Hillenbrand Industries Q3 2007 Earnings Call Transcript

Hillenbrand Industries (HB)

Q3 2007 Earnings Call

November 15, 2007 8:00 am ET

Executives

Peter H. Soderberg – President & CEO

Gregory N. Miller – Senior VP & CFO

Kenneth A. Camp – CEO Batesville Casket Company

Blair A. (Andy) Rieth – VP Investor Relations, Communications & Global Brand Development

Patrick De Maynadier - Counsel

Analysts

Greg Halter - Great Lakes Review

Adam Cahn - Citadel Investment Group

Unidentified Analyst

Presentation

Operator

Good morning and welcome to the Hillenbrand Industries conference call. [Operator Instructions] Later we will conduct a question and answer session and instructions will be given at that time. As a reminder the conference call is being recorded. [Operator Instructions]

On the call today will be Peter Soderberg, CEO and President of Hillenbrand and Hill-Rom, Greg Miller, Hillenbrand Senior Vice President and CFO, Ken Camp, CEO Batesville Casket Company, and Andy Rieth, VP Investor Relations, Communications & Global Brand Development.

Before we begin I would like to provide Hillenbrand’s usual caution that this morning’s call may contain forward looking statements such as forecast of business performance and company results and expectations about the company’s plans and future initiatives. Actual results may differ materially from those projected from 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 today’s press release. Also, you may reference the discussion under the heading risk factors in the company’s annual report on form 10-K for the period ending September 30, 2007, to be filed this month. If you have not received today’s release it is available on Hillenbrand’s website www.hillenbrand.com. Now I would like to turn the call over to your host Mr. Andy Rieth, please go ahead sir.

Andy Rieth

Thank you Darryl and good morning everyone. I would like to personally welcome you to this call; we’ve got lots to discuss today so we will jump right in. I’d like to establish a few ground rules for our call in order to optimize the amount of time available for your questions. We’ve scheduled about an hour for the call and our prepared remarks will take about 30-40 minutes. We will them move on to Q&A. Please limit your inquiries to one question plus a follow up per person and then if you have additional questions feel free to rejoin the queue. As noted in our press release, the telephonic audio replay of this call is available until November 22. And further, this webcast and the accompanying slides that you will see today will be archived on our website for about a year. Also I want to note that our 10-K for fiscal year 07’ will be filed before the end of November and will serve as a good compliment to today’s material. As we announced on November 5, Hillenbrand Industries filed an information statement on form 10 with the Securities and Exchange Commission on behalf of Batesville Holdings related to the previously announced separation of its two operating companies. This form 10 registration statement is posted on the SEC’s website at www.sec.gov and also can be viewed on the Hillenbrand website at www.hillenbrand.com. Finally, I’d like to remind you that an archive of the slides and audio from this call as well as our October investor conference are available on our website. With that I will turn the call over to Peter.

Peter Soderberg

Thank you Andy. Good morning to everybody. We’ve got a lot of ground to cover this morning as the face of change is accelerating at Hillenbrand Industries. I plan first to briefly review Hillenbrand’s consolidated results then I’ll dive deeper into Hill-Rom’s results and outlook before turning the discussion over to Greg and Ken. Later I’ll conclude with a brief update on the status of our separation then we’ll take your questions.

We closed out our fiscal year with a quarter that reflects continued progress in executing our operating strategy. The quarter also demonstrated some areas where our corrective actions have not yet taken hold as measured by our financial results. On a consolidated basis Hillenbrand’s worldwide sales of $530 million collected growth of 1.9% versus 2006. For the full year the sales were $2 billion 24 million, growth of 3.1% versus 2006. Hill-Rom’s capital sales showed another strong growth reaching 7.2% and 9.1% for the year. Hill-Rom’s rental revenue for the quarter decreased by 3.8% a bit more than we anticipated. For the year, rental revenues declined 2.3%. Batesville Casket sales of $158 million for the quarter were down 3.1% driven by what appears to be a 3.5-4% decline of funerals from the prior year.

Turning to earnings, consolidated net income from continuing operations was $.77 a share. On an as adjusted basis, earnings for the quarter were $.82 a share a decline of 26.8% versus the prior year. The year GAAP earnings were $3.07 per share versus $3.60 for the prior year. On an as adjusted basis, earnings were $3.17 per share versus $3.55 per share in 2006 a decline of 10.7%. Our EPS performance while down year over year reflects our commitment to execute the strategies for both companies we announced last October and is actually at the mid point of the guidance we provided you at that time.

Let me remind you once again that we’ve just completed the first full year of a three year strategic and operational journey designed to fix and grow Hill-Rom and lay a more solid foundation at Batesville Casket to withstand a period of low deaths and increasing death care industry consolidation. 2007 was a critical year of investment in our businesses; we will continue to invest into 2008 before we see a strong upturn in earnings planned during the second half of the year.

In line with these programs with prudent targeted investment fourth quarter saw operating expenses increase by over $25 million up 19%. Hill-Rom we aggressively ramped up marketing spending which increased 35% and R&D spending which increased 32% versus last years third quarter. Hill-Rom operating expenses were also impacted by separation related expenses of approximately $6 million. Ken will discuss Batesville Casket investment programs during his remarks. As a result of these investments we have made and will make we expect to see 2008 earnings per share as adjusted in the range of $3.20-$3.48.

