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Executives

Mark Guinan – CFO

Andy Rieth – Investor Relations

Analysts

Bruce Nudell – Credit Suisse

Hill-Rom Holdings, Inc. (HRC) Credit Suisse 2012 Healthcare Conference November 15, 2012 11:30 AM ET

Bruce Nudell – Credit Suisse

I’m the medtech analyst from Credit Suisse. Mark Guinan, the CFO of Hill-Rom, has graciously come to visit us today. He is at the lectern now and Andy Rieth from IR is here as well.

Mark Guinan

Thank you, Bruce, I appreciate it. Good morning everyone and thank you for joining us this morning. First off, I want to remind everyone that some of my comments this morning will be forward-looking statements and give you the usual caution about such statements, certainly refer to our Form 10-K, which should be issued very shortly, and for further clarification on some of the risks around our business and so forth.

So, for those of you who might be less familiar with the Hill-Rom story, we’re a global leader across the care continuum from acute care through post-acute. We provide solutions across the continuum from our core patient support systems or better known as our frames and surfaces as well as patient lifts, surgical disposables and positioning products, also furniture and architectural products. We also have a couple of key products within the respiratory category, both in the area of airway clearance.

We’re a company with a long history, great brand awareness and equity, been around since 1929. We also have a solid international footprint while a significant portion of our business is concentrated in North America, and I’ll go into that in a little more detail in a minute. We are a global company.

As I stated a moment ago, we are a global leader in the major markets in the categories in which we compete. As you look here, you can see we have the number one position in our core patient support systems, therapy rental within the acute setting, architectural products, respiratory care category as well as the consumable surgical products that we just acquired through Aspen. And then we’re a strong number two in some of the other categories, including the surgical positioning, patient lifts and furniture as well as medical equipment management services. And speaking of the recent acquisition, you can see that in the area both of blades and scalpels and in fluid management that came with the Aspen acquisition, they are strong number one.

So, as I mentioned a moment ago, we do have an international presence, solid international presence, but you can see that we’re a business with a reasonable amount of diversification, whether it’s by reporting segment, business model or geography. The reporting segments you see here are different than what we’ve been reporting historically. This was driven by a number of factors including our recent acquisition. In our forthcoming 10-K, you’ll be able to see reconciliations to our past segments, the biggest change being that in our old post-acute segment, a couple of those business lines moved into North America and then the respiratory business has been combined now with our surgical positioning as well as Aspen to form our surgical and respiratory care business. So among the three segments, obviously North America is the largest piece, solid international presence with a growing importance within surgical and respiratory care.

Within the business model, we do have about 70% of our business coming from capital, software and services, and within capital, I’m including the disposals for now, but differentiating it from a rental business. To be clear, our rental business is not driven from a lease versus buy decision. It’s typically different products. It’s for either specialized products or for episodic needs, so within the financing decision for our customers we stay out of that. That’s done independently. So really when you think about our business rental versus capital, it’s largely different products.

And then finally geographic, good concentration in North America and that comes across several of the segments from a geographical standpoint, which is why it’s larger than our reporting segment, about 16% in Europe and then the balance in the rest of the world.

You’re certainly familiar with all the challenges that the healthcare system is facing and our customers are no different. Hopefully you’re also familiar with our value proposition, but I’ll talk about that a little bit. It’s really centered around improving patient outcomes and patient and caregiver safety. Central to that are certainly our patient lifts for mobility. We focus on improved mobility preventing patient falls, helping with the area of pressure ulcers and bath. We also have powered surfaces in addition to our lifts. We have some frames that actually help with mobility as well. So our focus is really on improving those outcomes and helping both the patient and caregiver safety.

And as you can see on the slide here, we focus on things such as differentiating of the outcomes, certainly we believe there is a return on investment that we are with the grain as we say, helping them with some of those challenges as opposed to adding to some of those challenges. And then the importance is that we do expand the care continuum, so that we can help them, especially with the emergence to moving things out of the acute setting into post-acute. We have offerings that can help them to meet those challenges.

A couple of years ago we set forth several areas of strategic focus and I’ve talked about those pretty consistently, leveraging the channel, which I mentioned we’ve a very strong brand equity. We think that’s something that’s important and we can utilize certainly to grow our business.

