Hill-Rom Holdings, Inc.
Q3 2014 Earnings Call Transcript

Published: 7 Aug 2014

[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 August 14, 2014. 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 transmission 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:]

Thank you, Sam. Good morning, everyone, and thanks for joining us for our Third Quarter Fiscal Year 2014 Earnings Call. Before we begin, I'd like to provide our usual caution that this morning's call contains 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, we will discuss certain non-GAAP or adjusted financial measures on today's call. 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 on our website. Joining me on the call today will be John Greisch, President and CEO of Hill-Rom; and Mike Macek, Vice President, Treasurer, and Interim CFO. The usual ground rules will apply to make the call more efficient. We've scheduled an hour in order to accommodate our prepared remarks and leave plenty of time for Q&A. During Q&A, please limit your inquiries to one question, plus a follow-up, per person [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 on our website and will also be part of the archive. With that, I'll turn it over to John.

[John J. Greisch:]

Thanks, Andy. Good morning, everyone, and thanks for joining us. Despite a revenue shortfall, the quarter was solid overall with the following noteworthy highlights. Adjusted earnings per share were up 4% over the prior year and in line with our guidance. We achieved year-over-year and sequential improvement in adjusted operating margins, reflecting our commitment to drive sustainable improvement to margins, irrespective of revenue headwinds. Orders in our North America capital business were up sequentially and slightly above the quarterly average of the fiscal 2012 to 2014 periods, reflecting stability in one of our core businesses. Orders for our North American Patient Support Systems were at the highest level since the first quarter of fiscal 2013. Our capital backlog is at its highest level since the fourth quarter of fiscal 2011, and up over 20% sequentially, and 12% year-over-year. During the quarter, we were awarded multi-year rental or capital contracts with HCA, Health Trust, Med Assets, and the Resource Group, which is the GPO for extension health. Some of these contracts are sole-source. In International, capital orders increased year-over-year, as well as sequentially, driven by growth outside of Europe. And finally, our Surgical and Respiratory Care business achieved strong growth again this quarter, with a 7% year-over-year increase in revenue. This was offset by revenue declines in our North America and international patient handling businesses. The growth in our Surgical and Respiratory Care segment underscores the importance of our portfolio diversification efforts. So despite the revenue decline for the quarter, I'm pleased with the stability in our order rates, particularly in our North American capital product category. Year-to-date revenue was clearly impacted by the weak order rate we experienced in the first quarter this year, but that quarter appears to have been an aberration. The strength of our backlog and sequential, as well as year-over-year order rates, reflect relative stability in North America capital. We expect overall revenue comparables for the fourth quarter to be the most favorable of the year. I'm also very pleased with the competitive multi-year wins we achieved with several of the largest GPOs and health systems in North America, none of which is yet to materially contribute to our current strong order and backlog position. As you know, we closed the TRUMPF Medical acquisition on August 1st, significantly expanding our surgical portfolio and global presence. TRUMPF adds revenues of approximately $250 million on a full year basis, with over 80% of its revenue in markets outside of the United States and about 1/3 in emerging markets. The TRUMPF business complements our current global footprint in attractive high-growth markets, increasing Hill-Rom's international revenue to approximately 40% of our consolidated total. TRUMPF has leadership positions in several key product categories and geographies around the world and brings to Hill-Rom a strong history of innovation and growth. I'm very excited about the opportunity to leverage our combined geographic footprint and customer relationships, particularly in the United States, where Hill-Rom has outstanding positions with the major health systems, as evidenced by some of our recent competitive wins. We are pleased to add the TRUMPF product line to our portfolio and to welcome over 700 TRUMPF employees to the Hill-Rom family. On the innovation front, we launched a new cough assist device to expand our Respiratory Care portfolio this past quarter. The growth we have seen across our Surgical and Respiratory Care businesses, along with the strength in our ICU product category, has been driven by new product introductions over the past year, reflecting improved productivity from our innovation investments. We will continue to focus on driving growth with new product introductions along with M&A, such as the Volker, Aspen, and TRUMPF acquisitions. In closing, our adjusted earnings and margins were in line with our expectations, despite our disappointing revenue performance. We are pleased with the increasing stability in our core North America business and our recent competitive contract award wins. We will remain focused on optimizing our core business, enhancing operating margins and cash flow, while at the same time pursuing additions to our portfolio, as we did with TRUMPF Medical. As meaningful as the acquisition of TRUMPF will be to our growth in 2015, we recognize that it alone is not enough to materially change the growth profile of our overall portfolio. In this regard, we will remain disciplined as we pursue additional acquisitions in our 5 strategic focus areas of