Now I would like to turn specifically to Hill-Rom in order to recap our fourth quarter and full year accomplishments how much further on how we have set the stage for profitable growth in 2008 and beyond. A quick review of our original Hill-Rom financial guidance first presented last October shows that we hit our numbers for capital sales primarily due to the tremendous strength of our international business and for operating income as adjusted. We were softer than anticipated in rental sales and gross margins due to factors that Greg will explain. Operating expenses ramped a little slower than we expected but did accelerate in fourth quarter. Greg will introduce our full guidance for 2008 shortly but as a result of our investment program Hill-Rom’s sales guidance for 2008 reflects anticipated organic increase of 5.2% to 8.8% and increases in operating income before litigation one time separation expenses of 1.7% to 16.7%.

Now I’d like to discuss progress related to our strategic initiatives. As we shared before in presentations and in the many meetings we’ve had with investors, we are committed to fix and grow Hill-Rom as summarized in this slide. It is my strong belief that successful execution of this strategy must begin with the people and culture of accountability in performance. While cultureship never happens as rapidly as one would like, we have made substantial progress, 42 of the 80 positions that report to me or to my direct reports have seen changes in leadership over the past year or so. This includes a mix of external highly experienced talent that we have brought in blended with strong leaders already here. Then of structures, communications and transparency have all improved focused and align these teams. Our planned separation of Hill-Rom into a significant pure play medical technology company will aid us materially in thriving further a culture that will fuel more rapid innovation and profitable growth.

Our core as we referred to it is our cornerstone North America hospital capital sales business which recorded revenues of $197 million for the quarter up a meager 0.3% and $655 million for the year up 3%. During the quarter North America capital sales increased 5.6% excluding the decline in our total care ICU products. As we suggested last quarter we believe there is a temporary slow down of ICU purchasing decisions while customers evaluate a new competitive IC product as well as our own enhanced product now in its early launch base. These results are clearly unacceptable as they collectively represent some share loss in a category we believe is growing at mid to high single digits. This is why we are focused on executing the following two major initiatives.

First, new product development, we continue to increase spending in this area and a significant portion of this has been targeting North America Acute Care patient support, patient environment and IT solutions. Most recently we are bringing a broad array of new and or improved products into their launch stages including a long overdue set of enhancements to our total care ICU bed and the services we offer with it. Multiple new products for patient rooms to enhanced patient and caregiver satisfaction. A new range of Temper-Pedic services, [Bedcon] activity interoperability solutions couple our beds with hospital IT infrastructure and a portfolio of patient safety solutions programs powered by the NaviCare Patient Safety Software Suite. Our patient safety solutions programs bring together Hill-Rom clinical resources, proven processes, tightly integrated technology. Our Safe Skin, No Falls and Clear Lungs programs facilitated by our NaviCare software provide comprehensive solutions that are highly differentiated.

Recently updated CMS in patient reimbursement rules could accelerate the focus and adoption of patient safety solutions. As incremental reimbursement for several types of adverse events that often occur in hospitals will be eliminated effective October 2008. Patient falls and nosocomial acquired pressure wounds are two of the clinical conditions targeted by the skin is changing. We will work with our customers to help them identify ways in which Hill-Rom people processes and technologies will help reduce the incidents of these adverse clinical events.

Our second area sales force focus upgrade and expansion. During the quarter we concluded that we did not have adequate representation in the field both to accommodate the numerous new products we were launching and to service our installed base. Accordingly we are in the final stages of building a new market specialist sales organization. Very successfully tried out this concept in 2007 we will have in place a total of 30 new reps fully trained during this quarter.

Turning to our North American Acute Care Rental business the quarter was a tale of two cities. Rental revenue from our proprietary therapy products accounting for a majority of our rental revenue stabilized and grew slightly thanks in part to some strong performances by our new TotalCare Bariatric Plus platform. We are looking forward to renewed growth in our rental therapy products after securing a five year full source contract from [Broadlane] a large group purchasing organization covering Hill-Rom therapy services and certain services, rental and purchases. This is the first time in 11 years that over 900 hospitals were [Broadlane] members have access to Hill-Rom products on contract. On the other hand, further weakness in our Movable Medical Equipment (MME) products area. We are convinced that much of our problem here is that we ask 100+ clinical services sales force to represent MME along with their many other responsibilities. Given the need of sales force to increasingly focus on our numerous new products coming down the line and on patient safety solutions offering, we have decided to create our Midway in creating and recruiting and training a dedicated sales force of 34 professionals. We believe it will take until the second half of 2008 to see a turn around in MME.

Turning towards our strategies to improve gross margin, while we made progress for the year, we were disappointed in our gross margin decline in Q4. Greg will explain this further, however, let me confirm that our key low cost region manufacturing initiative is proceeding very well. Our Monterrey, Mexico plant is now staffed by great team coming online. Going forward our guidance reflects returns of positive gross margin trends in 2008. As we increase our sourcing from low cost regions, improve our sales mix from ICU hospital bed and surface sales and ramp up production in Monterrey.

Next let’s move down to our North America Post Acute business. As we have described previously to you we believe post acute care offers us an addressable marketplace approximately $2 billion per year. Growing at high single to low double digit rates. Our penetration of this space is only about 10%. We enthusiastically look for late in the quarter the introduction of our Hill-Rom 100 Low Bed pictured in the slide, which fills a large gap in our offerings. As we heretofore did not offer home based patients a frame on which to put our preventative and treatment surfaces. We believe we offer our customers a superior value proposition considering design, secures and functionality.

We will also be seeing on the highway the new branding that we have developed for our nearly 900 US delivery vehicles used to transport our rental products to and from hospitals, clinicare facilities and homes. As we increasingly focus on the post acute business we want to communicate to patients and their caregivers get the same great products in these settings as they are used to getting in the hospital. As such, our branding features Iconography presenting the full continuum of care. This fresh new look also features a No Falls, Space Spin, Clear Lungs, patient safety solutions methods.

