Hill-Rom Holdings, Inc. (NYSE:HRC)
The 31st Annual J.P. Morgan Healthcare Conference Call
January 10, 2013 12 PM ET
John Greisch – President and CEO
Kim Gailun – JP Morgan
Kim Gailun – JP Morgan
Okay. Good morning. I think we’ll go ahead and get started. I’m Kim Galen with the J.P. Morgan MedTech team. And presenting next, we’re happy to have Hill-Rom. So, I’d like to introduce Hill-Rom CEO John Greisch and after the presentation, we will go down the hall for break out in the Olympic room. One final reminder, please turn-off all cell phones in the audience. Thanks. John?
Thanks, Kim. Good morning, everybody. And thanks to Kim and JP Morgan for the opportunity to present to everybody this morning. What I’d like to cover this morning is a brief overview of the profile of Hill-Rom that the business that we’re in, review of our strategic focus areas, talk a little bit about 2012 and recent accomplishments that the company has achieved, touch on our continued disciplines, capital allocation framework and then talk a little bit also about the acquisition of Aspen Surgical that we made last year. Just to start off, I’d like to refer everybody to our SEC filings in the event that we discuss any non-GAAP financial information here this morning.
A quick overview of the company; for those of you that aren’t that familiar with us, we’re market leader in the patient handling area. We cover the entire acute care spectrum. Many of you think of Hill-Rom as a bed company only or primarily, we’ve got a much broader product portfolio covering not only acute care and post acute care beds, but also therapeutic surfaces, patient handling equipment with our patent lifting portfolio. The Liko acquisition that we made a few years ago, a growing surgical products franchise and a respiratory care franchise, all focused on either patient safety, improving outcomes or caregiver productivity.
As many of you know, company has been around a long time, very, very strong market positions in all our key markets, about $1.6 billion to $1.7 billion in revenue with very strong cash flows even through the challenging cycles as we’ve been through here over the past couple of quarters, and I’ll touch on that in a few moments.
One of the real strengths of the company that we’re trying to leverage and we’ll continue to leverage going forward is the market position that we enjoy, we’ve got over 70% installed base market share in the acute care, bed frame and surface market, tremendous brand name and very, very strong market presence and brand equity within the acute care and post acute care markets here in United States and overseas.
Financially, as many of you know, we’ve been committed to continuing to improve the operating performance of the company, I’ll touch on that in a few minutes, but we’ve seen some significant financial improvements, not without some speed bumps along the way, but good margin improvement and very, very strong cash generation coming out of the strong franchises that we enjoy.
Most of our businesses are either number one or number two in the global sectors in which we operate. On this slide, as you can see, patient support systems, which is largely our bed frame and therapeutic surface product categories a very, very strong, number one position in that area. We’ve also got a strong rental business. We’re in and out of hospitals everyday through a very broad service network that we have here in the United States and in Europe. So, the service capability together with a strong product portfolio that we have allows us to enjoy that number one position going forward.
Our Respiratory Care business, which really is a niche respiratory business serving patients such as cystic fibrosis patients with airway clearance challenges, strong number one position in that business, along with our recently acquired consumable surgical products, Aspen Surgical, which I will touch on later.
On the right side of this slide are Allen Medical surgical positioning business, strong number two along with patient lifts and healthcare furniture. So very strong franchises, really in all parts of the company, either strong number one or number two.
In terms of how the business breaks down, couple of things on this slide. We’ve rebranded our segments, if you will, we’ve broken out following the Aspen acquisition, our Respiratory and Surgical business into a separate reportable segment. That business today is about $250 million on an annualized basis. This slide here is representing the percentage of our revenues in 2012. We acquired Aspen, so that the 9% is not fully reflective of a contribution that Surgical and Respiratory Care will be, but going forward think of it as about a $250 million franchise, so slightly more than 9% of the total revenues of the company.
Our North American Patient Solutions business, that’s largely our acute care hospital business, where our patients supports systems, our IT business and our service offering falls. But take away from this slide is, whether it’s by reporting segment, business model or geographic split, a fairly diverse portfolio which gives us a flexibility to ride through the cycles that this business inherently has to ride through with the capital spending cycle.
