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Hill-Rom Holdings, Inc. (HRC)

F1Q 2012 Earnings Conference Call

January 26, 2012 8:00 AM ET

Executives

John Greisch – President and Chief Executive Officer

Mark Guinan – Senior Vice President and Chief Financial Officer

Blair A. Rieth - Vice President of Investor Relations

Analysts

Matt Miksic - Piper Jaffray

Lawrence Keusch - Morgan Keegan

John Demchak – Morgan Stanley

Lennox Ketner – Bank of America

Gregory Halter – Great Lakes Review

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 February 2, 2011. See Hill-Rom’s website for access information.

The webcast will also be archived in the Investor Relations section of Hill-Rom’s website, www.hill-rom.com. If you choose to ask a question today, it will be included in any further use of this recording. Also note that any recording transcript or other transmission of the text or audio is not permitted without the written consent of Hill-Rom. (Operator Instructions)

Now, I’d like to turn the call over to Mr. Andy Rieth, Vice President, Investor Relations.

Blair A. Reith

Thank you, Juan. Good morning everyone and thanks for joining us for our first quarter fiscal year 2012 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 Forms 10-Q. We plan to file our 10-Q for the first quarter later this week.

Joining me on the call today 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 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’re also displaying slides that amplify our disclosure and I would encourage you to follow along with us. The slides were posted last night on our website and will also be part of the archive.

And with that, I’ll turn the call over to John.

John Greisch

Thanks, Andy. Good morning, everybody, and thanks for joining us today. As you read in our press release issued last night we reported earnings and revenue for the quarter in line with our preannouncement of a couple of weeks ago. The quarter was one of mixed results for our company.

Let me start with some comments on our largest business, North America Acute Care. We continue to see strong performance here, 7% revenue growth in the quarter led by a 13% increase in our patient support systems category. Many of you’re aware that our [PSS] products have fueled much of our growth over the past two years. The 25% growth rate for this product category that we have achieved over the past 12 months has been driven by our stronger – by stronger hospital capital spending, our broader product offering and improved execution in the field by our sales team.

As pleased as we’re with the 25% growth over the last year, on our fourth quarter call we stated that we expected the rate of growth for this product category to slow in 2012. That is exactly what we saw in the first quarter. As we mentioned in our preannouncement, our North American Acute Care business also experienced a reduction in incoming orders during the quarter.

Given the headwinds that our customers continue to face, we’re acutely focused on the order trends that we’re experiencing and what they portent for the future. Despite the tough macro conditions, our sales team continues to execute exceptionally well and I’m confident that we have the portfolio and the people to continue to success we’ve achieved over the past two years.

As expected, we saw decline in our international business in the first quarter compared to last year. The first quarter of fiscal 2011 was the strongest quarter of the year for us in constant currency. And we knew coming into 2012 the comparables for this quarter were going to be particularly difficult.

However, we did have a solid quarter with respect to international order rates with an increase of approximately 8% over the prior-year. Given this increase in order rates combined with more favorable revenue comparisons for the remainder of the year, we’re confident that we will see improving revenue growth rates in our international business for the remainder of fiscal 2012.

Europe has remained relatively steady overall, although conditions remained somewhat volatile country to country. We’re seeing good performance in other regions around the world. Our North American Post-Acute business had a difficult quarter. Revenue overall declined approximately 3%. Reimbursement pressures are affecting all of our businesses here and we expect that the challenges our customers are facing in this regard will continue to put pressure on our top line.

With increased top-line headwinds compared to recent quarters, we will continue to focus on tightly managing our cost structure as we successfully did in the first quarter. I also want to comment briefly on the Volker acquisition announced last quarter. To remind everyone we signed an agreement in December to acquire the Germany-based Volker Group for approximately $85 million. We hope to close the acquisition in the current quarter.

