Hill-Rom Holdings (HRC) John J. Greisch on Q1 2016 Results - Earnings Call Transcript

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

Q1 2016 Earnings Call

February 01, 2016 8:00 am ET

Executives

Michael Macek - Treasurer & Vice President

John J. Greisch - President, CEO & Executive Director

Steven J. Strobel - Chief Financial Officer & Senior Vice President

Carlyn D. Solomon - Chief Operating Officer

Analysts

Jonathan Demchick - Morgan Stanley & Co. LLC

Travis Steed - Bank of America Merrill Lynch

Matthew Mishan - KeyBanc Capital Markets, Inc.

Gary Lieberman - Wells Fargo Securities LLC

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 6, 2016; 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 future use of this recording. Also note that any recording, transcript or other transmission of this text or audio is not permitted without the written consent of Hill-Rom.

Now, I would like to turn the call over to Mr. Mike Macek, Vice President and Treasurer.

Michael Macek - Treasurer & Vice President

Thank you, Teria. Good morning and thanks for joining us for our first quarter fiscal year 2016 earnings call. Before we begin, I'd like to provide our usual caution that this morning's call contains forward-looking statements, such as forecast of business performance and company results, as well as expectation 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.

Also, we will discuss certain non-GAAP or adjusted financial measures on today's call. Reconciliation to comparable GAAP financial measures can be found in our earnings press release, the associated Form 8-K and are also available as part of the presentation materials posted on our website.

Joining me on the call today will be John Greisch, President and CEO; Chief Financial Officer, Steve Strobel; and our Chief Operating Officer, Carlyn Solomon. 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'd encourage you to follow along with that. The slides were posted on our website and will also be part of the archive.

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

John J. Greisch - President, CEO & Executive Director

Thanks, Mike. Good morning, everybody, and thanks for joining us today. We're pleased to start the year with a strong first quarter with revenue and adjusted earnings ahead of expectations. Adjusted earnings per share of $0.68 was ahead of guidance and up 39% over 2015. This is our eighth consecutive quarter of year-over-year adjusted earnings improvement.

In addition to our strong adjusted earnings, operating cash flow was up 50% compared to last year. Underlying our strong earnings growth was a 430-basis point improvement in adjusted operating margin as our operating income more than doubled compared to last year. This improvement was driven by the addition of the higher margin Welch Allyn business, a great start with our cost synergy program and continued focus on leveraging our cost structure.

In addition, the mix of strong revenues at Welch Allyn and our North America PSS business, together with weaker performance in our lower margin International segment, had a positive impact on our overall margins.

Revenue for the quarter of $661 million was ahead of our expectations. While Welch Allyn grew 7% year-over-year on a pro forma basis, we achieved constant currency organic revenue growth of 3% driven by continued strong performance in North America where we again saw double-digit growth.

Surgical and Respiratory Care was up slightly on a constant currency basis. Continued double-digit growth in our U.S. Trumpf business was offset by lower sales in the Middle East and Latin America and the exit of several lower margin OEM surgical product lines in 2015, in conjunction with our portfolio enhancement strategy. Absent those declines, Surgical and Respiratory growth was in the mid-single digits.

Our International business continues to be challenging, driven mostly by weakness in the Middle East and Latin America. These remain very difficult markets for all of our businesses.

Overall, we're off to a strong start for the year. I'm pleased with our financial results for the quarter as well as with the progress on many of the initiatives we highlighted at our recent investor conference. We expect to see further progress as we move forward throughout the year.

Before I turn the call over to Steve, let me add some additional commentary on the quarter. In North America, our strong revenue growth was driven by record capital orders, which were up 25% year-over-year. Recall last quarter, we highlighted the fact that we expected strong orders from HCA in the first quarter this year, which we in fact received.

Excluding HCA, orders were up low-double digits, reflecting continued overall strength in hospital CapEx and outstanding execution by our commercial team. We've seen particularly strong growth in our ICU franchise as well as our clinical workflow solutions business, reflecting the benefit of new product introductions in the past couple of years.

