Hill-Rom Holdings (HRC) John J. Greisch on Q3 2016 Results - Earnings Call Transcript

| About: Hill-Rom Holdings, (HRC)

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

Q3 2016 Earnings Call

August 04, 2016 8:00 am ET

Executives

Mary Kay Ladone - Vice President-Investor Relations

John J. Greisch - President, Chief Executive Officer & Executive Director

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

Analysts

Jonathan Demchick - Morgan Stanley & Co. LLC

Robert Adam Hopkins - Bank of America Merrill Lynch

Matthew Mishan - KeyBanc Capital Markets, Inc.

Operator

Good morning and welcome to Hill-Rom's Fiscal Third Quarter Earnings Conference Call. During the presentation, all participants will be in a listen-only mode. At the end of management's prepared remarks, we will conduct a question-and-answer session.

As a reminder, this call is being recorded by Hill-Rom and is copyrighted material. It cannot be recorded, rebroadcast, or transmitted without Hill-Rom's written consent. If you have any objections, please disconnect at this time.

I would now like to turn the call over to Ms. Mary Kay Ladone, Vice President, Investor Relations at Hill-Rom. Ms. Ladone, you may begin.

Mary Kay Ladone - Vice President-Investor Relations

Thanks, Kat, and good morning, everyone, and thanks for joining us for our fiscal third quarter 2016 earnings conference call. I'm very excited to be joining the Hill-Rom team and look forward to working with all of you again.

Joining me today will be John Greisch, President and Chief Executive Officer of Hill-Rom; and Steve Strobel, Chief Financial Officer. On today's call, John will provide an overview and discuss highlights from our fiscal third quarter, and Steve will provide additional detail on the company's financial performance, financial outlook for the fourth quarter, and updated guidance for the full year 2016 before opening up the call for Q&A.

I'd also like to mention that in addition to the press release issued this morning, we have posted a corresponding presentation for your reference that we'll follow along with our discussion today. These slides can be accessed and viewed as part of our webcast or on the Investor Relations page of our website at hill-rom.com under Events & Presentations.

So, with that introduction, let me begin our prepared remarks this morning by reminding you that this presentation, including comments regarding our financial outlook, business plans and future initiatives, contain forward-looking statements that involve risks and uncertainties, and of course, our actual results may differ materially from our current expectations. Please refer to today's press release and our SEC filings for more detail concerning factors that could cause actual results to differ materially.

In addition, in today's call, non-GAAP financial measures will be used to help investors understand Hill-Rom's ongoing business performance. A reconciliation of the non-GAAP financial measures being discussed today to the comparable GAAP financial measures is included in our earnings release issued this morning and available as part of the presentation on our website.

Now I'd like to turn the call over to John Greisch.

John J. Greisch - President, Chief Executive Officer & Executive Director

Thanks, Mary Kay. Good morning, everybody, and thanks for joining us today. I'd like to welcome Mary Kay to the Hill-Rom team. Many of you know her quite well, having worked with her for many years and we're thrilled to have her join our team.

As you saw in our press release issued this morning, we delivered another strong quarter of revenue and earnings growth that exceeded our expectations. As a result, we have raised our full year earnings and cash flow outlook. This performance reflects the value of our diversified portfolio, our disciplined focus on commercial and operational execution, and our commitment to cost management and margin improvements across our businesses.

On virtually all fronts, we had a great quarter as we continue to make progress on the strategic priorities we outlined at our investor conference last September. Our commercial teams continued to execute well and delivered revenue growth ahead of our quarterly expectations. Throughout 2016, we've achieved solid pro forma growth in most geographies and businesses, albeit at a slightly lower rate in Q3, due to ongoing headwinds in several international regions.

Pro forma constant currency revenue growth was over 2% in the quarter and is up about 3% year-to-date, including a negative impact of approximately 3 points from declines in the Middle East and Latin America. The economic and political environments in these regions have impacted us more than most, due to the capital nature of the majority of our revenue in those regions. Excluding the impact from these regions, our pro forma growth rate was 5% in Q3 and 6% year-to-date, which gives us confidence as we look forward beyond 2016.