Additional progress is also made during the year in fixing our post acute rental billing systems for the cash processes other IT infrastructure challenges we previously faced.

Finally, we saw from a 33% increase reported in the current quarter our post acute care capital sales started offset decline in their rental side of post acute care as customers choose to capitalize their rental.

Now let’s turn to perhaps the biggest bright spot of our 2007 performance, our international business. By beefing up new product flow enhancing our channel presence, collectively pursuing acquisitions in alliance, we are growing our business at superior rates. We believe we are gaining significant share in Europe largely due to the introduction of the AVG 800 Bed and associated line of furniture. This platform will be iterated to other competitive products offerings. Introduction of a new derivative of this AVG frame launched late in the quarter will allow Hill-Rom to have compelling product available for customers medicalized long term care. Other care settings where we have had limited offering. This product and our renewed efforts international markets have enabled us to secure sole source multi year contracts in France for acute care, medicalized long term care, ICU and labor and delivery.

Integration of Medicraft acquisition in Australia is succeeding successfully contributes strong performance in 2008. Further, our partnership with Paramount in Japan should also begin to show its roots second quarter 2008. They have just commenced distribution of our high end patient support platforms in Japan. The second largest medical device market in the world.

Finally, let’s consider our three entrepreneurial units. Hill-Rom IT solutions, Hill-Rom Respiratory Care and Allen Medical. We’ve seen early successes with these units each under new leadership, collectively grew revenue over 9% in 2007 and margins by 26%. At Hill-Rom IT Solutions group introduced a variety of new software releases, including the Navicare Patient Safety Software Suite already mentioned. Our Respiratory Care Group has had remarkable success with the Vest. Our high frequency chest wall isolation therapy platform. The new Vest Airway Clearance System is designed specifically for hospital use and promises to continue to drive strong growth for respiratory care. Allen Medical our surgical patient positioning business continued to release sophisticated apparatus for use in specialized spine, orthopedic and lothodomy procedures.

In conclusion, fiscal year 2008 financial guidance will confirm that the initiatives I have described will begin to bear fruit in 2008. We are more confident than ever that our strategies are sound that our investments are prudent. While these investments will continue to provide us with headwind in the first half of 2008 they are consistent with a strategy we communicated previously. We believe they are essential to reverse historical underinvestment to position the company for accelerated growth at or above industry rates. I am pleased with early indications very pleased with the fine team we have assembled and have sufficient evidence to confirm this is an appropriate path.

Now I would like to turn the call over to Greg Miller.

Greg Miller

Thank you Peter. This morning I will discuss our fourth quarter and our fiscal 2007 performance, I will also include insights into our fiscal 2008 guidance. To begin with though I would like to highlight two items. First, as Peter mentioned the fourth quarter and full years lower earnings partial results from the plan and guided accelerated investment spending were in the key strategic initiative. As we ramped up these investments in 2007 especially in the last half, lower earnings on a year over year basis fault and are expected to carry into the first half of 2008.

Second, it is important to note that the fourth quarter results reflect a total of approximately $23.5 million of significant costs items including costs associated with our pending separation of the business unit to two independent companies increased Hill-Rom reserves for each rental and receivables, increased Batesville Casket customer rebate allowances a warranty item and costs associated with the termination of Batesville efforts to acquire Yorktown Casket. I will further discuss each of these later.

Let’s get started with consolidated revenue. Overall, consolidated revenue for the quarter increased $9.7 million or 1.9% on a year over year basis for a strong fourth quarter of fiscal 2006. The next few slides I will discuss revenues across our business more specifically.

First, fourth quarter consolidated revenue growth came entirely from Hill-Rom’s capital sales with an increase of $18.6 million or 7.2%. Leading the increase capital sales in the fourth quarter was our International Surgical business which increased sales $16.1 million or 29.2% which is an increase of $12.4 million or 22.5% on a constant currency basis. This results from strategic investments into new products, expansion of our sales channel, a first quarter acquisition of Medicraft.

Year to date International Surgical revenues are up 25.7% or up 20% on a constant currency basis. In 2008 we anticipate a continued double digit international revenue growth driven by growth from new products, increased expansion into the medicalized long term care market in select European countries and continued expansion of sales and marketing efforts and to under penetrated geographic regions.

Further, as illustrated by our 2007 acquisition of Medicraft and our recently announced distribution relationship with Paramount Bed in Japan we will continue to selectively evaluate acquisitions and alliance opportunities that provide us product extension, augment our capabilities or enable us to enter into a new geographic segment.

Capital sales in North America Acute Care were essentially flat in the four quarter and up 3% for the full year. We continue to see accelerated volume in growth areas where we have invested in new or improved products, however, this growth was offset by lower revenues within our mid to high acute hospital bed platforms in the ICU segment. As Peter discussed, excluding the year over year decline of sales, which in the ICU segment due to delayed purchases, North America Acute capital sales would have increased 5.6% in fourth quarter and 6.3% on a full year basis. In order to maintain our strong leadership position in the North America Acute Care patient support system business we will continue to focus on the investments, launch a number of new products and extension of important core products, increase our sales channel capacity with an additional 30 market specialists and work with our customers to enhance patient safety, reduce the number of adverse events.