Our North America capital backlog was also at a record level at the end of the quarter, up 12% versus the prior year. We had a strong quarter in our North America rental business, where we posted 11% growth driven by higher volumes while also achieving improved margins. Recent strength in this business reflects the benefit of the fleet investments we made in early 2015. As you can see by the strong Welch Allyn results, the integration of the business has gone very smoothly thus far.

For the quarter, constant currency revenue growth of 7% was slightly ahead of our expectations. This was driven by a great performance in the U.S. and solid growth in Europe. This quarter was the end of Welch Allyn's fiscal 2015 and is typically their strongest quarter. For our fiscal 2016 full year, we expect Welch Allyn growth to be in the mid-single digit range.

On the integration front, our teams continue to work to leverage the combined value we bring to our customers. In addition, we're well on our way toward achieving at least $40 million in cost synergy savings. I couldn't be more pleased with how this business has performed out of the gate and how seamlessly the cultural integration is coming together around the world. The Welch Allyn team under the leadership of Alton Shader, who we put in that role following the acquisition, is doing a fantastic job.

In Surgical and Respiratory Care, revenue was flat driven primarily by the challenges internationally and the exit of several low margin product lines. We also had a challenging quarterly comparison for Trumpf following the transition of their fiscal year-end through September during our fiscal 2015. We continue to remain very optimistic about our ability to accelerate the growth in our surgical franchise by leveraging our overall channel strength and increasing our investments in innovation.

An example of this investment is our recent announcement with Intuitive Surgical of FDA clearance for Integrated Table Motion, which seamlessly synchronizes the movements of Intuitive Surgical's latest robotic-assisted surgical system, the da Vinci Xi, and Trumpf's advanced operating table, the TruSystem 7000dv. We're very excited about this partnership and the growth opportunities it brings our surgical business.

On the International front, while we had strong double-digit growth in Asia Pacific, we expect the weakness in the Middle East and Latin America to continue in the near term, and we are reducing full year revenue expectations for our International segment to a mid-single digit constant currency decline.

Improving our cost structure and expanding our margins, while continuing to grow our investment in R&D, remain critical priorities. Our first quarter 430-basis point improvement in adjusted operating margin was driven by higher gross margin and SG&A leverage, offset slightly by increased R&D spending as a percentage of sales.

As expected, the majority of our adjusted operating margin improvement was driven by the addition of Welch Allyn and the related cost synergies. In addition, we saw a favorable mix impact of stronger performance in North America and weaker performance in our International segment.

As we look forward to the remainder of 2016, we are raising our adjusted earnings and cash flow outlook for the year due to our strong first quarter performance, the benefit of the R&D tax credit, as well as the suspension of the medical device tax, the majority of which we plan to reinvest to accelerate growth in several of our higher margin businesses.

With that, let me turn the call over to Steve.

Steven J. Strobel - Chief Financial Officer & Senior Vice President

Thanks, John. Good morning, everyone. First quarter revenue increased 42% to $661 million. On a constant currency basis, total revenue was up 47%. Organic revenue grew 3%. Capital sales increased 51% to $565 million. On a constant currency basis, capital sales were up 57% and up 2% organically. Rental revenue grew to $96 million, a 5% increase. Domestic revenue increased 56% to $443 million, while revenue outside the United States grew 21% to $218 million, a 34% growth rate in constant currency.

Turning to revenue by segment, North America revenue increased 11% to $249 million. North America capital revenue increased 11% on a constant currency basis to $179 million, driven by strong growth in our ICU franchise and Clinical Workflow Solutions.

First quarter capital orders were very strong, up 25% from prior year and up 12% sequentially. In addition, the first quarter backlog increased by 12% versus the prior year. North America rental revenue increased 12% on a constant currency basis to $70 million, driven by continued solid execution and increased volume.

Welch Allyn generated $198 million in revenue for the quarter, which, on a pro forma basis, represents 7% constant currency growth year-over-year. Growth was driven primarily by strong sales in the U.S. where pro forma growth was 11%. We continue to make good progress on the integration and are pleased with Welch Allyn's first full quarter of operations as part of Hill-Rom.

