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Edited Transcript of HRC earnings conference call or presentation 25-Jan-19 1:30pm GMT

Q1 2019 Hill-Rom Holdings Inc Earnings Call

BATESVILLE Jan 29, 2019 (Thomson StreetEvents) -- Edited Transcript of Hill-Rom Holdings Inc earnings conference call or presentation Friday, January 25, 2019 at 1:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Barbara W. Bodem

Hill-Rom Holdings, Inc. - Senior VP & CFO

* John P. Groetelaars

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

* Mary Kay Ladone

Hill-Rom Holdings, Inc. - SVP of Corporate Development, Strategy & IR

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Conference Call Participants

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* David Ryan Lewis

Morgan Stanley, Research Division - MD

* Frederick Allen Wise

Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Senior Equity Research Analyst

* Kristen Marie Stewart

Barclays Bank PLC, Research Division - Research Analyst

* Lawrence Soren Keusch

Raymond James & Associates, Inc., Research Division - MD

* Matthew Charles Taylor

UBS Investment Bank, Research Division - Equity Research Analyst of Medical Supplies & Devices

* 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 First Quarter 2019 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, Senior Vice President, Corporate Development, Strategy and Investor Relations. Ms. Ladone, you may begin.

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Mary Kay Ladone, Hill-Rom Holdings, Inc. - SVP of Corporate Development, Strategy & IR [2]

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Thanks, and good morning, everyone. Thanks for joining us for our fiscal first quarter 2019 earnings conference call. Joining me today are John Groetelaars, President and Chief Executive Officer of Hill-Rom; and Barbara Bodem, Chief Financial Officer.

Before we get started, let me begin our prepared remarks this morning by reminding you that certain statements contained in this presentation are forward-looking statements and are subject to risks, uncertainties, assumptions and other factors 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, on today's call, non-GAAP financial measures will be used. Reconciliations between GAAP and non-GAAP financial measures are included in our earnings release issued this morning.

Before turning the call over to John, I would 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 and Presentations.

As you know, beginning with our fiscal first quarter, we adopted the new revenue recognition accounting standard, ASC 606, on a modified retrospective basis. The focus of our commentary this morning will be on our financial results under the old standard, ASC 605, which will allow for comparability on an apples-to-apples basis as well as comparisons to our original 2019 financial guidance.

After this -- the discussion of our first quarter results, we will review our updated guidance, which now reflects the adoption of ASC 606.

With that introduction, let me now turn the call over to John.

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John P. Groetelaars, Hill-Rom Holdings, Inc. - President, CEO & Director [3]

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Thanks, Mary Kay. Good morning, everyone, and thanks for joining us today. Q1 was another successful quarter for Hill-Rom. We started the year with continued momentum, accelerating core revenue growth and driving solid operational execution, resulting in financial performance that exceeded expectations on both the top line and the bottom line.

In addition to these strong results, we continue to make great progress in our strategic priorities, advancing our category leadership with differentiated innovative health care solutions, expanding our category presence -- our geographic presence in emerging markets, and transforming the portfolio to enhance outcomes and drive value for patients, caregivers and our shareholders.

For the first quarter, we reported core revenue growth of 6%, reflecting continued progress and benefits from establishing a more durable and diversified business. This represents our third consecutive quarter of mid-single-digit growth.

Our focus on operational execution led to margin expansion of 110 basis points, and we delivered adjusted earnings of $1.03 per diluted share, an increase of 12% versus the prior year. This represents our 14th consecutive quarter of double-digit earnings growth. Importantly, this strong performance provides flexibility to reinvest in our key growth initiatives and sets a solid foundation for achievement of both our short-term and long-term financial objectives.

Our teams are doing an excellent job executing on our vision and our 4 strategic priorities aimed at enhancing our global category leadership to drive durable, sustainable top line and bottom line growth.

Their first priority is advancing our category leadership with differentiated solutions and innovation. As I mentioned before, new product revenue is a key metric in measuring the success of our strategy and meeting our objectives of driving core revenue growth 200 to 300 basis points above our weighted average market growth rate. The contribution of new products was a significant driver of top line growth in Q1 once again, with revenue of approximately $100 million, on track with our expectation of driving $400 million in new product revenue for 2019.

Supporting this performance were several new innovative products, including Centrella, Connex Vital Signs Spot Monitor, the Monarch Airway Clearance System, Integrated Table Motion and our Vision Care portfolio. In total, 8 new products represent 90% of new product revenue.

Our connected innovations are focused on addressing challenges faced by our customers. These challenges include escalating costs, lower reimbursement and the need for innovation to enhance efficiency, workflow and patient outcomes, while preventing events like falls, sepsis and pressure ulcers that may cause readmissions, unreimbursed complications or reimbursement penalties.

We highlighted a number of recent achievements in our press release this morning, including a global collaboration with Microsoft to bring actionable point-of-care data and solutions to caregivers in real time as well as the commercial launches of the LINQ Mobile smartphone application and EarlySense continuous contact-free heart rate and respiratory rate sensing technology.

We believe continued investments in innovation, connectivity and data will allow us to enter new markets and channels, creating even more opportunities to drive accelerated growth and value for patients and caregivers in the years ahead. Getting information to caregivers and proactively anticipating patient needs not only provides clinical and economic value, it is central to achieving Hill-Rom's mission.

Turning to our second priority, expanding internationally and penetrating emerging markets. I'm pleased to report we are beginning to see some progress. We generated international core revenue growth of 3% this quarter, reversing the trend from the second half of last year. While still in the early stages of a turnaround, we were encouraged by strong double-digit growth collectively across Asia-Pacific and Latin America.