For 2008, based on our strategic investments, the last half of fiscal 2007 and the first half of 2008 we expect revenue for North America Acute Care capital to increase at the market growth rate of mid to high single digits. Although less than 5% of total capital sales are post acute capital sales for the quarter and for the year continue to grow at a rate in excess of 30% the result of enhanced sales channel focus and proved bed frame sales.

We believe there are substantial opportunities for Hill-Rom to increase our low participation level in the post acute care marketplace for both capital and rental items. During 2007 our strategic investment capabilities have proved our business processes and extended our portfolio of products. In early 2008, we will be launching several new products including a new global patient support platform as well as patient room furniture and accessories. We believe we are well positioned to maintain mid teens revenue growth in this critical and expanding marketplace. Overall for 2008, Hill-Rom capital sales are expected to grow 5-9%.

Moving to Healthcare rental revenues. Fourth quarter revenues were down $3.8 million or 3.8% from prior year. This decline includes a charge for aged receivable reserves of $7.6 million up $2.6 million from a similar item in prior years fourth quarter in our acute and post acute rentals. During the fourth quarter we completed and extensive collection program of our aged rental receivables involving both sales and credit personnel. Following occurred higher allowances we believe we have now collected and or cleaned up the aged receivables related to prior year’s system implementation billing issues.

We also experienced continued declines in our North America Acute rental business due to cannibalization from capital purchase of pulmonary items and our Post Acute rental business due to lower Medicare reimbursement of Group II surface rentals. Both segments have also been unfavorably impacted by the year over year loss of business back to movable medical equipment products from GPO contract realignment.

That said, we have been able to offset some of these declines and have realized significant growth in areas we have invested in the past year including new products for bariatric rental which were up 22% year to date and fleet investments into the wound segment up 8% year to date.

Additionally our respiratory care business, the Vest, posted strong mid teen quarterly and year to date revenue growth. Year to date rental revenues are much the same story, down $9.9 million or 2.3% compared to the prior year. The decline was expected given the unfavorable impact of prior year GPO realignment activity, which at the beginning of the year we guided as potentially unfavorable impact of $25 million and from the carry over affect the past billing and processing issues service and product efficiency.

During the past year in line with our revitalization strategy, we have stabilized and improved the efficiency of our rental billing systems and processes. In addition, our revitalization efforts also included innovating and investing in fresh of rental fleets with new clinically superior products and to regain our competitiveness and better share of our customers.

We invested approximately $65 million of the original full year estimate of $60 million into our rental fleet in fiscal 2007. Carrying this momentum into 2008 in addition to continued investment in the higher value added clinical therapy new technology we intend to create a focus sale function of 34 specialists aimed at profitably growing our Movable Medical Equipment product line. Aligned with the opportunity tin post acute previously mentioned we expect 2008 rental revenues to increase 4.5-9%.

Moving to funeral service revenues, Batesville Casket company revenues of $158.2 million were down $5.1 million or 3.1% compared to prior year fourth quarter. Fiscal 2007 revenues declined $7.4 million or 1.1% from fiscal 2006. Revenues in the quarter consistent with the rest of the year were negatively affected as a result of lower burial volumes and a downward shift in product mix which was partially offset by positive net price realization. The trend in lower burial casket volume and an unfavorable product mix from metal to wood and to lower price point caskets all continued. After I complete my comments, Ken will address the efforts in place and the opportunities that should yield 2008 revenue growth of 1.5-4%.

Now I’ll cover some key points on gross profit. Fourth quarter consolidated gross profit was down $7.9 million or 3.4% year over year. Consolidated gross margin rate was also down from prior year by 230 basis points. Contributing to the lower margins in the fourth quarter was a number of significant cost items that I will cover in a minute. Year to date consolidated gross profit increased $31.3 or 3.7% which continues to be at a higher rate of increase in consolidated revenue in 3.1%. More specifically, in starting with Health Care capital sales, fourth quarter gross profit improved slightly from the prior year despite the higher volumes in favorable net price realization. As we outlined in our last call, we had expected margin pressure in the last half of the year reflected by the decline of 280 basis points to 41.4%. The lower overall margin rate in the fourth quarter is primarily the result of business segment sales mix. More specifically, during the fourth quarter our largest capital business unit, North America Acute grew slightly and recorded a margin improvement of 80 basis points our other major capital business unit International Surgical experienced significant growth at 29% and also recorded a margin improvement of 70 basis points, however, when viewed in total, fourth quarter capital margin rates declined as the heavier mix of international revenues have margins that are significantly less than North America Acute margin. All that said, overall, we are improving gross profit dollars and margins in each of our major businesses.

In addition to the overall segment mix overall gross margins were negatively impacted in the fourth quarter by $1.2 million of start up costs associated with our new Monterrey, Mexico manufacturing facility and a $4.5 million charge it was an increase of nearly $2 million versus prior year. On a year to date basis capital sales gross profit increased in line with the growth in capital sales with gross margin rates holding steady at 41.9%. This increase in gross profit was driven primarily by volume, various costs savings initiatives in our sourcing and manufacturing areas and favorable price realization. These improvements were offset in margin by similar factors as we mentioned in the fourth quarter including startup costs associated with our new Mexico manufacturing facility now totaling $3.4 million fiscal 2007.

In 2008, we expect to expand capital sales margins 90-240 basis points to a range of 42.8-44.3%. Margin improvement actions in 2008 include a continued focus on improved price realization, select price increases and improved pricing discipline. Continuous improvement activities in our current manufacturing facilities, the introduction of higher margins, new products and the increased utilization of low cost region manufacturing in Mexico and sourcing from China.