In addition to strong revenues, we also had a great margin performance this quarter. Adjusted operating margins were over 15% and are expected to exceed that level for the full year. In line with our objective to consistently drive margin improvement, we recently announced the closure of two additional manufacturing facilities in Europe, bringing the total number of closures to five. Along with expected future facility consolidations, we are making great progress on our targeted procurement savings opportunities, which are expected to significantly contribute to margin expansion beyond 2016.

Cash flow was also strong this quarter. We achieved a record level of quarterly operating cash flow, which is now up 65% year-to-date. Following the Welch Allyn acquisition, our focus on improving cash flow to delever as quickly as possible is certainly paying off. Our short-term and long-term incentive compensation programs are in part tied to cash flow performance. And we feel great about the progress we have made in 2016.

We've also been successful in driving portfolio optimization initiatives directed at focusing resources on higher growth, higher margin opportunities. These efforts are clearly yielding results and contributing to our enhanced revenue and margin profile. We still have several lower growth and lower margin product lines that we expect to exit, providing incremental benefits to our revenue mix and margins in the future.

At the same time, we continue to invest in innovation and are confident this will deliver a steady stream of new product introductions that will further accelerate revenue and margin growth. Recent examples of this include Integrated Table Motion; LikoGuard, our new overhead patient lift system; Compella, our new bariatric bed frame; VisiVest, our connected vest system; and several new products in our Welch Allyn portfolio.

I want to take a moment to add some additional commentary on the performance of our businesses. North America had another outstanding quarter. Our commercial team continues to execute very well as evidenced by product and service orders, which rose 4% for the quarter and are up 15% year-to-date.

In addition, our order backlog is at a record level, up 16% compared to the prior year, further highlighting the outstanding execution of our team in the field and the value of recent new product introductions. We're very pleased with the growth and margin performance in North America this year, and expect the overall environment in North America to remain stable for the foreseeable future.

Having said that, we do expect growth in Q4 to be somewhat challenging as a result of a record fourth quarter in 2015. Front Line Care performed in line with our expectations for the quarter, posting pro forma constant currency growth of about 2%. On a year-to-date basis, pro forma revenue advanced 6%. We continue to be very pleased with Welch Allyn's performance and the progress we have made on the integration front. For the year, we expect to exceed our original financial expectations, and we are tracking ahead of our synergy targets. With recent new product introductions and additional commercial synergy opportunities still ahead of us, we continue to be very encouraged about the future growth prospects for Welch Allyn.

Our Surgical business posted 3% growth in Q3, driven by strong 13% growth domestically. Similar to the prior quarter, we had a tough quarter in certain international markets, particularly the Middle East, which impacted our global Surgical growth rate for the quarter by about 3 points. We're optimistic about the long-term growth of our Surgical franchise, as we leverage our global channel presence and introduce new products. Our partnership with Intuitive Surgical on the new Integrated Table Motion product is a great example of our focus on initiatives that we expect to enhance future growth and margins.

Our International segment, which is largely our International PSS business, declined 8% this quarter on a constant currency basis, in line with our expectations. While down year-over-year, Q3 improved sequentially as expected, driven by improved performance in Europe. You may recall that our second quarter international performance was impacted by a weak quarter in Europe. We were confident then that we would see a sequential improvement in Europe in the second half of the year, which we in fact did in Q3.

We posted solid growth in Asia-Pacific this quarter, up approximately 13%. This was more than offset by other regional declines, with the largest percentage decline again coming from the Middle East, which is now down close to 50% year-to-date in PSS, similar to our Surgical business.

So to summarize, we're on track to have a great year. Looking forward, we're highly confident in our ability to continue to drive strong improvement in our margins, earnings, and cash flow while, at the same time, drive accelerated revenue growth in 2017 and beyond.

Before I turn the call over to Steve, I want to announce that Carlyn Solomon, our Chief Operating Officer for the past 18 months, will be leaving the company following the end of our fiscal year. Carlyn wants to pursue CEO opportunities outside of Hill-Rom and I want to wish him all the best and thank him for the contributions he has made since he joined us about 18 months ago.