Innovation, critical. We’ve been growing R&D at a faster rate internally than our rate of sales. We’ve talked about the criticality of doing that for the sustainability of our business and certainly continued differentiation. I’ve also mentioned that within that R&D spend, it’s also data generation, so it’s not just new products, but we understand the importance of generating that clinical data that supports the value proposition for our products.

And then also within that R&D spend is some technical cost out or money that’s spent on taking cost out of our current product portfolio through innovative approaches, for instance, to our electronics platform, which I’ll talk about in a minute.

International expansion, certainly a critical area. M&A, portfolio acquisitions, financial excellence, and people excellence. And I’ll just take a minute to talk about some specific examples of how we’re executing against those, so those are certainly more than words on a paper.

If you look at it here, certainly in leveraging the channel, in priority you can see that the Liko distributor acquisition that we did in France and Switzerland. About a year ago, the Volker acquisition, are clearly areas where we’re looking to leverage the channel. Volker brings a great presence in Europe and specifically within the post-acute setting and nicely complements the strength that we had in Europe in the acute setting.

We’re constantly looking at our service center footprint. We think it’s a great value we bring to our customers with 150 service centers in North America and then another 30 or so in Europe. And that enables us to be in and out of most of our customer settings on a regular basis, both to provide service on our own products as well as serve their rental needs.

The area of innovation, as I mentioned we do spend money on cost out projects. It’s not just on new product development. Obviously, that’s critical with the increasing challenges to reduce our cost and to drive margin improvements. And then within R&D, internal R&D, we are very happy to have a new ICU platform that’s going to be launched early in 2013. It’s going to be replacing our TotalCare which was launched in 1999. And while TotalCare is still an outstanding product, we feel that the enhancements we’re bringing to this new product are something of great importance to our customers.

We launched a powered structure within the last 12 months. That was a gap in our portfolio. And then the HR 900 split side-rail was an important product for our international business and specifically Europe.

Talked about international expansion, if you’ve followed our results you know that we’ve been growing very strongly in the Middle East. That’s a critical growth area that has very attractive markets. We’ve also been building our Latin American business and certainly continue to invest and grow in Asia as well, specifically in China.

Portfolio acquisitions, I’m sure you’re quite familiar with those with the recently announced Aspen Surgical acquisition as well as Volker, which we announced and closed in February.

Financial excellence, we’ve talked about in addition to growing top line and the importance of margin improvements. We’ve grown net margin from about 400 basis points from where it was in 2009. Some of the top line challenges recently have made that more difficult in the short term, but it is certainly something that in the longer term, we are going to continue to drive.

We also had very good year this year, even despite some of the top line challenges and EPS challenges, and cash flow grew at 18% operationally versus the prior year. And that we also have pretty stable cash flow and EBITDA, which I think is important, while there is cyclicality certainly in our revenue cycle because of the capital businesses we’re in and certainly drives the cyclicality in EPS. If you look at our cash flow and EBITDA, it’s much more stable.

And then finally, the most important thing of course is driving people excellence and improving our capability and we’ve talked previously, both John Greisch and I have about several areas including specialty and our quality area, we brought in some very experienced talent and they’re really focusing on improving us there.

In May of 2011, we rolled out our capital allocation strategy. We’ve talked about starting with the importance of funding some of our internal needs. 25% to 35% of our operating cash flow being utilized for either NPD equipment, some of it from plant, property and equipment, IT projects, some of the typical things. About half of this is to fund our rental fleets, so we do need to fund that when we launch new products, occasionally refresh. So all of that’s captured within that bottom bucket.

We’ve also talked about maintaining our historical proportion of return to shareholders that was in the 15% to 20% range. We’ve increased our dividend twice double digits within a period of less than 12 months. We’ve been very active in share repurchases as I am sure you have noted, in order to support that as we grow our operating cash flow. And then finally that leaves us about 45% to 60% for strategic and organic investments.