Moving to Surgical and Respiratory Care, revenue increased slightly on a constant currency basis to $121 million, growth at Aspen and continued growth in our U.S. Trumpf business were offset by declines in Latin America and the Middle East.

International revenue declined 17% to $94 million or about a 9% decline on a constant currency basis. We continued to generate strong double-digit growth in the Asia Pacific region, but significant headwinds in Latin America and the Middle East drove lower-than-expected results. While we expect challenging conditions in our international markets to persist, we're working hard to integrate our international commercial and supply chain organizations to drive stronger long-term performance.

Adjusted gross margin was 47.1%, an increase of 280 basis points compared to the prior year. The addition of Welch Allyn and its accretive gross margin profile drove the majority of adjusted gross margin expansion. Year-over-year adjusted capital gross margin increased 400 basis points to 46.5%, driven by the addition of Welch Allyn and favorable geographic mix. Rental gross margin in the quarter was 50.7%, a decrease of 60 basis points versus the prior year.

Moving on to operating expenses, R&D increased 54% year-over-year, driven by the addition of Welch Allyn and a 5% increase in organic investment. Adjusted SG&A increased 34% year-over-year, largely driven by Welch Allyn. As a percentage of sales, total adjusted SG&A decreased 180 basis points year-over-year.

Adjusted operating profit for the quarter was $87 million, an increase of 109% from the previous year. Operating margin for the quarter was 13.2%, an increase of 430 basis points versus the prior year. The adjusted tax rate for the quarter was 30.6% compared to 27.5% in the prior year. The rate was negatively impacted by unfavorable geographic mix, which more than offset the benefit from the reinstatement of the R&D tax credit.

So to summarize the income statement, we achieved adjusted earnings per diluted share of $0.68 in our first quarter, an increase of 39% over the prior year. Earnings were driven by strong revenue growth in North America and the addition of Welch Allyn.

Our operating cash flow of $46 million was in line with our expectations and up nearly 50% over the prior year, reflecting the addition of Welch Allyn. Capital expenditures of $18 million were down significantly from the first quarter of 2015, which included incremental investments in our rental fee.

Now, let's move on to 2016 guidance. For fiscal 2016, we continue to expect reported revenue of between $2.66 billion and $2.7 billion despite increased headwinds from currency compared to our previous guidance. Our forecast is based on the following assumptions: low-to-mid single digit constant currency organic revenue growth and, more specifically, mid-single digit constant currency revenue growth in North America, which is up from our prior guidance of low-to-mid single digits; International revenue decline of mid-single digits on a constant currency basis compared to flat revenue performance previously; and Surgical and Respiratory Care constant currency revenue growth in the mid-single digits.

For Welch Allyn, we now expect mid-single digit constant currency pro forma growth compared to the 3% to 5% previously. And overall, we expect a negative impact from currency of approximately 2% to 3% at current rates compared to approximately 1% to 2% previously.

Regarding earnings, we now expect fiscal 2016 adjusted earnings per diluted share of between $3.24 and $3.30 compared to $3.08 to $3.14 previously. Our revised earnings forecast assumes gross margin between 47% and 48%, R&D spending of approximately 5% of sales, SG&A will continue to improve as a percentage of sales, and we expect a tax rate of 29% to 30%, which includes the benefit of the reinstatement of the R&D tax credit, partially offset with unfavorable geographic mix. Finally, we expect approximately 66 million to 67 million shares outstanding for the year.

So to summarize, our revised forecast translates to approximately 300 basis points improvement in our adjusted operating margin and 23% to 25% growth in adjusted earnings per share compared to 2015.

Moving to cash flow, we are increasing our 2016 reported operating cash flow forecast from $300 million to approximately $315 million. We continue to expect capital expenditures of approximately $110 million to $120 million.

Now, moving to the second quarter, we expect reported revenue of between $645 million and $655 million. This reflects low-to-mid single digit constant currency organic revenue growth and a negative impact from currency of approximately 1% to 2% at current rates. We expect adjusted earnings per diluted share to be in the range of $0.68 to $0.70, compared to $0.64 in fiscal 2015.

