Hill-Rom Holdings, Inc.
Q1 2018 Earnings Call Transcript

Published: 26 Jan 2018

[Operator:]

Good morning and welcome to Hill-Rom's Fiscal First Quarter Earnings Conference Call. During the presentation, all participants will be in a listen-only mode. At the end of management's prepared remarks, we will conduct a question-and-answer session. [Operator Instructions] As a reminder, this call is being recorded by Hill-Rom and is copyrighted material. It cannot be recorded, rebroadcast or transmitted without Hill-Rom's written consent. If you have any objections, please disconnect at this time. I would now like to turn the call over to Ms. Mary Kay Ladone, Vice President, Investor Relations at Hill-Rom. Ms. Ladone, you may begin.

[Mary Kay Ladone:]

Thank you and good morning everyone. Thanks for joining us for our first fiscal quarter 2018 earnings conference call. Joining me today are John Greisch, President and Chief Executive Officer of Hill-Rom, and Steve Strobel, Chief Financial Officer. Before we get started, I'd like to mention that in addition to the press release issued this morning, we have posted a supplemental presentation which can be accessed on the Investor Relations page of our Web-site at hill-rom.com, under Events & Presentations. So, with that introduction, let me begin our prepared remarks this morning by reminding you that certain statements contained in this presentation are forward-looking statements 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. Now, I'd like to turn the call over to John.

[John J. Greisch:]

Thanks, Mary Kay. Good morning everyone and thanks for joining us today. As you've seen this morning, in addition to our financial results for our first quarter, we announced that after eight years as President and CEO, I have notified our Board of Directors of my intention to retire from Hill-Rom during our fiscal third quarter. It has been an honor to lead this great company and I'm extremely proud of the value we have created together for patients, customers and shareholders. We've been on a journey to transform our portfolio, expand globally and enhance our position as a global medical device leader. I'm extremely proud of what this talented team has accomplished, particularly the creation of over $4 billion of equity value or increase of over 4x during the last eight years. While there is never a perfect time, this is the right time for me personally and for the Company to transition to the next generation of leadership. With the initial phase of our transformation complete, the next phase will be a multi-year effort, so now is the right time to bring in a seasoned CEO that has a long enough tenure to execute the next phase of the journey. As part of our succession planning process, the Board will conduct a comprehensive search for my successor, including a review of both internal and external candidates. The Board expects the search to be completed during our fiscal third quarter and we expect a seamless transition between now and then. I want to thank each of our 10,000 employees around the world for their support and ongoing commitment to helping people get better care inside and outside the hospital. Hill-Rom is well-positioned for future success with a well-developed strategy, a strong team, solid foundation, and exciting growth prospects. We have never been in a stronger position than we are today. I'm confident that our next CEO along with the rest of our outstanding leadership team will continue our positive momentum and build on the important progress we have made. With that, let's turn to our financial results. As you saw in our earnings release issued this morning, positive momentum continued into our fiscal first quarter and we're pleased to report strong financial results. We're also raising our full-year 2018 guidance and are updating our long-range financial objectives through 2020 to reflect the benefit related to recent U.S. tax reform legislation. In the first quarter, we delivered adjusted earnings of $0.92 per diluted share, exceeding our guidance range. This represents an increase of 23%, our 10th consecutive quarter of double-digit earnings growth. This performance reflects solid core revenue growth, execution on margin expansion initiatives, investment in strategic initiatives to drive future growth, and a $0.06 benefit related to U.S. tax reform. From a revenue perspective, core growth was 2% on a constant currency basis, even after absorbing a modest impact from Hurricane Maria and a challenging comparison in our Front Line Care business. While we have made very good progress in establishing a more stable and diversified business, our continued focus is on driving accelerated top line growth over the course of this year and during our long-range plan period. I'm pleased with the momentum we continue to build in our international business, where all three businesses contributed to core revenue growth of 8% on a constant currency basis. With strong execution and disciplined focus on higher margin growth drivers, we expect to sustain the positive international growth trend and improve margins for the rest of 2018 and beyond. U.S. core revenue was comparable to the prior year, but adjusting for the hurricane impact and difficult comparisons in Front Line Care, core growth approached 3%. Key highlights include the contribution of new products as well as double-digit growth in our respiratory care and surgical equipment businesses. As we have discussed, innovation remains a key strategy for our Company. In 2017, new products contributed approximately $150 million in revenue and are expected to drive accelerated revenue growth and margin expansion in 2018 and beyond. With a strong first quarter, we are well on our way to achieving new product revenue of approximately $200 million in 2018. Let me take a moment to comment on some recent achievements. First, in Patient Support Systems, the introductions of the Envella Air Fluidized Therapy Bed for wound care and the Accella bed system for higher acuity patients in intensive and acute care settings outside the United States continued to progress. And most recently, we launched the Centrella Smart bed system. Now available in both United States and Canada, Centrella is expected to transform care by providing increased patient safety, satisfaction and caregiver efficiency. While still in the early days of the launch, feedback from clinicians has been positive. We continue to be optimistic about Centrella's potential to accelerate the Med-Surg bed replacement cycle. In the first quarter, U.S. Med-Surg orders are the strongest they have been in two years, up 12% year-over-year, and our backlog is building, exceeding our early expectations. Within Front Line Care, we are enhancing awareness with strategic investments in our Vision for All campaign, focused on promoting the early detection of amblyopic risk in children with the Spot Vision Screener, and making diabetic retinopathy screening simple and affordable in the primary care setting with the Welch Allyn RetinaVue Imager. We continue to see solid growth of Spot Vision Screener, particularly in the United States and Japan. For RetinaVue, we achieved a record level of device placements and screenings in the quarter. With the mounting incidence of diabetes in more than 30 million Americans with the disease today, RetinaVue continues to be one of our most exciting growth opportunities long-term. Within the Surgical business, we expect to drive growth with a focus on safety, efficiency and partnering with other medical technology companies to improve the breadth of our offering around the world. During the quarter, we introduced the TruSystem 7500 MR Neuro Surgical Table, which integrates with the IMRIS MR Neuro tabletop to support better patient treatment and optimize the surgical workflow. The new surgical table will be an essential component of the IMRIS Surgical Theater, a suite of intra-operative imaging technologies that allow neurosurgeons to see critical anatomical detail during surgery. And finally, placements of Integrated Table Motion were very strong, up more than 30% versus last year, with revenue again exceeding our expectations. We expect 2018 revenue to approach $30 million. So, to summarize, new product revenue is a key driver of our accelerated future growth and we continue to advance our commercial capabilities with appropriate investments to capture this value. Now let me turn the call over to Steve, who will review our first quarter financial results in detail, our 2018 outlook, and our updated 2020 financial objectives in his commentary. Steve?

