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Edited Transcript of HRC earnings conference call or presentation 1-May-20 12:30pm GMT

Q2 2020 Hill-Rom Holdings Inc Earnings Call

CHICAGO May 21, 2020 (Thomson StreetEvents) -- Edited Transcript of Hill-Rom Holdings Inc earnings conference call or presentation Friday, May 1, 2020 at 12:30:00pm 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] (sic) Second Quarter 2020 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.

Now I'd 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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Good morning, and thanks for joining us for our fiscal second quarter 2020 earnings conference call. I hope everyone is healthy and remaining safe during these challenging times.

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 by reminding you that this presentation includes forward-looking statements that are subject to risks, uncertainties, assumptions and other factors that could cause actual results to differ materially from those described, including any impact related to the COVID-19 pandemic. Please refer to today's press release and our SEC filings for more information 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.

I would also like to mention that in addition to the press release issued this morning, we have posted a supplemental presentation, which includes highlights on Hill-Rom's response to the current pandemic. These materials can be accessed on the Investor Relations page of our website.

So 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 I hope you, your families and friends are all safe and healthy. It goes without saying that we're living through an unprecedented and challenging times related to the COVID-19 global pandemic. Before we get into the details of the quarter, I want to take a moment to thank our entire Hill-Rom team for their unwavering commitment and extraordinary contributions to support our customers, frontline caregivers and patients in our united fight against this virus. Hill-Rom's mission of enhancing outcomes for patients and caregivers has never been more vital to the delivery of healthcare.

Our positive culture has never been more inspiring and our global response, nothing short of impressive on multiple fronts. We are supporting those on the front lines by rapidly expanding production of critical care products. We have pivoted our R&D efforts to introduce a spectrum of new products to meet the unique COVID treatment challenges, implemented a comprehensive business continuity plan to ensure minimal disruption of our global manufacturing operations and supply chain. And we've delivered approximately $6 million of support in the form of both monetary and product donations to support our healthcare heroes, who are at the front lines, saving lives.

Hill-Rom's diversified businesses are a source of strength in these turbulent times. As a result, we have both the ability and confidence to successfully navigate through the future environment. The combination of our exceptional execution, financial strength and diverse portfolio underscores our commitment to enhancing value for all our shareholders today and over the long term.

Moving to financial highlights for our second quarter. We once again exceeded our guidance on both the top line and bottom line. These results demonstrate our ability to modulate risk and reinforces the critical nature of our products' portfolio and our category leadership positions in the markets we serve.

Core revenue growth was 6%, our eighth consecutive quarter of mid-single-digit growth. Core revenue includes a contribution of approximately 200 basis points from recent acquisitions and a COVID-19 net tailwind of approximately $15 million that ensued toward the end of the quarter. We continue to be pleased with significant margin expansion, achieving a record adjusted gross margin of 51.2% and operating margin of 18.3%. This resulted in an adjusted EPS of $1.28 per diluted share, an increase of 12% over the prior year.

Our financial performance is supported by continued execution of our 4 strategic priorities. This is the foundation that allows us to respond globally while positioning us for the long term. Growth from new products accelerated in Q2. On a year-to-date basis, we've now achieved more than $260 million in new product revenue, an increase of nearly 30% to last year. Importantly, we continue to anticipate full year new product revenue of approximately $550 million. I'm proud about how our R&D teams rapidly responded to the challenge of developing 5 new product innovations for COVID-19 patients. In addition to receiving emergency use authorization to enhance our MetaNeb System for respiratory support, we are also pleased to offer new mobile communications and remote monitoring solutions for vital signs measurements that will help protect caregivers and reduce the overall demand for PPE as they deal with this virus.

Geographically, our U.S. performance was very strong, with all 3 businesses contributing to core growth of 8%. We also saw improved international performance with core growth of 3%, which was better than expected. This was the result of strong international COVID-related demand for products like ICU beds and thermometry, which more than offset the expected impact from the timing of large capital projects in selected markets. All regions, except EMEA, had positive results, including double-digit growth in Latin America, Canada and Asia Pacific.

As you know, we turned on key investments in China last year to enhance our position in emerging markets. This quarter, we once again achieved growth in China of more than 20%, validating our strategy and investment plans. While we expect to see some near-term choppiness as a result of the pandemic in China and other emerging markets, this will continue to be a key driver of our longer-term growth strategy.

Let me now turn to Q2 performance by business at constant currency rates. First, Patient Support Systems' revenue grew 7% and core growth was 8%. The majority of the early COVID-19-related demand benefited this business. In the U.S., core growth of 9% was supported, once again, by contributions across our broad portfolio of connected care solutions and services. This included double-digit growth from Med-Surg bed systems, including the Centrella Smart+ bed and Care Communications. Core international growth in this business was 5%, and was largely a result of significant demand for Hill-Rom ICU beds, particularly from Canada.

In Front Line Care, Q2 revenue advanced 7%, with strong growth both in the U.S. and internationally. This was the result of new products and broad-based global strength across the Welch Allyn and vital signs monitoring equipment, like thermometry and blood pressure monitoring, and certain respiratory health products, including the MetaNeb System mentioned earlier and our Life2000 Non-Invasive Ventilator.

Lastly, Surgical Solutions revenue declined 25%, reflecting the impact of the surgical consumables divestiture last year. Core revenue declined 3% as U.S. growth of 9% was more than offset by the expected decline in select international markets related to the timing of large capital projects that we discussed on our previous call.