Emerging markets today account for only 9% of Hill-Rom's total revenue, and we are in the process of reinvigorating our commercial operations. We have recently added experienced senior leadership in Asia-Pacific and are finalizing our assessment of product categories and go-to-market strategies to support meaningful growth and acceleration in the region.

Our third strategic priority is transforming the portfolio through M&A and portfolio optimization initiatives. We've thoughtfully considered our product offerings and have divested or exited a number of low growth and lower-margin product areas that were not strategic to our growth strategy. This has strengthened our portfolio, enabled us to focus all our energy and resources to drive more durable and consistent revenue growth in the core.

This diversification and our new product introductions have improved our overall revenue mix. This quarter, approximately 50% of our revenue is coming from categories that grow at 4% or greater, demonstrating progress towards our 2020 goal of achieving 60% of total revenue from these higher-growth categories.

In terms of M&A, this has been and continues to be an important part of our growth and diversification strategy. With improved balance sheet flexibility, we're in a strong position to enhance our category leadership and further our growth objectives. We continue to deploy capital with a disciplined approach, adhering to our rigorous strategic and financial criteria to generate attractive returns.

Our final strategic priority is driving operational execution and strong financial performance. We've previously discussed our business optimization program, focused on accelerating growth, reducing complexity and improving our cost structure. We have made significant progress, and we are currently executing on a number of initiatives.

We expect to drive $50 million of pretax savings over the next few years. These benefits are not included in our long-range plan, but provide us the financial flexibility to reinvest in key priorities like new products and emerging markets.

In conclusion, we are entering 2019 from a position of strength. We are energized by our progress in executing on our 4 strategic priorities. We remain focused on accelerating durable and profitable growth, while enhancing margins, profitability, and generating strong cash flow. We are capitalizing on new products, advancing our pipeline and expanding in emerging markets. We see a clear path to achieving our objectives, to deliver innovative health care solutions and improve outcomes for patients and their caregivers by advancing connected care.

Now I'd like to introduce our new CFO, Barbara Bodem. Barb is a seasoned finance executive with over 20 years of experience in health care. Barb joins us -- joins Hill-Rom from Mallinckrodt, where she served as the Senior Vice President of Finance. Earlier in her career, she worked at Hospira as the Vice President Global Commercial Finance as well as at Eli Lilly and Company, where she held a variety of finance roles in the U.S. and the U.K, including CFO for Lilly Oncology. With that, I'll now turn it over to Barb.

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Barbara W. Bodem, Hill-Rom Holdings, Inc. - Senior VP & CFO [4]

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Thanks, John, and good morning, everyone. For the fiscal first quarter, we reported GAAP earnings of $0.62 per diluted share. These results include after-tax special items related to intangible amortization, tax reform legislation, business optimization and other special charges. These results also reflect the adoption of ASC 606, the new revenue recognition accounting standard.

On an adjusted basis, excluding special items, we reported earnings of $1.02 per diluted share. On a comparable basis, under the old accounting standard, adjusted earnings increased 12% to $1.03 per diluted share, exceeding our guidance range of $0.97 to $0.99 per diluted share. These results reflect accelerated core revenue growth, continued margin expansion and strategic investments to drive future growth.

As Mary Kay mentioned, our commentary this morning will focus on our first quarter results on a comparable basis to the prior year period before the adoption of ASC 606. Please use the supplemental schedules posted to our website to follow along.

Now let me briefly walk through the P&L before turning to our financial outlook. Starting with revenue. For the fiscal first quarter, revenue of $684 million increased 2% on a reported basis and 3% on a constant-currency basis. Core revenue accelerated to 6%, exceeding our guidance of approximately 4% growth. Core revenue growth adjusts for the impact of foreign currency, divestitures and nonstrategic assets we may exit, including the Surgical Solutions international OEM business.

Domestic revenue on a core basis increased 7% in the first quarter, driven by mid- to high-single-digit growth across all 3 businesses.

International core revenue grew 3% in the quarter, driven by improved performance in emerging markets and solid growth in Patient Support Systems and Front Line Care.

Moving on to the business segments, I will address revenue growth on a constant-currency basis only.

Starting with Patient Support Systems. Revenue of $342 million increased 3% and core revenue advanced 8%. This represents the strongest growth we've seen in this business in several years and it was well-balanced geographically, with strong growth both in the U.S. and internationally. For the third consecutive quarter, we generated strong double-digit growth across our key capital product categories in the U.S., including Med-Surg bed systems, Clinical Workflow Solutions and safe patient handling equipment. Outside of the U.S, core Patient Support Systems' revenue increased 7%, driven by solid growth in Europe and double-digit growth in the Middle East, Latin America and Asia-Pacific regions.

Now moving on to Front Line Care. Revenue increased 5% to $233 million. New products, including the Connex Spot Monitor, the Monarch Mobile Vest and our Vision Care portfolio continue to be the key drivers. Domestic revenue increased 5%, while international revenue grew 3%, with solid performance across Europe, Latin America and Asia-Pacific.

Lastly, Surgical Solutions revenue of $109 million was flat to the prior year, while core revenue increased 2%. Double-digit growth in placements of the Integrated Table Motion and solid growth in surgical consumables and patient positioning equipment were partially offset by a decline in the Middle East, impacted by the timing of capital orders versus last year.

Now turning to the rest of the P&L. Adjusted gross margin of 48.3% improved 60 basis points versus last year, reflecting the positive contribution from mix as well as benefits from manufacturing productivity and procurement efforts. Collectively, these factors more than offset the impact of tariffs and raw material inflation.