Just one point on the business model mix here in the capital consumable, and software and services segment, that’s made up of our capital sales, which tends to be the biggest topic of discussion, any time we sit down with investors, but also in there is Aspen, it’s about a $120 million consumable surgical products business, and our IT and services business as well. So, of the 73% about 15% of that is represented by Aspen, and our hospice business and, service business. So, it’s not quite, 73% dependent on capital only.
I don’t have to tell anybody in this room about the challenges that our customers are facing, our success historically in going forward is going to be based on our ability to continue to address our customers’ needs to reduce costs, improve patient outcomes, and improve caregiver productivity.
Every one of our customers, you guys hear this from every single company, hear this week, is looking to take out significant operating costs out of their cost structure, we think our products help them do that in many ways, whether it’s our lifting portfolio that addresses both mobilizing the patient faster, getting them in and out of the hospital faster or addressing caregiver productivity, back injuries, and the like.
Also our therapeutic surfaces and the technology that we have in our bed frames, helps reduce, acquired – hospital acquired conditions such as pressure ulcers, patient falls, things that are going to become increasingly important to customers, particularly here in the United States with respect to re-admissions and re-imbursement going forward.
So, all of the challenges on the left hand side of this slide and I won’t go through every single one of them, I think our products collectively bring a lot of value to our customers and certainly help support the strong market positions and the strong profitability that we enjoy across the portfolio.
Internationally, obviously, increased access to healthcare is a big opportunity for everybody. Internationally, our non-European rest of the world business is still relatively small growing at a nice rate. We saw very good growth in 2012, in the Middle East and Eastern Europe, where significant investments going into new hospital construction and good bulls – good growth in China where the hospital bills are also growing significantly, so relatively small in Asia, but I think we’ve got a portfolio today, and an increasing focus on developing products for the emerging markets to give us greater growth opportunity in those markets going forward.
I’ll just touch on what we’ve been focused on the last few years and on the next slide; I’ll touch on some of the accomplishments here. I think you’ve heard me talk about this before and what attracted me and the team that I’ve brought into the company are really the things on this slide, the ability to leverage the strength of the Hill-Rom brand and the Hill-Rom channel presence that we enjoy here in the United States and across the world.
We have increased our investment and innovation, I’ll touch on the next slide, we are about to launch a new intensive care product here for the United States and rest of the world markets. I’ll touch on some other products that we’ve recently launched, but it has been the lifeblood of the company historically, and we significantly increased the investment in R&D to ensure that we maintain a competitive edge with respect to our product portfolio going forward.
International expansion has been a big focus for us, both the Völker acquisition as well as other investments we’ve made in other regions, which I’ll touch on here in a few minutes. We still have profitability, improvements, objectives internationally that we are not where we want to be with respect to the profitability of our international markets, but certainly a continued focus going forward. Acquisitions and financial performance improvements obviously have also been a critical focus for us.
And on the team, I think most of you know, I brought in a highly experienced senior leadership team to the company over the past two to three years, and I think we’re all very excited about the opportunities that lie ahead as we execute against these objectives here.
So in terms of what we’ve done along these focus areas, in terms of leveraging the channel, as I mentioned in my opening comments, this is really one of our key opportunities going forward. The Hill-Rom brand, the market position we’ve got, the relationships we’ve got with customers second to none in the acute care hospital channel. I think Liko, which was acquired back in 2008 before my arrival, the Völker acquisition and Aspen acquisition, all are really directed towards leveraging the Hill-Rom presence, the Hill-Rom relationships in the acute care and post acute care channels.
We’ve also made a lot of efforts over the past couple of years in right-sizing the service infrastructure. This is a key strategic asset for us. We’ve got about 140 service depots around the country here in the States and about 40 to 50 in Europe. As our hospital customers are looking to reduce their costs, they’re going after every supply chain dollar that they have in their cost space that includes the rental business and as that business is under pressure and the value requirement for us to bring value to our customers increases, we’ve right-sized that service center network cost structure over the past couple of years.