Volker which has revenues of approximately $100 million is a leading supplier of long-term care and acute care frames and surfaces, serving customers across Europe and around the world. They have a premier brand, particularly in Europe, and specifically in Germany. Hill-Rom currently has a relatively small business in Germany and this acquisition provides us with a significant footprint in Europe’s largest healthcare market. In addition to a strong brand and a leading presence in Germany, Volker provides us with a complementary product offering and strong operations experienced in the European market along within over 30% increase in our European scale, which will enable us to accelerate some of the cost synergies we’ve been developing.

Before I pass the call to Mark, let me comment on our decision to begin providing quarterly guidance. We’ve already speak to the lumpiness of our business. In today’s turbulent environment that fact is never been more evident. We’ve concluded that providing investors with only annual guidance does not allow you the best opportunity to fully understand and appreciate the volatility inherent in our business.

When you consider the macroeconomic headwinds and the uncertainty that increasingly exists today in many of our markets, together with the fact that over 70% of our business is in capital sales. We’re going to be dealing with a level of volatility in our business every quarter. It would be easier if this portfolio had a more linear rate of growth and predictability quarter-to-quarter, but it simply did not at this time. As a result, in addition to our annual guidance we decided to provide an outlook on the current quarter revenue and earnings per share expectations.

Obviously providing quarterly guidance will not eliminate the quarterly fluctuations associated with our markets or our specific businesses. So we believe it will provide investors with a clear understanding of our own outlook for the company. In short, we hope to providing investors with specific quarterly guidance for the current quarter as well as the full-year will enable us to better communicate the trends in the business as we see them and better enable you to understand the quarter-to-quarter fluctuations inherent in our business.

With that, let me turn the call over to Mark before I wrap up and take Q&A.

Mark Guinan

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 or 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 1.8% to $381 million led by our North America Acute Care segment. Foreign exchange impacts on revenue were negligible for the quarter. Our capital sales increased 4% to $267 million. This was driven by 10.9% improvement in North America Acute Care led by 12.9% growth from our patient support systems platform products. This strength was partially offset by an 8.1% decline in our international segment driven primarily by declines in Latin America and Europe. Our European capital business was off 6.5% on top prior-year comparables.

As we look ahead, we’re encouraged that we achieved double-digit sequential growth in European orders despite the continued tough economic conditions. Consolidated rental revenue decreased 2.8% to $114 million with growth in our international segment being more than offset by declines in North America. Domestic revenue increased 6.7% to $272 million, while revenues outside the United States decreased 8.5% to $109 million led by declines in Europe and Latin America.

Looking at revenue by segment, North America Acute Care increased 7.2% to $234 million led by significant growth in our Med-Surg products. Orders softened during the quarter resulting in a backlog that is off slightly from where we ended fiscal 2011. While we were forecasting a slowdown in growth of our North American capital business from the double-digit growth we experienced in 2011, the Q1 decline in orders was slightly worse than our expectations. This was the primary driver behind our previously announced decision to make a downward revision to our full-year revenue guidance.

North American Acute rental revenue declined 2.1% year-over-year, with strength in our room care products being more than offset by weakness in bariatric and moveable medical equipment. We continue to experience pressure on rental volumes to shorter lengths of stay and to a lesser degree of lower incidence of flu in the current year.

Moving to our North America Post-Acute Care business, revenue declined 3% to $51 million, as growth in our extended care business was more than offset by a decline in our homecare business. Pricing pressures continued to be prevalent in this segment and we expect this to be the case for the balance of the year. International revenue declined 6.8% to $97 million on tough comparables. Offsetting growth in the Middle-East were declines in Latin America and Europe as mentioned earlier. Despite continued concerns over the environment in Europe we’re encouraged by recent international order patterns, with first quarter orders coming in at the second highest level in the last five quarters.

Moving to margins, we posted lower adjusted gross margin performance for the quarter at 48.2%, representing 110 basis point decline over the prior-year. Both capital and rental adjusted gross margins were down, with rental margins experiencing the largest decline. Our adjusted capital margins were down year-over-year by 80 basis points, about a half of which is attributable to the effects of unfavorable product mix and the other half to higher material and fuel costs. This is consistent with the commentary we provided in October. We expect inflationary pressures to continue, but to abate in the second half of the year.

