Hill-Rom Holdings, Inc.
Q2 2013 Earnings Call Transcript

Published: 25 Apr 2013

[Operator:]

Good morning, and welcome to the Hill-Rom Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded and will be available for telephonic replay through May 1, 2013. See Hill-Rom's website for access information. The webcast will also be archived in the Investor Relations section of Hill-Rom's website, www.hill-rom.com. If you choose to ask a question today, it will be included in any future use of this recording. Also note that any recording, transcript or other transmissions of the text or audio is not permitted without the written consent of Hill-Rom. [Operator Instructions] Now I'd like to turn the call over to Mr. Andy Rieth, Vice President, Investor Relations.

[Blair A. Rieth:]

Well, thank you, Shannon. Good morning, and thanks for joining us for our second quarter fiscal year 2013 earnings call. Before we begin, I'd like to provide our usual caution that this morning's call may contain forward-looking statements such as forecast of business performance and company results, as well as expectations about the company's plans and future initiatives. Actual results may differ materially from those projected. For an in-depth discussion of risk factors that could cause actual results to differ from those contained in forward-looking statements made on today's call, please see the risk factors in our annual report on Form 10-K and subsequent quarterly reports on Form 10-Q. Also, certain financial figures discussed on today's call will include non-GAAP or adjusted financial measures. Reconciliations to comparable GAAP financial measures can be found in our earnings press release, the associated Form 8-K and are also available as part of the presentation materials posted earlier on our website. Joining me on the call today will be John Greisch, President and CEO of Hill-Rom; and Mark Guinan, Hill-Rom's Senior Vice President and Chief Financial Officer. [Operator Instructions] As you listen to our remarks, we are also displaying slides that amplify our disclosure. I would encourage you to follow along with us. The slides were posted last night on our website and will also be part of the archive. With that, I'll turn the call over to John.

[John J. Greisch:]

Thanks, Andy. Good morning, everybody, and thanks for joining us this morning. We are pleased to report adjusted earnings in line with our guidance. Revenue was down a couple of points from our expectations for the quarter, particularly in North America. Compared to the first quarter, we delivered slightly improved adjusted earnings on flat revenue as adjusted gross margins were up about 150 basis points and the impact of the medical device tax was offset by the benefit of the R&D tax credit. Compared to last year, adjusted earnings were down as the second quarter of 2012 was our strongest quarter of the year. Gross margins improved compared to last year. However, the impact of the device tax and intangible amortization reduced comparable earnings. Adjusted gross margin, as a percent of sales this quarter, was the highest level we have seen since the first quarter of fiscal 2012, and adjusted operating margin was up 100 basis points compared to the first quarter, excluding the device tax impact. So despite ongoing top line pressure, we continue to make progress on the margin front. As a result, adjusted EBITDA was in line with the first quarter, even with the impact of the device tax. Despite the revenue shortfall, I am pleased with how we managed the business and with our performance this quarter. For the full year, we have reduced our revenue outlook by $30 million to $40 million. However, we have largely maintained our adjusted earnings guidance. Mark will cover our guidance in detail in a few moments. During the second quarter, we saw a decline in North American orders compared to Q1, to a rate more in line with what we experienced during most of fiscal 2012. North America year-over-year revenue was down 6% in the second quarter, off of our strongest quarter last year for the North America segment and for our North America Patient Support Systems product category. Sequentially, our North American Patient Support Systems business was flat, which competitively, I'm very pleased with. Our customers continued to deal with a high degree of uncertainty over admission rates, reimbursement and other factors. So although the capital spending environment, overall, in North America is relatively stable, we expect to continue to see a high degree of volatility on a quarterly short-term basis in both orders and revenue. Internationally, the quarter came in as expected. We had a tough comparable last year due to an unusually strong quarter in the Middle East, which was offset this year by a full quarter benefit from Volker. As a result, notwithstanding, the tough comparable revenue for the quarter was even with last year overall. Capital orders were slightly ahead of the first quarter with increases in our non-European regions offsetting a modest decline in Europe. We expect our International revenue in the second half of the year to be relatively consistent with the first half, in line with our previous guidance. Turning to our Surgical and Respiratory Care business, we continue to feel very good about Aspen. We spent the last several months integrating the business into Hill-Rom, while strengthening the team with a number of internal and external talent additions. We are excited about the contributions we expect Aspen to continue to make to the company going forward. So in summary, as you've heard from most device companies, the external environment continues to be challenging, particularly in North America and Western Europe. We don't see any significant change in the environment anytime soon as austerity measures in Europe and margin challenges on hospitals here in the States will keep putting pressure on our top line growth. In this environment, we remain focused on margin expansion, while at the same time, we continue to invest in new product development and product enhancements, and we are excited about a number of product launches we have planned for later this year. As you saw in our release, we took a charge during the quarter in connection with eliminating approximately 100 positions. We saw no benefit from this reduction during the second quarter. Reducing our fixed cost base will be an ongoing focus for us as we balance increased investments in R&D and several legacy field corrective actions with the need to continue to drive down our overall cost structure. We are committed to continue to expand our margins, as we did this quarter, and we will take whatever actions are necessary to do so. This will include cost actions as well as product and portfolio changes. We will discuss specific opportunities for margin expansion at our investor conference on May 7. Despite our lower full year revenue expectations, we continue to demonstrate our ability to effectively manage the business in a challenging environment. Moreover, during the first half of the year, we have returned over 50% of our operating cash flow to shareholders. We will continue to aggressively manage our cash flow and deploy our excess cash in a disciplined manner, as we have over the past several years. With that, let me turn the call over to Mark before we open the call to Q&A. Mark?