As we’ve talked about this, this is – we positioned it as kind of a five-year average. It’s not something we’re going to be doing on an annual basis and certainly the 45% to 60% on M&A is going to be based on attractive value creating opportunities. It’s not something that we’re going to be wed to just because we put forth a strategy. And in any given period of time if there are not attractive investments or assets out there, then we’re probably going to drive more to shareholders in the short term. So that’s what we’ve laid out in the past.

So for the first time what I thought would be valuable to layout. So what have we done? We laid out the strategy and if you look at the time period since our CEO, John Greisch, has started in January of 2010, so a little less than a three-year timeframe, and you can see that we’ve held pretty consistent. So our capital expenditures have been right within the range, the return to shareholders has actually exceeded what our targeted guideline was laid out, and then we have exceeded the M&A piece with 72% really driven by the timing and the fact that we just closed a $400 million acquisition in July. So if you had looked at this earlier, you would have seen a significantly lower figure on the top there and certainly over time if we don’t do any more acquisitions in the next several quarters, you’re going to see that number come down.

Last thing I’m going to spend some time on is the Aspen acquisition. It’s certainly a very attractive company that has a lot of things that we looked at, that we’re excited about. From an operational standpoint, it has attractive margins. It is a growing business certainly, so there’re things that attracted us to Aspen. But from a strategic perspective there are couple things as well.

First of all, this company’s major products really fit with our focus on patient or caregiver safety. If you look at the area of blades and scalpels and certainly the introduction and evolution of safety blades and scalpels, this fits very well with the Hill-Rom heritage. Also there are other products for fluid collection, et cetera, are in the area of hygiene and safety as well.

So, strategically, it fits well with our goal of really expanding our platform around improving outcomes and patient and caregiver safety. In addition, we’ve talked about an aspiration to drive some diversification and to try to smooth out some of the cyclicality of our capital business. So this being a consumable or disposable business, it fits with that strategy.

As you look at some of the other aspects of the company, just going through some of the facts and figures, as I have showed you earlier it’s a leader in the categories in which we compete. It’s got three major sites, two of those – actually all three of them have some production, Las Piedras being a manufacturing location, the others having administrative functions as well, little less than 700 employees. Its customer base while somewhat different than ours, there’s certainly some commonality, but it’s really focused around clinicians, perioperative nurses and the OR staff.

I talked about the strategic rationale. It also fits with our desire to expand our existing surgical business, which at this point is more of a niche business, but it’s a space that we’re looking to expand in. It is a global business or at least it has presence outside the United States with business in Europe.

And then a little bit about channel. It is different than our current call point. They have a direct sales force in the U.S. and UK, which they added recently and also they go through distributors primarily for order fulfilling. There was a $400 million acquisition which I mentioned previously. It was accretive in 2012, so really just basically a stub quarter since we close it out in late July, but if you exclude the non-recurring purchase accounting which is for the most part inventory step up. It was accretive and then as we’ve discussed, it certainly will be accretive in 2013 and going forward.

So in closing, as you’re well aware, a very challenging external environment, but despite that we continue to generate strong cash flow. Certainly, our cash flow and EBITDA, as I mentioned, is much more consistent and less prone to the volatility than our top line and our EPS. We continue with those strategic areas of focus. They’re not things that we change on a regular basis and as you can see with my examples, we’ve executed against those.

Continued focus on clinical expertise and patient safety, we’re going to remain disciplined in our capital allocation strategy and hopefully you’ve seen that the with little less than three years of actual results.

And then finally, we’ve got a management team that really brings a lot of significant global healthcare experience and good track records of success and we think that’s a formula for success going forward.

That ends my prepared remarks. And thank you for your time and attention and I’ll turn it back to Bruce.

Question-and-Answer Session

Bruce Nudell – Credit Suisse

Thanks, Mark. Could you just talk briefly about kind of the top line trajectory year-to-date in the context of the U.S. and ex-U.S. hospital CapEx, spend cycle and what are the prospects, kind of, in the mid-term and what sort of trajectory might we expect when you get to enjoy the fruits of your labors with regards to acquisitions and such?