[Steven J. Strobel:]

Thanks, John, and good morning everyone. As mentioned in the press release, we've reported GAAP earnings of $1.31 per diluted share in the first quarter compared to $0.36 in the prior year. These results reflect after-tax special items, including a net tax benefit of $0.89 per diluted share related to new U.S. tax reform legislation. Excluding special items, adjusted earnings of $0.92 per diluted share increased 23%, exceeding our guidance range of $0.77 to $0.79 per share. The new U.S. tax reform legislation contributed approximately $0.06 per diluted share to our adjusted earnings. Excluding this benefit, adjusted earnings increased 15%. Now let me briefly walk through the P&L before turning to our 2018 financial outlook. Starting with revenue, for the fiscal first quarter, revenue of $670 million grew 5%. On a constant currency basis, revenue increased 3%. Domestic revenue increased 2% while international revenue advanced 7%. Strong international performance reflects continued momentum across multiple geographies. We are driving double-digit growth in Canada and the Middle East, where we benefited from our One Hill-Rom approach with some large competitive wins and we are encouraged by improving trends in Europe. Core revenue increased 2%, exceeding our expectation of flat growth in the quarter. As a reminder, Q1 core revenue excludes the impact of foreign currency, Mortara, divestitures, and other nonstrategic assets we may exit in both the current and prior year. Before moving on, keep in mind that as I discuss each business segment, I will address revenue growth on a constant currency basis only. Starting with Patient Support Systems, revenue of $334 million was comparable to the prior year, while core revenue increased 2%. As expected, domestic revenue declined 2%, but after adjusting for nonstrategic businesses and divestitures, U.S. core revenue was slightly above prior year. Mid-single-digit growth across the core bed portfolio, led by the introduction of Centrella, was partially offset by decline in lower margin rental revenue. Outside the U.S., core Patient Support Systems revenue increased 8%, driven by solid growth in service revenue as well as core bed and patient handling products. Improving trends, particularly in the Middle East, Europe and Canada, offset softness in Asia-Pacific. Now, moving to Front Line Care, revenue was $225 million, an increase of 10%. Excluding Mortara, Front Line Care revenue declined 1% as we faced a difficult comparison to the prior year in our U.S. vital signs monitoring business. On a comp-adjusted basis, Front Line Care revenue grew mid-single-digits. U.S. performance was driven by the contribution from new products, solid growth of thermometry, blood pressure and physical assessment tools, and double-digit growth in our respiratory care business. International revenue was again strong and increased 5%, excluding Mortara. This was the result of our focus and investment in leveraging Hill-Rom's geographic presence, brand and infrastructure. Lastly, Surgical Solutions revenue increased 6% and totaled $111 million. Performance was led by international, which grew 10%, driven by strong momentum in the Middle East and Europe. Revenue in the U.S. increased 2% despite the negative hurricane impact. Integrated Table Motion placements exceeded our expectations and other innovative products, like iLED 7 and the new TS 3000 Mobile Operating Table, also contributed to growth. Now turning to the rest of the P&L, adjusted gross margin of 47.7% improved 20 basis points versus last year and achieved a new record level for the first quarter. Margin improvement continues to reflect the positive contribution from portfolio diversification, new product launches, ongoing benefits of manufacturing cost and sourcing efficiencies, and the accretive contribution from Mortara. These tailwinds however were partially offset by lower margins within the rental and surgical business, including the hurricane impact. Collectively, these factors created a temporary margin headwind of approximately 70 basis points. R&D spending of $32 million increased 1%, while R&D as a percentage of revenue was 4.8%, consistent with our long-range objectives. Adjusted SG&A of $189 million increased 6%, primarily due to the addition of Mortara. Excluding Mortara, SG&A was flat to the prior year. Disciplined cost management more than offset selling and marketing investments, supporting new product launches and initiatives to enhance our global capabilities. Our adjusted operating margin in the first quarter was 14.7%, reflecting an improvement of 10 basis points compared to last year. The adjusted tax rate of 19.1% was lower than our expectations as a result of tax reform and the benefit of other discrete tax items including the impact of stock-based compensation. So, bottom line, first quarter adjusted earnings advanced 23% to $0.92 per diluted share, and as mentioned