[Michael S. Macek:]

Thank you, John. And good morning to everyone on the call. To start, third quarter revenue declined 6.3% to $398 million on a consolidated basis, or 7.2% on a constant currency basis. This decrease was driven by lower revenues in North America and international, partially offset by increases from our Surgical and Respiratory Care segment. Capital sales decreased 6.3% to $303 million, and rental revenue decreased 6.2% to $95 million. Both of these declines were primarily driven by lower revenue in our North America segment. Domestic revenue declined 9.4% to $255 million, while revenue outside the United States was flat at $143 million. Looking at revenue by segment, North America declined 11.4% to $212 million. Capital sales decreased by 12.2% to $146 million year-over-year and were down 3.2% sequentially. Although disappointed with the revenue results, orders for the period met our expectations as capital orders were down 2% year-over-year and up 1% sequentially. We ended the quarter with a backlog position up 12% year-over-year. As a result, we expect our fourth quarter North America capital revenue to reflect the strongest comparables of the year. North America rental revenue declined 9.7%. Excluding the impact from our previously announced plans to discontinue our home care rental bed frame business, rental revenue declined 6.3%. Moving to our Surgical and Respiratory Care segment, revenue increased 6.9% to $66 million, driven by growth in both our Surgical and Respiratory Care businesses. Specifically, Allen Medical revenue increased 10.1% year-over-year, and Aspen revenue increased 5.1%. We continue to be pleased with the strong performance and growth from our surgical portfolio. Respiratory Care also performed well this quarter, with revenue increasing 7.7% year-over-year. International revenue declined 2.9% to $120 million. On a constant currency basis, quarterly revenue declined approximately 6%. This decrease was driven by declines in Germany and the Middle East, partially offset by increases in Asia Pacific and Latin America. Adjusted gross margin was 46.8% for the quarter, an increase of 90 basis points compared to the prior year. This improvement was driven by product mix and cost controls. Year-over-year adjusted capital margin increased 80 basis points to 44.2%, primarily due to favorable product mix. Adjusted rental margin increased 130 basis points to 55.2% as targeted cost reductions and strong performance in our field-based service network more than offset the lower volumes and pricing pressure we faced in our rental businesses. Regarding operating expenses, our adjusted R&D investment increased 5.4% year-over-year. As a percentage of sales, our adjusted R&D investment was comparable to our recent quarterly averages at just over 4%. Adjusted selling and administrative expenses were down 5.9% year-over-year on the benefits of prior period cost reduction initiatives and lower compensation expenses. Adjusted operating profit for the quarter was $50 million, representing a 12.5% operating margin. In comparison to the prior year, adjusted operating margin increased 30 basis points despite the lower revenue for the period. The adjusted tax rate for the quarter was 28.7% compared to 31.5% in the prior year. The improvement was driven primarily by geographic mix. So to summarize the income statement, adjusted earnings per share of $0.59 increased 3.5% over the prior year. Adjusted year-to-date EBITDA was $194 million, down roughly 13%. The year-to-date decrease was driven primarily by lower earnings experienced in the first quarter of this year. Year-to-date operating cash flow of $134 million compares to $168 million, last year, down primarily due to lower earnings and a lower contribution from working capital. Operating cash flow for the quarter was up 2% to $56 million. Before turning to guidance, I would like to provide some comments about our TRUMPF Medical acquisition in addition to those John made earlier, and also provide an update on our previously announced restructuring actions. The TRUMPF acquisition price of approximately $250 million was financed with cash on hand, and to a larger extent, borrowings from our existing credit facility. TRUMPF Medical represents approximately $250 million of annual revenue and will be reported within our Surgical and Respiratory Care segment going forward. In fiscal year 2015, we continue to expect TRUMPF Medical with fiscal year previously ended June 30th, to add approximately $0.12 to $0.15 per share in adjusted earnings. However, consistent with most capital-intensive businesses, earnings will be stronger in the second half of the fiscal year. In regards to our previously announced restructuring actions, we are on track to deliver the benefits and savings previously outlined of approximately $30 million on annual basis. The U.S. portion is substantially complete while we still anticipate the activities in Europe will be completed over the next 2 years. Now let's move onto our full year 2014 guidance. We expect full year reported revenue to decline in the range of 2% to 3%. This reflects a favorable impact from currency of approximately 1% at current rates and incremental revenue from the TRUMPF Medical acquisition. We expect full year adjusted EPS to be in the range of $2.20 to $2.24 per diluted share. Our full year 2014 financial outlook reflects the following. Revenue decline of 7% to 8% in North America; constant currency revenue decline of 5% to 6% in International; Surgical and Respiratory Care revenue growth of approximately 20% to 22%, which includes the incremental revenue from the TRUMPF Medical acquisition; gross margin of 46% to 47%; R&D spending of approximately 4% of sales; SG&A is relatively flat as a percentage of sales, reflecting the benefits from the restructuring actions; a tax rate of approximately 30% to 31%; and between 58 million and 59 million shares outstanding for the year. We project 2014 operating cash flow to be approximately $240 million, excluding the impact of cash outflows from the current year restructuring programs. We also anticipate $65 million to $70 million of CapEx investment for the full year. And finally, we expect adjusted EBITDA to be approximately $280 million. Moving to the fourth quarter. We are projecting reported revenue to increase 6% to 8%. This reflects a favorable impact from currency of approximately 1% at current rates, and incremental revenue from the TRUMPF Medical acquisition. We expect adjusted earnings of between $0.68 and $0.72 per diluted share compared to $0.71 in fiscal 2013. With that, I'll turn the call back over to John for concluding comments. John?

