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Hill-Rom Holdings, Inc. (NYSE:HRC)

F1Q13 Earnings Call

January 24, 2013, 8:00 a.m. ET

Executives

Blair A. (Andy) Rieth – VP, IR

John J. Greisch – President, CEO

Mark Guinan – SVP, CFO

Analysts

Matthew S. Miksic – Piper Jaffray

David Roman – Goldman Sachs

John Demchak – Morgan Stanley

Lennox Ketner – Bank of America/Merrill Lynch

Robert Goldman - CLK

Gregory W. Halter – Great Lakes Review

Chris Cooley - Stevens

Ryan Halstead – Wells Fargo

Operator

Good morning, and welcome to the Hill-Rom conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. As a reminder, this conference call is being recorded and will be available for telephonic replay through January 31, 2013. See Hill-Rom’s website for access information. The webcast will also be achieved 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, either text or audio, is not permitted without the written consent of Hill-Rom. (Operator Instructions).

Now I would like to turn the call over to Mr. Andy Rieth, Vice President, Investor Relations. Please go ahead.

Blair A. (Andy) Rieth – VP, IR

Thank you, Stephanie. Good morning everyone and thanks for joining us on our first 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 forecasts 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.

Joining me today on the call will be John Greisch, President and CEO of Hill-Rom and Mark Guinan, Hill-Rom's Senior Vice President and Chief Financial Officer.

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. If you have additional questions, you may rejoin the queue.

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 a part of this archive.

With that, I'll turn the call over to John.

John Greisch – President, CEO

Thanks, Andy. Good morning, everybody, and thanks for joining us.

We're pleased to report that we delivered on our commitments for the quarter and that revenues and adjusted earnings per share of $0.47 were ahead of our expectations. Even though our earnings were lower than last year, our operating cash flow was ahead of last year and adjusted EBITDA was essentially even with 2012, demonstrating our ability to generate sustainable cash flow.

Mark will break down the numbers in more detail for you, but before I turn the call over to him, I want to provide a little more context on our first quarter results, comment on the external environment as we move into 2013, and review some of the primary areas of focus for our team as we move forward.

During the quarter, we returned over 40% of our operating cash flow to shareholders in the form of dividends and $20 million of share repurchases. As Mark and I have consistently stated, if there are no attractive inorganic investments on the horizon, we will return more cash to shareholders than our stated capital allocation calls for. This is exactly what we did in the quarter and we are committed to this strategy going forward.

Turning to our margins, we recognize that they are not where they need to be. This quarter was negatively impacted by volume declines in our higher margin North America capital business and by the growth we saw internationally where operating margins are still well below our corporate average.

In the face of these pressures, we continue to hold the line on SG&A. Excluding the impact of the medical device tax and intangible amortization from our 2012 acquisitions, we expect to have SG&A at roughly 30% of sales for the year as we have over the past few quarters. We remain committed to continuing to drive this down.

Turning to the external environment, we continue to see relative stability in our core markets on a sequential basis. Although revenues for our North America capital business were down as expected, capital orders in North America were up 4% compared to last year and were higher than any quarter since the fourth quarter of fiscal 2011.

Our North American capital order backlog is down from where it was a year ago, but it is up about 18% compared to the end of last quarter. This performance reinforces our comments over the past several quarters that we have seen relative stability in the North American market and we expect it to continue.

As Mark will discuss later, we still have some tough revenue comparables in North America ahead of us this year, but they will ease as we go through fiscal 2013.

Our rental business in North America remains challenging due to continued efforts by hospitals to reduce their operating and supply chain costs. We expect this to continue given the economic pressures they are dealing with.

Our rental business overall declined quarter-over-quarter, largely due to our previously-announced decision to exit the unprofitable portion of our rental business in the North America home care market. This accounted for about half of the decline in our global rental business.

Our international segment had a strong quarter with constant currency revenues up about 14%, excluding the impact of the Volker acquisition. We saw a strong growth in Latin America, the Middle East, and Asia-Pacific while European revenues, excluding Volker, remained relatively flat both sequentially and a year-over-year basis.

Orders in Europe have also been relatively stable. Given the macro environment in Europe overall, I feel very good about our performance in the region.

The respiratory component of our Respiratory and Surgical business had a challenging quarter consistent with the softening patient volume this segment of the industry has seen for the past several quarters. However, the first full quarter for Aspen has gone pretty much to plan. We have integrated the business where appropriate and I'm working with Greg Pritchard, Aspen's President, who joined our team to lead our respiratory and surgical business to ensure that we have the talent to drive the growth that we expect going forward.

So in summary on the environment, for the most part, I would say stability is the order of the day in most of our businesses. We will continue to see short-term volatility in our results given the capital and tender offered nature of our business. But the more cyclical parts of our portfolio appear to have settled down over the past few quarters.

Looking ahead, we expect the North American comparables to ease as we progress through 2013. In contrast, our international comparables will get tougher as the year goes on due to the unusual strength we saw in the Middle East and Eastern Europe in 2012. As a result, we expect our international business to be relatively flat year-over-year for the remainder of 2013.