earlier, this includes the benefit of approximately $0.06 per diluted share related to tax reform. Turning to cash flow, we are off to an excellent start this year with cash flow from operations totaling $93 million, an improvement of more than $20 million versus last year, while capital expenditures totaled $27 million. This resulted in free cash flow for the quarter of $66 million, which is $17 million or 35% higher than last year. Strong free cash flow enabled debt paydown of $62 million in the quarter, reducing our financial leverage to a debt-to-EBITDA ratio of 3.9. Now let me conclude this portion of the call by providing our fiscal second quarter and full-year 2018 outlook. As we stated in the press release, we are raising our full year 2018 adjusted earnings guidance to reflect our first quarter results and benefit of new U.S. tax reform legislation. For the full year, we continue to expect reported revenue growth of 3% to 4% and constant currency growth of 2% to 3%. Core revenue, which is expected to increase approximately 3%, excludes foreign currency, divestitures, nonstrategic assets we may exit, and Mortara prior to the anniversary date of the acquisition. As you may recall, collectively, divestitures and nonstrategic revenue in 2017 totaled approximately $100 million and is expected to contribute approximately $50 million in revenue throughout 2018. By business segment, there are no changes to our previous revenue guidance. On a constant currency basis, we expect Patient Support Systems revenue to be comparable to the prior year, reflecting the impact of completed divestitures and anticipated product exits. Core PSS revenue is expected to increase in low single digits, reflecting a continuation of stable capital spending environment. For Front Line Care, reported growth is expected to be in high single digits, while core growth is expected to be in the low to mid single-digits. Lastly, we expect low to mid single-digit growth for Surgical Solutions. From a profitability standpoint, we continue to expect adjusted gross margin to expand approximately 50 basis points and approach 49%, R&D spending of approximately 5% of sales, and adjusted SG&A of 26.5% of sales. We expect adjusted operating margin expansion of approximately 100 basis points, and other expense including interest of approximately $90 million. We now project a tax rate of approximately 23%, reflecting a 600 basis point improvement versus our prior guidance. This includes an estimated benefit of 500 basis points for tax reform and the remainder for the discrete tax benefits reflected in our first quarter results. Lastly, we expect a share count of approximately 68 million shares. So, to summarize, this guidance translates into adjusted earnings of $4.57 to $4.65 per diluted share, which includes the benefit from U.S. tax reform legislation of $0.30 per diluted share. As you may recall, our previous guidance range was $4.22 to $4.30 per diluted share. From a cash flow perspective, we are also raising guidance to incorporate a positive cash flow impact of approximately $15 million related to tax reform. Therefore, we now project operating cash flow of approximately $350 million, and with capital expenditures of around $110 million, we now project free cash flow of $240 million for the full year. For the second quarter, we expect reported revenue growth of approximately 4% and constant currency growth of 2%. On a core basis, we expect revenue to increase approximately 2% and are providing guidance for adjusted earnings of $1 to $1.02 per diluted share. As we mentioned last quarter, we expect core revenue in the second half of 2018 to accelerate as we ramp up new products, including Centrella, and anniversary the Mortara acquisition. Second, consistent with recent years, we expect adjusted gross and operating margins to be higher in the second half of the year compared to the first half, as we benefit from higher revenue, improved Surgical margins, the benefit of Mortara synergies, and continued savings from our cost and business optimization initiatives. Finally, as we mentioned in the press release, we are also updating our long-range financial objectives through 2020. The tax reform benefit is expected to result in an adjusted effective tax rate of approximately 24% going forward and therefore we now expect to grow adjusted earnings per share in the 12% to 14% range on a compound annual basis through 2020. This compares to our prior adjusted EPS compound annual growth guidance of 10% to 12%. We also now expect to generate cumulative operating cash flow of approximately $1.2 billion and cumulative free cash flow of $850 million over the next three years, reflecting a benefit related to tax reform of approximately $50 million. The remainder of our long-range guidance remains unchanged and I'm happy to address any questions you may have on this topic during Q&A. Now I'd like to turn the call back over to John.