The adjusted margin decline in our rental business of 150 basis points relates primarily to the lower revenues discussed earlier and the resulting reduction in leverage of our field service infrastructure as well as higher fuel cost. This is true in both North America Acute and Post-Acute Care, with Post-Acute also coming under some pricing pressure as mentioned earlier.

With that said, we feel our rental margins are stabilizing and we expect them to be relatively constant over the balance of the year.

Regarding operating expenses, our R&D investments for the quarter increased 3.4% year-over-year. As we’ve previously discussed, we expect to continue to increase investments in R&D over time at a rate faster than our revenue growth rate.

Adjusted SG&A expenses for the quarter decreased by approximately 1% year-over-year to $119 million that were down 90 basis points percentage of revenue to 31.2%. The SG&A decrease was primarily the result of lower personnel costs, which more than offset the incremental SG&A associated with Liko distributor acquisitions.

Adjusted operating profit for the quarter was $49 million, representing a 12.9% operating margin, down 40 basis points versus last year’s comparable period. As noted previously, the lower capital and rental gross margins in the quarter were the primary drivers as SG&A expenses under percent of sales declined year-over-year.

The adjusted tax rate for the quarter was 31.7% compared to 25.6% in the prior year. The higher rate in the current year was primarily the result of the research and development tax credit and a higher tax rate on certain international earnings.

$2.1 million of tax benefits were reported in the first quarter of fiscal 2011 primarily related to the research and development tax credit. This amount included a benefit related to fiscal 2010 following the reinstatement of the credit, which favorably impacted the first quarter 2011 tax rate by 3.4 percentage points. Also benefiting fiscal 2011 rate were international earnings, which were not subject to tax as a result of previously unrecognized operating loss carry forwards. These loss carry forwards, most notably in France, benefited the prior-year tax rate by approximately 2 percentage points.

Finally, the expiration of the Research and Development Tax Credit effective December 31, 2011 negatively impacted the current year rate by approximately 1 percentage point, the effect of which will continue unless the credit is reinstated.

So, summarizing our key adjusted income statement metrics, operating income of $49 million was down slightly from the prior-year with operating margin lower by 40 basis points on lower gross margins. Our effective tax rate was up year-over-year 6 percentage points. Adjusted earnings per diluted share of $0.53 in the first quarter representing a 4% decrease compared to $0.55 in the prior-year.

As noted earlier, last year’s EPS of $0.55 included a total of $0.04 related to the R&D tax credit compared to less than a penny in Q1, 2012.

One final comment on operating results, before I move on to cash flow and guidance. During the quarter, we had two items netting to $0.4 million of pre-tax income in our GAAP earnings that are not reflected in our adjusted results. The first item, a continuation from last year and one that will continue into the last half of fiscal 2012 is $2.1 million benefit reflected in rental gross margin related to an ongoing vendor product recall action.

The second item relates to the combined effects of inventory step-up and acquisition costs of $1.7 million incurred in relation to our recently completed acquisition of Liko distributors in France and Switzerland, and our pending acquisition of the Volker Group. Approximately $0.5 million of this amount is reflected in capital gross margin, while the remaining $1.2 million is reflected internationally. Additional acquisition and integration costs will be incurred in the coming months in relation to these transactions, which we’ll highlight as they occur.

Moving now to cash flows, our operating cash flow for the quarter was $62 million, compared to $24 million in the prior-year. The improvement year-over-year relates primarily to the improved receivable collections.

Now let’s turn to guidance, which I’d like to remind you, excludes any impact from the pending acquisition of the Volker Group. As John mentioned earlier, we intend to provide you with guidance on the upcoming quarter for revenue and earnings per share. We think this will provide you some additional insight into how we view the business and our near-term expectations.

For our second quarter, we expect constant currency revenue to be flat compared to last year with adjusted diluted earnings per share of $0.53 to $0.55. This guidance reflects low single-digit declines in our North America Acute Care and Post-Acute Care segments.