So to sum up, while we started the year ahead of expectations, we recognize we have a lot of work ahead of us. As we have for the past three years, we will continue to identify opportunities to bring efficiencies into our cost structure and our supply chain in order to drive sustainable margin improvements going forward. Moreover, we will remain disciplined in our capital allocation strategy and as we did this quarter, we will return even more cash to shareholders when we do not have attractive inorganic investments available.

With that, let me turn the call over to Mark before we open the call to Q&A.

Mark Guinan – Sr VP, CFO

Thank you, John, and good morning to everyone on the call.

Before we get started, I want to highlight that many of the figures we will discuss today are adjusted for non-GAAP measures; reconciliations to our reported U.S. GAAP numbers are included in the appendix to our slide deck.

Now let's get started with revenue. On a consolidated basis, reported first quarter revenue increased 12.4% or nearly 13% on a constant currency basis to $428 million. The increase was driven by incremental revenue from our fiscal 2012 acquisitions and international growth, which was partially offset by declines in North America capital sales and enterprise-wide rental revenue. Excluding acquisitions, revenue declined approximately 2% compared to last year.

Capital sales increased 21.5% to $324 million driven by increases in our surgical and respiratory care and international segments. In both cases primarily due to the 2012 acquisitions within each segment, this strength was partially offset by a decline in our North America segment.

Consolidated rental revenue decreased 8.9% to $104 million. Approximately half of the decline was attributable to the previously-announced exit from unprofitable portions of our home care business.

Domestic revenue was essentially flat at $273 million, while revenue outside the United States increased 42% to $155 million led by the impact of acquisitions and growth in Latin America and the Middle East. On a constant currency basis, revenue outside the United States increased 44%.

Looking at revenue by segment, North America reported a decrease of 7% to $235 million with almost equal declines in capital sales and rental revenues. Capital sales declined by 6% to $159 million led by a decline in our patient support system sales of 10.1%. Capital orders for the quarter were up sequentially and slightly higher than any quarter in fiscal 2012 with backlog coming in 18% higher than our previous quarter.

Order patterns over the last four quarters reinforced stability in the North America capital business. North America rental revenue declined 9%. Absent the impact of the exit of a portion of our home care business, the North America rental business was down less than 4%. We continue to experience challenges with rental revenue due to ongoing reimbursement and other cost pressures on our customers. However, the higher rate of flu incidence has recently increased demand for certain of our rental products.

Moving to our surgical and respiratory care segment, revenue improved 84% to $59 million driven entirely by the addition of the Aspen Surgical business. Aspen generated incremental revenue of nearly $29 million in the quarter. Respiratory care revenues declined 8.1% primarily due to continuing softer volumes. On an organic basis, this segment's overall revenue declined approximately 5%.

International revenue increased 39.3% to $135 million or 41.7% in constant currency. Excluding the impact of the Volker acquisition, on a constant currency basis, international revenue was up 14% led by strong sales in Latin America and the Middle East.

Despite continued concerns over the economic environment in Europe, sales appear to be relatively stable looking at the trend over the last two years. We had a strong revenue quarter in our rest-of-world regions. However, given the unusual strength we saw in the Middle East and Eastern Europe during 2012, comparables will get tougher throughout the remainder of the year.

Moving to margins, we posted adjusted gross margin performance for the quarter at 45.8%, which represents a 240 basis point decline year-over-year. Both capital and rental adjusted margins were down with rental margins experiencing a slightly larger decline. The adjusted capital margin decline relates primarily to a higher proportion of international revenue. Commodity and fuel costs were relatively stable. The adjusted margin decline in our rental business relates primarily to the lower revenue discussed earlier and the resulting reduction in the leverage of our product's leak in field service infrastructure.

Sequentially, rental margins are identical to the fourth quarter of fiscal 2012 and slightly higher revenues. Rental margins continued to be an area of focus for us.

Regarding operating expenses, our R&D investment for the quarter increased 12.4% year-over-year. As we previously stated, we are anticipating the launch of our new ICU product later this year, which has been a key driver in the increase in R&D investment.

Adjusted SG&A expenses for the quarter increased by 13.5% year-over-year to $135 million. And were nearly flat as a percentage of revenue at 31.5%. Excluding the impact of the Volker and Aspen surgical acquisitions, adjusted operating expenses were essentially flat to the prior year period. As we integrate these businesses, we will continue to look for opportunities to increase our leverage of operating expenses.

On a sequential basis, adjusted SG&A is up $7.9 million over the fourth quarter of 2012. This higher SG&A is primarily attributable to the inclusion of Aspen for a full quarter, increased international selling and marketing costs, higher quality and regulatory spend, along with the unfavorable impact of foreign exchange rates.

Adjusted operating profit for the quarter was $44 million representing a 10.3% operating margin down 260 basis points versus last year's comparable results. This decline in operating margin is driven by the decrease in gross margin and an approximately 100 basis point impact of intangible amortization partially offset by other SG&A leverage.

