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Hill-Rom Holdings Inc. (NYSE:HRC)

Credit Suisse Group Healthcare Conference

November 09, 2011 5:30 PM ET

Executives

Bruce Nudell – Medtech Analyst, Credit Suisse

Mark Guinan – CFO

Andy Rieth – VP, IR

Bruce Nudell

Good afternoon everybody. I’m Bruce, and I’m a Medtech Analyst for Credit Suisse. It’s my great pleasure to welcome Hill-Rom to our conference. As you know, they’re infrastructure supplier across the Care Continuum. Mark Guinan is here. And, take it away Mark.

Mark Guinan

Thank you, Bruce, I appreciate it. And thank you all for attending. I’m going – in the next couple of minutes give you a little overview and background on the company. And then, obviously I would appreciate any questions you might have after the presentation.

Before I jump into the presentation, just the usual caveats about forward-looking statements that might be in the next couple of slides and then in some of the things that I share.

Looking at the company, Hill-Rom overview, we are a global leader in medical technology across the Care Continuum. We go from the Acute Setting in the hospital through Post-Acute into extended care and home care facilities. We have patient handling, mobility and environment systems. And we also have a health information technology business as well.

We’re a company that’s been around for a while, 80-year history based headquartered in Batesville, Indiana. And in fiscal 2011, we were approximately $1.6 billion. Great brand recognition in market presence, certainly our customers know the Hill-Rom name, they know what comes with it. And it’s certainly a positive image of quality and innovation. We do generate revenue from capital sales, rental and service. And we have a solid international footprint with revenue sources in over a 100 countries around the world today.

In the businesses in which we compete, we hold a number one or number two position in each of those categories, I won't go through each of these but you can see it on the left hand side that, about half of our categories, we hold the number one position and a little more than half categories, we hold the number two position. So, we hold a very competitive place in the marketplace. And you know we attribute that to the competitive differentiation in the value proposition that we bring across that Care Continuum.

If you look at fiscal 2011, and you breakdown our revenue, first by reporting segment, we organize our business into three segments, North America Acute Care which is focused on the hospital. North American, Post-Acute, where we have three businesses, our Respiratory Care business and then also extended care and home care and the Post-Acute Setting and then our international business, which has a combination of all of those, outside of North America.

You can see that little over 60% comes from North America Acute, of that about a quarter from international and 13% in our Post-Acute business. If you break that down by business model, as I mentioned earlier, we have rental revenue and also revenue from sales, a combination of capital software and services. You can see that 70% of it is from the capital software and services and about a third of it from rental.

And then, finally if you break it down by geography, you can see the three quarters of revenue is generated in North America, 17% Europe and a little less than 10% in the rest of the world.

We recognized that there is, multiple challenges in today’s environment. And we think we have responses from many of those. I’m not going to walk through every one of these points, but certainly, you know, one of our challenges today is to provide more care with fewer resources. And we believe that our product offerings and our services are differentiated in terms of the outcomes that they can provide. We do believe that we offer a return on investment. We believe that we are an investment versus the cost and that we have clinical data to support that that we can prove outcomes and reduce operating expenses.

Certainly there are rising acuities across the Care Continuum. We, you know, see those as positive demographics for our business, ageing population, complex co-morbidities and obesity. And then, again, you know, we’re addressing those through daily driven clinical evidence and increasing R&D investment as we talked about at our Investor Day, and I’ll touch on that a little more in a minute. We’re looking to increase our level of R&D investment, combination of new products to meet some of these needs and also developing even more clinical evidence to support our value proposition.

Certainly, a care giver safety as a major issue and you know, that – its impact on satisfaction and turnover. We have products that improve our genomics. And certainly, can support reduction in injuries, especially back injuries etcetera through some of our aims to mobility. And both our lists and our frame businesses both help support that area.

Emerging populations, requiring increased access to care. You know, certainly we are focused not just in the developed world, North America, Western Europe, but we recognize the opportunities and the needs to develop region specific products and that are certainly things that we’re working on within our R&D investments as well.

And then, increased movement of healthcare outside the Acute Setting and into the Post-Acute Setting, be it in the extended care or home care, is certainly a trend that we see and one that we’re looking to meet. We do have product offering that’s been in the Care Continuum today. And we’re certainly looking to strengthen that position.