Our North American Acute Care business had a record quarter in Canada in 2011, driven by one large order. We expect low double-digit growth within our international segment. This international growth is based on expected stability in Europe and stronger performance from rest of world regions due to recent order patterns.

Moving to the full-year, we’re reiterating the full-year constant currency revenue growth of 3% to 4% and adjusted earnings between $2.45 and $2.50 per diluted share as we outlined two weeks ago.

This full-year 2012 financial outlook reflects low to mid single-digit revenue growth in North American Acute, slightly lower revenue in North America Post-Acute and mid single-digit constant currency revenue growth in our international segment aided by the acquisition of the Liko France and Swiss distributorships.

The gross margin of approximately 49%, mid single-digit growth in R&D spending as we continue to invest in new and innovative products, continued operating leverage of our SG&A infrastructure, operating margin improvement of approximately 100 basis points on the year, and a tax rate of approximately 32% to 33% adjusted for the failure to renew the R&D tax credit and the number of shares outstanding for the year to average $63 million.

Finally, we continue to project 2012 operating cash flow to be in the range of approximately $290 million to $300 million. We expect $75 million to $85 million of CapEx investment during the year.

One final note on guidance, as we covered with you in our original release of guidance back in October as a result of the timing of inflationary pressures and research and development spending we expect our operating margin improvement for the year to be somewhat skew to the back half of the year. This continues to be the case in our current guidance as we work through tougher comps in the first half.

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

John Greisch

Thanks, Mark. As you all know, the industry is facing significant challenges. Changes throughout healthcare are affecting providers, payers and suppliers in unprecedented ways. We’re committed to continue to manage through these turbulent times and deliver sustainable improvements in our operating results.

We’re taking all necessary actions to prepare for and adjust to the conditions of our markets, so that we deliver our long-term commitments. At the same time, as we did with the Volker acquisition, we’ll continue to adjust our portfolio and deploy the significant cash flows we’re generating to create long-term shareholder value.

Given the current quarter-to-quarter fluctuations we experienced in our results, I’m very proud of the performance that this team has delivered. Over the past two years, we delivered 50% and 29% increases in adjusted earnings, increased operating margin by more than 500 basis points that consistently delivered strong cash flow.

We’ve also increased our share of the North American Patient Support Systems category over the last year. We’ve some challenges ahead of us, but I’m confident, we’ll continue to deliver improved results to investors in the future.

With that operator, please open the call to questions.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] And our first question comes from Matt Miksic with Piper Jaffray.

Matt Miksic - Piper Jaffray

Hi, good morning. Thanks for taking our questions.

John Greisch

Hey, Matt.

Mark Guinan

Good morning.

Matt Miksic - Piper Jaffray

So, one question on the trends in Europe and how your guidance is positioned against that, you have some gives and takes, just to be clear the Volker plus the accretion from Volker in terms of your top-line growth isn’t there in the numbers that you’ve given us. Is that -- and that’s correct, Greisch?

John Greisch

That’s correct.

Matt Miksic - Piper Jaffray

And I guess, if we drill down into Europe and I’ve been hopping back and forth between a couple of calls, so I apologize if you gave this earlier, but if you drill down into Europe what exactly kind of assumptions are making on the European recession?

John Greisch

Yeah, we’re assuming Matt, relative stability in Europe, -- we as -- I think, Mark mentioned we saw a sequential up-tick in orders in Europe from our fourth quarter to our fiscal first quarter, but the outlook for the rest of the year assume stability in Europe which is what we’ve seen over the last several quarters.

Mark Guinan

Yeah, Matt and as I’ve mentioned previously, we had very strong orders in the latter half of 2010, and then they dropped-off fairly significantly, coming into 2011 we benefited shipment wise from the backlog that we entered 2011, and therefore the front half of 2011 had relatively strong orders in Europe. Since that period of time, we really had a pretty stable level of orders coming out of Europe, and we continued to see that during the first quarter, and our expectation is that’s what will happen in the balance of the year. So no significant deviation from what we’ve been experiencing for the last year.