The adjusted tax rate for the quarter was 32.6% compared to 31.7% in the prior year. The higher rate in the current year was primarily the result of reduced international income and lower tax rate jurisdictions and the expiration of the R&D tax credit, which was in effect for the first quarter of fiscal 2012.

As you are all aware, the R&D tax credit was reinstated retroactive to January 1st, 2012. We will recognize the related benefit beginning in our fiscal second quarter. This benefit will be recognized partly though a one-time catch up for the impact related to fiscal 2012 with a 2013 impact recognized as a reduction of our effective tax rate throughout the remainder of our fiscal year.

So to summarize the income statement, adjusted earnings per diluted share were $0.47 in the first quarter ahead of our guidance. This represents an 11% decrease compared to the $0.53 in the prior year comparable quarter. In the quarter, adjusted operating income for Volker was approximately break-even. And Aspen was accretive. We are projecting improvements in Volker starting this quarter as we benefit from SG&A reductions and lower product costs on certain of our Volker products.

One final comment on operating results before I move onto cash flow and our updated guidance for the balance of fiscal 2013. During the quarter, we had three items totally $7 million of pre-tax expense in our GAAP earnings that are not reflected in our adjusted results. These items were acquisition and integration costs associated with our recently acquired businesses of $3.5 million, a pre-tax charge of $2.5 million related to field corrective actions, and a $1 million litigation charge.

As we have discussed previously, with the intent of providing visibility to the underlying strength of our cash flow, we will continue to focus and comment on adjusted EBITDA. With the volatility inherent in capital sales and our recent and expected continued focus on merger and acquisition activities, our revenue and earnings can be somewhat volatile. Despite this, the cash generation of our respective businesses is much more stable. We believe the utilization of adjusted EBITDA provides insight into the underlying cash generating strength of our businesses. And is also a metric that we use internally to evaluate performance including as a component of our incentive compensation programs. Adjusted EBITDA for the quarter was even with the prior year at $75 million despite the 11% decline in adjusted diluted earnings per share I discussed earlier.

Moving now to cash flow, our first quarter operating cash flow was $65 million ahead of both our plan and the prior year. Operating cash flow increased 4% on lower earnings demonstrating positive working capital management and the increasing impact of non-cash expenses in our P&L related to our recent M&A activities.

During the quarter, we repurchased 700,000 shares of common stock for approximately $20 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 volume.

Now let's turn to our fiscal 2013 guidance. Our full-year guidance for reported revenue growth is unchanged at 78%. But we are updating our projection for adjusted earnings to reflect the positive benefit of the recently reinstated R&D tax credit. Our adjusted EPS guidance is now $2.01 to $2.11 per diluted share. This full year 2013 financial outlook reflects an organic constant currency revenue decline of 1% to 2%.

For the segments, our revenue decline of 1% to 2% in North America, approximately 65% revenue growth in surgical and respiratory care due to the late 2012 acquisition of Aspen surgical, and mid to high single digit constant currency revenue growth in our international segment aided in the earlier comparables by the acquisition of Volker. Gross margin of approximately 47% and R&D spending increase in line with our growth in revenue as we continue to invest in new and innovative products, flat SG&A as a percentage of sales excluding the impact of increased intangible amortization and the medical device tax. Intangible amortization related to 2012 acquisitions is $0.17 compared to $0.05 last year. And operating margin decline of approximately 200 basis points on the year driven by the impact of the medical device tax and amortization expense. Positive earnings accretion from both the Volker and Aspen surgical acquisitions, a tax rate of approximately 30%, and the number of shares outstanding for the year to approximately $61 million.

We project 2013 operating cash flow to be in the range of approximately $270 to $280 million, up $5 million from our previous guidance. We also anticipate $75 to $80 million of CapEx investment resulting in a free cash flow for the year of around $200 million.

And finally, we expect adjusted EBITDA to be in the range of approximately $315 to $325 million.

Now let's turn to guidance for the second quarter. Before I jump into the numbers, I want to provide some framing for expectations for the balance of this year versus fiscal 2012. As you were aware, our fourth quarter has historically tended to be our strongest quarter for revenue and earnings. However, last year the second quarter was the strongest quarter. For 2013, we are expecting to return to our typical pattern where the fourth quarter is the strongest quarter of the year. So for our second quarter, we are projecting reported revenue growth of 4% to 5% and adjusted earnings between $0.48 and $0.50 per diluted share. Compared to our first quarter, we are forecasting slightly higher revenue. And we also get the benefit of the R&D tax credit partially offset by the medical device tax.

With that, I'll turn the call back to John for concluding comments.

John J. Greisch

Thanks, Mark. Let me wrap up our prepared remarks with a few final thoughts.

We again demonstrated our ability to generate strong consistent cash flow even when our more sicklebill businesses are under pressure. The management team is highly focused on delivering strong cash flow and deploying it in line with our capital allocation policies as Mark and I have discussed.