R&D spending of $33 million increased 3% versus the prior year, reflecting our ongoing commitment to innovation and investments in key programs to drive future growth. Adjusted SG&A of $189 million was flat to the prior year as strategic investments were offset by disciplined cost management.

Our adjusted operating margin in the first quarter was 15.8%, an improvement of 110 basis points compared to the prior year.

The adjusted tax rate in the first quarter was 19.7%. Stock-based compensation was a benefit of $0.03 per diluted share versus a benefit of $0.05 per diluted share last year. Excluding the impact of stock-based compensation, our first quarter tax rate was 21.7%.

So bottom line adjusted earnings for the fiscal first quarter of $1.03 per diluted share increased 12%. Excluding the impact of stock-based compensation from both periods, adjusted earnings per share increased 15%.

Now turning to cash flow. Cash flow from operations was very strong in the first quarter, advancing 25% to $116 million. Higher net income and strong working capital management contributed to this performance. Capital expenditures totaled $15 million, $12 million lower than the prior year period, primarily due to project timing. As a result, free cash flow of $101 million is 53% higher than last year.

In terms of the balance sheet and financial leverage, our debt-to-EBITDA ratio at the end of December was 3.2x, and we returned approximately $92 million to shareholders in the form of dividends and share repurchases during the fiscal first quarter.

Now let me conclude this portion of the call by providing our guidance for fiscal 2019. As noted in the press release, we are reaffirming our full year revenue growth, margin expansion and adjusted earnings per diluted share growth guidance and are updating the adjusted earnings guidance range to solely reflect the adoption of ASC 606. The updated 2019 financial guidance now compares to the 2018 modified financial results, which are included in our supplemental schedules on the website.

The impact of ASC 606 for fiscal year 2018 is a reduction in reported revenue of $14 million and a reduction in adjusted earnings of $0.10 per diluted share.

So for the full year, we continue to expect reported revenue growth of 1% to 2% and constant currency growth of 2% to 3%. Core revenue growth is expected to increase 4% to 5%. Collectively, noncore revenue totaled approximately $110 million in 2018 and is expected to decline to approximately $50 million in 2019. This headwind is incorporated in our reported revenue guidance, while core growth guidance is calculated by excluding the noncore components in both the current and prior year period.

By business segment, on a core basis, we continue to expect all 3 businesses to grow in the 4% to 5% range in 2019. On a reported basis, given the decline in noncore revenue, we expect Patient Support Systems revenue to increase 1% to 2% and Surgical Solutions revenue to be flat to up 1%.

From a profitability standpoint, we continue to expect the following: adjusted gross margin to expand approximately 50 basis points, reflecting mix and productivity improvements that more than offset incremental costs associated with tariffs and raw material inflation; R&D spending to increase in mid-single digits, representing approximately 5% of sales; adjusted SG&A of 26% to 26.5% of sales, reflecting both savings related to our business optimization program and the reinvestment in key growth initiatives; adjusted operating margin expansion of approximately 100 basis points; other expense, including interest of approximately $90 million; and a tax rate of 21% to 22%; and finally, we expect a share count of approximately 67.5 million shares.

Again, we are only adjusting our earnings guidance range for the $0.10 impact related to the ASC 606, aligned with the estimated impact we disclosed last November. This adjustment lowers our previously disclosed adjusted earnings guidance of $5.08 to $5.16 per diluted share to $4.98 to $5.06 per diluted share. Importantly, there is no change in our adjusted earnings growth profile. We continue to expect growth of 7% to 9% and 12% to 14% growth, excluding stock-based compensation.

From a cash flow perspective, we now project operating cash flow of approximately $420 million and capital expenditures of approximately $90 million. This change reflects a reclassification related to ASC 606 between operating cash flow and capital expenditures.

Our 2019 free cash flow guidance remains unchanged at $330 million.

For the fiscal second quarter, under ASC 606, we expect revenue growth to be flat to the prior year and revenue to increase approximately 2% on a constant-currency basis. We expect core revenue to increase approximately 4%, and are providing guidance for adjusted earnings of $1.09 to $1.11 per diluted share. This represents growth of 7% to 9%; and 9% to 11% growth, excluding stock-based compensation.

You may have noted that the ASC 606 impact was immaterial to our first quarter performance. As we look forward, the calendarization of the impact of 2019 will vary from the impact in 2018. This is primarily due to changes in quarterly revenue mix, the timing of shipments and software implementations and the timing of the Monarch launch, which occurred midyear last year. We expect our second quarter adjusted earnings to be impacted by more than half of the expected $0.10 full year 2019 impact.

Thank you. And now I'll turn the call back over to John.

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John P. Groetelaars, Hill-Rom Holdings, Inc. - President, CEO & Director [5]

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Thanks, Barb. To summarize, we are off to an excellent start this year and look forward to building on that momentum throughout 2019.

By executing on our 4 strategic priorities, we are confident that we can sustain the momentum that have delivered over the past 3 quarters. We are committed to delivering durable mid-single-digit top line growth, strengthening our margins and driving double-digit earnings growth, while delivering on our mission and creating enhanced value for our shareholders.

With that, we'll open up the call for questions.

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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 Larry Keusch from Raymond James.

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Lawrence Soren Keusch, Raymond James & Associates, Inc., Research Division - MD [2]

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Maybe just 2 questions. But the first one to start is, John, could you talk a little bit about -- obviously, core growth in the first quarter was really very nicely strong at 6%. But the outlook decelerates to 4% in the 2Q. So -- and I think the core comps are essentially the same for the 1Q and the 2Q. So could you talk a little bit about thoughts around the deceleration?