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

John J. Greisch - President, CEO & Executive Director

Thanks, Steve. We're off to a great start in 2016 with our first quarter performance. While we continue to see stability in the North America hospital environment, the execution of our commercial team has been outstanding, driving above-market double-digit growth in North America the past four quarters. While several international markets will provide ongoing challenges in the near term, we're excited by the opportunities to drive growth with our expanded portfolio, as we continue to integrate our operations around the world and leverage our strong customer relationships across our portfolio.

The acquisition of Welch Allyn has been a great example of how we plan to execute our strategy. It has enabled us to build a stronger, more diverse portfolio of compelling solutions for our customers. Our leadership team has demonstrated the ability to successfully integrate businesses, such as Trumpf and Welch Allyn, while, at the same time, deliver on our commitment to accelerate the growth and improve the profitability of the acquired businesses.

In addition to accelerating growth and improving operating margins, we're aggressively driving cash flow as demonstrated by the strong first quarter and improved outlook for the full year. We will continue to maintain our disciplined approach to deploying our improving cash flow in a value creating manner, including pursuing growth through acquisitions.

We're well on our way to deliver on the long-term goal presented at our investor conference last year. Our cadence of new product introductions has accelerated over the past several years and we are confident that new products like Integrated Table Motion and others across our portfolio in the pipeline will continue to drive profitable growth for us in the future. We look forward to demonstrating additional progress on our goals throughout 2016.

With that, operator, please open the call to questions.

Question-and-Answer Session

Operator

Our first question comes from the line of David Lewis of Morgan Stanley. Your line is now open.

Jonathan Demchick - Morgan Stanley & Co. LLC

Hello. This is actually Jon Demchick in for David.

John J. Greisch - President, CEO & Executive Director

Hey, Jon. Good morning.

Steven J. Strobel - Chief Financial Officer & Senior Vice President

Hi, Jon.

Jonathan Demchick - Morgan Stanley & Co. LLC

Good morning. So, there was a fair amount of angst amongst, I guess, investors heading into the year about the future of the hospital capital expenditure environment. Results for hospitals so far have looked a bit better on profitability and, obviously, top line results for the North American business (23:17) didn't really show weakness for you all. Was wondering how you see this environment moving into 2016, starting with your, I guess, fiscal second quarter guidance, does imply, I guess, a sequential drop in revenues, which certainly isn't the norm for you all, so any details there would be great.

John J. Greisch - President, CEO & Executive Director

Yeah. I'll provide a couple of comments, Jon, and Carlyn can add to it as well. I think we've, said for the several months, the environment, from our perspective, remains pretty stable. I think you've seen double-digit growth in our North American capital business here for now five straight quarters, including a 10% growth here in the first quarter of 2016 and our overall North American business has been up for the last four, five quarters in double-digits as well.

So, we're seeing pretty strong capital environment overall. And as I mentioned in my prepared comments, our teams are delivering above-market growth and executing exceptionally well, not just with HCA, which has obviously helped, but I think you heard in my comments, ex-HCA orders here in the first quarter were up double-digits over a pretty strong year last year.

So, we're feeling pretty good about the environment. Our order bank continued – our quote bank continues to be strong. We're winning competitively and we're going into the second quarter here with the highest backlog we've ever had. I think our guidance for Q2, we don't provide it on a segment basis, but North America will be up again here in Q2 compared to last year as well.

Carlyn D. Solomon - Chief Operating Officer

Yeah. And maybe just to add, because the sequential drop, everything John said points to strength in what I think is your primary question, which is the U.S. hospital environment. What we see is, for Welch Allyn, it's kind of a normal drop-off here. As they finished the year and head into the new year, we've seen that as we've looked historically at their financials. So that's a big part of what you're seeing, coupled with we continue to see a drop in our international business, really driven by the Middle East and LatAm. And I think that's related to external environmental factors. Does that help, Jon?