So now with that as a backdrop, we look to the future with an eye toward disciplined execution of our priorities, adapting to the current environment to support our customers while advancing our mission. No company, including Hill-Rom, will be completely immune from this new reality. All healthcare companies will be faced with challenges, and the global macro environment may continue to pose obstacles for some period of time. The net impact to Hill-Rom in various regions and product categories will largely depend on the scope, intensity and duration of this pandemic as well as the shape of the recovery and the demand for healthcare. These new variables weigh on our ability to predict outcomes so we have elected to suspend our previously issued guidance. However, we thought it was important to share our point of view and provide transparency on the current environment and dynamics and the visibility we have on our businesses as of today.

From a demand perspective, our diverse portfolio represents a significant advantage due to built-in hedging. Some parts of the business are facing challenges, while others are resilient or performing at high levels to meet significant demand. We currently expect approximately 40% of our business to experience challenges related to installations and project delays, where hospital access is a requirement or where lower physician office visits may impact results. These dynamics primarily affect Surgical Solutions, Care Communications, and physician-oriented portions of our Front Line Care portfolio. We expect growth for this category of products to collectively decline by more than 20% in the second half of the year. However, we also believe it is fair to assume that starting in the fiscal fourth quarter, our access into hospitals for new installations will resume in a large majority of sites and patient access to primary care physicians will gradually return.

The remaining 60% of Hill-Rom's portfolio is fairly resilient to the current dynamics, including approximately 40% of the portfolio that is supporting higher demand. This, of course, comprises of our Smart Bed portfolio, portions of our Respiratory Care business and other devices and tools aiding caregivers on the front lines to diagnose, monitor and treat COVID patients. As of today, strong demand for these critical care products continues. This reflects the strong Q2 order book and backlog for Med-Surg and ICU beds, our rental fleet and a variety of products within the Front Line Care business.

For Smart Beds, we achieved a record level of U.S. orders, more than double a typical quarter and representing nearly a 70% increase over Q1. We estimate that more than half of this growth represents new incremental expansion demand versus an acceleration or pull forward of orders that were already in our funnel. A key consideration as we look towards the second half and the future is the impact of this pandemic on the outlook for beds and other capital purchases by hospitals, local and national governments, including the state of preparedness related to another possible wave or planning for future potential pandemics. While there are multiple reports calling for additional bed capacity, which could fuel a multiyear global growth cycle, we do not have clear visibility on the longer-term implications. Durability of increased demand is an evolving dynamic that we will continue to monitor vigilantly.

From a supply perspective, we have doubled down on our efforts to increase capacity. Our Hill-Rom operations team is doing a tremendous job, quickly scaling our workforce by hiring more than 300 additional employees, shifting team members to high demand products, while being very rigorous to maintain a healthy and safe work environment. Our team is monitoring, tracking and implementing countermeasures to proactively keep our supply chain moving and ensuring upstream parts availability. I'm very pleased to report that we continue to have no material disruptions to our global manufacturing or supply chain operations. We continue on track toward doubling capacity for Med-Surg and ICU beds and patient monitoring and thermometry where current demand far exceeds supply.

Lastly, we are in the process of increasing capacity on an annualized basis by greater than fivefold for our Life2000 Non-Invasive Ventilator. This device is currently approved in the United States as a critical care and a home care ventilator. It is ideal for support of patients with mild-to-moderate respiratory distress and for weaning from mechanical ventilation. Patients such as those with COPD or COVID-19 maybe eligible to use the product at home. Our capacity expansion will support our efforts to fulfill a $20 million order from Health and Human Services by this summer and additional demand from other acute customers.

So in summary, the entire Hill-Rom team remains committed to our mission, even during this time of great uncertainty. We believe we have the right solutions and strategies and are well positioned to meet the immediate challenges before us. We look forward to providing you with continued updates as we position our company for sustained success and deliver enhanced value to all stakeholders.

Thanks. And now I'll turn the call 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 second quarter, we reported GAAP earnings of $0.70 per diluted share. These results include after tax special items related to intangible amortization, acquisition and integration costs and other special charges.

Adjusted earnings of $1.28 per diluted share advanced 12% from the $1.14 per diluted share in the prior year period, exceeding our guidance range of $1.14 to $1.16 per diluted share. These results reflect solid core revenue growth, the impact of COVID-19 late in our quarter, ongoing margin expansion as well as strategic investments to drive long-term top line growth.

Now let me briefly walk through our Q2 2020 P&L. We reported revenue of $723 million for the second quarter, which was an increase of 1% over the prior year revenue of $714 million. On a constant currency basis, revenue increased 2%. Core revenue advanced 6%, above our guidance of approximately 4% core growth. Acquisitions contributed approximately 200 basis points of growth and the net impact of COVID-19 revenue was approximately $15 million.

Turning to the rest of the P&L. Adjusted gross margin of 51.2% represents a record level and reflects improvement of 180 basis points, with expansion across all 3 businesses. This reflects the positive contribution from product mix, new products, M&A and portfolio optimization initiatives and benefits of manufacturing cost and sourcing efficiencies.

R&D spending of $34 million declined 6% over the prior year, primarily due to project timing. Adjusted SG&A of $204 million increased 2% as lower discretionary spending, like travel, meeting and certain marketing expenses were more than offset by the impact of acquisitions and our IT transformation initiative.