We also recognize the need to continue improving our margins. As good as I feel about the margin improvement in cash generation we have achieved in the past three years, it is not enough. In addition to revenue growth challenges, we are now facing the burden of the medical device tax as well as increased intangible amortization from our 2012 acquisitions. Although the amortization is a non-cash item, it does negatively impact our operating margins in 2013 and beyond. In the face of these pressures, we remain committed to driving sustainable operating margin improvement as we look forward.

We will be holding our investor conference in New York on May 7th. We look forward to sharing with you our key strategic initiatives along with specifics around our planned margin improvement actions. I'm also eager for all of you to have the opportunity to hear directly from our leadership team about our plans for future value creation.

With that Operator, please open the call to questions.

Question-and-Answer Session

Operator

(Operator instructions). Our first questions comes from Matt Miksic from Piper Jaffray, your line is open.

Matthew S. Miksic – Piper Jaffray

Hi, good morning. Thanks for taking our questions. Can you hear me okay?

John J. Greisch – President, CEO

Yeah, we hear you fine, Matt. How are you doing?

Matthew S. Miksic – Piper Jaffray

Fine thanks. So, nice job it seems here on the cost containment side and the quarter in general. Two questions, one: It may have just been our estimates, but you called out some strength in the Middle East and Latin America. I’d love to understand if that’s – you know, how we should think about that going forward quarter-to-quarter. Whether there was anything in particular in the quarter, and then I have one follow-up.

John J. Greisch – President, CEO

Yes, I think Matt. As I think we said in our prepared remarks, our International business is going to flatten out year-over-year compared to last year and the strength that you saw here in Q1 is not going to be sustainable at the levels that we saw as you well know. You know, the business particularly in the non-European International regions tends to be tender driven and even more lumpy than some of our other cyclical businesses.

So, we did have strength in the Middle East in, I think the third quarter of last year, Middle East and Central Eastern Europe. We saw some strengths there again in Q1 on the back of very strong orders towards the end of last year. But, as we look forward, we expect that specific region – and Latin America also to slow down a little bit just based on the timing of the tender offers. And, you know, that’s the nature of the beast here. Short-term volatility and long-term expansion is the game plan, and we’re executing against that, but we are going to have some quarterly volatility particularly in some of those regions.

The International sales in Q1, I think were the highest percentage of our overall sales compared to any quarter for the last year or so, as the result of that strength that we saw. It impacted our margins as Mark mentioned, and as I commented in my prepared comments, that the comparables that we have going forward, again I think you’ll see stronger growth in North America, less growth in International, vis-a-vis prior year quarters.

Matthew S. Miksic – Piper Jaffray

Thanks. Very helpful. Then the second question was on some of your comments, just sort of understanding the context of some of your comments around the business trends sound encouraging in backlog and order rates. And it’s great to hear that that’s the way things are playing out, or at least played out in the last quarter. If you could help put that into context what looks like for the second quarter – I don’t want to say cautious, but maybe a little bit conservative guidance, or maybe there’s something in particular that you’d be able to call out. Just given that the R&D tax credit will be a benefit in the second quarter, I’m trying to understand how we should think about this next quarter, maybe the gives and takes?

Mark Guinan – SVP, CFO

Sure Matt, I’ll take a shot at that. As I said in my prepared remarks, you know, if you look sequentially we’re guiding to slightly higher revenue in Q2 versus Q1. And we certainly get the benefit – the catch-up on R&D tax credit and the quarterly benefit real-time in Q2. But that’s, you know, partially offset by the first time we have to pay the medical device tax. So, we don’t look at it as being conservative. The strength that we saw and some of the signs that John mentioned were things that we were planning on and expecting, and things that, you know, as you can imagine are necessary for us to hit the year or so. It’s certainly good news, and you know, not something we’ve seen in the last several quarters in terms of the strength of orders et cetera. It’s something that, you know, we were planning on and expecting. The good thing is it came through.

So, hopefully Q2 to Q1 makes sense. You know, as I said a slightly higher revenue would give us a couple pennies, but then the, you know, the R&D tax credit also several pennies more, but the net-device tax takes some of that away, which is why you see the slight increase sequentially in our APS guidance.

John J. Greisch – President, CEO

Yes, if you think of it at a very high level Matt, you know, slightly improved revenues sequentially as a result of the geographic mix improving from a margin prospective, slightly improving margins sequentially. And then the device tax and R&D credit as, Mark, indicated. There’s still a lot of moving pieces in this portfolio. You know, we’ve got, as you said, stability in our North American border rates for the last several quarters, and you right, it’s great to see particularly the first quarter of a fiscal year be the strongest quarter of order rates that we’ve seen in the last five quarters. That’s unusual, and that certainly supports, you know, stable to hopefully improving trends here in North America.