I mentioned the focus on innovation, we’ve increased our R&D spend about 20% over the past couple of years even in a challenging top line environment. We are about to launch, as I mentioned earlier, a new intensive care unit, bed frame, new technology, new features that has been very well received by customers who have had a chance to beta test it here and in Europe. Brought out a new powered stretcher last year to strengthen our stretcher portfolio, which was less than competitive relative to the competition. Then internationally, we’ve enhanced our Med-Surg portfolio, while at the same time adding to it and our long-term care portfolio with the Völker acquisition. And on the surgical side of the portfolio, both with our Allen Medical capital business and Aspen, we continue to introduce new products to those portfolios.
Internationally, I mentioned not only the Völker acquisition, but we’ve invested pretty heavily in the Middle East, I think many of you know there is a lot of investment going into that region, looking for U.S. technology or European technology. We have significant market shares in that region on the back of the investments that we’ve been making, and Asia has been growing double-digits for us, still relatively small, but long-term remains an attractive opportunity for us. Aspen and Völker, I have touched on.
Financially, if you go back to 2009-2010, when I got here, we’ve improved our operating margin substantially. It doesn’t feel like it necessarily coming off of 2012 with some of the bumps we’ve had with our stock performance, but it was a record year for us in terms of revenues, EBITDA and operating margin for 2012. So, despite the challenges that we’ve got with the top line pressures, particularly in the U.S. capital business and in Western Europe, I’m pretty pleased with the performance that we had in 2012. And as you see here operating cash flow, which has been a critical focus for us is also up about 18% over 2011. The leadership team, I touched on earlier, as you would suspect all of our incentives are highly aligned with those of our shareholders.
So, what’s on the list of, what we feel good about over the past several years? The acquisitions that we’ve made, Völker filled a large gap for us in Europe and in our long-term care portfolio, not only in Europe, but across the world. Aspen, really was the first diversification move that we’ve made, certainly since I’ve been here and I think that again encompasses all the things that I talked about earlier in terms of leveraging the channel, giving us another business with less dependency on the capital cycles that you guys don’t like and have difficulty understanding. And one of the objectives of Aspen was not only to leverage our acute care relationships, but also begin to give us less exposure to the capital cycle and I think you can expect us to see, expect us to look for more opportunities along those lines going forward.
I mentioned the operating margin performance, a lot of this was accomplished in 2010 and 2011, but over the last three years we’ve seen significant margin improvements in this business. We’re committed to continue to drive operating margin going forward even in the challenging top line revenue environment that we are experiencing now and we expect to continue to experience going forward. So, cost reductions, manufacturing improvements, supply chain improvements, we’ll talk a lot more about this at our Investor Conference in May, but we are committed as a management team to continue to drive operating margin performance going forward.
Internationally, I mentioned earlier, I’m not pleased today with where the profitability of our international operations are. We’ve made a lot of investments in that – in that business and in those markets over the past couple of years and today, including Canada 34% of our revenues are outside the United States with continued opportunities to improve the profitability there.
We have gone after the cost base pretty aggressively, as you see here, through a couple of different restructuring actions. We’ve taken out over 400 jobs while we’ve added a couple of acquisitions, I think we started talking about early on. After my arrival, the need to get our SG&A below 30%. We were just barely under that in 2012 and as I mentioned, committed to continue to go after our cost base very aggressively.
So, continued improvement in our operating margin very important strategic objective for us and I think the success that we’ve achieved even in a tough topline revenue environment the last few years, hopefully is evidence that we’re committed to do so regardless of the environment.
In terms of shareholder returns, as you can see here, we’ve also deployed quite a bit of capital back to shareholders something that the company had not done a lot of historically. We repurchased over $159 million of shares over the past couple of years and you’ve seen about a 10% dividend increase in each of the last two years.
In terms of cash flow, I think this is a really important takeaway for the business. I think the Street has trouble understanding – understandably so, the cycle. I spend most of my time, as does Mark, talking about where are we in the bed cycle, and my answer often times is it doesn’t matter.