Adjusted operating margin was 18.3%, reflecting an improvement of 190 basis points compared to the prior year. Interests and other nonoperating expenses for the quarter of $23 million included an unplanned impact from currency devaluations of approximately $5 million. The adjusted tax rate was 21% and adjusted earnings for the fiscal second quarter of $1.28 per diluted share increased 12%. Excluding the dilutive impact of the surgical consumable divestiture, which contributed $0.06 per diluted share last year, adjusted EPS increased 19%.

Now turning to cash flow. Cash flow from operations for the first 6 months of 2020 was $157 million, flat to prior year. Capital expenditures on a year-to-date basis totaled $46 million, $15 million higher than the prior year driven by IT transformation costs and capitalized software costs related to R&D investments. As a result, year-to-date free cash flow totaled $111 million. Our balance sheet and overall financial position remains very strong. During the quarter, we raised our dividend for the tenth consecutive year. To date, we returned $99 million to shareholders through dividends and share repurchases during fiscal 2020.

Our debt-to-EBITDA ratio at the end of March was 3.3x, and we ended the quarter with $291 million in cash. We continue to operate well within our debt covenants and have no material debt maturities until 2024. And lastly, given our recent refinancing efforts last year, we have access to a revolving credit facility of up to $1.2 billion to address any capital needs as necessary.

Now before turning the call back over to John, let me comment on our decision to suspend guidance. First, it's important to note that we are actively monitoring the evolving landscape and tracking the potential implications geographically and within each of our 3 businesses. We continue to see accelerated demand across some areas of the portfolio during April. However, we are now also experiencing some project delays, primarily in Surgical Solutions, Care Communications, and certain areas of Front Line Care due to lower physician office visits.

As a result, and given the ongoing uncertainty, scope and evolving nature of the pandemic, we are not in a position to reasonably estimate the net effect of these dynamics on our future financial performance at this time. We would also not recommend extrapolating our recent results into projections for the remainder of the fiscal year. We look forward to providing you with additional updates in the future.

Thanks. And with that, 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. I'd like to close our prepared remarks this morning by reiterating our commitment to Hill-Rom's mission and strategy. The value of our diverse product portfolio, ability to rapidly innovate and adapt and our response to the current crisis provides positive assurance in our ability to execute in times like these. Our balance sheet is strong and affords us the optionality to continue to invest in our strategic priorities, including new product innovation, emerging market growth and acquisitions. We are fortunate to be well positioned to play a pivotal role in the global response to COVID, and we remain focused on our longer-term growth prospects that will add further value to healthcare delivery.

Of course, none of our success would be possible without the hard work and dedication of our entire Hill-Rom team. I am humbled and inspired by our employees' consistent dedication and extraordinary efforts. On a daily basis, I receive messages about our employees' heroic efforts, customer and patient success stories and words of support, thanks and encouragement. We share these stories inside the company and postings that we call, Hill-Rom strong, as they acknowledge the power of teamwork and our role to help while bringing our mission to life.

So thanks. And now let's turn over the call to 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 Larry Keusch of Raymond James.

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

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Obviously, John, a lot of demonstration of what you guys are doing to continue to execute during the pandemic. I guess just some questions. As you think about the remainder of the year, and I recognize that you've suspended your guidance, but how are you thinking about just ramping up procedures at this point? Kind of what's the view right now relative to how preparedness, either by hospitals or governments, may shake out here? Again, just some high-level thoughts as you kind of think about the dynamics around the remainder of the year.

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

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Yes. Thanks, Larry. First, let me start with our vision and our strategy. I feel really good about the vision we outlined of Advancing Connected Care and the criticality of that in the prior pre-COVID environment, the current COVID environment and even the post-COVID environment. That strategy and our main strategic priorities really hold intact throughout this period of time. And in fact, if anything, they've been reinforced. So I mean -- and I think we're in this, as I tried to communicate in our prepared comments, we're in a really enviable position that we can stay the course without radical contemplation of significant shifts in resources and capital deployment to both invest internally and continue to look for external inorganic opportunities.

So let me start with that comment first as a backdrop. Specifically around the recovery, I think we're pretty much in line with what you're hearing around our peer group and our providers. We've listened very closely to what our providers are saying. I've had a lot of interactions with major provider networks and individual hospital CEOs and CFOs. And I think there's a growing consensus that we start to see elective procedures come back at the back half of the current quarter. And as we enter our fiscal fourth quarter, it continues to accelerate. Does it, in our fiscal fourth quarter, ever get back to the kind of pre-COVID volumes? That's a crystal ball that no one has. To really determine what that return to baseline activity looks like and when it comes back.

So our comment's around the shape and speed of recovery and what the healthcare demand effectively ends up looking like over the next 6 months is really hard to predict. And even the transition between our third quarter and our fourth quarter is really hard to predict in some of our areas and that's -- those are some of the main reasons we suspended our guidance. Even though we're halfway through our own fiscal year, just the timing of what the outcomes will look like in Q3 versus Q4 is a very complex equation with a not -- a lot of new variables that we've never seen before. So in general, we think things do start to recover from here. As states begin to open up and as the understanding of the financial implications to the healthcare providers, both in the hot zone of an impacted COVID area and equally important, those that were not heavily impacted. One would argue that those healthcare providers and those systems that kind of shut down activity and then did not have a wave of COVID patients arrive, they're suffering pretty significantly financially as well.