[John J. Greisch:]

Thanks Steve. So let me conclude our comments this morning. We're off to a great start with a strong first quarter and our team is successfully executing on our key strategic priorities. We continue to focus on generating durable and profitable growth, while enhancing margins, optimizing our cost structure, and investing in value-creating growth opportunities. We're capitalizing on new products, advancing our pipeline, and expanding into new markets. We have a solid foundation and I'm extremely proud of our seasoned management team. I have the utmost confidence in our team's leadership, broad healthcare expertise, and commitment to positioning Hill-Rom for sustained success. With a compelling strategy, strong operational execution, and financial strength, we are well-positioned to continue to deliver significant value to our shareholders. With that, let's open up the call for Q&A.

[Operator:]

[Operator Instructions] I would like to remind participants that this call is being recorded and a digital replay will be available on the Hill-Rom Web-site for seven days at www.hill-rom.com. Our first question comes from Bob Hopkins of Bank of America. Your question please?

[Robert Hopkins:]

John, I guess first of all just congrats on a fantastic run at Hill-Rom and really throughout the entire career. I'm sure that investors will have a lot of questions for you though on the retirement because it does come as a little bit of a surprise, so maybe I'll just throw out a couple of things I'd love you to address, if you don't mind. So, I'll just rattle them off. If this search takes longer than six months, would you stay on until that's complete? I guess the other two quick things is, is the search underway and just how confident are you that it can be completed in that six-month timeframe? And then the last thing is, just personally, I just want to get a sense for kind of the future for you, would you take another med-tech CEO job or is this kind of it on that front? Thanks very much.

[John J. Greisch:]

Sure. Great questions. Yes, we have commenced a search. Obviously I've been talking to the Board about this for a while and they are ready to roll with the search. We're confident it can be completed in the next several months. So, I think my commitment to working through a seamless transition here is pretty clear, I commented in my prepared comments, and both I, the management team and the Board are committed and highly confident we'll have an extremely seamless transition here. With respect to my future, highly unlikely, Bob, that I'll take on a CEO job. I want to, as I said in my prepared comments, focus my energy into some personal and other professional interests. It has been a great run here. I'm extremely proud of what we've accomplished. We've never been stronger than we are today as a company. We've got a great strategy and a great team, and I think handing off the transition 2.0 responsibility to somebody who's got a longer tenure ahead of them, as I had when I came in eight years ago, I think it's the right time for the Company and the right time for me. As I said in my comments, there is no perfect time and there's no way to leak out or pre-announce a change like this. So, I understand it may be a bit of a surprise in terms of timing, but I'm about to turn 63 and I've got other interests personally with my family and other interests professionally, but those are highly unlikely to include another CEO run. I mean I'd stay here if that was where my interest is. But there's plenty of other things I want to engage in personally from a charity perspective and whether it's Board work or private equity activities, that's where my time is going to be focused, as well as seeing my kids more than once or twice a year, which is kind of what it's been for the last eight years.

[Robert Hopkins:]

Yes, I hear you. So, just to be clear though, if the search took a little longer, you don't have like a hard stop date? You'd be there?

[John J. Greisch:]

Yes. I mean we expect it would be the third quarter and that transition will be, as I said, as seamless as possible.

[Robert Hopkins:]

Okay, thank you for that. I'm sure others will have questions too. I just want to ask one financial one and then move on. And the financial one is just really, Steve, on the tax rate. I'm just curious, could you explain why you had a tax benefit from reform this particular quarter? And then also your LRP tax rate guidance at 24%, given where U.S. tax rates are going, does seem little conservative. It seems like it could be lower than that. So, is there some conservatism in that 24% number or are there some structural issues that would keep it up at that level?