Matt Miksic - Piper Jaffray

Okay. And then one -- one question on margins, and since I look at the, where you came out on guidance given the lower tax rate and sort of the modest change in the top-line growth, it sort of implies that at least in the back half your -- it looks like margins need to be just a touch better than they -- and maybe you thought they would be at the beginning of this fiscal year. Is that right or am I looking at this the wrong way?

Mark Guinan

Well, margins need to improve obviously in the back half of the year disproportionately to what happened since we went backwards in the first quarter. Regarding our expectations, I can't tell you that it’s significantly different, I mean gross margin as you know from the fact that we took our guidance down from the range of 49 to 50 to around 49, has been disappointing. But as we’ve always said, we’ll manage our cost and total and we make assumptions into the extent that some of those assumptions don’t come true, we’ll adjust other plans. So certainly our intent is to manage our operating expenses for the change in gross margin and then therefore to deliver the guidance that we put forward.

Matt Miksic - Piper Jaffray

And speaking of operating margins mostly, and rather than gross margins, but last little clarification on the margins, as you head into the back half of the year, if there’s a piece that’s going to be moving faster to deliver that leverage that you’re expecting, is it been gross margins as you’re expecting to improve or is it, are we going to see more leverage from SG&A?

John Greisch

It’s going to be SG&A, Matt. I think you’re initial question was spot on. I think the -- as Mark said, the SG&A improvement and we’re tightening down that obviously given some of the top-line headwinds, so relative to our original expectations coming into the year, our SG&A management needs to be tighter and that’s what's going to drive operating margin improvement as we move into the second half of the year.

Matt Miksic - Piper Jaffray

Thanks a lot.

Mark Guinan

I just want to make -- Matt, I do want to make one statement on the first quarter. We – you know as I mentioned in my prepared remarks, we did know that we had tougher comparables on gross margin given the inflationary comparisons because you know inflation really didn’t spike into the latter half of 2011. So you had tougher comps of inflation, and also the rental margin erosion that we saw over fiscal 2011, obviously although we feel it stabilized sequentially, we had a tougher comp on our rental margins in the first quarter. So we knew gross margin was going to be a tough comp and we certainly tried to signal that with our comments at the end of Q4.

Matt Miksic - Piper Jaffray

Thank you.

Operator

Our next question comes from the line of Lawrence Keusch with Morgan Keegan.

Lawrence Keusch - Morgan Keegan

Hi, good morning. So John, I just want to pick-up on Matt’s questionnaire itself -- I think if I do the math correctly here, the guidance for the second half of the year implies to about 18% EPS growth at the midpoint in the range. And I just, so I understand the SG&A side and the tightening of the expenses, I get all that, but the flipside of that is, how are you managing that versus again your willingness to invest for future growth?

John Greisch

Well, a couple of comments, Larry. And I’m sure you’re doing the math right, as you always do. We had a weak third quarter as you may recall last year. So, that is going to help the second half comparables.

To your specific question, I mean we’re battening down where we need to in terms of expenses that are not going to be revenue generating and revenue driving, and we’re taking cost out where we can, across the business that is not going to impact our short-term or long-term business need. So, it’s a constant balance between driving our SG&A down, which as you well know, we’re committed to do and investing in markets around the world where opportunities are immediately available. As you’ve seen in Mark’s comments here in the second quarter, we’re expecting double-digit growth in international. A lot of that’s coming out of some of the emerging markets where we’ve invested resources recently.

So, I think we’re balancing it effectively. I’m not worried at all that we’re starving the business in anyways, and I think we’re going to have, as I said in my comments additional actions that we’ll be looking at in order to respond to both the growth opportunities of the business portfolio as it’s currently constituted provides us as well as cost reductions were necessary.

Lawrence Keusch – Morgan Keegan

Okay, that’s perfect. And then I guess the other quick question for you is, and I don’t know how much visibility you really have into this, but obviously the order pattern was softer than you had anticipated in the U.S. So again, just any thoughts around what’s going on out there, is that price, is that market share, was there some paralyses and sort of if you kind of look forward, kind of what you’re assuming or what you’re seeing right now?