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

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

Thank you, John, and good morning, everyone. Third quarter revenue increased 38% to $655 million. On a constant currency basis, third quarter revenue rose 39%. Revenue growth on a pro forma constant currency basis was 2.3%, which reflects stand-alone Welch Allyn and Hill-Rom revenue in both the current and prior periods. Product sales and service revenue advanced 48% to $556 million. On a pro forma constant currency basis, the increase was 2%. Rental revenue of $99 million also grew 2% on a constant currency basis in the quarter.

From a geographic perspective, U.S. revenue increased 47% to $451 million. On a pro forma basis, U.S. revenue increased 6%, driven by solid performance across each of our businesses. Revenue outside the United States increased to $204 million, reflecting a constant currency increase of 24% driven by the addition of Welch Allyn. On a constant currency pro forma basis, revenue outside the United States declined 4%, driven by lower sales in the Middle East and Latin America. Unfavorable macroeconomic conditions in these regions are negatively impacting capital spending and leading to project delays.

Now, let me turn to revenue by segment. North America revenue increased 6% on both a reported and constant currency basis to $268 million. North America product sales and service revenue increased 8% to $196 million driven by diversified growth across many of our platforms, including Clinical Workflow Solutions and our Patient Support Systems portfolio. Third quarter product sales and service orders were up 4% from the prior year while the backlog increased 16% to a record level. North America constant currency rental revenue increased 2% to $72 million.

Front Line Care revenue was $193 million in the quarter. On a pro forma constant currency basis, Front Line Care increased 2% year-over-year. The Respiratory Care franchise of this segment recorded growth of approximately 7% for the quarter, driven primarily by strong new product momentum in the United States.

Welch Allyn continues to perform well delivering 6% constant currency pro forma growth for the first nine months of fiscal 2016. Constant currency pro forma growth in the third quarter was 1% and reflects the exit of some non-core OEM business and weaker than anticipated results in the Middle East. Excluding these factors, pro forma constant currency growth was 3% in the quarter and 7% year-to-date.

Moving to Surgical Solutions, revenue increased 3% on both a reported and constant currency basis to $102 million. Strong U.S. sales growth of 13% was driven by Trumpf and Allen Medical. However, our domestic growth was partially offset by a decline in International revenue, particularly in the Middle East.

Our International segment revenue was $93 million, down 8% on both a reported and constant currency basis. We continue to experience macroeconomic headwinds in this segment and similar to the previous two quarters, the largest decline is in the Middle East where low oil prices and political instability are driving further capital project delays.

In Europe, revenue improved sequentially from the second quarter, but as expected, was down compared to the prior year. Adjusted gross margin was 48.1%, the highest level this year and an improvement of 340 basis points compared to the prior year. More than half of this expansion is driven by improvement in the organic Hill-Rom business with the remainder driven by the addition of Welch Allyn.

Moving on to operating expenses, R&D increased 44% year-over-year, primarily driven by the addition of Welch Allyn as well as a 6% increase in organic investment. Adjusted SG&A as a percentage of revenue was down 50 basis points to 27.8% of sales. Adjusted operating profit for the quarter was $100 million, an increase of 83% from the previous year. Given significant gross margin expansion and SG&A leverage, adjusted operating margin for the quarter was 15.2%, an increase of 370 basis points versus the prior year and the highest level of the year.

In addition, we continued to be ahead of schedule on the Welch Allyn integration as well as on the attainment of at least $40 million in synergy by 2018. The adjusted tax rate for the quarter was in line with our expectations at 29.6% compared to the 31.1% in the prior year.

So, in summary, we exceeded our revenue and adjusted EPS guidance for the quarter. Adjusted earnings per diluted share increased 31% to $0.81, exceeding our guidance range of $0.75 to $0.77 per share. Earnings were driven by the strong revenue growth in the U.S. across all of our businesses, the successful integration of Welch Allyn, double-digit growth in the Asia-Pacific region and continued operational execution. Year-to-date, we've achieved approximately 3% pro forma constant currency revenue growth, despite headwinds in the Middle East and Latin America, expanded our operating margins 340 basis points, and increased our adjusted earnings per diluted share 26% to $2.20.