[Steven J. Strobel:]

The first question you had as to why we are actually being able to recognize benefit in our first quarter, which was the calendar fourth quarter, has to do with some provisions in our existing tax code, Section 15 in particular, for fiscal year taxpayers where change in rate applies to your entire year. And so, as we estimate what that full-year impact would be, we obviously would take the appropriate rate into the first quarter as we estimate what our full year tax rate will be. So, our full-year tax rate is a blended rate, and if you get into one level further into detail, our blended rate is the 35% U.S. tax rate in our fiscal first quarter and 21% for the remaining three quarters, but we blend that rate across our entire year and then come back and estimate what that is for the full year and book that on a quarterly basis as well. So that's why we end up with an ongoing rate benefit in the first quarter. As to the question on our LRP rate, which we've said is about a 500 basis point improvement, it's a mix. We have about 70% of our business U.S., about 30% in foreign jurisdictions. Our foreign jurisdictions, actually tax rate is, where we do business in Germany and France and so forth actually averages around 25% our international tax rate. So when you mix that with what we expect to have here, plus the additional I'll call them claw-backs of things like the manufacturing credit and potential additional tax related to limitations on executive compensation or what's known as the [GIL] [ph] [indiscernible] tax which is a base erosion type of arrangement, we calculated out to be that 500 basis points on a go forward basis as the net benefit to us on a rate basis.

[Operator:]

David Lewis of Morgan Stanley is on line with a question. Please state your question.

[David Lewis:]

Just quick thoughts, stock is up 4x since you came eight years ago, so I think investors should buy you a drink, maybe two. So, thank you. I just want to, a couple of questions here on the CEO search and I'll get back to fundamentals. But your comments around the CEO search, you mentioned interest in a seasoned CEO. Does that suggest the Board is looking more external than internal? And then the second question is just on the Board dynamics. You've had some very specific views on corporate governance in the past, but your decision to leave the Board so quickly after your departure as CEO, maybe you could provide some commentary on those two points? Then I've got some fundamental questions.

[John J. Greisch:]

Let me take the second question first, David. You've heard me say this before, I personally feel very strongly that an outgoing CEO should leave the Board. I think it's awkward for an incoming CEO to have somebody who in my case has been around over eight years looking over his or her shoulder, and that's my own personal view. It happens to be aligned with our Board's view also. It's what happened when I came in. Not everybody agrees with that but my own view has always been that way and I think it's a cleaner break from the past. We've got a highly experienced Board, we've got a highly experienced management team, continuity will not be an issue here, and my and our Board's view fortunately are aligned that outgoing CEO should not stay on the Board. And again, I know that's not a universally-shared view but that's how I really strongly feel about that one and that's why I'm leaving the Board at the same time. In terms of the search, I think I commented, we will look at internal and external candidates. I think we are an incredibly attractive company today. I obviously found it very attractive eight years ago and I think we've made it even more attractive. So, I think a seasoned executive, whether it's a seasoned person with CEO experience or not time will tell, but I think our Board is going to look both internally and externally and pick the right person with the best background and experience to come in and pick up the ball and drive our transformation 2.0 and our strategy, which as I said is well-developed and focused on innovation, accelerating growth, expanding internationally, and continuing to improve our financial profile and continuing to execute against the LRP, just as we've been doing the last several years, and we'll pick the best person for that and move forward.

[David Lewis:]

Okay, great. And just a couple of questions here on the forward outlook, one top, one bottom. On the bottom line, if I back out tax, you are raising for the year a little less than the beat. Is there anything going on there other than just conservatism? And acceleration, the second quarter guide is very much in line with where we expected, but can you just talk about your comfort with the acceleration implies for the second quarter, from a momentum perspective, both for the second quarter and then obviously for the back half of the year and some of the pipeline catalysts and factors that give you confidence that you can execute that momentum acceleration? Thanks so much.

[John J. Greisch:]

This is John. I'll take that and Steve can clean up as needed. We flowed through most of the beat here in Q1. It's one quarter under our belt. So, I think we're being appropriately conservative as we look forward to the rest of the year, but most of the benefit did flow through and we feel confident with the outlook that we've got for the rest of the year. Q2, I think we've got a solid quarter here. The momentum going into Q2 and the second half of the year we feel really good about. As we've seen in the past, the second half of the year we do expect to have a stronger revenue and earnings performance and margin expansion in the second half, is pretty much our standard pattern for the year. And I think this year with Mortara coming in, post anniversary date of mid-February, with Centrella you heard in my prepared comments, orders were up 12% here in Q1 and the backlog is better than we thought it was going to be and that's going to drive, along with some of our other new products, accelerated growth as we move into the second half of the year. Everything on our new product pipeline list that we've talked about in the past, now including Centrella, Integrated Table Motion, RetinaVue, Spot Vision Screener, Connex Spot Monitor, they are all driving the growth in revenue that we expected. We put out there a $200 million target for new product contribution this year. We're well on our way towards that here in Q1 and I think you'll see that trend continuing which will drive the accelerated core growth as we go into the second half of the year that we fully expect.