Moving to health care rental business, fourth quarter gross profit decreased $.9 million or 2% when compared to the prior year on lower revenues of 3.8%. The fourth quarter margin decrease is directly related to the 7.6 million in rental reserve adjustments as outlined earlier this charge directly impacts gross margin as well. If the additional rental reserves were to be excluded we would have achieved our fourth consecutive quarter with margin rates in excess of 50%. As mentioned before we believe we have now collected and are cleaned up all the aged rental receivables related to previous year’s rental system implementation billing issues. Full year 2007 rental gross profit remained relatively flat despite a decrease of rental revenues of $9.9 million. As gross margins improved 120 basis points, 49-50.2%, improvements in gross margin rates experienced in fiscal 2007 is primarily related to lower field service costs which were down $4 million for the quarter and almost $13 million for the year. These lower field service costs are directly related to the affect of restructuring and other cost improvement actions taken at the end of fiscal 2006 and completed in 2007. Margins have also been favorably impacted by enhanced pricing discipline, product and customer profit improvement activities and investments into higher margin products.

In 2008, we expect to continue improved health care rental gross margin to 50.8-52.5% by increasing our leverage in economizing scale from our field service network to increased rental revenue. Continuous process and product improvement efforts and continued investments in higher margin rental products.

Batesville Casket business fourth quarter gross profit was down $7.6 million or 10.8% versus the prior year and down 340 basis points as a percent of revenue. While the prior year included a gain on a sale of a facility of $.8 million, a majority of the margin declined related directly to the affect of higher discounted rebates, overall lower volume, unfavorable product mix and higher commodity price of red metals. The higher rebates and discounts in the fourth quarter of $3.5 million related to year end true up of primarily independent customer sales programs and allowance accounts.

Fiscal 2007 gross profit has declined only $1.2 million despite a revenue decline of $7.4 million as gross margin rates increased 30 basis points to 41.8%. Our ability to slightly improve margins for the year despite some of the margin pressures discussed above is driven by favorable net price realization cost savings of approximately $2.7 million associated with our prior year wood plant consolidation and productivity improvements achieved in manufacturing, distribution and endless supply chain. As Ken will mention later, we believer there are still opportunities for improvement here.

As such, in 2008 we expect gross margins to expand as much as 120 basis points or within a range of 41.5-43%. Fourth quarter 2007 consolidated operating expenses increased $25.2 million or 19% versus the prior year. Fiscal 2007 consolidated operating expenses for the year increased $75 million or 14.2%. As mentioned in previous quarters, fourth quarter spending represents a year over year acceleration from the beginning of fiscal 2007 as we ramped up strategic investment spending in the last half of the year.

As detailed in the corresponding next slide the main components of the fourth quarter and the year to date increases include the following. First, the increased strategic investments in operating expenses of $12.8 million during the fourth quarter and $33.7 million for the year as outlined as part of our 2006-2009 strategic plan to accelerate revenue growth in future years. As Peter mentioned this increased spending included research and development, marketing, merchandising and sales channel development.

As part of this, Hill-Rom R&D increased a total of $8.6 million the full year and the percent of revenues from 3% in 2006 to approximately 3.5% in 2007. Further, we expect to continue to grow R&D as a percent of revenue to be more in line with that of our peer group of companies which spend 5-5.5%.

Also contributing to higher expenses were first costs incurred with respect to the pending separation of the two operating units of Hillenbrand of $6.2 million in the fourth quarter and now $12.4 million for fiscal 2007. Secondly, write off other costs associated with the discontinuance of Yorktown supply agreement of an additional $1.5 million in the fourth quarter and totaling $8.7 million for 2007. This matter is now fully behind us. Third, acquired company operating expenses are $1.6 million for the quarter and $6.1 million for the year associated with our acquisitions of Medicraft and a small distributor in the funeral industry. Fourth, foreign exchange impacted $1 million for the quarter and year to date of $3.5 million and then general and salary benefits and other spending inflation.

As Peter mentioned fiscal 2007 was a critical year of investment in our business and we will continue to invest in 2008. As such, considering the ramp up investments during 2007 we expect year over year increases in operating expenses to continue in the first half of 2008 with the benefits of earnings in the second half of fiscal 2008 and accelerating through 2009. Overall on a consolidated basis for 2008 we expect operating expenses to increase 5.7-12% when the range of $615-652 million excluding anti-trust litigation and separation transaction costs. This also excludes incremental costs that would be required for Batesville Casket to be operated as stand alone company upon separation.

Please refer to our details in the guidance release for a breakdown of Hill-Rom corporate and Batesville Casket Company operating expenses.

A reconciliation of GAAP to adjust diluted earnings per share has been provided in the slide for your reference. And also is a schedule of to our earnings release. In the fourth quarter as a result of the increased strategic investment and numerous large costs items our adjusted earnings for fully diluted shares declined $.30 on a full year basis adjusted earnings for fully diluted shares declined $.38 to $3.17 which is in line with our guidance and consistent with the investment gross strategy outlined last October.

As far as liquidity and balance sheet position I just point out that we continue to have solid financial position from which to execute our strategic initiative.

Moving to primary work in capital. Primary work in capital increased $9.3 million in Q4 year over year primarily due to increased inventory levels associated with the current year acquisition, new or scheduled product introductions and the ramp up of our Mexico facility. We have seen an improvement in overall sales outstanding and accounts receivable and as mentioned before we believe we have collected or reserved for the aged rental receivables resulting from previous year system implementation billion issues. This has resulted in slight reduction in accounts receivables despite increased four quarter revenues and acquisitions.