[Mark J. Guinan:]

Thank you, John, and good morning to everyone on the call. Before we get started, I want to remind you that many of the figures we will discuss are adjusted or non-GAAP measures. Given that currency movements had minimal impact in the quarter, I will focus my revenue comments solely on reported revenue. On a consolidated basis, second quarter revenue increased 2.6% to $426 million. This increase was driven by incremental revenue from our fiscal 2012 acquisitions, which was partially offset by declines in North America capital sales and enterprise-wide rental revenue. Excluding acquisitions, revenue declined approximately 6% compared to last year. Capital sales increased 5.9% to $318 million driven primarily by the 2012 acquisition of Aspen. This growth was partially offset by a decline in our North America segment, predominantly in our Patient Support Systems sales. Consolidated rental revenue decreased 6.2% to $107 million. Approximately half of the decline was attributable to the previously announced exit from unprofitable portions of our home care business. Domestic revenue increased nearly 5% to $274 million, again led by the incremental revenue related to the Aspen acquisition, while revenue outside the United States was essentially flat at $152 million. Looking at revenue by segment, North America reported a decrease of 6.1% to $240 million, with declines reported in both capital sales and rental revenue. Capital sales declined by 6.7% to $160 million, driven by a decline in our U.S. Patient Support Systems sales of 9.3%. Capital orders for the quarter were down sequentially and versus the prior year, with backlog coming in 3% lower than the first quarter. These results varied slightly from what had been an improving order pattern over the past couple of quarters, but remain in line with the relatively steady patterns we have experienced over the past 1.5 years. North America rental revenue declined 4.8%. Absent the impact of the exit from a portion of our home care business, the North America rental business was down just 1%. Continuing challenges with rental revenue due to ongoing reimbursement and other cost pressures on our customers were partially offset this quarter by a higher rate of flu incidents that increased demand for certain of our rental products. Moving to our Surgical and Respiratory Care segment. Revenue increased 80.5% to $61 million, driven by the addition of Aspen, which generated revenue of nearly $29 million in the quarter. Allen medical revenue increased 8.1%, while respiratory care declined 10.6% due to continuing weak market conditions. On an organic basis, this segment's overall revenue declined approximately 4%. International revenue decreased approximately 1% to $125 million. As expected, lower sales in Latin America and the Middle East were offset by the addition of Volker revenue. Revenue in Europe declined slightly from first quarter, but orders continued to be relatively stable. As we noted last quarter, given the unusual strength we saw in the Middle East and Eastern Europe during 2012, comparables get tougher throughout the remainder of the year. Adjusted gross margin performance for the quarter was 47.3%, up 10 basis points compared to last year and up 150 basis points sequentially. Adjusted capital margins were up while rental margins experienced a slight decline. Regarding operating expenses, our R&D investment for the quarter increased nearly 9% year-over-year. As you know, we are anticipating the launch of our new ICU product later this year, which has been a key driver to the increase in R&D investment. Adjusted SG&A expenses for the quarter increased by 10.5% year-over-year to $138 million. Half of the increase is related to the device tax and intangible amortization, while the other half is related to incremental SG&A from acquisitions made last year. Excluding the tax and amortization items, SG&A as a percentage of sales was 30.9%. Excluding the impact of the Volker and Aspen acquisitions, adjusted operating expenses were essentially flat to the prior year period, despite the inclusion of the new device tax. As we integrate these businesses, we will continue to look for opportunities to increase our leverage of operating expenses. Sequentially, adjusted operating expenses were up 2%, once again, entirely related to the device tax, which became effective this quarter. Adjusted operating profit for the quarter was $45 million, representing a 10.6% operating margin, up sequentially over last quarter, but down 250 basis points versus last year's comparable results, with the majority of the decline attributable to the device tax, intangible amortization and higher R&D investment. The adjusted tax rate for the quarter was 29%, compared to 30.7% in the prior year. The lower rate in the current year was primarily the result of the retroactive reinstatement of the research and development tax credit, partially offset by reduced International income in lower tax rate jurisdictions. As you are all aware, the R&D tax credit was reinstated retroactive to January 1, 2012. We recognize the benefit related to fiscal 2012 of $1.4 million, or approximately $0.02 per diluted share as a one-time catch-up this quarter, $0.01 below our earlier estimate. The 2013 benefit will be recognized as a reduction of our effective tax rate over the entire fiscal year. So to summarize the income statement, adjusted earnings per diluted share were $0.49 in the second quarter, in line with our guidance. Second quarter pretax adjustments to earnings of $11.7 million include a special charge for the 100-position elimination mentioned earlier by John, continued integration costs from our 2012 acquisitions, as well as several other nonoperational expenses incurred in the quarter. Please refer to our earnings release schedules and upcoming 10-Q for detail. As we have discussed, we will continue to focus on adjusted EBITDA to provide enhanced visibility to the strength of our cash flow. Adjusted EBITDA for the year-to-date period was approximately $150 million, down 5% from the prior year comparable period despite the 14% decline in adjusted earnings per share over the same period. Our second quarter operating cash flow was $48 million. Year-to-date operating cash flow of $113 million compares to $124 million last year, down due to lower earnings. During the quarter, we repurchased 700,000 shares of common stock for approximately $24 million, bringing our total for the year to $44 million. This share repurchase activity is consistent with our capital allocation strategy of returning a significant portion of our operating cash flow to shareholders as one of our key levers for creating value. We also paid down approximately $23 million of outstanding debt during the quarter. Now let's turn to our fiscal 2013 guidance. We have adjusted our full year revenue growth to 5% to 6%, down from 7% to 8%, due to tougher conditions in our North America capital business. We have narrowed our adjusted EPS guidance to $2.03 to $2.09 per diluted share from $2.01 to $2.11 previously, offsetting the impact of lower projected revenue with tighter controls on operating expenses. This full year 2013 financial outlook reflects the following