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John P. Groetelaars, Hill-Rom Holdings, Inc. - President, CEO & Director [3]

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Yes, Larry. Good question. First, we're very pleased with the first quarter results of 6% core growth. And a nice progression of acceleration from last year, starting the year at 2% in the first half and accelerating in the third and fourth quarter to 4%. So good trajectory. As we look at our guidance for Q2, we're certainly considering all the puts and takes that are occurring in the business. One of the things we see in Q2 is that we've got a tougher comp in Europe and some other international markets. It was a strong quarter last year. And we're really just factoring that into the guidance as we look at Q2. For the full year, we're still very confident with the 4% to 5% guide. But for Q2, it looks more like a 4%. And we're just calling it out to be representative of what we see across the business.

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Mary Kay Ladone, Hill-Rom Holdings, Inc. - SVP of Corporate Development, Strategy & IR [4]

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And, Larry, it's Mary Kay. With the 6% in Q1 and 4% in Q2, for the first half we're looking at 5%, which is at the top end of our 4% to 5% core growth guidance for the year.

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Lawrence Soren Keusch, Raymond James & Associates, Inc., Research Division - MD [5]

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Okay, Got it. And then, John, obviously, very encouraging comments around some of the progress being made overseas. I know that there have been geographies that have been challenged for a period of time. I guess, the question is, in that 3% growth that you recorded, how durable do you think that is? And if you could weave into your answer, what are the investments that need to be made into the emerging markets to drive that penetration higher, now that you've had a chance to kind of dig in and think a little bit more about the product portfolio and what needs to be done there?

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John P. Groetelaars, Hill-Rom Holdings, Inc. - President, CEO & Director [6]

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Yes. Great question, Larry. And we're pleased with the start to the year. 3% core growth in total international, mid-single-digit in emerging markets at above 5% and double-digit growth in the regions of Latin America and Asia-Pac. So really solid start to the year. As I mentioned earlier, Q2 represents a tough comp for us in some of our bigger international regions. So that's the primary reason for a deceleration in our overall core growth. But as I look toward international for the full year, we would expect to see acceleration at the end of the year in emerging market growth rates. And that is driven by some of the early investments we're making in the organization and aligning ourselves around the key product categories for those regions. We're in the final stages now of putting together an investment plan in Asia-Pacific for the emerging markets in Asia-Pacific, with, obviously, China being the biggest opportunity for us. We expect to turn on those investments, as mentioned before, in the second half of the year. So the next -- this current quarter that we're in is all about finalizing those plans and preparing ourselves to turn on those investments. We would expect to see those investments really begin to mature about a year later, right at the end of our LRP period, at the end of fiscal '20. So we're excited about the opportunities. They look promising. And similar comments in other emerging markets, in Latin America. And as we've previously discussed, we have shown an ability to drive emerging market growth in regions like the Middle East and Africa, where we've had, over a 3-year period, 18% compounded annual growth rate. So our confidence in being able to deliver more consistent, durable revenue growth in the emerging markets continues to grow, and we're pleased with the early success that we saw in Q1.

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Operator [7]

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And 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 [8]

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I realize there's a lot of moving pieces here with some of the accounting changes and such. But I just wanted to ask a question on the earnings guidance for the year. So just -- I'm curious, what are you assuming in the new guidance on EPS for the impact of stock-based comp on earnings? And the reason I ask that is that, it was my impression from the conversations kind of on the last call that the stock-based compensation may actually be an offset to the new accounting change. So I guess my question to be very clear is, what are you assuming in terms of the impact on EPS from stock-based comp in this new fiscal '19 guidance?

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Barbara W. Bodem, Hill-Rom Holdings, Inc. - Senior VP & CFO [9]

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I'll take this one. Bob, it's Barb. Thank you for the question with regards to stock-based comp. If you recall last year, we recognized a pretty large benefit from stock-based comp, about $0.24 or -- yes, $0.24 on the full year. When we think about our guidance, we don't typically include this in our earnings guidance. And last year's $0.24 was really driven by much of the executive changes that were going on, something that we don't anticipate seeing a like-for-like. And as you look forward, we don't typically try to project what stock-based comp benefits are going to be because they're driven by a couple of different factors. It's driven by individual choices, about when they're going to exercise options. It's also driven by market performance as you go along. So we have not included stock-based comp in our LRP guidance, we have not included it in our 2019 either what we gave last November, nor what we've provided today under 606. It's just not something that we've incorporated because we think it's pretty hard to forecast and pretty hard to transmit out. What we have done is, we've been very transparent about it. So quarter-by-quarter, to the extent that we see a benefit, if you recall, I said earlier that we saw a $0.03 benefit this quarter. We'll be transparent about that to the extent that, that allows us some reinvestment opportunities in the business, we may consider that, but we will not include it in the guidance as we go forward. As we think about the impact of ASC 606, the $0.10 impact that we have shown in the revised adjusted earnings guidance on EPS is purely the ASC 606 impact. So it's looking at what we experienced or what we've seen in the restatement of 2018 and carried that forward into 2019. And then again, I want to reemphasize that as you think about the calendarization of that $0.10, we're anticipating the majority of that to be coming through in Q2.

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John P. Groetelaars, Hill-Rom Holdings, Inc. - President, CEO & Director [10]

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Yes, and just to -- for the full year then, our ex stock-based comp for the full year is still 12% to 14% growth rate. Growth rates are not impacted by the ASC 606 changes. And then in Q1, ex stock-based comp, we had a 15% EPS growth rate. So I hope that answers your question, Bob.