Before I turn to cash flow, I want to note two items included in our third quarter GAAP earnings. The first pertains to our GAAP tax rate this quarter. Because of the improved profitability outlook in our French entity, we released the valuation allowance on the French net operating loss carryforwards, which resulted in a $19 million benefit for the quarter. The second item concerns restructuring charges related to our manufacturing footprint optimization. During the quarter, we announced closure of two European manufacturing facilities in Sweden and France. These actions are in progress and will be completed in 2017.

Turning to cash flow. Our third quarter operating cash flow of $118 million was more than three times the prior year's level. Year-to-date, operating cash flow increased $81 million or 65% to $205 million. Year-to-date capital expenditures of $61 million declined significantly from 2015, which included sizable investments in our rental fleet. This strong cash flow performance and tight management of our capital expenditures has enabled $107 million in debt repayment, during the current year ahead of our plan.

Now, let's move on to 2016 guidance. For fiscal 2016, we're raising our adjusted earnings guidance to $3.32 to $3.34 per diluted share, compared to our previously disclosed range of $3.26 to $3.30 per diluted share. We now expect full-year reported revenue of approximately $2.65 billion, reflecting 2% to 3% growth on a pro forma constant currency basis, and a negative impact from currency of approximately 2 points at current rates.

By segment, this assumes mid-to-high single-digit constant currency revenue growth in North America, which is higher than our previous mid-single-digit range, as we continue to experience strength in orders across key products in our Patient Support System portfolio. For Front Line Care, we continue to expect mid-to-high single-digit pro forma constant currency growth, and we now expect Surgical Solutions revenue to be approximately flat year-over-year, due primarily to project delays internationally. And we continue to expect the International segment revenue to decline 10% to 12% on a constant currency basis.

From a profitability standpoint, we expect an adjusted gross margin of approximately 48%, R&D spending of approximately 5% of sales, adjusted SG&A in the range of 27% to 28% of sales, a tax rate of approximately 30% toward the top of end of our previous range of 29% to 30%. And lastly, we expect approximately 66 million to 67 million shares outstanding for the year.

To summarize, our revised 2016 guidance translates to an adjusted operating margin of over 15%, an increase of approximately 350 basis points compared to the prior year and growth of 26% to 27% in adjusted earnings per share. From a cash flow perspective, we now project 2016 operating cash flow to be higher than previously expected and approximately $320 million, while capital expenditures of approximately $90 million, which is $20 million to $30 million lower than our previous guidance.

For the fourth quarter, we expect adjusted earnings of $1.12 to $1.14 per diluted share, compared to $0.89 per diluted share in fiscal 2015. Also, we expect reported revenue of $695 million to $705 million, which is comparable to the prior year on a pro forma basis and includes a negative impact from currency of approximately 1% at current rates.

With that, I'll turn the call back over to John for his closing comments.

John J. Greisch - President, Chief Executive Officer & Executive Director

Thanks, Steve. We're pleased with the results we achieved in the third quarter and with our improved full-year outlook for adjusted earnings and cash flow, as you just heard from Steve. We expect to see strong full-year growth in our North America PSS business and at Welch Allyn for our first full year of ownership. The integration and performance of Welch Allyn could not have gone better, and we're very excited by the growth potential we see for this great business.

At the same time, we are seeing sequential improvements in our European Surgical and PSS businesses, while we manage the challenges in Latin America and the Middle East. We're very proud of the margin expansion we have achieved in our legacy Hill-Rom business, which together with the addition of Welch Allyn has contributed to our overall margin improvement, resulting in an expected full-year adjusted operating margin in excess of 15%.

Looking forward, we're moving into 2017 with positive momentum. We have a clear strategy and a talented team. I'm confident we will continue to deliver on our strategic priorities, including deploying our strong cash flow in a disciplined manner to drive enhanced shareholder value in the years ahead.