At the same time, you know, we’ve got the pressures in the rental business, respiratory care business is under pressure. Those two are, you know, two of our higher margin businesses. So balancing, you know, the positive trends with some of the headwinds and a couple of the portfolios along with the external factors that we can’t control, obviously the device tax and R&D credit, kind of is how we piece together the quarter and the rest of the year.

Clearly we expect improvement towards the second half of the year. I think Mark mentioned in his comments, you know, our traditional fourth quarter strength. We’re expecting that to continue because we’re seeing continued strength in the core business where we typically see that strength in Q4.

Matthew S. Miksic – Piper Jaffray

Great. Thank you very much.

John J. Greisch – President CEO

You bet. Thank you. Next question please.

Operator

Our next question comes from David Roman from Goldman Sachs. Your line is open.

David Roman – Goldman Sachs

Good morning everyone. Thank you for taking the question. I wanted just to follow-up on one – couple of comments that you made in your prepared remarks, maybe beginning with the discretionary piece of the puzzle. I think, Mark, you said that (NYSE:X) acquisition operating expense was roughly flat, but that’s in the context of down organic revenue. Can you just first start off by talking about the operating levers that exist in the model? I would think that with organic revenue down, there was enough you could do on the cost side to sort of balance out that trend in revenue. Is that not an accurate representation?

Mark Guinan – SVP, CFO

Well, just to be clear, I said SG&A was flat, not operating expense. So, R&D was up significantly over the year almost $2 million. And as I pointed out, that’s really related to some critically important investment behind the launch of our ICU product.

We also have a number of things that are critically important to build, including our (QUARA). So, we’ve substantially increased that investment, we see that as something that’s necessary. So, you know, David, certainly we’re always looking at tradeoffs between [inaudible] and things that we can lever back a little bit to your point.

As we gave guidance for the year, we talked about flat SG&A, whereas over the last couple of years SG&A was obviously being leveraged significantly. And that flat SG&A being if you exclude the device tax and [inaudible] amortization. And we said we thought that was the right level of SG&A for the long-term and short-term health of the business. So, that was obviously a decision, you know, strategic decision we made in terms of 2013.

So, as John pointed out, we’re going to continue to be on SG&A, and certainly expect it to get below the 30% level, but for 2013 we decided the right decision for the business was to hold it flat.

David Roman – Goldman Sachs

So, if I flip that around and take a scenario whereby the revenue eventually improves or you start to see some acceleration, there should be a decent incremental leverage because you’re not really – you’re not starving the business right now despite a weak top-line. Is that – would you agree with that?

John J. Greisch – President, CEO

Yes, David, this is John. I would definitely agree with that, and I’d probably add to that, in the sense that whether we see pickup in organic revenue or not, you should expect SG&A leverage going forward. And as you’ve seen over the last few years, it’s a bit more of a step function rather than just a linear let’s manage the cost perfectly in line with, you know, in reality what a relatively small this quarter organic revenue changes.

But as I mentioned in my comments a couple of times, you know, we need to do more work on our cost structure. We recognize that. We’ll obviously talk about that more in May. And you should expect cost leverage going forward. It may not be perfectly linear quarter-to-quarter, but you know, the short-term volatility will manage through with a goal of long-term margin expansion being the goal.

David Roman – Goldman Sachs

Okay, and maybe just one last one on your comments on GAAP allocation. I know you’ve been very clear on this, but if I look at the cash generation, the business, in spite of all the earnings volatility, it’s extraordinarily attractive. You are integrating some fairly large deals right now, so I’m just sort of wondering your near term or sort of logic around not looking to return more cash to shareholders as you integrate these transactions, and sort of as we wait to see a pickup on the revenue side of the equation.

John J. Greisch – President, CEO

Well, as you saw what we did in the first quarter, you know, we returned I think more than 40% of our operating cash flow to shareholders, which is double out stated capital allocation. I think you should expect us to continue to aggressively return cash to shareholders through both dividends and buybacks in the absence of deals. And you’re right, we have a lot on our plate right now, and we’re focused on doing that at the moment.

David Roman – Goldman Sachs

Okay, thank you very much.

Operator

Our next question comes from David Lewis from Morgan Stanley, your line is open.

John Demchak – Morgan Stanley

Hello. This is actually John Demchak in for David.

John J. Greisch – President, CEO

Hey, John.

John Demchak – Morgan Stanley

Hi. So, a lot of the lower margins appear to be related to the higher year [inaudible] mix. Where are we in initiatives to drive up the European margins, and how high do you think they can go?

John J. Greisch – President, CEO

Well, we’re still in the early innings as they would say. Everybody on this call is well aware of, you know, the revenue headwinds in Europe. We’re dealing with those as much as anybody. We’ve taken actions over the past couple of quarters as we integrated Volker and consolidated activities, you know, with our existing operations in Germany and in other markets where Volker had a presence. At that same time, we are investing in our European Management Team, we pretty much have that behind us now. But, we’re continuing to look at cost opportunities in Europe and portfolio shifts in Europe.