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

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Yes, no. That's very clear. I appreciate that. So my interpretation of all those comments is that, it makes sense not to include it, it's hard to predict. But all else equal, that could be an offset. You may choose to invest it, depending on how things play out. But it's still a potential source of offset, at least as I read it.

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John P. Groetelaars, Hill-Rom Holdings, Inc. - President, CEO & Director [12]

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Yes, I think that's a good way to read it.

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

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Okay, perfect. And then the other comment I wanted to ask was just on Surgical Solutions in particular because that was the one that was maybe a little weaker than we thought, and you called out Middle East. Maybe you could just talk a little bit, John, about how big is that Middle East portion in Surgical Solutions? What was kind of the growth rate this quarter? And how long do you think it'll take to turn that around? Because that's obviously been a source of volatility in the past as well.

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John P. Groetelaars, Hill-Rom Holdings, Inc. - President, CEO & Director [14]

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Yes. I guess, I would start out, Bob, by saying when we put our plan together, this is how we expected that Surgical business to kind of phase through the year that we knew it was going to be a lighter Q1. Still confident about our 4% to 5% full year performance there. We did have double-digit Integrated Table Motion take place internationally, but it was offset by some orders that we expected to have come out of in Q2 or Q3. So it's -- to us, it's what we expected. It's not a surprise. We're on track. And we do have the confidence in the full year guidance of 4% to 5%.

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Operator [15]

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And David Lewis is on the line of Morgan Stanley with a question.

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David Ryan Lewis, Morgan Stanley, Research Division - MD [16]

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Just a quick follow-up for Barb and then maybe 2 for John really quickly. Barb, just taking ASC 606 aside and the stock-based comp aside, I think you're pretty clear there. And if we just sort of think about the beginning of the year. Margin sort of in line with expectations, you're kind starting the year kind of above expectations, Mary Kay's commentary in the first half kind of suggests your operating performance is at the top end of your guidance. So with margins coming in where they expected and revenue kind of towards the top end of the range, why does that necessitate an earnings revision at this time? And just update us again on tariffs, $0.10 to $0.15, is that still the right number? And then a couple for John.

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Barbara W. Bodem, Hill-Rom Holdings, Inc. - Senior VP & CFO [17]

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Sure. So why don't I start then and we'll talk a little bit about -- I'll kind of go in reverse order and we'll come back to where we are on our guidance for the year. So starting with our margin expansion. I'd like to take you all the way back to what we said in the long-range plan, which that, over the long-range plan, we expected to see an operating margin improvement of about 300 basis points. And we delivered 100 basis points last year and our guidance this year is to provide another 100 basis points. As you will have seen, that kind of ebbs and flows from quarter-to-quarter depending on the specific performance in that given quarter. Of that 100 basis points, we would expect about half of that to come from gross margin and the other half of it to come from OpEx leverage and the rest of the P&L. And what we saw in Q1 was very, very consistent with that. So in Q1, we showed the 110 basis points, of which, 60 was coming through gross margin and the balance of it coming through the rest of the P&L. Of the 60, when we looked at the 60 basis points and when we looked at the guidance for the full year on gross margin, we took into consideration tariffs. I think we estimated last fall that we thought the headwind from tariffs was going to be about $10 million to $15 million. In addition to that, as you're probably aware, we're all experiencing a little bit of inflation on our direct materials as well. But what we said is that mix and productivity in gross margin would more than offset that, and we'd be able to deliver the 50 basis points worth of improvement even after absorbing those. As we look at Q1 and we look at our experience with the tariffs in Q1, it's very consistent with that $10 million to $15 million for the full year. And as you know, we still have some uncertainty about where tariffs are going to land for the full year as well. So as we're thinking about gross margin, as we're thinking about our operating margin expansion, we're feeling pretty confident and pretty comfortable with where our Q1 is and how it fits with our overall guidance. So to your question about if we're seeing growth at the higher end of it and we're seeing a nice margin expansion in Q1, why is it that we're not adjusting our earnings for the full year? And I think the answer to that at this point is that it's still very early. While we're very excited about and pleased about our performance in Q1, it is the only the first quarter of our 4-quarter year. And so we have a lot of ground to cover. And at this point in time, we thought it would be too certain to signal any upside to the earnings. I hope that answers your question.

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David Ryan Lewis, Morgan Stanley, Research Division - MD [18]

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Yes. Very clear, Barb. And then just, John, 2 kind of -- 1 tactical, 1 strategic for me. On Centrella, could you just kind of talk about the contribution of Centrella to the pipeline this particular quarter? How has that changed over the last couple of quarters? And from here, does the growth contribution from Centrella improve from here? And then strategically, just the $50 million you talked about a few weeks ago in and above the LRP, can you give some sense of sort of as you're thinking right now where those investments go, whether it's just the Front Line Care business, the communications portfolio or the emerging markets piece? Where is it likely we see that money go?

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John P. Groetelaars, Hill-Rom Holdings, Inc. - President, CEO & Director [19]