[Steven J. Strobel:]

David, from an EPS flow-through standpoint, we've raised our full-year guidance by $0.35 and that reflects some flow-through from the benefit in the first quarter and the full year tax law change.

[David Lewis:]

Okay, perfect. Thanks guys.

[Operator:]

Larry Keusch of Raymond James is on the line with a question. Please state your question.

[Lawrence Keusch:]

Good morning, and again, John, congrats on a terrific period here at Hill-Rom. I just had two brief questions. One is, sort of any updates that you might be able to provide just as you think about the potential divestitures for the business, are we getting closer to some of those? And then secondly, I know, Steve, the cash flow didn't change a lot but it is up from your prior guidance. So again, just wanted to get a sense of how you're thinking about the deleveraging in the context of potentially generating more cash flow?

[Steven J. Strobel:]

I'll take that one first, Larry. I think for 2018, we took our expected operating cash flow up really in recognition of the new tax law and the impact on cash taxes for us this year, so $10 million to $50 million, and we increased our outlook for that over the three-year period. And as it relates to deleveraging for 2018, it won't have a material impact on our deleveraging there, but it did – every little bit helps and most of our cash will be going toward that. Over the three-year LRP timeframe, we see around $50 million of additional benefit from the tax law, which again will help us get to the less than 2.5x leverage ratio, assuming all other things equal, assuming that there's no other acquisitions or anything in that timeframe. But it certainly helps us from a deleveraging standpoint going forward.

[John J. Greisch:]

On the divestitures, just to remind everybody, we got two components. One is third-party service revenue that we are phasing out over the course of the year. So that's really not a divestiture, that's a non-core revenue stream that will phase out over the course of the year. And then the second piece is our third-party equipment rental business that we – right now we probably expect that to be a second quarter event for us as we wrap up Q2 here. So, that one is progressing well and the other one is progressing as planned just as a phase-out as we exit some of the manufacturing facilities that support that third-party service revenue. So, we should have some news in Q2 and some positive cash coming in also. I think just to add to Steve's point on cash flow, we're off to a great start. We're up 35% in Q1 year-over-year. So, I've been saying for years that this is a cash machine and I think it gets stronger and stronger every year both from our earnings growth as well as the disciplined focus on the balance sheet that Steve and his team are leading, and Q1 a great start for us as we come into 2018.

[Lawrence Keusch:]

Okay, very good. Thank you very much.

[Operator:]

Rick Wise of Stifel is on line with a question. Please state your question.

[Rick Wise:]

Couple of questions, John. First on, you recently mentioned publicly, I think your words were that you were disappointed that Hill-Rom hasn't better realized sales synergies from Mortara and Welch Allyn. Could you just expand, if I'm getting it right, could you expand on those comments and help us put that into perspective? Obviously you had a good quarter but what did that mean, what are the implications for the rest of the year and beyond, what's happening there?

[John J. Greisch:]

So, I think my comments were more specifically around the performance of Mortara right out of the gate. We actually feel really good about the Welch Allyn sales synergies. It's good news/bad news this quarter, the bad news being last year in our first quarter we had a major win with one of our largest customers with Welch Allyn which was entirely on the back of our relationships that we had within our Hill-Rom business that we were able to bring Welch Allyn into. So, the tough comp in Front Line Care this quarter was really due to a very good order we got. I think it was around $10 million last year for Welch Allyn. So, from a sale synergy and Welch Allyn perspective, and we're two-plus years into it now, we feel really good on that and I think the growth we're expecting in Front Line Care is partially being driven by some of that sales synergy. Mortara, we did get off to a slow start last year. As we look forward to the rest of this year, we expect Mortara to be in the mid-single-digit growth range, which is what we laid out at the time we made the acquisition, and we're probably in the early innings of seeing some of the synergies by flowing Mortara into our portfolio. We had some of the disruptions with the company going from a small family private company into Hill-Rom. It was relatively immaterial, but it was a little less than what we expected in fiscal 2017, but as we look forward for the rest of this year, I think you'll see Mortara in the mid-single-digit growth range year-over-year, just as we expected it to be.

[Rick Wise:]

Got you. Moving on to international, obviously you had a really solid first fiscal quarter internationally. Was that the surprise in the quarter where the upside was from and how sustainable is that kind of growth or just what went better than you thought and will those trends continue?