But the headwinds that we and everybody else is experiencing in Europe certainly has proved to be a bit of a rate retarder on the margin expansion, but we still have more ahead of us John. I think it’s going be quite a while before they get anywhere near what our North American margins are, but this quarter significantly higher than last quarter. First quarter last year in terms of our International margins, but as I mentioned in my comments, not just in Europe but in other regions. You know there’s going to be some short-term volatility on that, but we’re continuing with a high degree of focus to take cost out where appropriate and expand our International margins.

I’d rather not specifically comment on where they’re going to go. Continued upward trends is obviously our objective here.

John Demchak – Morgan Stanley

Okay, thank you, very helpful. And also with I guess yourselves reporting and also a competitor, I was wondering if you had any thoughts on how much of your – I guess the revenue this quarter was related to maybe stabilization or improving market [inaudible] or more related to share?

John J. Greisch – President, CEO

Well, from what I’ve seen, the competitive year-over-year change in the comparable products category to our patient support systems business here in the United States was pretty much dead on hours in terms of year-over-year change. So, it would appear that there’s, you know, as I said in my comments, relative stability in the market based on our order rates anyway, and relative stability in at least the two largest competitive performances here.

And again, I don’t really focus on one quarter sales change, as much as you guys do. I think the long-term trends are more important, and I think that’s been stable here in recent quarters as well.

John Demchak – Morgan Stanley

Okay, thank you guys.

John J. Greisch – President, CEO

Thank you John. Next question please.

Operator

Our next question comes from Lennox Ketner from Bank of America. Your line is open.

Lennox Ketner – Bank of America/Merrill Lynch

Hi guys. Thanks so much for taking the questions.

John J. Greisch – President, CEO

Good morning.

Lennox Ketner – Bank of America/Merrill Lynch

Good morning. I guess, first Mark, if you could maybe just speak to your gross margin expectations for the full year. You [inaudible] your guidance for 47%, which honestly is doing some pretty meaningful improvement from Q1 levels. I wonder if you could just speak to what you expect to drive that improvement over the course of the year. I know it sounds like North America might get a little better, it also sounds like you’re expecting maybe less of a contribution from emerging markets over the course of the year, which it think you said at the top, is certainly a profitable business. So, maybe if you could just give people a sense as to what you expect to drive that gross margin improvement in the coming quarters?

Mark Guinan – SVP, CFO

Certainly Lennox. I appreciate the question. It really is – a majority of it really is (NEX) driven, so we’ve talked about it in the past, there’s a number of mixed factors that really impact our gross margin. Rental versus capital is one of those. We’re not expecting that to materially improve, but we’re not expecting that to materially erode for the balance of the year. We talked about geographical mix, and yes, absolutely that will be a factor. And despite our comments about the Middle East, and that being a profitable segment, if you look at total International and its contribution for the balance of year and our expectations, it will be smaller than it was in Q1. So, that will give us some mix left.

And then finally, importantly is product mix. We talked last year as the, you know, business was declining in North America, that it was heavily skewed in the patient support systems area relative to the other businesses within North America Capital. And was even skewed more in the upper end so, in the ICU part of our business, and then in the upper end Med-Surge piece as well. And that was true not just in North America, that was also true in Europe, ICU declined significantly more than the business overall.

As we look forward, a combination of the order trends we see, and the launch of our new ICU product, we are expecting that product mix to be substantially better as we get later in the year.

So, it’s really the drivers and the geographical mix becoming more favorable, which is a reversal of the trend we’ve seen over the last several quarters, and the product mix within mostly North America, but also within International as well that we’ve seen reversing the trend and becoming positive as we go forward, certainly aided by the launch of our new ICU product.

John J. Greisch – President, CEO

Lennox, this is John. Just to add one thing to what Mark said. I want to make sure that we’re clear on this. The rest of world regions bottom line dropped through is very attractive, very profitable. The gross margin in most of those regions tends to be below average, but we have very little SG&A in those regions. So, less rest of world revenue is actually going to be accretive to our gross margin for the rest of the year.

Lennox Ketner – Bank of America/Merrill Lynch

Okay, that’s really helpful thank you. And then…

John J. Greisch – President, CEO

Just one other point too, one other point too about the strength of that Q4. We talked about returning to that sort of historical pattern where we have a strong Q4, which allows us to have some greater absorption and improved margins in that fourth quarter as well.

Lennox Ketner – Bank of America/Merrill Lynch

Okay, very helpful, thank you. And then I’m wondering, you said that the Aspen integration is going well. I’m wondering if you could just talk a little bit about your growth expectations for that business, you know, kind of long-term, what you would expect that business to grow and how that compares to, you know, market growth in that segment. Whether it’s based on the actual market growth or taking share, just any collar you can give on your growth expectations for that business?

John J. Greisch – President, CEO

Yes, I think as you guys know, you know surgical procedures are growing in the low single digits. The incremental growth we expect from Aspen above that is going to be more driven by some product mix shifts to – I think we talked about this when we bought Aspen, you know, to a higher priced, higher safety featured product grouping particularly within the Bard-Parker scalpel portfolio within Aspen. So, our target over the next several years when we acquired it was, you know, call it low to mid-single digits. You know, slightly above market.