We as a company have a handful of areas of strategic focus. These are things that we talk about regularly within the company. Things at every quarter, our CEO John Greisch goes over our progress and certain metrics that we have within an individual year. If you look at the first one, certainly the one that we believe is very important to us is leveraging a channel. We have a very strong position in that channel. And we think a combination of our brand equity in our market position puts us in a great position to further enhance that by new product offerings and services.

Innovation as I mentioned earlier, we’re looking to grow our level of R&D. We know, it’s critically important to the sustainability of our business. We’ve talked about low double digit rates in R&D expenditures through 2015. And it’s certainly something that we’re committed to do. That R&D investment will be on a combination of new products but also on developing clinical data as well to support our value proposition. And also we spend a portion of our R&D on cost improvement as well on our current product portfolio.

International expansion, an area on key focus, certainly much of that will be done organically, both through our current product portfolio as well as some of our NPD pipeline. But then also, we’re going to look for strategic possibilities to accelerate that through M&A.

Portfolio acquisitions, again, and parties (ph) have continued to exist, add to our existing portfolio to extend our overall offerings.

Financial excellence, we’re very focused on a number of key financial metrics and in fact our compensation system for a majority of our employees is tied to a series of financial metrics. And as we all know the – people are rational and we respond to our measure and how we rewarded. And so, this is definitely something that we’re focused as a company.

And then, finally, probably most importantly people excellence. So, driving a high-performance culture, where we can attract and retain top talent.

Again going back to with our reference, on our long-range plan summary, which we rolled out and shared in May at our Investor Conference, you know, here is the key areas that we touched on and how we see things through 2015. You know fairly modest growth in the current markets in which we compete, that being low to mid-single digits. We see ourselves having a slightly higher organic revenue growth of mid-single digits.

Gross margin, that will be in the low 50s from where it was in the high 48s in 2010 our base year. R&D spending, that will grow as I said just a minute ago in low double digits getting up probably to the area of around 5% of sales. We’ve looked at some competitive benchmarks in the Medtech space, we believe that the 4% to 6% is the benchmark that you know, we should be looking at for sustainable growth. And we’re targeting something in the middle versus the upper end or lower end of that.

Our SG&A, from where it was in 2010 to something below 30% by the end of this horizon. Adjusted operating margin get into the high teens by 2015. Adjust EPS curling at low double digits and a compound rate through 2015 and then adjusted operating cash flow getting to around $350 million by 2015.

If you breakdown the revenue part of that long-range plan by our business segments, you could see it’s made up of mid-single digit revenue growth in North American Acute, low to mid-single digit revenue growth in our North America Post-Acute business and then high-single digit revenue growth internationally.

Certainly some of the recent challenges in Europe caused 2011 to be slightly below our international growth rate but that was more than offset by slightly higher growth rates in other areas especially our North American Acute Care business. We still think this is reasonable through the 2015 timeline. And we expect the slow growth in Europe which we foresaw and talked about in the long-range plan to be offset by much higher growth in some of the other areas of the world, especially in Asia and Latin America.

I referenced our capital allocation strategy, and again, this is what we shared in our long-range plan in May. This is a target this is not something that you should assume we will hear to every year. But certainly, over this multi-year horizon, we’re expecting to spend anywhere between 25% and 35% of our operating cash flow on our internal capital needs. Internal capital is made up of a combination of your normal plan property and equipment but also more than half of it is investment in our rental fleet, which of course is revenue generating.

So, we have to periodically refresh that. We also obviously launch new products into our rental fleet. And so, we see that continuing in the 25% to 35% range. We committed to a return to shareholders to maintaining it on what was our historic average over the last five or so years in the 15% to 20% range, majority of that has come historically through dividends although this year, we spent returned a substantially larger portion and that was through share repurchases.

And then, a target of 45% to 60% for our strategic M&A activity, and again that’s a target, it’s going to be situational dependent. We certainly believe that over time, we’re going to find value creating opportunities that makes sense strategically. And so, we’re going to target that. And if, you know, in given year we don't find those opportunities for an extended period of time, then certainly we would look to readjust some of this, we would not look to sit on our cash.