[John J. Greisch:]

I think that I commented at a recent conference that the upside we saw in Q1 really came from across the board, including international. I've also been saying I think for a few quarters that probably the one area that might be under-appreciated by the investment community is the power that we are developing in our international business. You saw that last year. I think we grew on a core basis about 4%. And 8% here in Q1 is a fantastic performance for us. Steve mentioned, Europe had a good quarter, we had double-digit growth in the Middle East, Canada, Latin America, so great performance around the world. Asia continues to be a bit of a headwind for us, so that looking forward is actually a positive factor as we look at maintaining the momentum in international. That said, 8% is not what we expect to continue to grow. I hope we're pleasantly surprised as we go forward, but we got a tough comp here in Q2 internationally. But continuing the positive contribution and accretive contribution from international is something I certainly do expect. I'd like to sit here and say 8% is the norm but I think it's a little premature to do that. As you know, with our portfolio, and we saw it last year with international, 7% one quarter, 3% the next quarter, we're probably going to continue to see that, but the good news is we're in strong positive territory now on a sustainable basis internationally and at the same time our margins are improving there too. So, I think Carlos Alonso, who runs that business for us, and his team are doing a fantastic job leveraging the portfolio and capitalizing on the investments we've made in our commercial teams around the world, and expect that to continue going forward.

[Rick Wise:]

Last from me, John, on the M&A front, I'd assume because of the leverage just in the short run or the near-term you would not be as active on the M&A front. But now with your announcement, should we have to assume that M&A is on hold for now a much more extended period of time, even as the balance sheet gets leveraged, as you deleverage the balance sheet, until the new CEO would be in place for a period of time, is that the right way to think about it, or no, there's an M&A pipeline in place ready to go in some way that that thought process doesn't contemplate?

[John J. Greisch:]

We're going to continue to execute against our strategy and the strategic priorities we got, Rick. That said, expectations near term of anything sizable, probably not, but smaller Mortara bolt-on opportunities that are of interest financially and strategically I think we as management team and the Board committed to continue to execute against that strategy.

[Rick Wise:]

My thanks and congrats as well. You've done amazing job. Sorry to see you make this decision.

[John J. Greisch:]

Okay. Thanks Rick.

[Operator:]

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

[Matthew Taylor:]

John, congrats on your accomplishment here at Hill-Rom. We wish you the best of luck in your very busy retirement it sounds like. So, first question I had, I just wanted to talk about the revenue growth in the first quarter and for the rest of the year. You had a nice beat versus your core expectation. It seems like your orders are tracking really well, and so I'm just curious why you didn't have enough confidence yet to raise the core guidance? That's kind of the first question.

[John J. Greisch:]

We did have a nice beat in Q1. Again, our Q1 guidance calls for flat growth and we beat it despite some headwinds that we had here in Q1, both from the hurricane and Front Line Care. I think as you look forward beyond one quarter, I think the accelerated growth we do expect in the second half of the year is right in line with our expectations. We came into the year with an expectation for 3% growth on a core basis, most of which was going to be in the second half of the year, and I think our guidance here today is pretty much in line with what we said three months ago. We're one quarter into the year. We're slightly ahead of where we thought we're going to be, and I don't think Steve nor I want to get out over our ski tips prematurely and I think we'll take another look at it as we hit the half year point. But we're thrilled with where we are here in Q1 both on revenue, margins, earnings, and obviously cash flow, and are highly confident that we've got another very strong year ahead of us.

[Matthew Taylor:]

Thank you for that. And maybe just a more detailed question, so you talked a lot about Centrella and orders being up, I guess can you, A, talk about when those orders convert, and then also, when will we start to see some of the orders and revenues from the other bed launches?

[John J. Greisch:]

Sorry, did you say, when those orders deliver, Matt?

[Matthew Taylor:]

Yes, when we recognize those, if you could give us just a sense are they all next quarter, over the next couple?

[John J. Greisch:]

No, we had a good chunk of them in Q1. So, we trained the sales force in October. We had some early adopters in the fourth quarter of fiscal 2017, but we really hit the ground running in October and we did get revenue here in Q1, as we expected to, for Centrella. Our expectation as we go forward is obviously quite high for this product, and I think you'll see in Q2 and beyond continued growth in Med-Surg and significant contributions from Centrella, a big part of the growth from 150 to 200 in terms of new product contributions here for fiscal 2018. The other products that I mentioned, Envella, that was launched last year and that's largely a rental product for us, but we're seeing good contributions from that product here in United States already, both in terms of our rental revenue and it's a margin-accretive product for us in our rental portfolio. So that's already in play. And then Accella, which is our international Med-Surg product, is also beginning to contribute as well. We're actually showing that product at Arab Health this weekend and next week, and we're highly optimistic about that product and we'll begin to see more contributions from that as we move through 2018 as well. I think our other bed products that we've talked about in the past, Compella, which is our bariatric product, that's in the market already and contributing, and obviously Progressa, our ICU product we launched now about four years ago and saw a significant growth in our ICU franchise and continue to see pretty good performance for that product as well.