[John J. Greisch:]

Thanks, Mike. As I mentioned in my earlier comments, we are pleased to have delivered adjusted earnings in line with our guidance, as well as with a relative stability in North America capital orders. Our recent large competitive contract wins demonstrate the success of our investments in sales force effectiveness and our enterprise selling efforts. At the same time, we delivered improved adjusted operating margins year-over-year and on a sequential basis, reflecting our commitment to drive margin improvement, irrespective of the revenue headwinds we are experiencing. Looking ahead, it is clear, we need to deploy our strong cash flow in a disciplined manner to accelerate growth of our portfolio. We've been speaking about our commitment to do so for several quarters, and that is exactly what the TRUMPF acquisition represents. That said, it is neither large enough nor does it have a sufficiently different revenue profile to make a meaningful difference to the growth challenges we face. We will continue to pursue growth opportunities in the strategic areas I referenced earlier. I'm confident in our ability to continue executing investments to drive additional growth and shareholder value, consistent with our capital allocation strategies. With that, operator, please open the call to questions.

[Operator:]

[Operator Instructions] Our first question comes from David Roman from Goldman Sachs.

[David H. Roman:]

So I -- one sort of general macro question for your comments and one specific follow-up on the numbers. So maybe just starting with the macro question, in your prepared remarks, you did reference a number of times stabilization and potentially some improvement with respect to your core North American market, and as we look at the numbers that hospitals are reporting this quarter with significant upside in their EBITDA profile, that does seem to portend a potential improvement in overall capital spending. So maybe you can sort of give us some update on your thoughts of what's happening in the end markets and when we can start to see some of the favorable trends that you started to reference, at least on the order side, translate into revenue?

[John J. Greisch:]

That's obviously the $64,000 question, David. I think it's a great question. And I think your assessment is consistent with the way I see the world also. And you're right, the stability that I referenced several times, I certainly feel better about today than I have for several quarters. I think, I mentioned last quarter that it was -- and even at your conference, it was feeling like there was more tailwind at our backs than we have felt for quite some time. And I think that's reflected in not only the order rate and the strength of the backlog, which is up 20% over the end of Q2, but in some of the contracts that I referenced in my comments as well. Some of the larger systems, HCA and extension specifically, their spending has been reduced over the past year, and they're 2 very significant accounts for us where we have very strong positions. And they specifically, I expect, to be spending more capital as we go forward on our specific products. That's an end of 2, but as you all know, that's 2 very large systems, the largest for-profit and one of the largest not-for-profit systems in the country. And locking them in with the contracts that we've got, I feel very good about our position there. And the rental contracts I referenced, I think, again are examples of the strength of the position that we've got with some of the large GPOs as well. I think those, together with the stability we have felt up until now -- and as you said, improving economics within the provider universe, I think looking forward, I'm certainly feeling better about our ability to translate orders and backlog into improving revenue going forward than I probably have for quite some time.