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Yes. Thanks, David. So let me kind of broaden it out a little bit beyond Centrella at first, and then I'll get into specifics on Centrella to the extent I can. So for new products, first of all, as I first said in my prepared comments, about $100 million of contribution in Q1 from new products. What I didn't say is, that's an 80% growth rate over the prior year. So we really like the momentum we're seeing with new product growth. It is contributing significantly to top line overall core growth, probably to the tune of something above 300 basis points in first quarter. As we look at that total new product category, which, again, consists of 8 products that are really driving that overall performance, it continues to look promising to us, this ability to continue to be that fuel that drives above our -- above weighted average market growth rate comfortably of that 200 to 300 basis points. So that's the overall characterization of that new product bucket, specifically, with respect to Centrella and probably the best way to address that is our Med-Surg category because there's some cannibalization of Centrella over other Med-Surg product offerings. We saw a double-digit growth rate in Q1, I guess, more specifically, in the neighborhood of 30% growth. So very strong growth. We're really excited about the new technology we're bringing into the -- into that ecosystem with our new launch of EarlySense and WATCHCARE. In the case of EarlySense, we think that's breakthrough technology. Noncontact, twice per second measurement of heart rate and respiratory rate. And getting a really -- a running trend of heart rate and respiratory rate to provide actionable insights and early intervention where required to reduce costly complications and life-threatening complications. So Centrella is that digital hub in that ecosystem. We're pleased with its progress. Very pleased with engagements. Since the last time we had a call, I visited customers in China, visited customers in the United States, in Europe and in Canada, and all of them are very excited about the offerings that this product provides them. But not just on its own, but with the whole ecosystem of sensing technology, immediate care communication technology and being able to provide a turnkey solution that we can scale and integrate into their system. I think one of the highlights of the last 3 months is visiting North America's first digital hospital and seeing how they've incorporated these types of products in that setting with connected vital signs and connected beds, and really a command center that really allows them to show significant workflow improvements of 30% plus as well as falls reductions in that same neighborhood. So very excited about the response we're seeing from customers around the world on the value that these connected products bring, not just as a stand-alone, but as a complete ecosystem. Getting to your second question, David, about the $50 million. We have a lot of investment proposals that are coming forward in the organization, now neighboring around 30 or so. We are vetting those as we speak and racking and stacking what those best opportunities look like. It'll be a mix between new products and innovation and emerging markets. And perhaps a couple of select other investments in commercial operations or clinical studies and clinical data generation. So it's a little bit too early to say what exactly those are. But certainly, with $50 million over the coming years that we'll have to invest, we'll be looking to pace new investments as the savings are realized and put our best investments forward first as we think about how to deploy that cash. But thank you for the question, David.

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Operator [20]

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And we have Matt Taylor on the line with UBS.

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Matthew Charles Taylor, UBS Investment Bank, Research Division - Equity Research Analyst of Medical Supplies & Devices [21]

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So I wanted to ask you about your kind of guidance [for last fee unit] just seeing newer -- with this team. Understand not raising at this early stage in this year, that's certainly prudent. I guess, could you give us a little bit more color on when you might feel comfortable raising it? I feel like it's a little bit of an unfair question. But if you had a 6% growth rate in the second quarter, does that give you enough confidence? Or maybe you could just talk about, with 6% growth this quarter, are you getting more confidence that you can actually grow above 4% to 5% or were there just kind of onetime things that helped this quarter?

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John P. Groetelaars, Hill-Rom Holdings, Inc. - President, CEO & Director [22]

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Yes, great question, Matt. Let me reiterate. We're very happy about the momentum from 2% a year ago to now up to 6%. So clearly, organic momentum is driving the portfolio and driving our core growth. As we think about providing guidance, we're looking at all the puts and takes across the business. And I think our philosophy would be summarized pretty simply in 3 words, meet or beat, right? We're looking at the guidance as a meet or beat number. We certainly don't want to disappoint anybody, including ourselves. So when we look across the portfolio and all the businesses in the regions of all the dynamics that go on in a business as diverse as this, I can boil it down to those 3 simple words. That's our view, meet or beat.

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Barbara W. Bodem, Hill-Rom Holdings, Inc. - Senior VP & CFO [23]

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And, Matt, this is Barb. With regards to timing of when we might revisit, Q2 is the obvious time. So as we get through the second quarter, we'll revisit our position. And if we have an update, we will obviously be sending that out. So thanks for the question though.

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Matthew Charles Taylor, UBS Investment Bank, Research Division - Equity Research Analyst of Medical Supplies & Devices [24]

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I just had one follow-up. I was wondering if you could expand on some of the cost-savings initiatives that you've laid out here. It seems like they're kind of coming into focus. Can you talk about any that you have prioritized that'll be helping margins sooner or anything that have changed sequentially to give us some flavor for the initiatives that you'll be executing on here in the back half of the year?

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John P. Groetelaars, Hill-Rom Holdings, Inc. - President, CEO & Director [25]

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Yes, sure, Matt, I'll start with that question and hand it over to Barb for additional comments. We're kicking those off right now. It's going on, on multiple fronts. So they're a couple of very -- I'll point at 3 big ones. One is continue the consolidation of our manufacturing footprint. More recently, we've begun to consolidate some of our R&D centers. So we can concentrate our R&D in centers of excellence around the businesses and around specific areas such as digital and software development. So that is underway as we speak. And the third one is really the whole category of just spending more wisely on everything from meetings to consulting to outside services and travel, et cetera. Things we call indirect spend. That's the third kind of big bucket that we're pursuing as we progress. And because of the decentralized nature of the company, we're able to execute on multiple fronts with respect to -- of manufacturing footprint or reorganizations, like the ones I mentioned. So those are the first 3 that I would point out. And as you look over the 3-year period, it's relatively evenly spread between the 3-year period in terms of when we see the savings. A lot of it gets kicked off this fiscal year. We begin to realize it at the second half of this year and then annualize it more into next year as it rolls out. Any additional comments, Barb, you would add?

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Barbara W. Bodem, Hill-Rom Holdings, Inc. - Senior VP & CFO [26]

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The only other thing I would add is that what you don't see, and so you see relatively, say, well, we've got 3% growth in our R&D spend, we've got flat SG&A. In particular, in the flat SG&A, what's not visible is the fact that we are actively repurposing investments within that flat SG&A. So we've taken some actions that have really brought down our G&A area spend, so that we can turn around and reinvest that in selling and marketing activities or commercial activities and other areas. So some of the changes we're making are really not going to be visible in the P&L lines, the expense lines, as you see it, because it's all happening in the redirection and the realignment of the spend that we have. I hope that's helped in giving a little extra color.