[John J. Greisch:]

Thanks, Mark. While the entire industry is dealing with the challenging external environment, at Hill-Rom, we continue to focus on what we can control to improve margins and deliver sustainable cash flow. We achieved those objectives again this quarter. We have significantly improved the profitability and cash generation of this portfolio over the last 3 years, and I'm confident that you will see additional improvement in the quarters and years ahead despite the top-line challenges we face. As I mentioned earlier, we will be holding our investor conference in New York in a couple of weeks on May 7. We look forward to sharing with you our key strategic initiatives, along with our margin improvement objectives. I'm also very eager for all of you to have the opportunity to hear directly from our leadership team about our plans for future value creation, and we look forward to seeing many of you in New York on the seventh. With that, operator, please open the call to questions.

[Operator:]

[Operator Instructions] Our first question is from Lennox Ketner of Bank of America.

[Lennox Ketner:]

I guess first, just on a positive note, your gross margins came in much better than we were expecting this quarter. I'm wondering if you could maybe just talk a little bit about what drove that improvement and how sustainable it is. I know you talked about the impact of flu a little bit, I don't know if that's something that would suggest we might see a sequential decline in Q3 or if you think these margins are sustainable?

[Mark J. Guinan:]

Thanks for the question, Lennox. If you -- I'll point you to our guidance for the year, which would suggest that we're not going to see significant declines in gross margin in the back half, in fact, the back half will be stronger than the first half and probably more -- the second quarter being more representative of the gross margin performance we're expecting. As I've said in the past, mix can have a pretty significant impact. So the gross margin improvement was largely an outcome of some of the mix being more favorable, but it also is a result of the continued efforts we have to take cost out of our supply chain and also out of our rental infrastructure to drive margin improvement. So really all of those things contributed to the improved gross margin, and we expect those to continue to be relatively favorable in the back half.

[John J. Greisch:]

And, Lennox, as Mark said, the full year guidance calls for, I think, 47% margin, which is ahead of what we've had for the first half of the year, which obviously implies a stronger second half, specifically to Mark's comment.

[Lennox Ketner:]

Okay, great. And then just -- I was wondering if you could just comment on the competitive environment a little. I think you said you feel comfortable about your position competitively. But one of your larger competitors reported last night and actually saw meaningful improvement in their bed business this quarter and you obviously have the combination [ph] of getting on the PSS business in the market now. So I'm wondering just, one, if you feel like you lost any share this quarter; and two, now that there is a third large player in the U.S. market, whether you've seen any change in pricing dynamics.