Our detailed fiscal 2008 guidance is included within our earnings release today and our related conference call slide. As I have already discussed many aspects of our guidance I will summarize it now.

For fiscal 2008 we expect Hillenbrand consolidated revenue of $2 billion $104 million to $2 billion $170 million, where Hill-Rom total revenues are expected to increase 5-9%, Batesville Casket revenues are expected to increase 1.5-4%. We expect GAAP earnings per share in the range of 299-327 and adjusted earnings per share in the range of 320-348. Adjusted earnings per share range reflect gross of approximately 1-10%.

As final comments, we generally have performed consistent with our expectations in relation to our investment and gross strategy for fiscal 2007 we remain confident we are on the right track and as such we will continue to make necessary and prude investments and continue to fix and accelerate our rate of growth in our Hill-Rom business and protect and grow Batesville Casket business in 2008. With that I would like to now turn the call over to Ken.

Ken Camp

Thanks Greg. Good morning everyone. It is a pleasure to address you this morning with a few prepared remarks and to be available for questions at the end of our combined presentation.

My purpose this morning is to provide an additional level of transparency about our operation more consistent with reporting requirements of a separate public company instead of a wholly owned division. As many of you know from your experience with Batesville and from the recent releases of the other publicly traded companies, the past two years are in the base volume challenge. Although these volume challenges represent a continuation of flat to declining deaths and increasing cremation the recent past second straight year without a significant combine to reduce the number of caskets and in so doing, provide a challenge to revenue growth. As we have analyzed these drivers and search for weaknesses in our own performance and for corresponding opportunities, we find that the diminished volume is present across all geographic areas -- rural and urban, U.S. and Canada -- and all customer types, large and small, public companies and independent.

That said, I'll provide a high level summary of Batesville's results and some commentary on our actions and counter measures. As Greg mentioned, our fourth quarter revenue of $158 million was down 3% from the fourth quarter of 2006 and the total 2007 revenue was $667 million, down 1% from the prior year.

Our disappointing performance in this period was most heavily affected by the aforementioned reduced demand for caskets which is consistent with industry trends, as we noted in our press release. The casket business is one where the consumer's purchase is not discretionary and the sale is driven by adequate floor representation, shelf space if you will, and an effective and timely funeral director reorder process. While there is no industry reporting system for market share and we do not comment on our estimated share numbers, it is our belief that our customer base is intact and the representation of Batesville Caskets in these selection rooms is undiminished.

Another factor which reflects revenue is the mix of products sold. Our mix has been somewhat negatively affected by the long-term industry trend toward a lesser mix and by our introduction of several new metal products in those lower price point segments where we have traditionally been underrepresented. The results of these introductions have been good, but they naturally increase the mix effect.

In order to respond to our substantial core of customers, who are also facing the recent volume challenges, we have expanded our capabilities and conducted sales rep training around effectively merchandising the selection rooms of more customers in '07. Batesville's proprietary merchandising system enables a funeral home to present a broad array of products to serve all of their client families and to articulate the value of the product at each price point. The system permits us to accurately predict incremental average sales based on the casket assortment offered.

The gains we have experienced here have been very encouraging. We believe there is still tremendous opportunity for our customers and for us. Perhaps most important, families report higher levels of purchase satisfaction when provided with more information about the features and benefits the products offer.

Another driver of revenue is effective price realization. Batesville brand continues to be strongly viewed among most industry professionals and to some degree by consumers. This positioning enables us to command a premium price for our premium brand. We are especially effective among those customers and client families who recognize the value of added features, materials and overall quality and are naturally less effective with funeral directors who are solely price buyers.

One element of our results which clearly deserves explanation is our fourth quarter gross margin percentage decline of 340 basis points. Despite the challenging fourth quarter results, our year-over-year gross margin improved 30 basis points as a result of increased productivity and price realization.

Fourth quarter's gross margin results were driven by several factors:

• The effective lower volume on our manufacturing and distribution fixed cost base;
• Previously mentioned mix trends;
• Inflation on key commodities, which include red metals and steel, total of which increased 18% in average price;
• Increased distribution costs as customers and consumers demand ever more rapid service. This item, while adding to our cost profile, is one of our key competitive advantages.
• We also had a one-time gain on the sale of a distribution facility in 2006 that is comparable during that period.

Another driver of our results was some year-end adjustments of nearly $3.5 million, $2.5 million primarily for existing independent customer sales programs and fixturing agreements and slightly less than $1 million to increase our reserve for estimated customer product returns.

As I mentioned earlier, we are not satisfied with our gross margin performance this quarter. As we push to grow top line revenues, we are also are challenging ourselves to ensure that we're achieving the most efficient and effective cost structure.

We have several key margin improvement projects in place which we expect to generate savings in 2008. Our first is a new computerized wood optimization system which will improve yield throughout our wood manufacturing facilities by reducing the amount of wood that is lost in the manufacturing process.

Second, we have made investments in robotics in our metal plants in 2007 and are seeing the effects of those investments now.

Third, we are realizing the full benefits associated with assembly plant consolidation.

Fourth we will continue improvements as we have done in past years to generate year-over-year productivity gains using our kaizen skills.

Despite the challenge we've identified, there are a number of elements in our business about which we are very pleased. The merchandising success we have had is good for our customers and for us. We are working to expand and accelerate that effect in 2008 and beyond.

We are also developing products that match the changing society needs, an example of which is our dimensions caskets that serve the needs of an increasingly obese population.

Another growth opportunity for us is our veneer wood products made in Chihuahua, Mexico. This product line continues to show steady growth as funeral directors recognize they can provide the uniqueness and beauty of wood at lower cost than solid wood products.