So, finally, the key takeaways, I’d like you to take with you are that, you know, we have a management team that has significant global healthcare experience. It’s a somewhat new management team. But the people that we brought onboard, pretty much all have global experience and deep experience. We think that our diversified portfolio, although we are somewhat concentrated in our bed business, our frames and surfaces we talk about it. We do have several other significant businesses including our Respiratory Care which I mentioned earlier, our health information technology business, our surgical positioning business, and then we’re also diversified between rental and capital and then, also geographically.

We do believe we have the clinical expertise and patient safety focus that will position us well to meet these challenges. With those are our ability to substantiate the value proposition that we have to offer with the products that we bring to market. We’re targeting significant international profit improvement, specifically focused on Europe. We talked about this in fair amount of detail at our Investor Day. And finally, that earnings and cash flow momentum is strong. And that we’re going remain very disciplined in our capital allocation strategy in here to the slide that I talked about a couple of minutes ago.

So, with that, I appreciate your time and your attention. And I’d like to open it up to questions.

Question-and-Answer Session

Bruce Nudell

Mark, Andy and I were chatting about it before your visit here. And I think I heard correctly that the North American Acute Care segment is growing faster right now than most people think or am I missing something there?

Mark Guinan

The North American Acute Segment, as we reported had a low double digit growth in 2011, driven heavily by what we call out as our patient support systems, which is basically our frames and services. So, it was a very strong year, stronger than we had expected coming into the year. It continued pretty much consistently throughout each of the four quarters. And we ended the year with a strong backlog. So, yes, that’s been the strength of our business in 2011.

Bruce Nudell

And looking at, could you comment briefly on the relative share – your share position over the last five years or so relative to Striker and you know, Andy had mentioned that there is a period where maybe you know, the ball was dropped a little bit. And what are you doing to kind of regain your momentum?

Mark Guinan

Actually, I’ll defer that to Andy given the fact that I’ve have been here less than a year and Andy was been around those five years so.

Andy Rieth

Sure, I think what Bruce is alluding to is that we had underinvested in our opinion around sales channel and innovation R&D in particular and kind of got behind a little bit in terms of innovation as we saw it. And I think we have some very strong competitors in the marketplace who exploited that relative underinvestment. For several years now, we’ve been what we believe is reinvesting in both those important key strategic areas, that being innovation as well as sales channel. And that continues, we continue to embrace that going forward.

And we think that it has had an impact on our competitiveness in the marketplace. Share numbers are very difficult to get our arms around. We have to sort of impute them from our reported data. There are not real good metrics around that but we do think that we’ve improved our competitive stature as a result of R&D investment as well as sales channel investment.

Bruce Nudell

And so, the share bleed has stopped do you think?

Andy Rieth

Well, there is some evidence. Again, we look at comparative growth rates and things like that. And there are some data out there that would suggest that that is at least stabilized and maybe we’ve picked up a little along the way as well. But we feel comfortable that we are in a good competitive space and a good competitive position.

Bruce Nudell

And what are the kind of dimensions of innovation, you know, people will (inaudible), where are dimensions of innovation, how tangible are the products of that innovation and how much does it mean to your customer base?

Mark Guinan

Well, our customers make it very clear when we ask them what they’re looking for. They’re looking for opportunities to improve outcomes and reduce their operating expenses. You know, across our product portfolio, innovation means enabling patients to become mobile either more easily or more quickly. And it could be anything from a surface that rotates the patient or helps the patient rotate or helps the care giver rotate the patients to, you know, some of our products, which actually goes from the a bed into a standing chair and helps us.

Since we also have a list business, as well it supports that. And again, it’s a combination of clinical benefit of getting that patient up and around faster which has been demonstrated to result in getting healthier and out of the hospital more quickly and also enabling the care giver to not put as much strain on their physical being especially around their back. So that’s something that they certainly recognize.

We have surfaces that have some (inaudible) activity and qualities as well. So, those help reduce certainly in some way to support the potential for reducing risk of infection. And you know, we have products in our health information technology that actually helps monitor certain aspects of the patient condition and help record those systemically reducing the time that it requires for churning (ph). So that freeze up time for nurses and other support staff to be spending time with the patient instead of doing some of the more medial tasks.