[John J. Greisch:]

Yes, I'll take the second part of your question first because the first part of your question is a little more complicated. But I haven't seen any competitive dynamic changes in the marketplace. I'd rather not comment on pricing specifically. But haven't seen any changes at all with the PSS ownership change. On the share issue, I don't focus on one specific quarter, and I know you guys like to look at this business, particularly on a percentage growth change quarter-to-quarter. I've obviously seen what Stryker reported, and the positive that I look at is on a sequential basis. Our revenues in PSS from last quarter to this quarter were relatively flat, which I think is a very different picture than what Stryker saw sequentially. I think you also heard in our comments, we have very difficult comp on the PSS business from last year which, again, I think, is a very different comment that you heard from Stryker last night. I've also taken a look at what you put out overnight, Lennox, which was a very good analysis. So just one thing I'd like to point out, the table that you've got in your report compares our North American percentage change to Stryker's U.S. percentage change, which is a bit apples-to-oranges comparison only because our numbers include Canada, where we have a very significant share, and the buying patterns in Canada, obviously, given that the government spending are very different. So we can get you the U.S. numbers, but on a -- I don't like to look at quarterly percentage changes. If you do an apples-to-apples comparison for U.S. to U.S., it's about 6 of the 9 quarters are favorable to Hill-Rom, 3 of them are favorable to Stryker. And as we both consistently say, this is a very lumpy business, and a quarter-to-quarter percentage change, I think, is less relevant than on a sequential and on a trending basis, how is that the revenue dollars' performance comparing and how are the trends comparing. And I think if you look at the last 2 to 3 years, I would say share is relatively stable with ups and downs each quarter for each of us. But on a longer-term basis, I think it's pretty stable. And I think if both of us look at those numbers consistently, I think you'll hear the same things. So I feel good about where we are. And again, in the choppy environment that we're in, a sequential flat revenue dollar performance quarter-to-quarter the last couple of quarters, I think, is pretty good performance competitively.

[Lennox Ketner:]

Okay. No, that's all very fair. And then just last question on the restructuring that you announced. I know you said you didn't see any benefit this quarter, but what -- how much of that $8 million are you expecting to see in 2013?

[Mark J. Guinan:]

Yes, Lennox, I'm not going to give you a precise number, but I will tell you less than half. I mean, it's going to be a staged restructuring. We only took a portion of that charge at the end of this quarter, so we have more actions yet to implement. So you can expect less than half of it.

[Operator:]

Our next question is from Matt Miksic of Piper Jaffray.

[Matthew S. Miksic:]

So I'm wondering, I didn't -- I've been hopping between a few other calls this morning like everybody else, and I'm not sure you mentioned anything like this. But John or Mark, if you could talk about any orders or large kind of events that either dropped in or dropped out or pushed in or pushed out of the quarter, things we should point out relative to the prior year in either your U.S. or OUS [ph] capital business.

[John J. Greisch:]

Yes, as I just mentioned, Matt, we had our toughest comp in the U.S. capital business here in Q2 compared to last year, and the comparisons get modestly easier as we go into the second half of the year. So that's point number one. We didn't have any big order move-outs this quarter, so no excuses for the revenue shortfall other than, as Mark mentioned, orders for the quarter were lighter than what we saw in the first quarter. And I think, as I mentioned in my comments, they were more in line with what we've averaged over the past 4 or 5 quarters with Q1 of this year being the strongest quarter in terms of order intake that we saw, I think, since the last quarter of fiscal 2011, again, evidence of the choppiness, lumpiness of this business. So orders were a little weaker and we decided to conservatively take our revenue outlook down on the back of a weaker quarter order rate than we saw in the first quarter. And I'll be surprised if we don't see any choppiness in the second half of the year. But rather than hope for a return to what we saw in Q1, we decided to take the conservative route on revenue and continue to manage the heck out of the business to deliver the earnings commitment that we've got for the full year.

[Matthew S. Miksic:]

That's very helpful. And then one just follow-up, maybe stepping back on your sort of broader view on the acute care business, acute care trends or secular trends. And I know that you'll get into this in some detail, I would imagine, at your upcoming Analyst Day meeting. But absent the lumpiness, absent whatever competitive back-and-forth there is or is not happening in the quarter, could you give us your sort of current thoughts on, I guess, where the market's headed and what the big drivers are?

[John J. Greisch:]

Yes. And you're right, Matt, we'll get into this in more detail with Alton Shader, who runs our North American business, in May. But over time, I think our view is pretty consistent with where it has been. The bed unit volumes are not going to grow, and I think we've been pretty consistent on that. And I think most folks in the industry understand that. I think where the growth is going to come from and, I think, over a longer period of time, our view is it's a low-single-digit growth opportunity for us, is going to continue to come from features that enhance products. We've got some new product introductions coming out. I think I've mentioned or Mark mentioned our ICU product launch coming this -- later this year. And those sorts of things are going to be driving a fairly modest low-single-digit growth for us. But volume-wise, we're not expecting to see any volume growth in the business over a longer period of time, which, again, is consistent with what, I think, you've seen over the past 10 years.