I think the other thing that I would comment on, which is a bit of a macro comment, Larry, and that's really around the point of the stimulus money that's been provided and approved from Congress. The actual flow of those funds is only starting to begin to show up. And so the amount of funds that any individual provider receives is still unknown. They've received some small portion of the total amount allotted to them. But they haven't received nor do they have visibility to what that ultimately looks like for them.

So we have a short period of uncertainty where providers don't understand their current P&L and their own balance sheet. That should get resolved in the next couple of months along with the resumption of normal activity around surgical, ambulatory care and diagnostic care. So once those 2 things come together, I think the environment for our customer, our biggest customer, group of acute care centers will be much better understood. And I think we'll be able to then provide better clarity on what that -- what the implication of that is to the CapEx environment.

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Lawrence Soren Keusch, Raymond James & Associates, Inc., Research Division - MD [4]

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Okay. Very good. I guess just one other one here and maybe just a super-fast one for Barb. But again, you sort of got into this a little bit on your prepared comments that one might think that the buying, right now, of beds would represent a pull forward of demand and you might find yourself in an air pocket, but I think you're sort of suggesting that may not be the case. So again, maybe if you could expand on what you're seeing out there. And why do you think this may not just be a pull forward situation? And then just quickly for Barb, I think if I have this right, I know that you're now looking for $40 million of noncore revenues in this fiscal year. I thought it was previously closer to $25 million. So if I am right on that, could you just please help us understand what changed?

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

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Yes. I'll take the first part, Larry, and then pass over the noncore revenue piece to Barb. I think if you look at Slide 25 in our presentation, I think that really gives you a nice depiction of the resilient part of our portfolio to 60%, of which, as I stated in my prepared comments, 40% of that 60% is experiencing high demand of -- remains significantly high demand, as we stated in our comments, both in beds, vital signs monitoring, thermometry, respiratory care, all of those are seeing a significant increase in demand.

On the bed portion, we tried to, and did, provide commentary of how much we think of that as pull forward. Roughly half of it or more than half of it, we think, is just increased demand for additional capacity. And we saw many areas around the U.S. and around Canada and Europe where suddenly, there was an increased demand for expansion capacity. And it was clearly not pull forward of our pipeline, at least our near-term pipeline that we had visible to us, and we're actively working. So roughly, a little more than 50% was expanded demand in the bed category, and the remainder was pull forward from future periods, more in the near term.

So that said, I mean, I think we're obviously looking at a very robust Q3. We have good visibility to it. We have a significant record orders and backlog of Smart Beds coming into the quarter. And the continuing orders and backlog building in some of these other critical products like monitors and respiratory products. So those continue to give us near-term visibility that we're going to have a very strong Q3.

What happens and how we transition, I think you laid it out well, which is we're going to have a transition. This is -- none of us wants this to be sustained for the sake of humanity that we have this ongoing rush for expanded capacity. So there will be a transition. What I like -- what I love about our portfolio is that we're really well positioned to adapt. And I think we've proven we can be quick and agile to adapt to the new environment as it transitions. And our portfolio being as broad and diverse as it is, will allow us to transition when that time comes, transition away from some of these critical care products into the portfolio of products that are driving value for healthcare and represent some nice growth opportunities for us in the future along the lines of respiratory health and remote patient monitoring.

And I'll turn it over to Barb for the comment around the -- or the question around the noncore revenue.

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Barbara W. Bodem, Hill-Rom Holdings, Inc. - Senior VP & CFO [6]

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Larry, thanks for the question. You are absolutely right. Previously, we have been estimating that the noncore revenue from our international OEM surgical business was going to be $25 million. We've actually seen some increased demand from them this quarter. And so we are working to meet that, and therefore, we're now estimating that it's going to be closer to $40 million. It does not change our trajectory about exiting this business nor does it change our goal of sort of retiring the core, noncore calculations for next year.

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Operator [7]

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Rick Wise of Stifel.

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Frederick Allen Wise, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Senior Equity Research Analyst [8]

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John and Barbara, let me start off with care comm. I mean obviously, it sounds like it was impacted and understandably, hospitals are focusing elsewhere. Maybe you could help us appreciate in a little more detail exactly what's happening and how you expect this critical part of your business and strategy? How you expect the care comm story to unfold over the next 6 months or get restarted? And maybe just as part of that, John, you could -- given the significant Smart Bed demand, you could spend a minute on helping us understand how that possibly -- I don't know if I'm thinking about it correctly, but possibly potentially accelerate your connectivity initiatives as we recover, if I'm thinking about it correctly.

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John P. Groetelaars, Hill-Rom Holdings, Inc. - President, CEO & Director [9]

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Yes. Great. Thanks, Rick. Yes. So care comm did deliver double-digit growth for us in the second quarter, including double-digit growth for Voalte. So we came into the quarter feeling good even as the initial phase of COVID was hitting, we still ended up with a double-digit growth product category for us. However, as we ended the quarter, we saw our customers completely focus on preparedness around COVID and the patients that were about to be coming indoors, so -- and restricting access, of course, which makes complete sense.

We're still in that phase of taking care of these patients and restricting access to our teams who would need to be there to be on-site to install and complete the verification and validation of the communication systems and be able to recognize revenue. So we expect that will occur again along the trajectory that we tried to outline around the next 2 quarters. And as we get into our fourth quarter, our fiscal fourth quarter, our access greatly improved, and we can -- in the majority of sites and we can get back in there and complete the work and begin to get revenue recognition going.