Mark Guinan

I think I can talk to this. There are a couple questions there, Bruce. Let me try to break them up into pieces. So, first off, in terms of where we see the North American market going, we talked about that on our last call. And, we don’t see any signs in the immediate future of a rebound, starting in really the fourth calendar quarter of 2011, which was our first fiscal quarter of 2012. We saw the capital market in the U.S. drop off substantially from where it was in 2011. 2011 had seen tremendous growth versus 2010. It didn’t quite get back to the peak of the low cost of capital spending of 2007, but it almost reached that point. So, one could argue it was getting close to the highest level.

When I talk about that, ours is – and this is in our core business and certainly we’ve got other business lines as well, but in the frames and surfaces area, it’s largely driven by replacements. So, really what – on a typical year, 6% or so of the beds are replaced of the 800,000 licensed beds within the U.S., and you’ve seen that vary somewhere between the trough of 2008 and 2009 of maybe 5% to a peak close to 7%. So, it’s always somewhere within that range, and where it is within that range can drive a significant year-over-year, quarter-over-quarter difference.

So, we’ve seen it falling off from that, so we didn’t quite get back to the peak. What the new normal is, is there a new normal? Not sure. If you look historically, this business does bounce around. So, what are the signs to the future? We don’t see anything to say in the immediate term we’re going to bounce back. A lot of the same pressures that were there in 2012 are still out there. Specifically what are those? I think a lot of it’s around uncertainty. When we talk to our customers, they can’t tie anything specific to, it’s the Affordable Care Act, and whether it was going to be passed or it was going to be revoked, what about that exactly is getting you to be more cautious about capital? We don’t get that tangible kind of response.

So, it’s really more about uncertainty and their willingness to put down a chunk of capital at a time when there is certain things like reimbursement and other aspects of the employment situation and the health of their consumers and patients that makes them a little bit risk averse. So, we gave caution around that business in North America for 2013, but certainly it can turn in a short period of time.

In terms of the acquired businesses, as I mentioned, Aspen certainly has showed growth over the last couple of years. The business that we do believe has growth potential. Yes, it’s subject to some of the same things that people in this space are subject to. But, one of the attractive aspects is within their blade and scalpel business, really in somewhat of the early stages of converting the safety blades and scalpels, we think there is growth opportunity there. And there is a lot of brand loyalty around our Parker business. So, it’s unlikely that it should be commoditized in the short-term is our view. And that lends some strength to that and solidity to the business as well.

Bruce Nudell – Credit Suisse

And how tough an environment is Europe right now for the capital – the hospital capital markets?

Mark Guinan

Well, in our specific categories, it’s a tough market. But, it really hasn’t shown signs of getting tougher. It’s been tough for about two years. So, our orders in Western Europe were quite strong in late fiscal 2010, some of those orders carried forward into revenue strength in early 2011. But when you look at the order rate where it really dropped off in early fiscal 2011 for us, it’s been pretty consistent for almost two straight years. So, tough market, certainly we’re not seeing growth prospects, but it’s also not a market that is either a melting ice cream counter for that matter collapsing, it’s been pretty stable for us.

Bruce Nudell – Credit Suisse

And for the prior recent years, Stryker seemed to have been gaining share momentum and I know it’s a tough market to actually allocate share. How would you characterize your position – your share position in the beds market now on a global basis?

Mark Guinan

I think there’s two ways to look at share. I agree with you that if you look at share as a base on the installed base, so of all the beds out there, we’ve been losing our share of the installed base. If you look at period share, so of all of the beds that were sold in a given quarter, we actually feel that we strengthened our share slightly over the last two years or so. So, there’s two different ways to look at it. Certainly, they’re both important and we don’t want to lose our share of the installed base.

But to the extent that in a period, we’re not selling the same proportion as our installed base. By definition we’re going to lose some of the share of the installed base. And that installed base is, obviously, somewhat influenced by history. So, if beds are out there 10, 15, 20 years and haven’t been replaced and Hill-Rom had a much higher market share back at that point in time that’s influencing. And so if you look at the last couple of years, I think shares have been relatively stable between the two primary competitors including us, and we think we’ve done well competitively gaining a little bit of share over the last couple of quarters.

Bruce Nudell – Credit Suisse

Okay. I think in deference to the next speakers, we’ll move to the break out room and thank you very much.

Mark Guinan

Thank you, Bruce.

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