[Mark J. Guinan:]

And just to make sure we're clear here, that's in North America.

[John J. Greisch:]

Yes, North America, right.

[Operator:]

Our next question is from David Lewis of Morgan Stanley.

[Jonathan Demchick:]

This is actually Jon Demchick in for David. So I had a question on the revenue guidance revision. Some of it, obviously, was a reflection of this quarter's performance but some of it also on tougher conditions, I guess, moving forward. By our math, the guidance does imply that still organic growth in the back half of the year, I guess even adjusting for the comparables, gets better. And I was wondering if you could give us a little more detail on segments where you could see some improvement. And from the sound of the call, it may even be more focused on the fourth quarter.

[John J. Greisch:]

Well, I think our -- I think we've mentioned that comps for North America do get easier. From what we saw in the first half, they're modestly easier. So I think your math is correct, and it's all to do with the comparables. You may recall we came in to fiscal 2012 last year with a very strong backlog in North America and in International. And the first half of revenues last year reflected the strength of that backlog, and that worked itself down as we went through fiscal 2012. So I think your math is correct. The organic growth rate percentage improved slightly in the second half of the year compared to the first half of the year.

[Jonathan Demchick:]

Very helpful. And also, a quick follow-up on the cost cutting and just kind of a question of whether it's more of a broader plan that's going to continue throughout or if it's more of a necessity given the challenging environment, just your thoughts on more of a short-term and long-term nature to the cost-cutting plans of the business.

[John J. Greisch:]

Yes, it's a great question, John. I'm glad you asked that one. It's not a reactionary move at all. We commenced the action early in the quarter in terms of identifying what we wanted to do. And we pulled the trigger on it at the end of the quarter, but it was not in response to the revenue guidance outlook. As we have done over the past several years, and I think as I commented in my prepared remarks, it's an ongoing focus for us. And we'll talk a little bit more in May at the investor conference. But obviously, in a challenged top line revenue environment, we're only going to drive margin expansion and earnings growth through some of the actions that we have taken and through some of the things that I mentioned in my comments, cost actions, as well as product rationalization and, as necessary, portfolio changes. So it's certainly more of a longer-term focus that we have. And I'm not going to panic over a quarterly revenue lumpiness or choppiness. I think I've consistently made that comment. And over time, given the challenges we have with the top line growth, we're going to continue to focus on actions, as necessary, and take them when we're ready to do so.

[Mark J. Guinan:]

And I'll just add, as you heard in John's comments, we didn't get any benefit in the second quarter. So certainly, this wasn't done to manage our earnings. And then in my response to Lennox's question, we're going to get less than half of this benefit from the balance of the year. So certainly, this is not what we're using to cover the revenue shortfall. Certainly, we'll get some benefit, but we're managing other expenses. And this action, as John said, was really planned for the long term.

[John J. Greisch:]

And we'll -- Jon, we'll lay out, at the investor conference, specific margin expansion objectives that we're marching towards going forward.

[Operator:]

Our next question is from Larry Keusch of Raymond James.

[Lawrence S. Keusch:]

John, just coming back to a question that you answered earlier when you were talking about the growth of the market and the enhanced features of the products that will be the primary drivers of the revenue increases, what -- look, if volumes are flat and the industry is going to start to rely on feature sets, what is the value proposition that you are trying to bring to your customers that's going to get them to trade up to what I presume are higher cost, higher margin products?

[John J. Greisch:]

There are several. Obviously, patient safety is clearly one that we're focused on. Getting patients in and out of the bed and in and out of the hospital as quickly as possible is something that, I think, all of our products are geared towards. A combination of our beds and our lifts, increasing patient mobility as quickly as possible so they can reduce the length of stay, infection control, an area that -- both with some of our therapeutic surface products and some of the other products that we wrap in the portfolio are all directed towards the same kinds of objectives.

[Mark J. Guinan:]

Larry, I'd like to add also that this is not a new dynamic. If you look over the last decade, there has been a slight decline in the number of licensed beds in North America. So we're focused on the North American business. So the growth has really come, over that period of time, from featuring from innovation. So this is not a new dynamic going forward. It's a continued dynamic. And certainly, as we have mentioned, there is a lumpy business. You can point toward certain exogenous events that may have driven some of the peaks and valleys, like the credit crunch in 2009, et cetera. And then you look at other points in time where there was significant innovation by us or one of the competitors that could have driven volumes. But over the long term, this has been a condition in the North American market and is not new.