[David H. Roman:]

Okay, and then my follow-up to that would be the -- if I sort of take the $250 million you've talked about for TRUMPF and simplistically divided it by 4, I'm still getting to a decline in underlying business on a year-over-year basis in the fourth quarter for your updated guidance. So how do we kind of reconcile the order in backlog trends with that guidance?

[John J. Greisch:]

Yes, a couple of comments. I think your math is right, firstly. And secondly, as we saw this quarter, the orders and revenue timing doesn't perfectly match up quarter-to-quarter. I certainly, as well as anybody, understand the importance of translated orders in their revenue and earnings as quickly as possible, but that's as much a function of the timing of our customer requirements as anything. So the consistency of orders and the growing backlog is what led my first response to your first question in terms of confidence going forward. As we look at the fourth quarter, here we are in August 7th, we have a pretty good visibility and how much of that backlog and our current order rate is going to translate into revenues, and it's still probably going to result in a decline in North America year-over-year, even with strong order rates as we close off the year here. Internationally, if you look at our guidance for international that Mike specified for the full year, that has come down from our guidance of a quarter ago. So our international revenues, we expect to be a little softer here in Q4 than what we were looking at 3 months ago. Germany has been a particularly soft market for us. And, I think, we referenced last quarter in Mike's comments, some significant tender push-outs, both in the Middle East and specifically in France, where the government tender process, for a number of reasons, has been delayed several months. And that's going to impact our fourth quarter in France, which, as you may recall, is our biggest market in Europe currently.

[David H. Roman:]

Okay, so that's -- sorry.

[John J. Greisch:]

Sorry. So your math is absolutely right. And again, I think, as I look forward, we're going to start seeing more favorable revenue comparables. And obviously, as our North America stability transition to revenue and some of these bigger contracts begin to kick in next year, not only on the capital side, but on the rental side, I think, you'll see some increasingly favorable revenue comps.

[Operator:]

Our next question comes from Larry Keusch of Raymond James.

[Lawrence S. Keusch:]

Two questions for you guys

[John J. Greisch:]

Yes, we're willing to do so, Larry. I'd rather not get terribly specific on how big, but the recognition of the need to change the revenue profile of the portfolio is clear, not only with me and the management team, but with our board. And the need for a -- as -- I will use your word, transformative acquisition, we clearly see and we have the appetite for. So without getting specific, on rather that's $0.5 billion, $1 billion, or $2 billion. We have the appetite to do that, and I think we have the financial wherewithal to do that as well. And so very willing and actively considering those sorts of things.

[Lawrence S. Keusch:]

Okay, that's great. And then, specifically on TRUMPF, the details thus far have been a bit limited. So I'm wondering if you could help us, again, sort of understand the margin profile of that business now that, that comes in. And maybe you could help us a little bit with how we should think about sort of the income statement items, whether it be gross margin or SG&A, as a percent of sales? And then on top of that, again, Mike, you mentioned the financing, and you said the majority was under your credit agreement. But if you could help us understand how much was cash? And how we should think about the incremental interest expense coming in? That would be great.

[John J. Greisch:]

Yes, I'll take the first part, Larry. I don't plan to share specific margin profile of our individual businesses. But I'll give you some insight, and I think we shared some of this earlier. As Mike said, it's roughly a $250 million revenue business, which you know. Their first quarter is the quarter ending September 30th. So just as quarter ending September 30th will be our strongest capital revenue quarter, it will be their weakest revenue quarter, since they just finished their year. And as you all know, capital businesses tend to have their strongest quarter in the fourth quarter. And so the relatively immaterial contribution to earnings here in our fourth quarter. We paid roughly 10x EBITDA for the business, so that, that gives you an idea of their EBITDA profile. Obviously, going forward, we have objectives of improving that. And we're well into identifying where those opportunities are. And, I think, the most exciting thing about the TRUMPF acquisition is our ability to accelerate the growth of the company, as I mentioned, not only here in the states through our channel presence and customer relationships, but around the world as well. And with that, accelerated top line growth, I expect margin improvement to come. And, I think, we've demonstrated the ability to improve margins in some very challenging revenue environments with our own business. And, I think, as we can, either from an external perspective, or in this case of TRUMPF, and with the combination of the 2 businesses, drive additional revenue growth. I think, our excitement about driving improved margins in the business is quite high.