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

Question-and-Answer Session

Operator

Thank you. We will now begin the question-and-answer session. I would like to remind participants, this call is being recorded and a digital replay will be available on the Hill-Rom website for 30 days at www.hill-rom.com. The first participant, our question comes from the line of David Lewis with Morgan Stanley. Your question please.

Jonathan Demchick - Morgan Stanley & Co. LLC

Good morning. This is actually Jon Demchick in for David.

John J. Greisch - President, Chief Executive Officer & Executive Director

Hey, Jon. Good morning.

Jonathan Demchick - Morgan Stanley & Co. LLC

As we looked across the results this morning, I guess the main head scratcher we had when we looked at them was Welch Allyn growth. It was up I guess 8% the first half of the year and this quarter it looks to have dropped a bit, even if you exclude the impacts you mentioned from the OEM discontinuations and Middle East. I was wondering if you could maybe address what else may have led to the deceleration. Is it just that – difficult comparisons for the quarter there, or yeah, how should we be thinking about Welch Allyn growth I guess moving forward into next year?

John J. Greisch - President, Chief Executive Officer & Executive Director

Well, as you heard, our full year outlook for Welch Allyn is still mid to high-single digits. So, that's how you should be thinking about the growth for Welch Allyn. I think I commented last quarter, Jon, this isn't going to be a win year business with a perfect growth rate every quarter. We have had a couple of headwinds there. You mentioned one of them.

Welch Allyn was slightly down in the Middle East this quarter, not anywhere near as impacted as our Surgical and PSS business. But it took a bit out of the growth rate there here in Q3, but the full year focus is the way to look at this business. It's going to have some ups and downs. I don't look at the quarter's performance in any way as a momentum changer for this business. We've got some great new products we've introduced recently.

We're beginning to see some traction with some of the large IDN relationships that we're getting Welch Allyn into on the back of the Hill-Rom relationships. We've restructured our International regions to bring the Welch Allyn business into our country operations internationally. And the growth expectations going forward are going to be similar to what we're seeing this year for the full year. So, mid to high-single digits expectation for this year and we're very confident about growth expectations going forward for the business.

Jonathan Demchick - Morgan Stanley & Co. LLC

Thank you. Very helpful. And just one follow-up on margins. Obviously, this has been a big step-up in margin here for Hill-Rom, a lot driven by Welch Allyn, both on the mix and synergy side. Obviously, we can't expect that level of a jump next year, but I mean, as we start thinking about the attributes that are going to impact margins next year, obviously, you can't get into guidance but when we think about adding on additional Welch Allyn synergies, some of the impact from some of these facilities closures and then just broader mix, how should we be thinking about the pushes and takes to margins, as we move into next year?

John J. Greisch - President, Chief Executive Officer & Executive Director

Yeah, great question, a couple of comments. I just want to remind everybody that about half of the margin improvement this quarter is from our legacy Hill-Rom business and about half from Welch Allyn. So, we feel great about the progress we're seeing across the rest of the Hill-Rom portfolio, portfolio optimizations that I mentioned in my prepared comments, cost improvements, procurement savings, they're all starting to take hold as well as the facility closures that Steve made in his – referenced in his comments.

So looking forward, we made the commitment last year for 450 basis point to 550 basis point improvement in operating margins from 2015 to 2018, we're well on our way towards that this year. And as I think – as we both mentioned in our comments, we have additional closures to come. We've got additional procurement savings. We're really just at the beginning of what we expect to be a meaningful contribution from those initiatives going forward. And we're going to continue to address the portfolio and really focus on growth of our higher – investments in our higher growth, higher margin product and business category.

So, I feel great about where we are here, year one, following the commitment for 450 basis point to 550 basis point improvements. I think we're up 340 basis points year-to-date. And a lot more to come, in addition to I think some of the comments we've made in the past, about taking out some of our lower margin, lower growth revenue product category. So, I could not be more pleased with where we are today, year one, and the opportunities that lie ahead of us, I think, are as exciting as the ones we achieved this year.