As part of our continued efforts to drive volume and improve mix, last month we introduced several new bronze and wood caskets, all with interchangeable life symbol corners and our patented memory safe drawer. These caskets are positioned at price points well above our current average sale.

As the gradual consumer shift from metal to wood purchases continues, maximizing efficiencies at our consolidated modern wood plant continues to be critical. While we have made good progress here, there have been some periods of efficiency variation as we finalize the consolidation of two wood plants into one. We believe that there are still further gains to realize as we apply our continuous improvement capabilities to further increase the level of performance.

As some of you may know, in 2005 we purchased casket stamping and other tooling to enter the business of manufacturing casket parts and finished products. The strategy is to develop relationships with independent distributors and manufacturers while using our production capacity to provide high quality, private label caskets to them. This product line, which we call North Star, is separate and distinct from the Batesville brand and does not contain the patented Batesville piece. North Star business continued at a nice growth pace in 2007. We have added sales and engineering capacity to expand our customer base in '08.

In the last year-and-a-half we completed the acquisition and integration of two small regional casket distributors. The retention of their customer base exceeded our targets and the financial result in both instances was several times our weighted average cost of capital. These successful acquisitions have provided some positive learning, helped us refine our capabilities and future opportunities.

Finally, our e-business initiatives continue to bear fruit. We are now the largest creator and host of funeral home websites in the industry. In fact in 2007, the number of funeral homes that have opted for Batesville's website services doubled over the prior year, providing the foundation for us to bring a continuing series of new features and products to our customers and their client families in future years. As you can see, we've had a number of successes this year and we view them also as opportunities on which to build solid results in both the near and long term.

The core principle in Batesville is building upon existing competencies, strengthening our ability to meet emerging trends and making investment decisions to provide increased shareholder value over the long term.

With that guiding principle in mind, I would like to comment on the elements of our strategy and the priority Batesville places on investments. Our strategic direction is aligned with our core competencies and industry dynamics. Our first investment priority is protecting and growing the casket and cremation products business.

In addition to the items that I discussed earlier, our efforts to grow the casket business involve expansion of our sales presence by adding sales representatives to improve account coverage over the next couple of quarters. All of these sales representatives will be trained in effective merchandising and that will be the cornerstone of our selling process.

As I previously mentioned, we're also expanding sales coverage in our North Star private label business. We continue to deepen our relationships with all independent distributors. We believe that this supply relationship with those distributors and manufacturers may in some cases lead to future acquisitions.

Our last strategic priority will be to periodically evaluate and consider the relative returns of entering businesses that capitalize on our core competencies and are adjacent to the [healthcare] business.

Despite a tough quarter, our ability to produce attractive, industry-leading margins and turn them into operating profit and shareholder value and our ability to generate substantial free cash flow remains strong. We have counter measures in place for most of the business conditions we face, we're structuring our business for solid performance if death rates do not increase in 2008. If there is a return to historic influenza patterns, our results will be stronger.

In addition to the risk of lower mortality, it should be noted that we face the risk of continued inflation in some commodities, particularly steel, red metals and as we've all experienced recently, fuel.

In conclusion, our entire organization is excited at the prospect of becoming a standalone public company and providing significant and consistent financial returns to our current and new shareholders. We will discuss our plans in more detail in future investor presentations.

I'll now turn the call back to Peter Soderberg for closing comments.

Peter Soderberg

Thank you, Ken and Greg. In wrapping up our prepared remarks, I would like to briefly update you on the status of our planned separation. As we announced on November 5th, we filed our Form 10 with the SEC related to the spin-off of Batesville Caskets. Filing the Form 10 is an important milestone in the journey towards separation, which remains on track for completion in February 2008.

While we await clearance of the Form 10 and a ruling on the accounting treatment of the sharing agreement related to the Batesville Casket antitrust litigation, we are hard at work in preparing for separation by February. I am pleased to say we have also just received from the IRS the favorable tax ruling we had anticipated.

Our operating executives are focused on executing their respective operational strategies while we have our small corporate group laying the foundation for this defining event. We will provide you with more information on the progress of the SEC's consideration of our filings and related accounting treatment of the JSA as soon as we have more information.

Before we take your questions, I would like to summarize by observing that we remain committed to the strategies we laid out for you just over a year ago in New York. While we have much to accomplish, we are pleased with the early signs of progress in the areas we are heavily invested in. We are starting to see results from our fiscal year '07 investments, but are not yet satisfied. Our guidance reflects continued investment during the first half of fiscal '08, especially in sales channel expansion and new product development, as well as the beginnings of accelerated growth in sales and profits.

Separation is proceeding and we continue to believe that it will be a transformational event that will unlock value creation for shareholders and employees of both operating companies.

We will now be pleased to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Greg Halter - Great Lakes Review.

Greg Halter - Great Lakes Review

I know you filed the form for the spin relative to Batesville, and we certainly appreciate the detailed information there. Trying to get at the same data on Hill-Rom on a pro forma basis, will there be any sort of information provided in that regard?

Greg Miller

In regard to Hill-Rom, typically the process is we file the Form 10 for the “spinnee” and then the “spinnor” will file an 8-K within four days of the actual distribution of dividends. That being said, I think that the information in the Form 10, you could pretty much use that and the consolidated results that you have to model out where Hill-Rom is at. I think it has enough pieces to be able to figure out Hill-Rom.

Greg Halter - Great Lakes Review

I certainly attempted that but there's a lot of investment income and things going back and forth.