[Michael S. Macek:]

And Larry, this is Mike. From a financial perspective, it was roughly 3/4 stat, 1/4 cash to fund the acquisition.

[John J. Greisch:]

Obviously, Larry, just to add to Mike's comments, with the strength of our cash flow, we have the ability to pay down our acquisition debt relatively easily. And so in line with your first question, the TRUMPF deal, in no way, hampers our ability we looking at additional, even larger acquisitions as we speak here.

[Operator:]

Our next question comes from Bob Hopkins of Bank of America.

[Robert A. Hopkins:]

So 2 questions. First, on the M&A comments. I understand that you're willing to do transactions, I appreciate all the color you're offering there. But I'm curious, John, is the pipeline full from what you see here today? And can you do more and larger deals before you have a full-time CFO on board? Is that a limiting factor at all?

[John J. Greisch:]

That's a good question, Bob. I don't see it is a limiting factor. I mean Mike's been here for quite some time. He is a guy I'm incredibly comfortable with and I have a lot of confidence in, and our team as well. We were highly focused on cost reductions and on M&A before Jay came and left, and Mike has had a significant hand in both of those efforts. So I have a high sense of urgency to get a permanent CFO in place, but it has not slowed down our appetite or the efforts that we've got. Between our corporate development team and our finance team, I think we have adequate resources. That's said, that role is a critical role. And adding to the management team somebody of the appropriate caliber is a high priority for me. But, I think, the focus on M&A, as well as our continued focus of cost reductions will continue and has continued over the past several years. In terms of the pipeline, it's a tough question to answer. How full is the pipeline. And we, like everybody else, are constantly looking at a number of things, some of which we've been engaged in deeply and some of which we continue to study and evaluate. But there's no shortage of activity or opportunities that we're interested in. And as you all know, some take a lot more time than you'd like, and some, you kiss a lot of frogs before you find a deal that you're interested in. And, I think, the driving force behind all of our activity is, again, remaining disciplined and not panicking into buying growth because of our revenue profile over the last several quarters, that's something we're not going to do.

[Robert A. Hopkins:]

And then, and -- a question on the market and the uptick in orders and the conversation around order conversion. If you could comment on Q4, just state a lot of the orders you're seeing or orders for fiscal '15? Or is it that there could be upside to Q4? And then I'm just curious, generally, given that capital cycles take time, and you may not have firm orders yet, but I am just curious as to what you're hearing as it relates to fiscal '15, again, given the clear improvement in the hospital reporting season this quarter. So just curious on kind of anecdotally, what you're hearing as you look forward a little bit further out in the future. And then on the order conversion around Q4 again, is that simply a timing issue? Or most of those orders a little further out?

[John J. Greisch:]

We probably have a little higher percentage of our backlog with more extended delivery dates than we've had in the past. I think if you look at the analytics at the backlog up 20% over last quarter, orders were up slightly, sequentially. And obviously, revenues continued to be down in North America. So you do the math. Our backlog is building even though orders have been relatively steady, which says that there's more in the backlog for later deliveries. Might there be conservatism in the fourth quarter? We came out with guidance that we want to have a high degree of confidence in. And, as you know, Bob, the predictability of the timing of individual orders, even as we sit here, and despite my comment earlier in response to David's question, can change between now and the end of September, both for the good, as well as to the downside. So we've tried to balance that volatility risk of shipment timing with the guidance that we put out, and we feel comfortable with what we have out there. Looking into '15, it's hard to translate, to use your term, "anecdotal" discussions or comments that I'm hearing from individual hospitals, given the replacement cycle of our products. That said, as I mentioned earlier, some of the bigger systems with whom we have strong relationships, their spending this year has clearly been down from the historical average. And I know several of the large systems are planning to ramp up their spending as we going to '15, whether that's going to early or late '15, it's hard to predict. And -- but as long as we maintain our position with the systems that we have strong relationships with and some of the ones that I referenced earlier, we whom we now have extended multi-year contracts, and I'm feeling that, again, there's more tailwind behind us and there is headwinds in the capital spending environment.