[John J. Greisch:]

Yes, Larry, I also want to make it clear. We're not expecting our customers to pay up for enhanced features. The cost pressures are clear. I think what we can do is, hopefully, accelerate some of the replacement cycles that folks are looking at if we can bring those value propositions that help them reduce their cost and enhance outcomes, patient safety, et cetera. So we're under no illusion that we're going to get paid more for our products going forward.

[Lawrence S. Keusch:]

Okay, that's great and very helpful. And just so that I fully understand, the reduction in the outlook for the organic growth for the year, I recognize, again, is being driven by the order flow that you saw and, I suspect, trying to be cognizant of kind of what you were assuming in the back half of the year. But is there any other driver that is resulting in the decrease in the outlook other than the North American order rates? I just want to make sure I'm thinking about all the factors.

[John J. Greisch:]

No, that's really it. I mean, the rest of the businesses are in line with what our expectations were a quarter ago. And if you look at Q2, I think everybody on this call knows our top line miss was somewhere in the $10 million range. Pick a number depending on whose model you want to look at, but it's in that ballpark. So 1/3 of the reduction is already in the bank, if you will, through Q2. And as I mentioned to an earlier question, Q2's order rates were down in that ballpark from Q1. And rather than assume we're going to have a big hockey stick in Q4, like has been done in the past, we decided to take the pain and take it down for the second half of the year on the back of the second quarter order rate.

[Lawrence S. Keusch:]

Okay. And then just a last one from me and I'll drop off, just the decline in the respiratory business, what was behind that? Because you did, obviously, have a benefit of flu in there as well.

[John J. Greisch:]

Yes, that's been a business that's been under pressure the last several quarters, patient volumes across the industry. And there's only a couple of companies that have really played in this market. And I think we both have seen reduction in volumes. And reimbursement pressure is impacting that business to some degree as well. It's a reasonably high cost therapy that has a reasonable out-of-pocket for a lot of patients, and I think that has been affected -- or that has been affecting volumes over the past several quarters. We've seen a bit of a turnaround in terms of our performance in that business over the last quarter, which gives me more optimism about the revenue profile going forward than I have had for several quarters. But it's really driven by reduced volumes industry-wide, and I think cost has a lot to do with it.

[Mark J. Guinan:]

And Larry, just the other thing I'll add is the way to think about that business is because it's a rental business, it's really the cumulative amount of patients you have using the device as you enter a quarter has a much larger impact on revenue in that quarter than new patients. So we did see actually strength in the business, given the flu incidence in the past quarter. We certainly saw an increase in our referrals. As John said, the business does appear to be bouncing back a little bit. But it's really a cumulative impact of over the last 6 to 12 months where there was a decrease in the size of the market and new entrants that is now impacting that revenue.

[John J. Greisch:]

The other thing to remember here, Larry, is the vast majority of the patients on our products are not flu-driven. It's, I think, as you know, cystic fibrosis and other neuromuscular diseases that really require this treatment. Flu has some impact, but it's generally not a big seasonal business for us at all.

[Operator:]

[Operator Instructions] Our next question is from David Roman of Goldman Sachs.

[David H. Roman:]

I was wondering if we could go in just to a little bit more detail regarding the change in dynamics around orders in Q2 versus Q1. I know that you're saying that this quarter reflects a little bit more the trend you'd seen, and maybe last quarter is a little bit more of a positive anomaly. But maybe you could just shed a little bit of light on what the conversations with your customers sound like and what type of feedback you're getting from the channel and maybe how that might have changed during the quarter and if there's any change in the progression throughout the 3 months.

[John J. Greisch:]

I don't think it's changed at all, David. I hate to sound like a broken record on the use of the word lumpy or choppy or volatile. Take your pick from us and others in the capital space. But nobody, certainly internally, has seen any changing dynamics during the last 3 or 4 months. My comments -- and I'll give you some specifics here. I think I've mentioned, in response to an earlier question, orders were off about 10% Q1 to Q2. And if you look at last year, we had similar volatility quarter-to-quarter in the order rate. You annualized Q1. You obviously got a much better picture of a full year order rate than if you annualize Q2. Our outlook for the rest of this year is pretty comparable to the first half of the year. How it's going to shake out Q3 versus Q4 is really a function of timing of decision-making on individual orders. Folks have to remember there is only about 6%, 7% of the beds in the market being replaced annually. And the timing of any individual hospital or system decisions are going to impact the choppiness, if you will, quarter-to-quarter. So when I sit back and step out of the weeds, I don't see any dramatic change in the environment. It continues to be difficult. And I think I've mentioned a number of us in the organization sit on hospital boards, and every single hospital that I talk to has a customer or in our capacity as sitting on their boards, they're all looking at delaying, deferring and taking cost out wherever they can. That's not news to anybody on this call. But I think it is impacting the predictability of when buying decisions are going to be made. But I can't point to anything over the last 3 or 6 months for that matter that has changed anything dramatically. It's just continuing to be choppy.