Jonathan Demchick - Morgan Stanley & Co. LLC

Yes. Very helpful. Thank you very much. Just a quick follow-up kind of just on the margins. So, operating margin improvement this year, obviously, year-over-year was very impressive, over 400 basis points, and just a few kind of details behind there would be great. Obviously, some of this was driven from investments in fiscal 1Q 2015 that depressed margins and then, obviously, a good chunk of (26:22) improvement this year was driven by Welch Allyn mix, especially on gross margin, as you guys obviously pointed out.

Can you maybe quantify how large of an impact you believe Welch Allyn mix drivers were and then kind of where we are, obviously, progressing through the synergies target? And then lastly, I was kind of curious at how much margin improvement do you believe will be achieved in 2016 from organic measures rather than mix?

John J. Greisch - President, CEO & Executive Director

Yeah, Jon. This is John. Couple of responses to that. Obviously, we're very pleased with the first quarter with the 430-basis point improvement in our operating margin. So we came out of fiscal 2015 with a strong fourth quarter. Sequentially, our margins are down slightly, but our fourth quarter margin is always higher than the rest of the year, but year-over-year 430-basis point operating margin improvement, we are very, very pleased with.

As I said in my prepared comments, the majority of that is from Welch Allyn and the synergies, which really hit across the company. I'll take you back to the full year guidance that that Steve laid out. We're expecting our operating margin for the full year to be up about 300 basis points, so that gets us into the 14.5% to 15% operating margin level for the full year, which is getting us towards where we want to be and well on the way towards the 450-basis point to 550-basis point improvement that we committed for the next three years off of fiscal 2015.

The mix of that, I think, last quarter we said we expected about two-thirds of the improvement this year to come from Welch Allyn and for the year. That's still roughly in line. The synergies were on track. I think we committed this year about a third of the $40 million. We feel comfortable with that. And going forward, we're confident in our ability to continue to drive margins across the portfolio, so feeling good about our margin profile here in 2016 in line with our long range commitments.

Jonathan Demchick - Morgan Stanley & Co. LLC

Sounds great. And just one quick follow-up, I guess, on that one. Basically, when I look at the margin guidance across gross, R&D and SG&A, it doesn't look to be a change. I was curious to how the medical device tax reinvestment kind of factors into those margin estimates?

John J. Greisch - President, CEO & Executive Director

Yeah, as I said, we're reinvesting the majority of that into R&D and SG&A to drive growth in some of our higher margin businesses. There is a lot of puts and takes in R&D and SG&A. We're also combating, as Carlyn mentioned, some declines in the international market. So at the same time, we're taking some cost out to address some of those pressures. We're reinvesting in areas where we can accelerate growth, namely our surgical business, our respiratory business and, obviously, our North American business at the moment as well.

Jonathan Demchick - Morgan Stanley & Co. LLC

Very helpful. Thank you very much.

John J. Greisch - President, CEO & Executive Director

Okay.Thanks, Jon.

Operator

Thank you. Our next question comes from David Roman of Goldman Sachs. Your line is now open.

Unknown Speaker

Hi. It's actually Justine (29:39) in for David. Thanks for taking the question.

John J. Greisch - President, CEO & Executive Director

Hey, good morning, Justine (29:43).

Unknown Speaker

Good morning. I was wondering if you could provide some color around how the da Vinci table rollout is progressing in Europe and how you see that rollout panning out in the U.S. And do you expect this product to be margin accretive?

Carlyn D. Solomon - Chief Operating Officer

Yeah. I'll take the last point first. This is Carlyn. Hi, Justine (30:01).

Unknown Speaker

Hi.

Carlyn D. Solomon - Chief Operating Officer

We expect the margin to be accretive to what we have in the company. We have seen in – and it's taken off in Europe, we're seeing what you would expect to see in Europe in terms of uptake of a product like this. And in the U.S., we have strong interest in the table. And just to kind to remind you, there are two segments that we'll be selling into. The first is new placements of the Xi robot and the second is old placements or base business, where the Xi robot was already purchased in the U.S. market, and now there's an opportunity for us to go back and explain to them the value of having our table coupled with that Xi robot.

So, it's very early days, we're just getting started, but early interest is strong and what we see from the marketplace, and we're just pleased to be able to offer an innovation like this, which is great for patients, it's great for surgeons, and we really appreciate the collaboration that we have with Intuitive Surgical.

