I expect to see some activity on here in the second half of the year. So I'm hopeful by the time we get together in 3 months, we'll have some news on the remaining piece and it's one separable revenue source. So more to come on that probably 3 months from now. Some of the other things, Matt, like the third-party equipment rental, that's something we do constantly, where we have either lower growth or margin opportunities. We called out the $75 million largely because of the significance and there were 3 separable chunks of business for us. The impact of other portfolio optimization, relatively small, not completely immaterial. But like the third-party rental business that I mentioned, that's going to be up probably 20% this year on a base of roughly $40 million to $45 million. So that's, what, 30 basis points on our growth. There's a couple of those around the company but there always will be. So I think for our reporting purposes, as anything material gets our attention, we'll continue to talk about that to make sure everybody's got a clear picture of what's going on. But things of that size, it's kind of normal daily business that we intend to do just to try to optimize the portfolio.

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Matthew Ian Mishan, KeyBanc Capital Markets Inc., Research Division - VP and Senior Equity Research Analyst [40]

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Okay, that's very helpful. And then on new products, you've had a really great run with RetinaVue, Table Motion, Connex Spot Monitor, but most of those are about to lap like -- or anniversary. How do you compare the new products that you have coming out this year compared to the strength that you saw from the products last year? And on the Monarch, you called that one of the biggest in domestically. I'm just was hoping you could elaborate a little bit as to why.

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John J. Greisch, Hill-Rom Holdings, Inc. - CEO, President and Director [41]

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Sure. I think we're really excited about some of the things coming out of the portfolio. I mentioned a few of them here today between our next-gen med-surg bed and Monarch. RetinaVue has got a lot of runway ahead of it as does our Spot Vision Screener product and our Connex vitals monitor also. So you're right, the launch date anniversaries, but the growth we're seeing from those products, some of those were launched over a year ago, we're continuing to see some good strength on. So I think the portfolio and the pace of new product introductions that we've seen over the past 2 or 3 years, we certainly expect to continue going forward across the 3 businesses. Monarch itself, it really is, I think, a life changer for our respiratory care patients. And again, this is about a $90 million to $100 million business, our Respiratory Care business. And the real benefit of this product relative to both our current product and competitive products is it allows a patient to do their therapy with our products without being tethered to a device. So the mobility and the ability to walk around the house, walk around the yard, walk around the park and actually have a life as opposed to sitting in a chair tethered to a device is a massive life improvement for customers and we think is going to be a really attractive addition to our portfolio, particularly for patients in our Respiratory Care business, obviously.

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Mary Kay Ladone, Hill-Rom Holdings, Inc. - VP of IR [42]

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And our last question?

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Operator [43]

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Our last question comes from the line of Lawrence Keusch from Raymond James.

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John Hsu, [44]

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This is John in for Lawrence. John, I just had a couple quick strategic questions for you. I believe the progress you were just talking about and some of the other Welch-Allyn products you had, you've been selling it to the home care channels. So just broadly speaking, can you talk about the opportunity within home care? And then maybe as part of that, would you look for -- potentially looking for a distributor to accelerate expansion within that vertical? And then similarly, within surgical, you've diversified your capital offerings with Trumpf, selling lights, booms, tables in the OR. What are your thoughts about expanding into HD video with an integrated OR offering? Is that -- it seems like that could be a natural adjacency as well.

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John J. Greisch, Hill-Rom Holdings, Inc. - CEO, President and Director [45]

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Sure, John. Home care, yes, that is an exciting opportunity for us. You're right, the respiratory business is largely a home care business with our best product. We have other products that go into the acute care setting and there's some use of the vest in acute care settings, but most of it's in the home. That business is largely a direct business, which I expect to continue with our direct sales force here in the U.S. and in select markets around the world. The Welch Allyn products, we've got a few products in the home. We expect to have more products in the home going forward. It's part of our pipeline that I alluded to earlier. And you will see us tap into new channels going after the consumer home care market with some of our Welch Allyn products. We use distributors today, as you all know, for a lot of our Welch Allyn products into the physician practices. But as we look at our home blood pressure monitor, for example, and other opportunities to bring some of the Welch Allyn technologies into the home, we will be tapping other channels going forward. And I'll talk about those as we get those relationships in place.

And that wraps it up, Charlotte. So I appreciate everybody joining us this morning and look forward to catching up with you over the coming days and weeks.

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Operator [46]

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Ladies and gentlemen, this concludes today's conference call with Hill-Rom Holdings, Inc. Thank you for participating.