Operator

Our next question comes from Robert Goldman from CLK. Your line is open.

Robert Goldman - CLK

Okay, thank you and good morning.

John Greisch – President, CEO

Good morning, Bob.

Robert Goldman - CLK

Good morning. Would you mind giving us just sort of an update on the Batesville manufacturing facility? I gather there was an FDA re-inspection at the later part of calendar 2012. Could you share with us if there was a Form 483 and if there was, you know, any details that you could provide about it, and what the past forward is to fully resolve the issues at Batesville?

John Greisch – President, CEO

Sure, Bob. As we disclosed last year, we received a warning letter in the spring of 2012 on the back of an inspection in October of 2011. As part of a routine follow up to the 2011 inspection, the agency came in and re-inspected Batesville in October/November of 2012. We did receive a 483 as part of that inspection. I think Mark commented on the increased investment in our QA/RA organization as being one of the factors driving our SG&A up year over year and we’re continuing to invest in that area to ensure that we’ve got the appropriate resource and capability across the company, not just in Batesville. And we are marching towards the remediation plan that we committed to the agency after we received the warning letter and that remediation plan is on track and in progress.

Robert Goldman - CLK

And if I can as my follow up, sometimes as part of the remediation plan, you know, there would be some sort of a third party audit, you know, prior to inviting the FDA in for sort of their final inspection. Is that the case here and could you give us any sort of timing if it is on when that third-party audit might be?

John Greisch – President, CEO

I’ll just comment on what’s included in the warning letter, with which includes, you know, our bringing a third party auditor to assist us as part of the remediation process and we’re working with that company as we committed to and as was suggested in the warning letter.

Robert Goldman - CLK

Okay, thank you.

John Greisch – President, CEO

All right, Bob. Thank you.

Operator

Our next question comes from Greg Halter from Great Lakes Review. Your line is open.

Gregory W. Halter – Great Lakes Review

Thank you. Good morning.

John Greisch – President, CEO

Hi, Greg. Good morning.

Gregory W. Halter – Great Lakes Review

I just wonder if you could elaborate a little more on the field corrective action and whether or not those in charge will be ongoing or continuing.

John Greisch – President, CEO

Yeah, Greg, this is John. You know, as we mentioned last year, and again, it’s not inconsistent with my comments I just made to Bob’s question. We have been investing to improve our quality function and ensure that we’re on top of, you know, both the quality system improvements that we need as well as any product issues that we identify. And you know, this is a second action that we identified requiring some field corrective action activity on one of our med-surg products. It covers what is anticipated to be needed for this action. Might there be more in the future? I’d rather not speculate on that. You know, every device company in the world is dealing with field corrective actions every now and then. We think we’ve got the ones that we know about well under control and with this charge certainly accounted for and it’s part of really the quality improvement program that we’ve been marching towards here over the last couple of years.

Gregory W. Halter – Great Lakes Review

All right. And another one on the litigation of the million dollars. Does that relate to the case versus Stryker or is there something else involved in there?

John Greisch – President, CEO

No, it’s a completely separate situation. I’d rather not comment on the specifics, but it’s got nothing to do with that.

Gregory W. Halter – Great Lakes Review

All right. Thank you.

Operator

Our next question comes from Chris Cooley from Stevens. Your line is open.

Chris Cooley - Stevens

Good morning, and thank you for taking the questions.

Mark Guinan – Sr. VP, CFO

Good morning, Chris.

Chris Cooley - Stevens

Just two quick ones. One, when you think about the domestic opportunity, I realize that’s – you’re playing with the cards that you’ve dealt, but are there opportunities there to either improve the revenue growth from mix or from shortening the replacement cycle more aggressive to coupling of the service and the frame? I realize that’s going to take some time to see that play through in the P&L due ot the nature of the business, but just curious if you see opportunities for that over say the next two-to-three year period that would also maybe enhance the margin and the cash flow?

And then just the final quick question there, you guys have been great, very transparent in terms of the capital allocation strategy. But just in the dividend, any thoughts at setting a target on the yield itself? You are in kind of a unique position there to maybe have a higher dividend yield than many companies in the med-tech space. I would think that would make this Hill-Rom proposition even more so attractive, but just curious about your thoughts there. Thanks so much.

John Greisch – President, CEO

Chris, this is John. Let me take the first part. As you said, the hand we’re holding is the hand we’re playing, you know, and as you all know, at least in North America, the bedframe market and surface market is relatively flat. That said, our opportunity to capitalize on that market as much as possible is going to be driven by the technology enhancements that we bring into the market to address our customer’s increasing needs for lower cost, improved outcomes, improved patient safety, et cetera. I think Mark commented on the introduction of our new ICU bed offering later this year. We certainly hope that will accelerate replacement cycles; feedback from customers has been very positive on that thus far in terms of the beta testing that we’ve done. We will continue to do that with our med-surg portfolio going forward. And the more technology we can bring out to get at the things I just mentioned, you know, enhanced outcomes, lower costs, et cetera, that’s going to enable us to accelerate some growth opportunity in a challenged unit volume market.