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Operator [27]

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And we have Rick Wise of Stifel on the line with a question.

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Frederick Allen Wise, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Senior Equity Research Analyst [28]

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John, maybe just to help us think about the current new product pipeline. Obviously, R&D spending has gone up sort of in the neighborhood of 5%. Clearly, new products are making a difference. Sort of 2 questions about it. One, today, what percentage of the new product revenue you're generating is capital? And do you -- related like Centrella, but what's next? And how is that pipeline changing -- likely to change and evolve over the next few years?

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John P. Groetelaars, Hill-Rom Holdings, Inc. - President, CEO & Director [29]

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Yes, good question, Rick. I mean, if I look at our new product revenue, to specifically answer your question about how much of it is capital, it's probably in the neighborhood of about 15%, maybe 20% at the most. But it looks like around 15% if I eyeball the numbers in front of me here. The -- that's actually consistent with our frames business. Our bed frames is 20% of our total revenue today. So it's proportionately similar to our current mix or a little bit less capital dependent. If I think about the future of what we're looking forward to, we've talked about 4 key product launches this year, with LINQ Mobile as part of our CWS or clinical communications portfolio; WATCHCARE, which is our in incontinence detection device with a consumable recurring revenue stream business; EarlySense, which is our heart rate, respiratory rate monitoring in the bed; and then RetinaVue, next generation. The first 3 are already launched or in the early phases of launch. We're getting great feedback on all of those. They haven't really had the dollar impact in terms of new products yet because they're really in the early phases. But each of those 3, LINQ, WATCHCARE and EarlySense, we'd expect those to grow substantially over the coming quarters and couple of years here. The one that's not yet launched is our RetinaVue next-generation product, which is a -- really a point-and-click, easy-to-use retinal-scanning device. And that's expected to come in the second half of this fiscal year. So we feel good about what's in that portfolio of the 8 products that drive 90% of the new products basket and then 4 new products coming into it this year as well as a pipeline of additional innovation that we have not yet disclosed. Looking very promising at driving category leadership in these 7 strategic focus categories that we've outlined most recently in the JPMorgan presentation. Those 7 focus areas and categories represent about $26 billion of total available market to us. So we've got a lot of room to grow in these 7 strategic categories that we've outlined, many of which have nice growth rates above the overall weighted average market growth rate for the company.

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Frederick Allen Wise, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Senior Equity Research Analyst [30]

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That's very helpful. A second question, sort of a multipart and it's really for both you and Barbara. Just maybe you could just talk through -- I'd like to hear both your perspectives on. Barbara, you're a new CFO, walking in the door. Both of you are building on the great work and foundation that John Greisch and Steve did. Barbara, what are your key priorities? You talked about SG&A, sort of repurposing inefficiencies. What do you think are the key opportunities over and above what we may know about the company priorities? John, I'd be hear -- happy to hear your perspective. And maybe the second part of the question is, given the significant reduction in leverage and in balance sheet improvement and cash flow growth. John, you've been in place for a while now, how are you thinking about M&A? I heard you promoted a rockstar biz dev strategy kind of person. How are you tasking that excellent individual? What can we expect on the M&A front and portfolio front?

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John P. Groetelaars, Hill-Rom Holdings, Inc. - President, CEO & Director [31]

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Yes. Thanks for the question, Rick. And I don't know if I'm a rockstar or not. But time will tell and you can -- you guys can judge. But I don't aspire to be a rockstar. So when it comes to M&A, and it kind of feeds into my priority at this point, I do feel very good about the operational execution of the organization. I feel very good about the leadership team, both my immediate leadership team as well as the broader leadership team. And I feel very good about our ability to continue to deliver mid-single-digit top line growth organically. So a lot of time and attention is now being directed towards M&A. We are looking for accretive acquisitions, accretive to growth, accretive to our growth profile, improving the profile of the company that drives higher growth rates, higher profitability and gives us the kind of returns on the investments around M&A that we are looking for and we'll be rigorous and disciplined around. So that's where I'm spending my time. Obviously, can't comment on things that are speculative at this point. But I would say, in general, I do like the pipeline that we're developing of opportunities. We're engaged on multiple fronts around M&A. They are going to be supportive and you're going to -- if we get something done, you'll, I think, see a very clear strategic fit of how these acquisitions would fit into these product categories that we've identified as strategic to us. And I think you'll see that they're going to be accretive to the overall growth of the company. So that's where I'm spending my time, Rick, in addition to everything else that you would expect me to spend time on. Barb?

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Barbara W. Bodem, Hill-Rom Holdings, Inc. - Senior VP & CFO [32]

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So, Rick, great question, and I appreciate you asking it. It has been not quite 2 months for me, but it's been a very good 2 months. And I've been very impressed with the organization and how focused the organization is on the strategic priorities that John outlined for everybody earlier today. It's embedded in the cadence of how we operate every day. When I think about where am I going to be spending my time, clearly, from an M&A perspective, externally doing everything with my team to make sure we're supporting the M&A process and that we're doing the right deals that are going to drive the future growth of the company. Growth is also where I'll be focusing from an internal standpoint. It's really about making sure our resources are lined up to the best opportunities that we have. Over the past few weeks, I've had the opportunity to really get a view of our internal innovation pipeline and it's very impressive. And so making sure that we are funding that appropriately, moving things forward is key, making sure that as we look at our internal resource allocation, that we are as streamlined and efficient in those areas that are not business-facing or not driving growth, so that we can free up resources for those areas where they will drive growth is going to be a key agenda and area for us. It's not new from what Steve was doing. But it'll be a particular area of focus for me. I hope that helps give you some insight into where my head is.