Unknown Speaker

Great. That's really helpful. And then a quick follow-up. Can you talk about the challenges you face in the International core business and what opportunities exist to turn that around? So are there any initiatives you can put into place to drive growth or is it simply just tethered to the macro environment?

Carlyn D. Solomon - Chief Operating Officer

Well, International is – obviously, there is a story in every region. So where we have an opportunity we're pressing that opportunity. So, for instance, John mentioned in Asia Pac, we see nice growth like you would expect to see there, and we're doing things to press our growth there. We had an opportunity with our Trumpf business in Australia, which we took, which had a nice response and helped us there. We see opportunity in China and we continue to do very well there.

In Europe, we're – and throughout the region, we're taking some of our higher margin products that were available in the U.S., a good example of this would be, our CWS business, and over the next several quarters, we're going to work very hard to get that introduced into the international market. That will take some time because you have to get it approved. You have to make sure you get all the languages appropriate to be able to launch it. But that will be an example of taking higher margin products like that one and there are others that we'll introduce into these markets.

We're also working on our cost structure. Cost is something that we can do – we can do some integration and get some synergies with our acquisitions. So that's one of the reasons we announced the reorganization of the company into a global international division. And so we'll start that consolidation. And then finally, we'll make trade-off decisions – strategic decisions, where we move investment from parts of the business that aren't doing as well into the higher margin products like Welch Allyn and throughout the world, but particularly in Europe.

To finish with the regions, Europe is doing largely what we had anticipated; a little short of what we had hoped, but largely what we had anticipated. Our two big issues, really, the primary issue is the Middle East and the core of that is Saudi Arabia, where we've seen a very precipitous decline in our business. And then LatAm as well and we really placed that, as you noted, on the external environment. I hope that's helpful.

Unknown Speaker

Yeah, definitely. Thank you.

John J. Greisch - President, CEO & Executive Director

Justine, (33:41) just to add to what Carlyn said and to frame it a little bit, even though they're relatively small regions when we compare to Western Europe and North America, the Middle East and Latin America cost us about 3 points of constant currency growth here in the first quarter. So we came out of last year, as I'm sure you recall, with about a 7% constant currency growth throughout the year, we had 3% here in Q1, and Latin America and the Middle East, for all the reasons that everybody on this call are all too familiar with, caused us a little over 3 points of growth.

So as Carlyn said, Europe's hanging in there, it's not blowing the doors off by any means, but we're certainly in line with our expectations, but those two regions, which, as I said in my comments, are going to continue for the foreseeable future, have really dampened our constant currency growth momentum that we came into the year with out of fiscal 2015.

Unknown Speaker

Got it. Thanks.

John J. Greisch - President, CEO & Executive Director

Thanks a lot.

Carlyn D. Solomon - Chief Operating Officer

Thank you.

Operator

Thank you. Our next question comes from Bob Hopkins of Bank of America Merrill Lynch. Your line is now open.

Travis Steed - Bank of America Merrill Lynch

This is Travis Steed on for Bob.

John J. Greisch - President, CEO & Executive Director

Hey, Travis.

Travis Steed - Bank of America Merrill Lynch

Just a quick follow-up. Hey, just a quick follow-up on the rotating bed. Just how quickly can you get the bed to customers? Just thinking about how quickly you can penetrate the current Xi (35:11) installed base the customer interest is there?

Carlyn D. Solomon - Chief Operating Officer

Yeah. This is Carlyn, Travis. Hi. We have been building some inventory and we'll be able to start shipping that relatively quickly. So I don't think that we'll have an issue operationally getting product into the market. This is a capital expenditure and you know this – like the timelines that it takes to get those approved within a hospital environment, so that slows things down, there's definitely a cadence to it that we'll experience, but, like I said, the interest has been good and we're pretty excited about it.

Travis Steed - Bank of America Merrill Lynch

Okay. And with Tenet recently joining the HealthTrust GPO and your strong relationships with HealthTrust, could this be a material driver for new business in 2016, 2017?