[Matthew Taylor:]

Okay. Thank you very much.

[Mary Kay Ladone:]

Kelly, we have time for two more questions.

[Operator:]

Thank you. Matthew Mishan of KeyBanc is on the line with a question. Please state your question.

[Matthew Mishan:]

Thank you very much, and John, congratulations on the job you've done over the last eight years. You've seen really broad elevated performance from a number of your peers over the last several quarters. And then when you look at your past two quarters where you were in that 2%, 3% core growth area, your guidance for core growth for next quarter is in that similar area. I guess my question is, are there some headwinds in your business that are preventing you from realizing some of the same kind of strength of your peers?

[John J. Greisch:]

We talked about a couple of headwinds being the hurricane here in Q1 and a tough comp from an unusually sized order in Front Line Care last quarter – or last year first quarter, excuse me. We're still peeling back some lower-margin business that we haven't thrown into the non-core category, but I think we're executing right in line with what we committed to execute this year and we're marching towards our LRP core growth rates that we laid out there last quarter. So, I'm more focused on executing on the strategy that we've laid out and delivering on the commitments that we've made, which we've done very successfully the last several years and again are on track to do again here in fiscal 2018 and confident we'll do so as we move into the rest of the LRP period.

[Matthew Mishan:]

Okay, thank you. And you mentioned some savings from business optimization, potentially impacting you or potentially benefiting you later this year. Are those the same $50 million in SG&A optimization initiative you had laid out last quarter and are they starting to come in a little bit faster than you thought?

[John J. Greisch:]

It is the same initiative we talked about last quarter, and I'd say, no, there's no acceleration to what we're looking to achieve. We're deep in the planning mode right now. I think our comment last quarter was, that was going to benefit us more over the LRP period than here specifically in 2018. So, the vast majority of that, one, is going to benefit the three-year period, and two, we're looking to use a lot of that to reinvest behind some of our growth initiatives as we go forward to continue to drive the accelerated top line growth rate as we move into the rest of the LRP.

[Matthew Mishan:]

All right. Thank you very much.

[Mary Kay Ladone:]

And Kelly, our last question?

[Operator:]

Mike Matson from Needham & Company is on the line with a question. Please state your question.

[Mike Matson:]

Just wanted to start with a question on gross margin. So you called out a 70 basis point drag on gross margin for the first quarter. There were two things there, the hurricane impact and lower surgical and rental margins. So I was wondering if you could break those two items out. And then specifically on the surgical and rental margins, what's the timing in terms of when that kind of turns around?

[Steven J. Strobel:]

Mike, this is Steve. As far as the composition, you can think about it as probably half and half of that headwind between the two factors we talked about. And as far as surgical margins turning around, we've talked for last few quarters about the plant consolidation disruption that's been one of the drivers of the negativity in the margins for surgical, and we're making really good progress on rectifying the issues in the receiving plant I'll say. And as well the hurricane impact as we've experienced here in the first quarter will not be with us as our folks in the plant at Puerto Rico have really done a fantastic job of getting the plant back up and running. So I think the impact of that is going to lessen as we go through the rest of this year. So, I think those two things as well as the continued growth in the higher-margin products within surgical are going to be the drivers of improved margin for surgical going forward.

[Mike Matson:]

Okay. And then just wondering if you could give us a little more detail around this TruSystem 7500 Neuro Table that you just launched, how big of an opportunity does that represent?

[John J. Greisch:]

I'd rather not quantify that specifically, but that's a hybrid OR partnership we've got with IMRIS. We're looking to do that with other hybrid OR players as well. And as I mentioned in my comments, Mike, in addition to some new products and focusing on surgical efficiency, partnering with the IMRISes of the world and others with whom they compete has been and will continue to be an important strategic initiative that will continue to drive the growth we've seen in surgical. We haven't talked a lot about surgical this morning, but we had another great quarter there globally with a 6% growth in our surgical business on top of I think it was about 6%, 7% last year core growth. So, the investments we're making there both on the partnership front and the new product front are all contributing to great growth globally. And as you've seen, the partnership we had with Intuitive obviously has been a part of that and I'm confident IMRIS and others will be so going forward as well.

[Mike Matson:]

All right, thanks. Congrats on the track record at Hill-Rom and good luck with your retirement.

[Operator:]

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

[John J. Greisch:]

Thanks everybody. Just final comment here, thanks for your support, great first quarter, and we'll see you on the road and be back in three months with second quarter story. We'll talk to you then.