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Operator [33]

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Our final question will come from Kristen Stewart of Barclays.

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Kristen Marie Stewart, Barclays Bank PLC, Research Division - Research Analyst [34]

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Barb, welcome to the [fold]. Just to go back. I guess, more of a couple clarifying questions. So when you were talking about flat year-over-year growth for the second quarter, is that going to be also on a ASC 606 revised basis? Is that fair? Or is that flat versus ASC 605?

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Barbara W. Bodem, Hill-Rom Holdings, Inc. - Senior VP & CFO [35]

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Kristen, it's Barb. Thanks for the welcome. Excited to be here. All of our guidance going forward is under 606. So the only time we were going to do anything under 605 is helping you understand Q1 2019 performance. Go forward is only 606. So when we talked about guidance for Q2, we said it would be flat on a reported basis, 2% on a constant currency and then looking at 4% from a core growth for the quarter. All under 606. And remember that I also flagged that we do think we'll see a disproportionate impact from an EPS perspective of the 606 change in Q2.

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Mary Kay Ladone, Hill-Rom Holdings, Inc. - SVP of Corporate Development, Strategy & IR [36]

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And, Kristen, it's Mary Kay. Just to clarify, you do need to update your models for the 2018 modified results. That's the base for Q2 under 606.

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Kristen Marie Stewart, Barclays Bank PLC, Research Division - Research Analyst [37]

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Okay. That's what I thought. So it's flat off of that, call it, $706 million revenue, the kind of restated ASC 606 number?

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Barbara W. Bodem, Hill-Rom Holdings, Inc. - Senior VP & CFO [38]

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Yes.

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Mary Kay Ladone, Hill-Rom Holdings, Inc. - SVP of Corporate Development, Strategy & IR [39]

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Yes. That is correct.

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Kristen Marie Stewart, Barclays Bank PLC, Research Division - Research Analyst [40]

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And then the EPS was lowered by $0.03 under ASC 606 a year ago. But you're basically saying the benefit is going to be greater and that's one of the things driving the little bit lower EPS relative to expectations. It also looks like margins are going to be a little bit lower than at least the full year run rate. Is there any kind of thing causing that or they're just timing of investments? Or FX effect? Or anything you can speak to into why margins may be a little bit lower in 2Q as well? Or maybe that's all it.

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Barbara W. Bodem, Hill-Rom Holdings, Inc. - Senior VP & CFO [41]

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I think when we're looking at Q2 and we're looking at margins for the quarter, margins are going to be driven by a multifactorial sort of thing. The mix of the products that we're projecting for the second quarter. And that mix does fluctuate a little bit from quarter-to-quarter as well as timing of initiatives as well as headwinds. So there's a lot of different moving pieces in there. I don't know that you can draw any straight conclusions between 606 and the margin for the second quarter.

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Kristen Marie Stewart, Barclays Bank PLC, Research Division - Research Analyst [42]

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Okay. And then just to kind of go back, I guess, to the beginning conversation, not to beat a dead horse, but the stock-based comp was $0.03 in the quarter. You're kind of keeping the guidance. If I'm hearing kind of how you responded back to everyone else's comments. Should we just think about you guys just really targeting kind of that range for the full year and to the extent there's additional stock-based comp, more of a willingness to kind of reinvest those opportunities? And along the same lines, with the $50 million in savings that you've talked about, should we just think about that as something that just automatically will get reinvested and not necessarily be additive to the LRP?

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Barbara W. Bodem, Hill-Rom Holdings, Inc. - Senior VP & CFO [43]

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Kristen, thanks for the question, and thanks for the opportunity to clarify back on the SBC side. First of all, from an LRP perspective and from a fiscal year perspective, again, we don't forecast the SBC, which you know. Also on the business optimization, that is not -- it is incremental to what we have in the LRP with the goal of reinvesting all of that. So when we think about the guidance, these two things are not things that we would have factored into achieving the EPS guidance that we've laid out either in the long-range plan or for 2019. When you think about how are we looking at SBC for the remainder of the year, again, I believe that it's a good position to not try to forecast that out and put it in the guidance. To the extent that we are seeing benefits and we're seeing those benefits early enough in the year where we can do something with those benefits, we will look for reinvestment opportunities to the extent that the timing of when we see the SBC benefits come through and when we have investment opportunities within the quarter and within the fiscal year don't align, then that will end up being potentially incremental to our guidance for the full year. Does that help?

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Kristen Marie Stewart, Barclays Bank PLC, Research Division - Research Analyst [44]

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Yes, it does.

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Operator [45]

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I'll now turn the call back over to John Groetelaars for closing remarks.

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John P. Groetelaars, Hill-Rom Holdings, Inc. - President, CEO & Director [46]

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Well, thanks, and thanks for all the great questions and engagement this morning. I guess, summary comments would be, look, things have never been better. We've gone from a 2% growth in core growth in first half of '18; 4%, Q3; 4% in Q4 last year; coming into this year with 6%. The organic growth engine is alive and working well. We feel very confident about our ability to deliver mid-single-digit top line growth that's consistent and durable. In addition to that, I think we've shown over 14 quarters, our ability to deliver double-digit adjusted EPS. So we're confident in our guidance for Q2 and are confident in our guidance for the full year. And I want to thank you for all your time and attention this morning.

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Operator [47]

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