John Greisch

Yeah, that’s a great question. Let me answer that a number of different ways. A couple of years ago, we chose to report order levels and backlogs for our core business in North America. The reason we did that, we think that’s the best leading indicator to our biggest business.

This quarter, as Mark indicated, as we said in our preannouncements, it’s the first time we’ve seen a bit of a hike up in the order rates and a slight decline from last year, and I think in Mark’s comments he said that was lower than our expectation.

I don’t think there has been any share movement in my comments here; let me say, over the last 12-months. We’re confident, we’ve grown share in this business. What we refer to as our Patient Support Systems category over the last four quarters was up 25%, which relative to everything we see on an organic basis is as strong as anybody is reporting out there. So, I think our share has been maintained and actually uptick a bit certainly over the past four quarters.

Last quarter was a disappointment in terms of the decline as I mentioned in my comments, it is the one area that we’ve got our eyes acutely focused on. And what we’re assuming as we go forward is that the stability in that business as we expected coming into the year plays out for the rest of the year, if a declining order rate and again it was relatively small, but it was a decline, if that continues and we’re seeing the front-end of a wedge here in terms of lower spending in this product category across the board, then we’re going to have a different order pattern than what we expect, but I don’t see any share movements. There were certainly no major competitive losses during the quarter that concern me. Our product portfolio and the execution we’ve had in the field over the past couple of years, I’m very happy with it and very proud of and that certainly hasn’t changed in the last three-months.

That said, it was a disappointing order intake that we had and we expect it will improve going forward, if not and we’ve obviously got some other challenges for the Company going forward.

Mark Guinan

And to comment specifically on price, just to be clear, well, price has been a factor in our rental business and most significantly in Post-Acute. Price is not a contributing factor to the softening of orders in the last quarter as we mentioned.

Lawrence Keusch – Morgan Keegan

Okay. And John, just lastly, would you be willing to just provide any clarity on sort of what you’re seeing as you kind of started into this current quarter, are the trends sort of the same, worsening?

John Greisch

Yeah, rather I’d comment on the current quarter, Larry for obvious reasons…

Lawrence Keusch – Morgan Keegan

Okay.

John Greisch

…and just stick with the reported quarter.

Lawrence Keusch – Morgan Keegan

Okay. Understood, thanks very much.

John Greisch

Yeah, just one other comment, and again, you will live by the sword and you die by the sword, but providing orders and backlog information at the time we did it when I got here, we thought was, as I said, not only a leading indicator for the business, but the most transparent way for us to talk about the business and we’ll continue to do that because to me that is the most critical piece of the Company and obviously the most critical leading indicator that we’ve to see it for this business.

Lawrence Keusch – Morgan Keegan

Yeah, absolutely and we appreciate that transparency. Thank you.

John Greisch

Thank you.

Operator

Our next question comes from David Lewis from Morgan Stanley.

John Demchak – Morgan Stanley

Hello, this is John Demchak in for David.

John Greisch

Hey, John.

Mark Guinan

Hi, John.

John Demchak – Morgan Stanley

Hi. My question is focused on the rental segment and particularly the margins, margin dropped sequentially in a bit more year-over-year, hospitals clearly had a strong focus on reducing operating cost, which had an impact, and I was wondering if you could provide some color on some of the initiatives to maintain an increase on these rental margins, and how you expect the rental margins to trend in the future? Thanks.

Mark Guinan

Yeah, as I mentioned in my prepared remarks, we’re expecting rental margins to be fairly stable over the balance of the year for a combination of reasons. One is as I referenced, if there was some inflation especially around fuel costs, which impacted our rental margins year-over-year, we don’t expect that to be a factor sequentially over the year at this point.

Regarding other impacts we’ve as rental volumes declined somewhat against our expectations as I mentioned it emits our ability to leverage our cost structure, but that’s a short-term factor. We obviously continuously look at and manage our infrastructure that supports our rental business, our service infrastructure. So, we’ll continue to manage that to offset some of the margin erosion.

And finally, it’s really a focus on driving higher margin products within that category and helping with the mix, which is also a factor within our rental margin performance. So, a combination of those things you know, are really what we just believe that will get some stability.