In the interim period, 1 of the 5 products we launched was around Voalte Extend, which was deployed in several applications to allow a cloud-based solution for off premises use in a field hospital situation specifically. And that was met with strong response. We also partnered with AgileMD, which is really an AI -- a small AI company with some great technology to help really develop best practices around pathways and clinical pathways in early warning detection for patients who are deteriorating, specifically around COVID-19, which I think was a good early deployment of the strategy we talked about many times around our digital products offering, and how do you take the connectivity of monitoring patients to the next level so you can provide insight and intelligence. And we're happy to be doing that with this partner in the current environment.

As it relates to the second part of your question around the longer-term strategy, I think you're absolutely right, Rick, that this does validate the importance of clinical communication workflow, communicating with patients who are potentially in isolation, monitoring their vital signs very closely in real time and being able to respond and adapt to a changing condition for patients. Some of these solutions can easily be adapted to help preserve PPE and manage patients, as I mentioned, in isolation, preventing ICU visits, so we think that is strategically very well aligned. And the recent acquisition we did with Excel Medical is another good example, right? You have live waveforms on a smartphone, you're able to monitor patient status and see and interact with the patient vitals without having to be in the room. So we are, again, it reinforces our strategy and gives us confidence that we're on the right path here as we think about a post-COVID world.

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Frederick Allen Wise, Stifel, Nicolaus & Company, Incorporated, Research Division - MD & Senior Equity Research Analyst [10]

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Great. And maybe just on the financial side, you obviously had excellent record gross margin. It seems like you're long term on a path to moving them higher because the portfolio, the mix, new products, et cetera. But just, I know it's tough to give guidance now, and I'm not expecting something precise. But just as we think about the next couple of quarters, are you sustainable at this level because of the strength of -- the strength in the portfolio we're seeing? Or no -- the mix is actually going to be a headwind for the next quarter. How should we think about it? And as long as you're -- I'm doing financial, I'll sneak in, maybe you can talk about capital deployment and M&A. What are your priorities now?

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Barbara W. Bodem, Hill-Rom Holdings, Inc. - Senior VP & CFO [11]

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Rick, it's Barb. First, talking about gross margins. We have seen really healthy gross margin expansion in the first half of the year. When we think about Q2 in particular, we saw 180 basis points, 140 of that coming from portfolio mix. But it's important to remember that of that portfolio mix, about half of that contribution is coming from the divestiture of the surgical consumable business last year as well as contributions from our acquisitions. And as we anniversary those dates, you're not going to see that same lift that you get in the first part of the year from those actions. So that is going to wane as you think about the back end of the year.

Now as you think about the mix of the portfolio, as John outlined earlier, we do think that there's about 40% of our portfolio that's going to see some challenges in the remainder of the year. In that bucket are some of our lower-margin products. So overall, we think product mix in the latter part of the year will still be a positive for us. But there will be many puts and takes in there as we look at demand changes and think about what the underlying cost structures are. So I would just encourage you to think about the anniversarying of our M&A activities and how that will reflect in the gross margin over the course of the year. But also take into consideration, we do think we'll see positive contribution from portfolio mix, just from the changes we're seeing in demand in the second half of the year.

With regards to capital deployment, John used the phrase earlier about staying the course. And I would say that, that is exactly the same when we think about capital deployment. Balance sheet is really strong. Cash position is good. Access to capital is good as well. And so when we think about our priorities, as we've talked about before, first and foremost, we're going to be looking for ongoing growth opportunities. So M&A will remain a priority for us, looking for the right M&A, with the right financial and strategic criteria. We will continue to maintain our dividend. We just recently increased it. That's the tenth year in a row that we've increased our dividend. That's not something that we see changing at all. And then with regards to other areas, stock repurchases, we have traditionally used repurchases as just a way of managing our dilution over the course of the year. And in fact, the beginning of Q2 before COVID really started to be felt in the markets here, we completed this year's repurchase to offset dilution for 2020.

And then finally, if we don't have great investment options to go after in front of us, we're going to use whatever cash we have to continue to pay down debt and build up our coffers for when we do see the right opportunities. So really staying the course here, the priorities really haven't changed as we think about capital deployment.

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Operator [12]

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David Lewis of Morgan Stanley is online with the question.

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David Ryan Lewis, Morgan Stanley, Research Division - MD [13]

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Thank you for all you're doing for patients and hospitals, John and team. I want to go out a little bit more, John. I know you've got some questions here in the next 6 months. I mean it's very clear from your presentation that the next quarter is going to see a significant demand in the business. I don't think investors are very focused on the next 6 months. There are kind of two debates out there, John. If you think of the next 12 to 18 months, one debate is they're going to see some level of pandemic preparatives that's going to be sustained.

And the other is that this is just an acute demand dynamic and the capital environment is get -- it's going to get challenging. So my kind of questions there related are, what are hospital CEOs and procurement officers saying about how prepared they were and how prepared they have to be in the future? And then on the other side of the equation, how do you think this crisis compares to the 2008 financial crisis from a capital perspective? And then I have one quick follow-up for Barb.