[Operator:]

Our next question comes from David Lewis of Morgan Stanley.

[Jonathan Demchick:]

This is actually Jon Demchick in for David. Following up on some of the M&A questions, John, you mentioned on number of end markets that you're interested in and then you also talked about size a bit, and that timing really wasn't an issue as long as everything kind of lined up. And I was just curious about some of the operational and financial benchmarks that you view as important boxes to check before executing on a deal. I'm mostly talking about returns, margins, and some -- whether you wanted to be more capital or recurring revenue base.

[John J. Greisch:]

Yes, I think, I'll repeat some of my comments that we've articulated over the past couple of years, John. We do have a desire to diversify the portfolio into more consumables or disposable products as we did with Aspen. TRUMPF clearly did not check that box, but it brought us a great product line with significant global footprint and market leadership in some critical categories as we doubled our surgical portfolio. So diversifying into more consumables and less dependency on capital? Absolutely an objective we have. But that's not to say every acquisition that we're looking at or that we're going to execute accomplishes that objective. Financially, obviously, as we did with TRUMPF, we're looking to have anything we do be accretive to earnings. And everyone on this call knows that's relatively easy to do today with the cost of capital. But in terms of specific return objectives, what we said in the past is double digit ROIC within a 3- to 5-year period is our driving principle as we go forward. And margin profile, we certainly are looking to bring businesses in that are as good or better than our current profile or have the ability, as TRUMPF demonstrates to improve their margins up to our level. I'd say those are the key financial metrics that we've got and the strategic focus areas that I mentioned, were in those areas today. So it's really leveraging our channel, expanding our global presence, and building the franchises that we have in those specific areas as we look forward.

[Jonathan Demchick:]

And just a quick follow-up as for John and Mike. Over the last few quarters, the level of margin improvement has been -- is impressive, especially given the declining top line. And you've mentioned that you expect margins to come up, regardless of the top line profile. And I was kind of wondering, heading into '15, where you see the most opportunity to take out further costs and whether you think margins can -- and should improve year-over-year heading into '15.

[John J. Greisch:]

Yes, I'd rather not answer anything specific to 2015 at this point, John. We'll obviously cover that in 3 months from now. But I think, the thing that gives me the greatest confidence, as I look forward, is exactly what you mentioned. The last 2 quarters, we've improved operating margins year-over-year with some pretty significant revenue declines. And some of that is cost improvement, some of that is the restructuring actions we've taken, some of that is -- excuse me, variable compensation expenses are coming down. But the margin commitment for improvement, irrespective of the revenue profile, is one that we've clearly signed up for and I think are executing against. And as I look forward, as we get revenue growth in the portfolio, our ability to leverage our cost structure even further and drop more meaningful operating leverage to the bottom line is, I think, a very exciting opportunity for us. If you look at Q4, even with the TRUMPF, which is dilutive to our margins, our operating margins will improve from Q3 to Q4. So we're continuing to drive margin improvements with some of the revenue chances we got. And as that revenue profile turns around, I think we have that much more opportunity going forward.

[Operator:]

[Operator Instructions] Our next question comes from Gary Lieberman of Wells Fargo.

[Gary Lieberman:]

It would seem that there would, based on your comments on just sort of the prolonged period of slower capital growth, that there would be some degree of maybe pent-up demand for product from U.S. hospitals. Is there any way that you -- you measured -- you'd had to measure that? And perhaps you have any idea of what the average life of Patient Support Systems in the hospitals is now and how that compares to what it's been historically?

[John J. Greisch:]

Yes, I mean, it's roughly 12, 13 years, that there's, on average. Some hospitals have our products for 20 years, some replace them after 7 years. But on average, the replacement cycle is probably 12, 13, 14 years. And if you look at the comments I made earlier, some of the larger systems, and it's the best way we can measure it, Gary, it's just track spending by large customers year-over-year. There's clearly been reductions over the past couple years from the late 2010, 2011 period when we also experienced some pent-up demand spending following the '08, '09 prices. So, yes, we do measure it. We track by account spending levels. I mentioned a couple earlier that they are significant customers of our's where spending this year has been down from historical averages. And, I think, we'll see that spike back at some point in the future. Again, I can't say, didn't say, whether that's first half of next year or second half of the fiscal '15 for us, or '16, for that matter. So I think generally, yes, there is some pent-up demand. We do track it both by GPO, by hospital system. And with some of the contracts that we've recently won again, both from the capital and rental side. I feel good about our opportunity to continue to benefit from whenever and how much the capital rebound cycle occurs next year and beyond.