John J. Greisch - President, CEO & Executive Director

Yeah, I think given the relationships we've got with HealthTrust and some of the contracts we've got, it should be a net positive. We've already got a strong – pretty strong position with Tenet, but net-net, yeah, I think it'll be beneficial to us.

Travis Steed - Bank of America Merrill Lynch

Okay. And then you assume zero benefit from sales synergies with the Welch Allyn deal, and I think most people believe that's a fairly conservative assumption. Now that you've owned Welch Allyn for a few months are you seeing any opportunities on the top line yet?

John J. Greisch - President, CEO & Executive Director

Well, I think if you look at our first quarter, 7% year-over-year constant currency growth from Welch Allyn pretty much answers that question. As Carlyn mentioned, that was the strongest quarter of their year. So, we're going to see sequentially a drop-off here coming off their strong first quarter, but we're confident we're going to accelerate the growth from what they had historically, which, to remind everybody, was about a 3% constant currency growth. Our guidance for the full year is mid-single digit and we're off to a great start here in the first quarter.

Travis Steed - Bank of America Merrill Lynch

Okay. Thanks a lot.

John J. Greisch - President, CEO & Executive Director

Thank you.

Operator

Thank you. Our next question comes from the line of Matthew Mishan of KeyBanc. Your line is now open.

Matthew Mishan - KeyBanc Capital Markets, Inc.

Great. Thank you for taking my questions, and good morning.

John J. Greisch - President, CEO & Executive Director

Hey, Matt.

Matthew Mishan - KeyBanc Capital Markets, Inc.

On the EPS guidance, the bump in EPS guidance, you had given some color also around some of the recent tax legislation changes when you preannounced sales. Could you help us to walk from your previous EPS guidance of $3.08 to $3.14 to your new EPS guidance of $3.24 to $3.30 with the recent tax legislation changes, the beat in the quarter, what would be the offsets there to that?

Steven J. Strobel - Chief Financial Officer & Senior Vice President

Hey, Matt. This is Steve. I'll start and John can add some color on this. But the R&D tax credit to us is a big chunk of that. That's worth probably $0.06. The beat in the first quarter of about $0.03 gives you $0.09 right off the bat. We're going to have – you'd seen that we've taken our guidance up on both Welch Allyn and our North American business, and that's offsetting – more than offsetting International business decline. You've seen that we've taken our guidance down there. So all that said, and as John mentioned, the medical device tax being largely reinvested gets us into the range – the new range that we're now guiding toward.

John J. Greisch - President, CEO & Executive Director

Yeah, Matt, I think that the key points Steve made the – two things. The mixed impact of stronger revenues, North America offsetting weaker revenues in International are benefiting earnings. And then the device tax, we quantified that the total impact was about 12%.

Steven J. Strobel - Chief Financial Officer & Senior Vice President

$0.12.

John J. Greisch - President, CEO & Executive Director

$0.12, excuse me. And as I mentioned in my prepared comments, we're reinvesting the majority of that into areas where we're seeing some growth, which I think I addressed on an earlier question. So, it's a combination of all of that. The stronger Q1, the R&D tax credit and then the mix benefit of the strength of Welch Allyn and North America. The offsets are really the reinvestment of the device tax.

Matthew Mishan - KeyBanc Capital Markets, Inc.

Okay. That's fair. That's very helpful. And then, on the 2Q EPS guidance, I think there's a delta between where the Street was at with their EPS numbers and where your EPS guidance came in. As you looked at where we were versus where you're coming in, what do you think the biggest differences were?

Steven J. Strobel - Chief Financial Officer & Senior Vice President

It's hard to – I guess I wouldn't speculate as to where the – what the Street calculations were so much as to say, but as we look at our second quarter, particularly, in comparison with first quarter, they're pretty similar in terms of top and bottom line. The kind of position is going to be a bit different. Obviously, we've said before that we'll have a stronger second quarter in North America. Welch Allyn will be coming down from their very, very strong first quarter.

But the top line guidance is in line with where we were in the first quarter. We'll have a little bit stronger as we have a little bit of mix. We'll have a little bit stronger bottom line impact. So, I think, sequentially, we're very comfortable with where we end up in guidance for the second quarter.