Jonathan Demchick - Morgan Stanley & Co. LLC

Thanks. If I could just squeeze one more quick follow-up...

John J. Greisch - President, Chief Executive Officer & Executive Director

Sure, go ahead.

Jonathan Demchick - Morgan Stanley & Co. LLC

...on that point. You mentioned taking out some of the lower margin product lines. I was just wondering from a modeling perspective – obviously, it's not going to be a big impact on the profit line, but as you think about the top line impact, how much revenue are we talking about that we should be kind of adjusting out of our models?

John J. Greisch - President, Chief Executive Officer & Executive Director

Yeah. It'll occur throughout 2017 next year, Jon. It's probably in the $75 million range in total. Yeah, we've talked about some of it in Europe, but all-in, it's probably $75 million bucks and again the margin contribution is negligible on that revenue. So, we'll roll that into the margin percentage improvement. That's not an insignificant contributor also and that's probably going to be towards the second half of next year.

Jonathan Demchick - Morgan Stanley & Co. LLC

Thank you very much.

John J. Greisch - President, Chief Executive Officer & Executive Director

Okay. Thank you.

Operator

Thank you. And Bob Hopkins of Bank of America is on the line with a question. Please state your question.

Robert Adam Hopkins - Bank of America Merrill Lynch

Okay. Thank you. Can you hear me this morning?

John J. Greisch - President, Chief Executive Officer & Executive Director

Hey, Bob. We can. What's up?

Robert Adam Hopkins - Bank of America Merrill Lynch

Hey. Good morning. So, two things. I feel remiss if I didn't ask a question about the Chief Operating Officer change that you talked about at the end of the prepared comments there. So, John, are you going to take over the role or are you going to hire from the outside and is Carlyn staying on during that transition? Just if you wouldn't mind giving us a little more color there, that'd be helpful because I think it's an important question because that role was put there to free up your time for business development and activities of that nature. So, we'd just love a little more color.

John J. Greisch - President, Chief Executive Officer & Executive Director

Yeah. Great question, Bob. So, yeah, Carlyn will stay on working with me for the next few months. He wants to be a CEO and the potential for that here didn't match his current timing ambitions, and we've had great discussions about his desire to seek that kind of job in the right professional manner going forward. We've got a great team here. I don't plan to replace him as the COO, but as we've done in the past, I'll continue to look to strengthen the team to allow me to continue to spend my time on the strategic growth of the company and focus on the things that I've been doing for the last couple of years since Carlyn's been here.

So, I don't think we'll miss a beat going forward with the strengthening of the team that we've made over the past several years, and I'll continue to do that going forward to ensure that I don't get sucked into the operational detail that would detract me from continuing to focus on the strategic growth and other areas that I've been focusing on.

Robert Adam Hopkins - Bank of America Merrill Lynch

Terrific. Thank you for that. And then the second question is, things are obviously going as well as we could expect, if not better, on margins and cash flow and earnings growth. And it certainly looks to me like the targets you set out in that long-range plan are now looking pretty conservative.

So I'll ask a revenue question. It seems like in your response to the previous question that the $50 million you were talking about as divestitures on the last call has now increased to $75 million. So I'm just curious as you – obviously, it's a – you've got a lumpy business from a revenue perspective. As you look to 2017, can you still grow the business in the low single digits, including that $50 million to $75 million? And just curious as to what drove the decision to move to kind of $50 million to $75 million.

John J. Greisch - President, Chief Executive Officer & Executive Director

Yeah. The $50 million was one component that we highlighted the last couple of quarters because it was the biggest chunk. We've been doing this all along, Bob.

Robert Adam Hopkins - Bank of America Merrill Lynch

Okay.

John J. Greisch - President, Chief Executive Officer & Executive Director

Yeah. In terms of pruning the portfolio. We've really only got a couple of other things that we want to reduce the emphasis on, and very happy with the rest of the portfolio. So consider the $50 million to $75 million not quite a rounding error, but an inclusion of a second product category that I hadn't at least stated previously when we talked about the $50 million in Europe.