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

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Yes. I think it's early innings, right? To -- we're still in the middle of the crisis dealing with these illnesses coming in the door. And at the same time, planning on getting back into some level of normalcy on elective and urgent procedures. The early indications would be, and I wouldn't want to extrapolate too far off of this, but there's a tremendous amount of input from providers, both here in the U.S. and internationally that we were not prepared, and we don't have enough capacity. Whether that was our intense discussions on ventilators, that we were directly involved in or the panic that people had in their eyes and in their urgency around getting new ICU beds and Med-Surg beds into their environment, not to mention monitoring equipment and the like.

So post this pandemic and post the analysis of how well we were prepared here in the U.S. and how well various countries in Europe and around the world have been prepared, I think we'll see some -- I would be surprised if we don't see some large-scale changes around what our surg capacity is and how we deal with it. We clearly -- as bad as this has been, it could have been a lot worse. And we were not in the state of preparedness that we should be. So that -- there's likely a longer-term opportunity here for market expansion, too early to say.

And then I guess as it relates to the CapEx environment, we went through this before. We've been through multiple cycles, and we did a retrospective review recently and we looked at it again in the last couple of weeks. During a very uncertain and -- looking at uncertain time around Obamacare and a liquidity crisis -- around the financial crisis. During that time, which is different than this, and I would argue worse in some ways as it relates to CapEx. During that time, we saw a double-digit decline in what is now 10% of our portfolio. So that would represent about a 1% headwind in the future as we get past -- into the time frame you're talking about of 12 to 18 months.

So if that scenario develops, I think that's a reasonable headwind to consider. I don't think we would change our view on that. What's unknown in the near term is really this transitional period. When we come off of this strong Q3, what does Q4 look like? What does Q1 look like? It will be what it will be. I think we are extremely well positioned to adapt and adjust and move our emphasis and our portfolio with the times and with the changing needs in the healthcare environment. And I do think that our strong value propositions around care comm, around remote patient monitoring in the acute care setting and integrating that with care comm platform, driving our Respiratory Care business for home ventilation as well as acute ventilation that we're seeing now from this pandemic.

But also as we pivoted on our -- several of our new product introductions, I would highlight that one of the ones in there deserves a special attention, which is adding remote monitoring to our -- one of our vital signs monitoring devices for temperature, blood pressure and SpO2. This will be a device that next month, we're going to launch. And it will allow us to have multi parameter vital signs monitoring in an ambulatory or home setting that is directly connected through an app and a website to allow clinicians to monitor patients without seeing them, without needing to be at their bedside, without having them to come in the office. Ideal for COVID patients but also for remote patient monitoring and telehealth. So I think that represents yet another accelerated growth factor for the company as we look forward.

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David Ryan Lewis, Morgan Stanley, Research Division - MD [15]

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Okay. That's very, very helpful over the next 12 months. Very detailed. And then, Barb, just a quick one for you. I think the volatility of the device environment is giving us kind of a new definition of what incremental and decremental margins are for many of our businesses. I guess I was struck by some of your comments here, other supply companies are seeing significant upside to numbers, but significant spending associated with that upside. Can you just give us a sense of how you're thinking about incremental and decremental margins during this process? And specifically, with some of these increased demand forecast and increased capacity dynamics, what type of manufacturing spending and what type of logistical spending you're having to do to support these customers and what that means kind of from a margin perspective here over the intermediate term?

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Barbara W. Bodem, Hill-Rom Holdings, Inc. - Senior VP & CFO [16]

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No worries, David. Nice to hear from you. As we think about what we're doing to expand our capacity, we've talked about how we've done some additional hiring. We have done some minor reprioritization in our CapEx spending to make sure that we're putting the right equipment in there as well. But in general, the only real headwind that we've seen with regards to the overall cost has been related to freight and transportation. And we were experiencing some of that already into Q2, and yet, we still posted that 40 basis points of productivity improvement. And so we feel like we've got a good handle on the incremental costs that are coming our way as a result of the stress in the supply chain. But they're not material, and we're more than able to offset that with the ongoing initiatives that we have in our manufacturing organization.

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John P. Groetelaars, Hill-Rom Holdings, Inc. - President, CEO & Director [17]

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Yes. And the only other point I might make there, David, is as we've seen our outlook being as confident as is, we are looking and we're -- of course, we're saving money on less travel and less meetings and so on. We're going to redeploy that money into investments internally where we can get more out of our new product launches and come out the back -- the other side of this pandemic really in a state of preparedness and readiness to adjust and adapt. So those organic investments are going on and are activated as we speak.

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Operator [18]

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Bob Hopkins of Bank of America is online with the question.

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Robert Adam Hopkins, BofA Merrill Lynch, Research Division - MD of Equity Research [19]

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I wanted to follow-up on some of the questions that have already been asked. One on beds and capital and the other on Care Communications. And I guess the way I'd asked the question on the outlook for beds and capital, I realize there's a lot of uncertainty here about the near and intermediate term. But John, you highlighted at least the potential for what you call the multiyear demand cycle. And I'm just curious from where you sit today, kind of how would you characterize the potential for that to actually happen? Is that sort of low conviction level at this point, high conviction level at this point? Just wondering from what you're seeing today, how much conviction you might have, if that's a possibility.

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John P. Groetelaars, Hill-Rom Holdings, Inc. - President, CEO & Director [20]

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Bob, as we've all looked at various pandemic models and learned more acutely what epidemiologists do on a day-to-day basis, I think we've -- it's become -- in this particular case, it's become highlighted to me and to our team here in the area of ICU capacity, in particular, whether it's certain spots in our country in the United States or significant increases in demand that we've seen internationally. And I'll point out recently Canada, as an example. And they came in with a flurry of orders across the country. And Italy was another one where their action really spoke volumes around from a relative point of view, how they recognize they are woefully short of ICU capacity to deal with these kinds of pandemics or outbreaks.