John J. Greisch - President, CEO & Executive Director

Hey Matt. I just – Matt, yeah, just to add to that. This is John. Gross margins, again, are up 200 basis points here in Q2. I think the one area that's probably higher than what we expected coming into the year and possibly higher than where the Street was, is our tax rate. I think Steve commented on the negative impact of the geographic mix that we're dealing with this year with International having a pretty weak year. That's not helping our tax rate. And I think it's pretty much in the first quarter all but offset the benefit of the R&D tax credit.

Matthew Mishan - KeyBanc Capital Markets, Inc.

Yeah.

John J. Greisch - President, CEO & Executive Director

So, tax rates definitely going to be higher than what the easy math would lead you to despite rolling in the full year R&D tax credit, but aside from that I think we're pretty much in line with where we were. And obviously for the full year, higher operating margins and higher net earnings operationally as well as resulting from the benefit of the R&D tax credit.

Steven J. Strobel - Chief Financial Officer & Senior Vice President

Yeah. Matt, if you look at the first half, second half – first half EPS growth from second half EPS growth will both be in excess of 20%, so...

Matthew Mishan - KeyBanc Capital Markets, Inc.

And just one last quick one if I can squeeze it in...

John J. Greisch - President, CEO & Executive Director

Yeah, go ahead.

Matthew Mishan - KeyBanc Capital Markets, Inc.

Second quarter, you typically get the benefit of higher rental revenue, given the seasonality, what do you anticipate – how are you seeing the flu season shape up in the second quarter?

John J. Greisch - President, CEO & Executive Director

Yeah. Again, we're not going to give specific segment or even part of a segment revenue guidance on a quarterly basis, but we had a strong Q1 with 11% growth, the margins are up in North America, I think we're delivering exactly what we said we'd be delivering in the rental business here in North America, which was stronger growth and improving margins, as we benefit from the volume gains that we achieved last year, so we're feeling good about that business.

Matthew Mishan - KeyBanc Capital Markets, Inc.

Right. Thank you.

Steven J. Strobel - Chief Financial Officer & Senior Vice President

Thanks, Matt.

Operator

Thank you. Our next question comes from Gary Lieberman of Wells Fargo. Your line is now open.

Gary Lieberman - Wells Fargo Securities LLC

Good morning. Thanks for taking the question. Maybe just a follow-up on that last point, can you discuss in a little bit more detail kind of where you are in the reinvestment process in the rental business and what the – what if any margin opportunity there is still there?

John J. Greisch - President, CEO & Executive Director

Yeah. I think you're probably addressing the large capital investment we made last year in the rental fleet. That's pretty much behind us. We're now in maintenance mode with that business. So we're back to a normalized investment level. And I think, as my comments to Matt's question just indicated, the operating leverage that we're able to get and historically have gotten off of that business on the back of volume gains. We're driving the heck count of our cost structure to ensure that we continue to drive that operating leverage to stronger margins, which we saw here in Q1.

Gary Lieberman - Wells Fargo Securities LLC

Okay, great. And then maybe just one more question on the U.S. capital business, any visibility, I guess, last quarter maybe there were some visibility into spend by some of your large purchasers, is there anything this quarter or throughout the rest of the year that you're aware of that you expect?

Carlyn D. Solomon - Chief Operating Officer

No, kind of – this is Carlyn, Gary – kind of the same old story. We see stability. We don't see any evidence at this point of a decline. We see stability as far out as we can see, which isn't that far, but when we look out over the next quarter, it seems like we're in a pretty stable environment.

Gary Lieberman - Wells Fargo Securities LLC

Okay, great. Thanks very much.

Operator

Thank you. And at this time, I'm showing there are no further participants in the queue. I would like to turn the call back to management for any closing remarks.

John J. Greisch - President, CEO & Executive Director

Okay. Thank you everyone for joining our call today.

Operator

Ladies and gentlemen, thank you for your participation on today's call. This concludes your program. You may now disconnect. Everyone have a great day.

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