You know, so, those are just a couple of examples we’re bring innovation and technology that are both improving the outcomes from the patients to save you from patients including, preventing patient falls. And then, also freeing up time and, you know, increasing the safety for the carry over.

Bruce Nudell

And just looking at the, you know, kind of corporate pitch, you know, I think people are – could be pretty comfortable that you know, mid-single digit is probably possible especially with international expansion. But you’re also thinking about improving operating leverage, I think 12 to the high teens or something is my recollection. What are the challenges there and what do you need to do to do make that happen?

Mark Guinan

So, I don't think the challenges are dissimilar to any business trying to improve their margins. So, what do we need to do to make those happen? You know, if you look at the improvements in gross margin and SG&A leverage that I referenced, somewhat offset by an increased level of R&D investment that’s how we get to that operating margin in the high teens from where it was in 2010 and where it is today.

So, when you look at gross margin, you know, which is typical lean manufacturing exercises, its, you know, procurements, initiatives, it’s a steady stream of cost improvement projects and partnership between our R&D organization and our supply chain, that will incrementally help us reduce the amount of material we use. Potentially the amount of time it takes and labor required to, manufacture our products.

And then, also you know, could be things around redesign of our electronics platform, all of those kinds of things are going to contribute. It’s a consistent rationalization of our product portfolio to deemphasize or in some cases divest or discontinue our less profitable products and then, obviously introducing a steady stream of higher margin products, through our product development pipeline.

In the SG&A area, it’s really looking for opportunities to leverage across our enterprise. It’s looking for places to create shared service centers. It’s looking for ways to rationalize, optimize our service network. We’ve got 185 service centers today. In North America, we’ve got 30 plus in Europe. And it’s really looking – how to operate those most efficiently. It’s a – we’re just into operation that comes with all the challenges and opportunities that a logistical operation does so, really optimizing that. And again, ensuring that we manage our fleet very tightly, our rental fleet so that we don't have too much capital out there but the right amount of capital and the efficient use as well.

And you know, areas like I focused on in direct procurement where we spent quite a bit of money and we’re really looking for some of the best practices to be applied here around identifying perform (ph) providers, leveraging our spend and giving visibility to spend to reduce volume. So, all of those levers, you know, just good business practices in combination, we believe is going to get us to those margins. We don't have anything anticipated at this point in terms of a significant restructuring or for that matter, a significant growth and leveraging of growth that is more dependent on or how to get to those margins, it’s just the normal good practices of business, with you know, year-over-year improvement getting us into that margin.

Bruce Nudell

And you know, in the single use segment of Medtech, pricings, you know, if it isn’t brutal yet, it will be brutal soon. And how are the capital components you know, hospital purchasing viewed? Is it, you know, is it more of an investment and they are more willing to pay fair value, you know, how would you characterize the pricing environment you face?

Mark Guinan

The pricing environment at least recently and historically going back couple of years has been fairly stable. In the capital environment, in terms of the ways the customers look at our products, there is certainly a segment that sees it as investments. We see it as an investment, we believe there is a return as I mentioned in my presentation. They are focused on decreasing their operating cost and if you buy into our value proposition, we can do that. Because we can ensure that the nursing staff spends their time in a more productive fashion.

We can reduce the injuries which of course impacts our operating costs. And we can help to support the reduction of infections, you know, both healthy skin as well as healthier lungs. So, all of those things would be positive. We know that the clinical bar is going to be increasing over time. And it’s certainly something that we’re focused on. But even today, we have, you know, some clinical data that’s strong enough for excitement of our customers to buy into it, you know, combined with their own experiences.

Then, there is certainly a portion of potential customers who don't buy into that yet. And then there is a group in the middle that are, kind of waiting to be influenced. And those are the folks we’re most focusing on because we believe we have that proposition. I mean, one might ask at a time, when everyone is focused on reducing cost and anticipating potential reductions and reimbursement that the capital business to be as strong as it is, we certainly don't have the absolute answer. But one potential answer is we’re seeing this as an investment for a certain expense.

Bruce Nudell

Well, thank you. And we have our breakout afterwards in the Sedona. Thank you so much.

Mark Guinan

Okay.

Bruce Nudell

Thank you.

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