So I actually think it's more -- potentially more international, where it's really clear that ICU capacity is not at the level it should be. And probably some regions that have been hard hit, namely New York, New Jersey, who have came very close. And without the additional field hospitals that were put in place, they could have been in a really difficult situation even worse than it was. So it's so early to say, but I do think the postmortem on this or the post action review of this activity is likely going to recommend something in that area. I'd be surprised if it didn't -- that's speculative. So what's my conviction level? Less than 50-50. All that said, less than 50-50. We have a -- unfortunately, humans have a short memory. So once this is passed, I don't know if we're going to really take on the lessons and change our behavior, but I think it's warranted in this area that we have better capacity.

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Robert Adam Hopkins, BofA Merrill Lynch, Research Division - MD of Equity Research [21]

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Very fair answer. And then on community -- Care Communications, I heard you answer to Rick's question, and there's a potential for this on the other side of this pandemic for that business to potentially accelerate, I guess, because the need for it seems so acute. That's a decent-sized business for you now. I am just wondering, given all that you know today, just thinking about the long-term outlook for that business. And I know it's connected to the whole company, but independently roughly around pre-pandemic, around $300 million, what do you think the growth outlook -- a durable growth outlook is for that Care Communications business? Is it double digits? Is it 20% plus? Just kind of a rough thought on what you think the durable growth outlook is for Care Communications on the other side of the pandemic, understanding that today, you're limited in terms of your ability to install inside a hospital.

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

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Yes. Great question. I can tell you what it was in our prior outlook. We did have a view to double-digit growth there over that 3-year period. That's under a revisitation as we kind of get through this remaining part of the year and think about our guidance for next year. But strategically speaking, the growth outlook, the need and the innovation that's going to take place in that area does not change my view. It is -- reinforces the importance and the direction we were taking. And I think puts us in a really good position to have acquired some of the best assets out there, added to it with the recent acquisition of Excel Medical. And quite frankly, some of the opportunities for innovation there as we exhibited with our partnership with AgileMD, we can rapidly partner and expand in that digital product offering very quickly and adapt very quickly.

So I'm excited about it. And we're excited about the prospects of adding even more value to clinical communications in the acute care setting, integrating it with Smart Beds and smart monitoring of beds, and making sure that vision comes to life in a meaningful big way, but also taking it off premises and looking at ways to do that in the non-acute care setting in the future. So I think strategically, great business. We're going to continue to invest there, and we really like our positioning.

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Operator [23]

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Kristen Stewart of Barclays is on the line with a question.

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Kristen Marie Stewart, Barclays Bank PLC, Research Division - Research Analyst [24]

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Just a couple of questions from me. Just first on just this Slide 25, it's very helpful. Just want to get a sense for kind of the 60%. I think you've done a good job of kind of quantifying some of the downside of the 40% of the reduced demand. I guess I'm just trying to understand what the upside level is. The 60%, they said resilient demand, but it seems like that's more significant upside, particularly in the third quarter. It seems like you're having a harder time kind of quantifying what that fourth quarter looked like. But any way you can kind of help us just sort of size maybe your backlog of business. I know you've got that $20 million contract coming in from HHS, but any other way to just kind of size the rest of the backlog in terms of dollars or anything in that. And then I just have one follow-up.

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

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Yes. Thanks, Kristen. We tried to do that in the slide here in our prepared comments with orders on the bed side of things, being 70% above our Q1 level. And having orders 2x our normal level in beds in total. So those are probably the best indicators we can provide you at this point. As we come into April, our view hasn't changed. That continues to look solid. What might -- what we -- some of this activity, whether it's on the capital side, around beds or the surgical side, it's very easy, whether it's here or internationally for a project or a delivery to ship in Q4 versus Q3 or vice versa.

So the timing around Q3, Q4, there is -- it is hard to predict and one of the primary reasons that we decided to withdraw our guidance just because of that -- the timing element and the shape and slope of that recovery, where we can get back in and complete the work around care comm and surgical installations that were scheduled. So I wish I could give you more. I just don't have the clarity of the crystal ball between Q3 and Q4.

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Kristen Marie Stewart, Barclays Bank PLC, Research Division - Research Analyst [26]

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I mean it wouldn't be correct to say the 40% of the business is kind of looking down, 40% of your revenues are down more than 20%, and then the 60% is up x percent or anything...

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John P. Groetelaars, Hill-Rom Holdings, Inc. - President, CEO & Director [27]

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Yes. I guess what I would do is, if you take that 60% and then split it into 20% being pretty stable, flat to low single digits. So now you have this remaining 40% that's the offsetting ballast to the 40% declining, right? So the 40% increasing is increasing at a much higher rate than the 40% declining, right? I mean that's where we're seeing significant -- we took action to double production in many of those product areas. It takes time to ramp up to that level and then replenish your inventory, so you can't directly correlate. Doubling production means doubling revenue because of the timing element and a supply chain element that doesn't get factored in. But it gives you a sense of -- it's a high double-digit growth area for us, and it's a strong tailwind.