And then, you’re right, within the Acute segments, certainly, price pressures and as we mentioned shorter length of stay and its impact on leverage is a factor, but there also is price pressure in our Post-Acute segment. And as we said, we expect that to continue. So, that will provide additional challenges to our margin, not just on the cost side, but on the pricing side.

John Greisch

Hey, John, this is John. I’ll just add to what Mark said. As you all know, within our rental business is what we refer to as our immense business, which is our on-demand rental business of other products like infusion pumps and ventilators and such. We’ve consciously been declining that business because it is one of our lower margin businesses. So that’s been part of the top-line decline, and to some degree you’ve been offsetting some of the margin pressure that we’ve seen in the rental therapy segment of our rental business. But as Mark said, this business is supported by a fairly high cost infrastructure and to the extent that we continue to see the top-line pressure and the mix upgrades are not sufficient to address margin improvements. We’ve got a sizable infrastructure that we will address as necessary to get the margins back on track.

John Demchak – Morgan Stanley

Thank you, very helpful. And as a follow-up, I was wondering if you could talk about the reduction of incoming orders that you mentioned on the call for North America Acute Care. And I was curious about your confidence level on the guidance of its flat growth in the second quarter given lower orders year-over-year and very tough comparables? Thank you, guys.

Mark Guinan

Well on the confidence of the second quarter, as I’m sure you recognized, we’ve taken that into -- the order pattern in the most recent quarter into account in building that forecast. So certainly we’ve recognized that we came in with a backlog that was a little bit below what we would have expected and that’s built into our quarterly guidance and in fact was a factor as I mentioned in my prepared remarks about our updated guidance on revenue for the year. So that’s certainly taken into account.

In terms of order -- order softness in the previous quarter, as we mentioned previously, our view is that its not, we’re not seeing in that short period of time a trend break and certainly we feel its mostly market driven, not price driven, not share driven, but obviously as we progress through this quarter and throughout the year, we’ll get additional data to make that assessment.

John Demchak – Morgan Stanley

Thank you very much.

Operator

Next on the line we have Lennox Ketner with Bank of America.

Lennox Ketner – Bank of America

Hi, can you hear me okay?

John Greisch

Hey, Lennox, sure.

Mark Guinan

Good morning, Lennox.

Lennox Ketner – Bank of America

Hey, thanks so much for taking my question, I appreciate it. Just to go back to gross margins for a second; Mark, I think the message is that, rental margin they’re expected to be relatively stable going forward and that the improvement that gets you to 49%. Margins for the year is expected to come from capital margin, so to that extent, I’m just wondering if you can talk a little bit about what impacted capital margins this quarter, I think you said about half of the decline was from product mix, but I was wondering if you could elaborate a little bit there, and then maybe just talk about what you’re expecting to drive the improvement in those margins throughout the course of the year?

Mark Guinan

Certainly. So two different comparisons, obviously the one I was referencing and the one you just mentioned was year-over-year. So year-over-year inflation was about half the driver in the margin erosion and about the other half was product mix was referred as two product mix, it’s a combination of the mix between capital and rental and also the mix within our capital business. And we do have a fair degree of variability of gross margins within our capital product lines.

So in the first quarter we had higher proportion of our IT business than we expect for the balance of the year, and that was a pretty major contributor. There was also some, as we’ve mentioned with the lumpiness of orders outside of the U.S. there was a pretty significant order internationally that had a relatively lower gross margin than the average of the portfolio and based on our outlook for the year we expect a more favorable mix. So its really, heavily mix driven, Lennox, although there are – as we've mentioned before there are a steady stream of cost improvement projects that we have in partnership between R&D and our supply chain, and those are kind of a rhythm as they appear as we deliver them and certainly those will help as well to loose some cost to the balance of the year and those were in our original plans that are still in our plans.