[David H. Roman:]

Okay. And then maybe as you take a step back, and I'm sure you'll get into this at the analyst meeting in 2 weeks, but as you think about the business in general terms, what's kind of the plan? Is that, that the end markets remain lumpy, the top line kind of is what it is and you'll do the best that you can to manage cost and return cash to shareholders? Or should we think about this more as given the weakness in the top line or the volatility in the top line that there's more diversification on the horizon and that, over time, you're going to look to restore the top line to growth regardless of what happens in the end markets?

[John J. Greisch:]

I think it's the latter, David. I mean, we did that with Aspen. We've got a tremendously valuable franchise with our brand equity in the acute care hospital space. We've got very strong positions in our existing franchises, not just our Patient Support Systems business, but our surgical business between Aspen and Allen Medical and despite some revenue challenges, a very strong, very profitable respiratory care business. And I think you should expect us to continue to manage the portfolio as it is and optimize the performance of the portfolio and at the same time, look at opportunities to leverage the channel strength we've got and leverage the brand equity and the position that we've got within the hospital space here in North America, as well as internationally.

[David H. Roman:]

And then maybe if I could sneak in one more follow-up based on that comment. Have you seen, at least with Aspen or any anecdotal example you could provide that through the -- you're getting channel leverage whether it's 1 plus 1 equals 2.5 or some type of selling synergy that might be materializing and to what extent that factors into your competitive advantage when it comes to M&A?

[John J. Greisch:]

I think it's something that we certainly want to achieve as we bring other products into the portfolio. I think we've seen that with Liko when we acquired that. I think the combination of Aspen and Allen Medical and Aspen's focus on patient safety and, obviously, surgeon safety plays right into our patient safety story with the rest of our portfolio. And I sit here today and say from an enterprise value, there has been meaningful revenue synergy achieved not at this point in time. But the value proposition of the portfolio and of the diversity of what we bring to the hospitals is certainly a conversation we're having more and more on the back of the Aspen acquisition than we were having before it. So our goal is to bring products into the portfolio and, as you said, accelerate the top line growth where we can with products or services that are going to enhance our value to our customers. And that's going to mean some diversification because obviously, the bed business, we have a pretty significant position in. And we want to wrap other products and services around that to enhance our value to our customers going forward.

[David H. Roman:]

Okay. That's very helpful perspective. I look, obviously, forward to hearing more of that in a couple of weeks.

[John J. Greisch:]

Yes, and we'll talk about that in more specifics in May.

[Operator:]

Our next question is from Chris Cooley of Stephens.

[Christopher C. Cooley:]

Could you guys just kind of walk through -- I mean, you've done a great job being aggressive in terms of managing the cost structure in a very challenging environment. But when you look at the P&L going forward, where do you -- since it's baseball season, I guess we should use that for the analogy now. Are you in the seventh inning in terms of cost reductions or past the stretch? And if there are additional cost reductions to be realized, assuming a normalized environment or a static environment, do those come more through the middle of the P&L? Or are there still opportunities at the gross line? And then I have one quick follow-up.

[John J. Greisch:]

I think you'll see it in both areas, Chris, and I don't want to say what inning we're in. We continue to drive expansion in our margins. Obviously, when we bought Volker, that came with a lower margin and impacted us somewhat, short term. And then the device tax and acquisition amortization is, obviously, depressing our margins this year relative to last year from a GAAP earnings perspective. But I think the actions we've taken the last 3 years to drive margins up several hundred basis points come across the P&L from the actions that I talked about earlier, both cost actions, as well as reducing the focus in the home care business, for example, a lower margin business for us, as well as manufacturing and productivity improvements. I think you should expect to continue to see the same going forward. And again, I don't want to steal the thunder from May, but we'll lay out exactly what that means in terms of the margin targets that we're chasing the next several years.

[Christopher C. Cooley:]

Okay, super. And then this may be a point for the May 7th investor meeting as well, but just thinking back to your prior meeting in '11, initially, obviously, one of the key focuses here was growth abroad and has continued to be an area of focus. When we look at the results, I guess what I'm just trying to drive out here is what can we see that might give us some more confidence in an acceleration in the organic rate or of growth with the businesses that you have in place now? Or alternatively, do you see a more favorable environment for acquisition or strategic partnership to further accelerate that growth profile?