The margin expansion that, you now, I’ve commented on, we’re going to drive that we have over the past three years regardless of the revenue headwinds that we may be facing going forward. So product mix changes as well as, you know, as we did with Aspen, you know, and LECO. What other products can we add to the Hill-Rom value proposition in addition to what I commented on in terms of new products and next-generation enhancements to really capture our share of the hospital market in which we play in right now. I’ll turn the dividend question over to Mark.

Mark Guinan, Sr. VP, CFO

Thanks for the question. You know, when we put forward our capital allocation strategy when we introduced it at the investor conference back in May of 2011, obviously we put a lot of thought into that and we felt that was the appropriate allocation in order to maximize shareholder value creation. We constantly, you know, re-evaluate, consider; we certainly wouldn’t want to constantly change the strategy. We like to give the strategy a while to, you know, ride out and see how it’s doing. But we’re certainly in rigor conversations about whether that is the best value-creating allocation of our healthy-healthy cash flow.

I will tell you that as part of the investor conference, you know, it’s coming in May, you certainly can expect to hear from us, whether we will continue with that strategy or if need to adjust it in some way. But I appreciate the input and certainly, we get a lot of that in terms of whether the allocation strategy today should be what it is in the future and we’ll give you more of an update in May.

Chris Cooley - Stevens

Thank you so much.

Blair A. (Andy) Rieth – VP, IR

Chris, one other thought too about R&D investment and accelerating that cycle. As we’ve mentioned before, we are making investments in R&D to improve the clinical and cost effectiveness information that we can share with customers. So that’s part of our investment as well.

Chris Cooley - Stevens

I appreciate that, Andy. Thanks so much.

Operator

Our next question comes from Gary Lieberman from Wells Fargo. Your line is open.

Ryan Halstead – Wells Fargo

Thanks. Good morning. This is Ryan Halstead on for Gary.

John Greisch – President, CEO

Hey, Ryan. Good morning.

Ryan Halstead – Wells Fargo

I was wondering if you could – could you please repeat the 2013 North America revenue growth guidance?

Mark Guinan – Sr. VP, CFO

Yeah, organic decline of 1 to 2%.

Ryan Halstead – Wells Fargo

Okay. And then, I guess, going back to the stability you mentioned that you’re seeing in the North America capital markets, I was hoping you could provide some sense of the specific environments you’re seeing in the acute care portion compared with the former post-acute segment?

John Greisch – President, CEO

Yeah, those comments, Ryan, are exclusively related to the acute care segment.

Ryan Halstead – Wells Fargo

Okay.

John Greisch – President, CEO

In terms of the stability and the 4% growth year over year in terms of border rates and the strongest quarter of the last five. So that really is the acute care channel that they – the post-acute segment that’s now managed within that North American business unit is relatively small.

Ryan Halstead – Wells Fargo

Great. And then as far as the capital orders and the backlog that you guys cited, are you able to provide how much of that is for the patient support systems?

John Greisch – President, CEO

We don’t break that out.

Ryan Halstead – Wells Fargo

Okay. And then, I guess, any general thoughts on the acquisition environment?

John Greisch – President, CEO

Nothing specific. I think, you know, as evidenced by our share repurchases in the first quarter and our comments, you know, there’s nothing on the horizon and we’re focused on making sure that we’re maximizing the performance opportunity of what we’ve got right now and working on the Aspen and Volker businesses.

Ryan Halstead – Wells Fargo

Okay, great. Thank you.

Operator

(Operator Instructions). Our next question is a follow up from Lennox Ketner from Bank of America. Your line is open.

Lennox Ketner – Bank of America/Merrill Lynch

Hi, thanks so much. I have a very quick follow up for Mark on the restructuring that you guys implemented last year. I think you expected that to be 18 million in savings once it was fully implemented. Should we assume at this point that that, you know, full 18 million has worked its way through [inaudible] or is that another potential as far as the savings going forward?

Mark Guinan – Sr. VP, CFO

Yeah, it’s worked its way through in terms of all of the actions that we planned at that time have been executed, Lennox. I think we also shared some of that benefit we experienced in 2012, a good proportion of it and some of it, you know, started this year. But you should assume that those savings have been executed and therefore are helping us with our SG&A.

Lennox Ketner – Bank of America/Merrill Lynch

Great. Thanks so much.

Operator

I’m showing no further questions at this time. I will now turn the call back over to management for any closing remarks.

Blair A. (Andy) Rieth – VP, IR

Thanks, Stephanie, and thanks everybody for joining us today. We look forward to speaking with you. Have a good day.

Operator

Thank you, ladies and gentlemen. That does conclude today’s conference. You may all disconnect and have a wonderful day.

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