If you look at the growth for this year, even with some of the pruning that we've been doing, I think we're going to report about a 3% growth for the year pro forma with a 3-point impact from what we clearly did not anticipate, nobody anticipated coming into at least our fiscal year, that being the Middle East and Latin America meltdowns. Those alone are nearly $70 million year-over-year declines, particularly in our PSS and Surgical businesses.

So, we've absorbed those hits, still growing pro forma 3%, which is at the low end of our target 3% to 5% growth rate. But with those businesses now, those geographies now close to where I think the trough is going to be, I don't want to say ever that they are definitively at the trough, given the environment there. But as those bounce back to a more normalized level, yeah, we feel great about the ability to continue to drive towards the growth level that we've committed to as we look forward.

And the good news is, as you've seen in our margin performance, the growth areas that we have been focusing on, whether it's in Asia-Pacific or if you look here in North America with our Trumpf business this quarter up 13% and North America, most importantly, the growth that we're seeing in that business is really being driven by our higher margin products, like our Liko business, our ICU platform, our service business, our Clinical Workflow product category, and we're growing that business this year – I think, year-to-date, it's up 8%, at a time when our more volatile revenue stream our Med Surg Bed frame product is actually down this year.

So the confidence that we have as we look forward to absorb the headwinds where they exist, we feel great about still delivering on the revenue growth that we've got, because the one that I know investors have been most concerned about historically here, has been our Med Surg revenue cycle. And in a year where that's down, we're still positing high-single digits in our North American PSS business. It's a long-winded answer to your question, I apologize, but all really important points, I think, for everybody to understand.

Robert Adam Hopkins - Bank of America Merrill Lynch

No. That's very important. So, I guess the conclusion I would take from that commentary is that, given what you're achieving this year with the headwinds, that that guidance you've laid out of 3% to 5% is inclusive of all these headwinds and gives and takes. So, as we think about 2017, even though you're going to still be exiting some businesses, that range is still a decent range to think about at this point.

John J. Greisch - President, Chief Executive Officer & Executive Director

Yeah. And I think we'll be looking at our business ex those product lines that we'll be exiting. So, I think your question, can we absorb 75% and still grow 3%, 4%, 5%, I'd rather look at it on a pro forma ongoing basis because again those revenues contribute next to nothing to the bottom line.

Robert Adam Hopkins - Bank of America Merrill Lynch

Yeah, yeah.

John J. Greisch - President, Chief Executive Officer & Executive Director

So, I hope that's clear.

Robert Adam Hopkins - Bank of America Merrill Lynch

Yep, no, very clear. Thanks very much.

John J. Greisch - President, Chief Executive Officer & Executive Director

All right. Thanks for your questions, Bob.

Operator

Thank you. And Matt Mishan of KeyBanc is on the line with a question. Please state your question.

Matthew Mishan - KeyBanc Capital Markets, Inc.

Yeah. Good morning and thank you for taking my questions.

John J. Greisch - President, Chief Executive Officer & Executive Director

Hey, Matt. How are you doing?

Matthew Mishan - KeyBanc Capital Markets, Inc.

I'm good. It looked like the third quarter came in a little bit above your revenue guidance and then I think the FX assumption came in a little bit. But then if you look at your full year sales guidance, it came in I guess at $6.5 million, (39:10) a little bit towards the low end. I'm just curious what may be a little bit incrementally worse as you enter the fourth quarter than you thought.

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

Yeah. I think – Matt, this is Steve. I think probably the largest element of change in our forecast going forward was our expectations around what's going on in the Middle East. That continues to decline, as we've mentioned a couple of times. I think if I look at our overall view here, lots of other puts and takes, but I can isolate on that a little bit on Latin America, but a lot on the Middle East.