[John J. Greisch:]

Yes, I think you'll hear from us in May. We're more focused on improving the profitability profile of the business that we have internationally today. It's not where we want it to be. I think we've been pretty consistent on that point. So before we start really chasing more aggressive top line growth internationally, the near-term focus is going to be more on improving the margin profile in the business. We're making some progress this year, as you'll hear in May, but we've got to get more traction on that before I start going after significant acquisitions, internationally. I think -- we're seeing some good growth in some of the regions outside of Europe, again, a bit choppy as you've seen with the Middle East particularly. But the growth we are getting outside of Europe has been profitable and attractive for us. Europe, obviously, continues to be a challenge for us and everybody in the device space.

[Operator:]

Our next question is from Gary Lieberman of Wells Fargo Securities.

[Gary Lieberman:]

I was hoping -- is there any update on any of the FDA issues that had been outstanding?

[John J. Greisch:]

Yes, we're on track with our remediation efforts. We have responded to the 483 that we got earlier this year and putting a lot of effort into the remediation efforts and on track with our commitments. And as you've seen in this quarter's results, we're addressing what we need to address, both with the remediation efforts and any legacy field corrective actions that require our attention. And we're putting as much resource behind that as is necessary.

[Gary Lieberman:]

Okay, and there are no new issues?

[John J. Greisch:]

No, no. All the actions that we have taken, all the field corrective actions you've seen, those are completely voluntary on our part, but no update in terms of specific new issues since the 483 came out.

[Gary Lieberman:]

Okay. And then in terms of the comment that you made of the second half being stronger, were there specific orders that you are aware that moved into the second half or just sort of the way you're seeing the volatility of the business that's the expectation?

[John J. Greisch:]

It's really a function of the comparables from last year, stronger first half of the year that we had last year than the second half. So it's really that simple.

[Gary Lieberman:]

Okay. And then maybe just last question. Any -- is there any way to quantify any contribution from the ICU product later this year and also Volker?

[John J. Greisch:]

I'd rather not quantify anything on the new ICU product. It's a replacement for TotalCare that we're very excited about and customers are very excited about -- who have seen it so far. And Volker continues -- I think we commented at one of the last couple of calls it's relatively on track. The only exception has been the weakness in Western Europe that's affecting our entire business, but no great surprises.

[Operator:]

We have a follow-up question from Lennox Ketner of Bank of America.

[Lennox Ketner:]

John, you may have actually just answered this with your last question. But I'm just trying to get comfort in terms of the sequential improvement that you're expecting from Q3 to Q4. I know that Mark said earlier you're expecting a return to normal seasonality patterns there. But given that you also seem to be kind of emphasizing the unpredictability of the business from quarter-to-quarter, how can people get comfortable that we really will see that improvement from Q3 to Q4? Is that more EPS-based in terms of taking costs out? Or just how should we be thinking about that?

[John J. Greisch:]

Yes. I think if you look at Q3 to Q4 with our outlook as of now -- and I'll let Mark follow on to this, too, Lennox, the -- I think you've seen historically the Q3 to Q4 jump that we've had. Last year's was somewhat less than historical and our revised outlook calls for a much more modest Q3 to Q4 ramp-up on the top line. So I feel comfortable with the outlook that we have now. And again, I didn't want to hang on to a big hockey stick for Q4, which is what we would have had to do had we maintained our revenue outlook. So the ramp from Q3 to Q4 this year is significantly less than what we have seen in prior years. And as we mentioned earlier, the margin profile, second half of the year, first half of the year both from a mix perspective and some of the actions we've taken, we expect to improve.

[Mark J. Guinan:]

Yes. And I don't have a lot to add, Lennox. It's just as we have talked in the past, we've got pretty good visibility, quite good visibility into the next quarter. Obviously, the backlog makes up a portion of those shipments. Those are purchase orders in hand. And we've got a number of deals that are very close to being close in terms of purchase order. And then certainly, the subsequent quarter, we've got a more -- tighter view of that as well. So when we look at our order funnel, it seems to be richer in that quarter than it has been the first 3 quarters. So it's really that combination of factors, Lennox, that gives us the confidence, obviously, that hopefully will give you the confidence that the revenue guidance we've given is something that's deliverable.

[Operator:]

I'm showing no further questions at this time. I would like to turn the conference back over to Andy Rieth for closing remarks.

[Blair A. Rieth:]

Thank you, Shannon. I'll turn it over to John for some quick comments.

[John J. Greisch:]

Yes, just to wrap up and -- thanks to everybody for the call. And we very much look forward to seeing you in New York on May 7. So I appreciate all the questions this morning. Thanks.

[Operator:]

Ladies and gentlemen, this concludes today's conference. Thanks for your participation. Have a wonderful day.