John Greisch

Lennox, this is John, and just to add what Mark said the, you’ll see in the 10-Q, the international mix impact in Q1 was not great. And as I mentioned in my comments, the confidence we've in the international growth going forward is coming largely out of the rest of world regions as opposed to Europe and we get higher margins out of those regions than we do out of Europe. So there’s certainly some mix benefit as we go through the rest of the year internationally relative to what you saw on the first quarter.

And as Mark said, the capital business is, going to drive the rest of the year as well and, as I mentioned in my previous comments, the big wild card for the rest of the year is the order trends that we’re seeing in North America, as I mentioned we’re assuming its going to be stable for the rest of the year and that’s the one that we’re going to keep our eye on as much as possible.

Lennox Ketner – Bank of America

Okay, that’s helpful. So I guess, when you say you’re expecting order rates to be stable for the rest of the year, should people be modeling the U.S. the Acute Care U.S. business relatively flat for the year?

Mark Guinan

No, we had -- our guidance was mid single digits. So, no – we’re talking about order rates overall, so international obviously we said, we’re expecting a high single digit growth, so a strengthening especially against comparables in Post Acute we’re expecting a slight decline and then, we stick to our previous guidance on North America. So, order rates are also depended on prior-year comps and as we said the fourth quarter was a fairly, relatively soft quarter for us last year so – strengthened perhaps against that quarter, but overall in the year we’re talking about mid single digits for North America.

Lennox Ketner – Bank of America

Okay.

John Greisch

Yeah and when I say stable, Lennox, I mean, we’re not expecting to see a continual decline.

Lennox Ketner – Bank of America

Got it. Okay and then just last one, I’m just wondering if you could maybe talk a little bit about how your – if there was any change in your thoughts on capital allocation, I know you’ve talked in that prepared remarks for that continue to diversify the portfolio. And then in the past you’ve talked about really the main focus for capital allocation being M&A, but I’m wondering if there is any change for that in terms of the percentage of your capital that maybe allocated to share buybacks there, if there is really no change there?

John Greisch

At this point, no change, Lennox.

Lennox Ketner – Bank of America

Okay, great. Thanks so much.

Mark Guinan

Okay. Thanks.

John Greisch

Thank you.

Operator

(Operator Instructions) And next on the line we have Greg Halter with Great Lakes Review.

Gregory Halter Great Lakes Review

Hello.

John Greisch

Good morning, Greg.

Gregory Halter Great Lakes Review

Good morning.

Mark Guinan

Good morning, Greg.

Gregory Halter Great Lakes Review

You just answered the question I was going to ask about capital deployment and share repurchase and so forth, when I saw the share repurchase was just minimal based on the cash flow statement in the quarter with, I think, 2 million shares left under authorization, if I’m not mistaken. So …

Mark Guinan

That’s correct.

Gregory Halter Great Lakes Review

… move to my next question, you obviously commented last quarter about the new powered stretcher and in this release you talk about commercializing it, and just wonder what your strategy is for going to market with that particular product?

John Greisch

Well, we’ve gone to market with it here in our North American segment. So obviously it expands our stretcher portfolio and fills a big gap that we had and as you all know the stretcher market is one in which we’ve a very small market share and we have not been gaining share in that segments over the last several years. So the strategy is with a broader portfolio now and with a critical gap filled with that product that we’re going to be more competitive in the marketplace. And initial feedback from the customers and from the field has been positive and we’re often running over the past few months as we launched it roughly mid way through the first quarter.

Gregory Halter Great Lakes Review

And is that a different selling force than others, the company have?

John Greisch

No, it’s largely the same sales force. We have some product specialist within the sales force, but it’s largely the same sales force that we have in the North American Bed Frame and Surface market.

Gregory Halter Great Lakes Review

Okay. Thanks a lot.

John Greisch

Okay. Thanks, Greg.

Operator

At this time I’d like to turn it over to our speakers for any closing remarks.

John Greisch - President and CEO

Thanks everyone for joining us on the call today and we look forward to speaking with you in the future. That ends the call. Thanks everyone.

Operator

Ladies and gentlemen, thank you for participating in today’s conference. This concludes the program. You may all disconnect. Everyone have a great day.

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