[Gary Lieberman:]

Is there anyway to try to compare it and to what it was in '08, '09 versus what it might be now in terms of just the order of magnitude of potential sale?

[John J. Greisch:]

Yes, I don't have that data in front of me, Gary. '07, '08 were certainly the peak years of capital spending within the provider system here in the states. Yes, if I remember correctly, the decline from '08 to '09 was about 25%, 30% for our product category. It is not recovered back to that level. It bounced back into the mid-teens and '10, '11, and then has fallen slightly, obviously, by looking at our capital revenues in the single digits over the past 4 to 6 quarters. But again, as I look at our order rates over the last couple of years, it's stabilized with more tailwinds behind us than we've been looking out over the past several years.

[Gary Lieberman:]

And on market share, you're still comfortable that you're not losing market share?

[John J. Greisch:]

Yes, I do. And obviously the first quarter for us, this year, and our order rates, I mentioned this in my prepared comments, Gary. Our order rates very were weak in the first quarter. So if I look at over the last 12 months, the impact of that quarter, which was a significant decline from the other quarters of this year and last year, and there was probably some share loss. I can't point to any single large system that was a Hill-Rom account that switched out to anybody else. But that quarter for us clearly was an aberration in terms of order levels, and I don't think you have seen that with Stryker. And so that quarter has hurt us. But beyond that one, I think, over the past year and even back further than that, I feel good that share has been relatively stable within the industry.

[Operator:]

Our next question comes from Matthew Mishan of KeyBanc.

[Matthew Mishan:]

Just to start on these large competitive contracts that you won. You kind of surprised by the timing of some of these contracts, as far as the bidding process? Or the size or was this kind of as you thought that was going to be heading into the quarter?

[John J. Greisch:]

Well, they weren't a surprise. We've been working on them for quite some time. And a number of them were contracts that we already had. A number of them were new contracts that were competitive wins. So as with any major multi-year contract, both the bidding and the negotiating processes is a lengthy one. So, no, I wouldn't say, I was surprised at all. We've been well aware of them for some time. And we were fortunate enough to have 4 very significant multi-year contracts come in at the same time and in the same quarter, anyway. But I'm not surprised. We've been actively engaged with them for over a year, in some cases.

[Matthew Mishan:]

Okay, and then just on the tax rate, it seems like they came in a little bit lower in the quarter and seems that, in the guidance, it's a little bit lower than you would have expected. And what's the driver of that?

[Michael S. Macek:]

Sure. It's primarily a little bit of a change or favorable adjustment in our geographic mix. So better earnings in some of our lower tax jurisdictions. We lowered it roughly from the range from 31 -- 31 to 32, to 30 to 31. So we are expecting a little improvement versus our prior guidance range.

[Matthew Mishan:]

And how should we think about that going forward?

[John J. Greisch:]

We'll talk about that next quarter, Matthew.

[Operator:]

And our next question is a follow-up from David Roman of Goldman Sachs.

[David H. Roman:]

I do have another math question as it relates to the fourth quarter guidance and the impact from TRUMPF. I guess, as I look at the 20% to 22% number that you're providing on the Surgical and Respiratory for the full year and just assume the midpoint of that, and $60 million to $65 million for TRUMPF, that does imply a significant sequential decline in that -- in the underlying base business. Is there anything specific to call out there. I'm getting like $30 million to $45 million of base Surgical and Respiratory Care for the fourth quarter, is that correct or am I missing something there?

[John J. Greisch:]

TRUMPF is only two quarters, David.

[Michael S. Macek:]

Two months.

[John J. Greisch:]

Excuse me, 2 months, yes. So it's about 2/3 of -- a little less than 2/3 of the number that you've got there. We're not seeing any slowdown in the core Surgical and Respiratory Care business. The growth percentages are going to be a little more challenging in the fourth quarter because we had a very strong fourth quarter, last year, in our Allen Medical business on the back of a new product introduction, but the sequential revenue performance of those businesses is not changing at all.