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Barbara W. Bodem, Hill-Rom Holdings, Inc. - Senior VP & CFO [28]

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I would just add, Kristen, that as you think about those magnitudes, then it becomes all about time, and it becomes about the sustainability of both of those elements, right? Both the upside and the downside. And that's where it gets really tricky is how well those are going to match up to one another.

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

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Yes. And I think and the one -- yes, sorry, Kristen, you can -- But the one thing I wanted to just clarify is that with the surgeon Smart Beds, a lot of those, again, are fully featured beds, right? With connectivity, with sensors. We saw a lot of them requesting early sense deployments in there. So we think that's positioned us really well compared to our peers and our competitors out there because like we've always said, when you're making these capital purchases, even in the middle of a pandemic, you're going to want a future proof what you're buying because this is a long lived asset. You want to make sure you're going to get the most out of it. And I think we've been well positioned to add future features to this increased demand surge.

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Kristen Marie Stewart, Barclays Bank PLC, Research Division - Research Analyst [30]

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Right. And those all have recurring type of revenues associated, like you said, watch sense and all those.

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

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Yes. That's right.

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Kristen Marie Stewart, Barclays Bank PLC, Research Division - Research Analyst [32]

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Okay. And I think, Barb, you had made the comment on don't extrapolate out kind of this quarter, but it kind of sounds like, if I'm hearing you right, on those numbers, that it sounds like you're kind of thinking that net-net, these numbers look like your future quarters may, again, depending upon the timing and when not. It sounds like you're thinking things still seem positive going forward on the balance, maybe 3Q, just with timing with this event order probably coming in and just the timing of maybe some of these bed deliveries maybe a bit stronger, and then we'll kind of see how the quarters kind of shake out, I guess, directionally, not guidance.

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Barbara W. Bodem, Hill-Rom Holdings, Inc. - Senior VP & CFO [33]

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Yes. I think that there are certain things that you can feel good about in terms of gross margin expansion. You can feel certainly clear that we're expecting peak demand in Q3. But just where we don't want you to extrapolate or where we all need to be cautious, because there's too much that's unknown, is really about this timing. And it's the timing between Q3 and Q4. And it's the timing of how long you sustain the high demand versus how long it takes us to recover and to see the improvement in that 40% that is being challenged. So I would just -- we're not giving guidance for the year for a reason because that timing is really difficult to estimate.

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John P. Groetelaars, Hill-Rom Holdings, Inc. - President, CEO & Director [34]

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Now just for the sake of clarity, I don't think we've said this, but we do expect Q3 to be a stronger quarter than Q2, right? I mean that -- it seems like what you're kind of getting at there, Kristen, and I think we can say that with a high degree of confidence that Q3 will be better than Q2. What the shape of that looks like? How big it is versus Q4? That's the part we just don't have good visibility on.

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Operator [35]

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

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Matthew Charles Taylor, UBS Investment Bank, Research Division - Equity Research Analyst of Medical Supplies & Devices [36]

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So I just wanted to ask you because it is kind of a microcosm of this bigger question that other folks were referring to what happened in Canada. Could you talk about the size of the orders there, how much that contributed? And maybe what it represents versus what you normally see there? I just wanted to get a sense for the kind of expansion that you're seeing in one market.

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John P. Groetelaars, Hill-Rom Holdings, Inc. - President, CEO & Director [37]

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Yes, Matt, it's -- I don't think we have specific numbers here, but it's -- Mary Kay is looking. But the overall demand we saw -- and it's some part of that got delivered in Q2 and part is going to get delivered in our fiscal Q3. We're also seeing that in Europe playing out. We didn't talk about Europe today on the discussion. In our prior call, we said there were project delays, and EMEA was going to have a stronger Q3 than Q2, and that still remains our perspective. And part of that now is going to be reinforced with the demand signal and the demand we've seen in our critical care products that we outlined earlier. So we'll see a nice contribution from international on a go-forward basis as they implement. Some of these expansions in Canada was one of the one -- as an example of a market close to home where new demand was -- clearly came through. We didn't anticipate this kind of level of ICU demand coming from Canada. It wasn't in our funnel and almost province by province, we saw increasing demand for expanded capacity as they were moving quickly to get to be prepared for the coronavirus.

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Matthew Charles Taylor, UBS Investment Bank, Research Division - Equity Research Analyst of Medical Supplies & Devices [38]

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Okay. And then as a follow-up, you mentioned you have this $20 million order for the non-invasive ventilators for HHS. And I guess I was wondering, are those products earmarked for a stockpile? And then have you had any conversations with the federal government, with state governments or international ones about any of your products that could be used in future stockpile?

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John P. Groetelaars, Hill-Rom Holdings, Inc. - President, CEO & Director [39]

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Yes. Good question. This $20 million will go to one destination, HHS. And I think it will either go in their stockpile or FEMA will distribute it. I think they're working through with that what that scenario is. We also had several states make some purchases of the same product. We, of course, want to follow the usage of that product and support it and see that it gets deployed in the right setting to avoid additional ICU stays or help wean patients off of mechanical ventilation, which will be the ideal use. And there's clearly also a use case to provide it in the home and potentially avoid a hospitalization if you can provide it like you with oxygen just that next level of support because you have oxygen plus ventilation support in a non-acute care setting, which for COVID patients could be a real benefit. But we haven't -- we don't have the use case yet develop there, but we're actively looking at trying to do that.

Well, thanks, everybody, for the call today, and appreciate all your questions and interest, and we look forward to our next update in the interim meetings we might have.

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Operator [40]

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