The rest of the business is, as we look at the third quarter, versus where we had our guidance at and into the fourth quarter are for the most part on, as you can see in how we've laid out our guidance. But the impact in the Middle East – and John mentioned a little bit – the impact in the Middle East on Front Line Care has been a little worse than we thought and in the PSS business and Surgical business as well. So, that's probably the largest variance, I call it, from when we were last thinking about our full year outlook.

John J. Greisch - President, Chief Executive Officer & Executive Director

Matt, if you look at the geography mix, as Steve said, it's the Middle East. If you look at the business unit guidance that we've got out there, compared to last time, North America's up slightly, Front Line Care is the same, International PSS is the same and the only real erosion, which is fairly small is in our global Surgical business, which went from low single-digit growth to about flat expectations for the full year. So, on a $400 million business, call it $10 million bucks roughly.

As you said, we're close to being in the middle of the range last time. We've obviously tightened that. So, our guidance hasn't changed materially from where we were before on the top line, but the change that we did have was in our Surgical business, which is now an expectation of flat because of what Steve mentioned, the Middle East particularly. The rest of the businesses are pretty much right in line with where we thought they're going to be last quarter.

Matthew Mishan - KeyBanc Capital Markets, Inc.

Okay. Got it. And then around the optimization that appears to be ongoing; can you kind of characterize the level of sales that you've optimized this year? And then as you think about the $75 million next year, how are you looking to go about the rationalization? Are you going to kind of raise price and see what sticks, divest the business or kind of just let it go?

John J. Greisch - President, Chief Executive Officer & Executive Director

Yeah. I'd rather not quantify because we've got puts and takes going on all the time in the portfolio. So, you're talking about portfolio optimization initiatives this year. We've got a number of things going in both directions. So, not anywhere near as material as the $50 million to $75 million we talked about. We will – I think I commented last year, we'll either exit via a divestiture or just exit the products that we've got as we've done with, again, certain product categories over the years here.

So, that's why I say during 2017, we'll be exploring whether a divestiture of a couple chunky product categories that comprise the $75 million are able to be divested or whether we just exit those two product categories. So, TBD, in terms of what that exit looks like and the timing but I think by the time we get to the second half of fiscal 2017, we'll be out of roughly that level of revenue with, again, virtually no impact on our earnings or cash flow generation.

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

As far as 2016, Matt we've probably got less than $5 million of OEM business, OEM type low margin business that we're exiting in a couple of businesses, so not a huge impact this year, as John said, some puts and takes, but those are – that'd probably be the one highlight I'd offer.

Matthew Mishan - KeyBanc Capital Markets, Inc.

Okay. Perfect. And then, could you talk a little bit about sort of the initial response to the RetinaVue, the diabetic retinopathy products from Welch Allyn? And then, are there other things that you're similarly looking at that could be – that wouldn't necessarily be outsourced to a specialist that maybe a primary care physician could perform and digitally send to Welch Allyn experts? Is that a business model you can grow outside of that product?

John J. Greisch - President, Chief Executive Officer & Executive Director

It's a great question. So the reaction to RetinaVue has been incredibly positive. We're really excited about that, as our distributor partners with whom we're working to really create demand for that product. So we launched it in April and three months on, the enthusiasm from physicians and from our distributor partners has been great.

As a channel and as a business opportunity for Welch Allyn, absolutely looking to leverage healthcare outside of the acute care hospital with other potential areas with the Welch Allyn technology. We've talked about some of our sensing technologies that we want to bring across our portfolio, as well as getting into the home health care space along some of the areas that you mentioned. You should expect to see more of that coming out of Welch Allyn as we go forward for sure.

Matthew Mishan - KeyBanc Capital Markets, Inc.

All right. Thank you, guys.

Operator

Thank you. And I'm showing no further questions at this time.

John J. Greisch - President, Chief Executive Officer & Executive Director

Okay, operator, and everybody who took the time to join us this morning, thanks for your time and look forward to interacting here in coming days and weeks. Thanks.

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

Thanks.

Mary Kay Ladone - Vice President-Investor Relations

Thanks, everyone.

Operator

Ladies and gentlemen, this concludes today's conference with Hill-Rom Holdings, Incorporated. Thank you for participating.

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