This is a cyclical business as currently constituted and as you see here, despite the cycle, we’re able to continue to drive consistent and improving cash flows over the past three years. I’m not saying the cycle is something any of us can ignore, but it is a fact of life for our business portfolio today, but despite that the commitment that we’ve got and obviously the obligation we have to our shareholders is to continue to address whatever leverage we can to drive the kind of cash flow that we’ve achieved here in the last three years.
So, very proud of the consistent growing cash flow that we have achieved here over the past three years. And in addition to strong EBITDA, the free cash flow generated by the company significantly above our net income, so the free cash flow conversion rate over this timeframe has also improved, and I think you’ll continue to see that going forward. So, very, very strong cash generation coming out of the business.
What are we going to do with that? What have we done with that? I think Mark and I, laid this out a couple of years ago in terms of the capital allocation framework that we’re committed to. We’ve gotten a lot of questions, particularly after the acquisitions of 2012, are you guys deviating from what you laid out two years ago? I think this shows we are not. Relative to CapEx and returns to shareholders, as you can see on the right side of the slide here, we’re right in the middle or ahead of our framework objectives for CapEx and returns to shareholders.
We are committed to sticking to this framework. We were able to accomplish the $500 million of acquisitions in 2012, really on the back of an unlevered balance sheet that we’ve had the last several years, but how we use our operating cash flow or free cash flow, we’re committed to this framework. We recognize both the appetite and the need to return cash to shareholders, and you can certainly count on us sticking with the discipline that we’ve had, and the commitment to this framework going forward.
In terms of M&A, I think as you see here, we have targeted 45% to 60% of our operating cash flow for inorganic investments. In the event that nothing needs our return requirements, you should expect us to plough more cash into the shareholder return part of this chart on a short time basis.
Over time, I think this is the right allocation for us; again one of the strengths in the portfolio is the ability to generate strong cash flow and our commitment to you guys and to the Street is to use that in as disciplined way as possible. It doesn’t mean we won’t be doing acquisitions, but it does mean we’re not going to be doing acquisitions just for the sake of growing the company to the extent we can’t find strategically relevant acquisitions at the right financial value you should expect us to return more cash to shareholders.
We’ll just touch on Aspen real quickly. I’ve gotten lot of questions over the last six months, why did this make sense to us? I think I’ve touched on it a few times already this morning, but again the opportunity to add to the value proposition that we bring to our customers was, point number one, it gave us an opportunity to build what already was a very profitable but small surgical franchise within our portfolio, Allen Medical, which is our patient positioning – patient support positioning business, is about $50 million capital business growing nicely, very profitable, selling into the OR, Aspen has the same call point in the OR with a disposable, consumable revenue stream.
Also had a very strong brand name with the Bard-Parker brand that they bought from Becton-Dickinson a few years ago, and lastly but certainly not least, very strong profitability for the business. Now we paid about $400 million, roughly 10 or 11 times EBITDA, not cheap, but certainly not out of market in terms of the price for high margin, attractive assets, and going forward we think it’s really going to be able to be leveraged with our relationships and enable us to continue to look at opportunities to build a surgical franchise.
So, we are four months into it, we’re very pleased with the business, pleased with the leader that came with the business, who is now responsible for not only Aspen, but also our Respiratory Care business, and our Allen Medical capital surgical business.
So, in summary, we’re obviously in a challenging time, I don’t need to tell you guys that. We’re probably more on the leading edge of challenging times, given the capital intensity that we have in our portfolio. Despite that we’ve continued to drive financial improvements in the business, continued to generate significant cash flow and continued not only to add strategically to the portfolio, but return significant cash to shareholders. We’re not going to change that focus, we’re going to continue to look for opportunities to leverage all the strategic focus areas that I talked about while at the same time maintain a very disciplined approach to our capital allocation framework that we laid out.
So tough times for capital intensive business like Hill-Rom, but as I mentioned whether we’ve got a growing top line revenue environment as we had back in 2011 on the capital business here in the United States or a more challenged one as we had in 2012, I think our ability and our commitment to continue to drive financial performance improvement in the company is something you guys should certainly expect to continue to see us accomplish and whatever it takes given the environment that we are in, we’re committed to continue to drive improved operating margins going forward and deploy our cash in a disciplined way. So, thanks very much for your time.
[No Q&A session for this event]
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