[Michael S. Macek:]

And this is Mike. One other comment that I have submitted in my remarks. Looking at their annualized -- from annualized revenue of $250 million, it is backloaded for, say, a kind of straight-line, if you could just divide by 250 by 12. So of the first color of months, we do expect to be a little lower than that, straight-lined average.

[Operator:]

Our next question comes from Matt Miksic of Piper Jaffray.

[Matthew S. Miksic:]

So just a couple of follow-ups, if I could. One on the, I think, John, you mentioned earlier in Q&A there's a question of the capital cycle potentially picking back up or that's in fact what you seeing and love to understand if that's a seasonal or annual cycle that you're describing? Or is there's been any sense that maybe things will sort of structurally begin to change direction in the Acute Care segment here, generally. And then I have one follow-up.

[John J. Greisch:]

Yes, I wouldn't translate either our competitive wins or our stability into a ramping up that's going into materially change our capital business, Matt. I think the macro pressures in terms of unit volumes of hospital beds is no different than what I've been commenting on for the last several years. So is there some pent-up spending that will come out as we go forward? More than I've been able to see over the last several quarters? Yes, I think there is, and I think that will benefit us. But on a macro secular basis, I still don't see it here and see an increase in the number of hospital rooms or increased capacity of hospital beds. So that headwind is not going to change going forward. But, I think, the stability and spending is as good as it has been for the last 2 or 3 years and, I think, as we look in the '15, again with some of the major systems spending, timing, I feel better as I look forward then I have for some time.

[Blair A. Rieth:]

And Matt, I think, we have to be -- this is Andy. I think we have to be careful not to confuse cyclicality with volatility. And we don't really believe that there is cyclicality around hospital capital purchases. It has a lot to do with their profitability profile and so forth. But there certainly is volatility and the decision-making process does lead to volatility, but it's general going to be driven in large part by patient demand, volumes, utilization, admissions things of that nature, which is not necessarily a cyclical thing.

[Matthew S. Miksic:]

Right, that's helpful. So, I mean, generally, I guess, what we're seeing and what we've talked about in the past has been sort of a -- some consolidation in the Acute Care and sort of Patient Support area over the longer-term. The -- I guess, the second question I have is a follow-up on M&A and, I guess, the TRUMPF acquisition we though was while it's capital, a nice change in that, it is -- it does -- it's not consumable, but it ramps up your exposure to OR equipment, which kind of get you out of the way of that general trend of Acute Care patient support we talk about. So, I guess, to put up finer point on that, we think of your platform service support sales brand has a great place to put more hospital and equipment and services and brands that you can bring into the hospital. But to what degree can you think of you as also trying to tap into? I don't know, if it's a higher tech or sort of smaller new technology opportunities within the hospital. Where there is investment and growth, it does take some development it's different in selling of different for you. But something that traps into a growth area, albeit at maybe smaller than the more mature areas that you have exposure to now?

[John J. Greisch:]

Yes, the best example we have of that, Matt, is that at least within the existing portfolio is our clinical workflow solutions business, where we're providing tools into the room around our nurse call system and other IT applications to improve productivity within the room. Obviously, those are not clinical products or new technologies around devices. But they certainly are of interest to our customers and improve clinical workflow and caregiver productivity. And you're right around our service infrastructure as being a strategic asset that we can leverage more going forward and we are certainly interested in doing so. Relative to our investing in for a field new technologies that aren't adjacent to the areas that I articulated earlier. And we're not looking at anything that I think I would put in the head-scratcher category, as investors look at why Hill-Rom would be getting into that. However, there are some things that, as you said, whether the new technologies or new product categories for us, if they can help leverage our channel and our channel presence can help us accelerate growth of some newer products or technologies or clinical areas, we'll consider them. But don't expect us to do anything sizable that is not in the strategically obvious category for us.

[Operator:]

And at this time, I'm showing no further questions. I'd like to turn the call back to management for closing comments.

[Blair A. Rieth:]

Thanks a lot Sam and everyone else for joining us today. We'll wrap it up for now. Thank you.

[Operator:]

Thank you, sir. Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program. You may all disconnect. Everyone, have a wonderful day.