The second question I had is on the antitrust litigation, who will be responsible for paying those costs going forward?

Peter Soderberg

We have our general counsel, Patrick De Maynadier here. Patrick, I'll let you respond to that.

Patrick De Maynadier

The costs of the litigation going forward would be paid by Batesville Casket Company.

Greg Miller

It will be paid by Hillenbrand as long as we're together and then after separation, Batesville Casket Company.

Operator

We'll take our next question from Adam Cahn - Citadel.

Adam Cahn - Citadel Investment Group

It seems that if we take out the costs that you've just identified on the operating expense line as relating to the spin of the Yorktowne failed acquisition on integration, we have around 150 point increase as a percent of revenue and op expense at the midpoint of the guidance of 2008 versus 2007. Curious what the dynamics are around that? Did we not increase R&D this year and what are the expenses that increased op expense in 2008 versus 2007?

Peter Soderberg

Let me take Hill-Rom and I'll let Ken respond to Batesville Casket. In Hill-Rom, we showed you a chart in the presentation of R&D and you'll see the infection point was in the second quarter of this past fiscal year. So we are maintaining that in fact we will increase year-over-year R&D spend and that's just because it takes a while to fill the pipeline.

I am very pleased with the projects in the pipeline and the fact that they're going to come to market shortly. As you know, we are several hundred basis points below the industry average.

The other thing we are doing is we spent some time on the call describing our channel initiatives, particularly in North American Acute Care. We cannot adequately sell all of the new products coming to market plus this change in the market dynamic of safety solutions. We are adding feet on the street and I think we've also improved the feet that were there. Our focus is really on the things that are going to yield acceleration in top line and margin which is channel costs, sales and marketing.

Greg Miller

One of the elements of the ramp-up in 2007 is the fact that we also have the annualization impact of some of the items that we did execute on in 2007 occurring for the full year of 2008 in the categories that Peter discussed.

Ken Camp

For Batesville Casket, it's actually a negligible result if you take out the one-time expense current year for Yorktowne in the guidance and investment in some of the items I mentioned to you when I spoke, that gets us right back to about the same level we were at prior.

Adam Cahn - Citadel Investment Group

I am sorry. Can you speak up somewhat? We are having trouble hearing you here.

Ken Camp

I'm sorry. I'm a little gravelly. I may be leading the charge in the winter cold season here. What I was saying is that the change in our OpEx is negligible. If you take out the effect of Yorktowne in 2007, we have some expenditures for some of the growth items that I mentioned to you, which essentially nets out the Yorktowne effect. From a dollar point of view, we're essentially flat year over year.

Peter Soderberg

I go back kind of big picture here and say that on our fix and grow strategy at Hill-Rom, we promised The Street 6% to 8% compounded growth over the three-year period. You can see admittedly it is not as large a base in '07 as a straight pencil out on the '06 base would indicate; we are getting that kind of growth in '08 and I think you'll be pleased to see the trajectory thereafter.

These expenses support that commitment. We also remain committed to delivering the bottom line performance over time at Hill-Rom that we've indicated to you. I think none of our fundamental views of the market opportunity has changed. In fact, the events of the last year, if anything, confirm our vision of where the opportunity is.

Adam Cahn - Citadel Investment Group

So we're still seeing on a 2009 basis, based on the three-year guidance, what would be a double-digit acceleration in 2009 versus 2008 for operating income and earnings per share?

Peter Soderberg

We're well aware of the math and we expect to reap the investment. Remember, we're at the front end of the power curve on some of these investments with this great new sales source we're fielding and with the Monterey start-up, so I'm pretty encouraged that we're going to get to where we promised we're going to get.

Adam Cahn - Citadel Investment Group

Finally, in the other income line for 2008, you put out this $2 million number where we had $22 million in 2006 and then $13 million for this fiscal year. What's happening in this line item and how does it go to $2 million next year after we've had in excess of $10 million for the past couple of years?

Greg Miller

In that line, the major variance is the investments that we have in private equity limited partnerships. Some of them were historical corporate investments, some of them were separated when we sold the [inaudible] business back into corporate and those are very volatile. They're in various industries and various types of investments. They're very volatile. If you go back a few years prior to that, you'll see that we had losses as big as gains that we're experiencing over the past two years.

So it is not part of our underlying operations and so therefore, we do not project those in our guidance favorably or unfavorably. We let those happen as they happen throughout the year and as you can see, we also adjust our earnings per share. That would be the line called net realized gains on investment, that's the primary thing going through other expenses.

Adam Cahn - Citadel Investment Group

Should we expect the cost of capital return over time on the investment that you have in these partnerships?

Greg Miller

Obviously, the intent on these investments was when we originally invested in them was to get our cost of capital out of them. Most of these are very historic and date back. Quite honestly, we've tried to monetize a few of these from time to time which is not an easy thing for us to do, just the nature of the limited partnership deals that they are. So yes, right now, the last two years they've been doing very well.

Operator

Your next question comes from Greg Halter - Great Lakes Review.

Greg Halter - Great Lakes Review

I didn't see this anywhere and maybe I missed it, but did you have what you spent for capital expenditures in '07 as well as your depreciation and amortization?

Greg Miller

We have in our press release, you can look on one of the schedules that's attached to the press release and for capital expenditures in total for the year, we spent $118 million at Hill-Rom and $17 million at Batesville Casket. Our depreciation was $89 million at Hill-Rom and $18 million at Batesville Casket. That's detailed by quarter and for each fiscal year in the press release.

Greg Halter - Great Lakes Review

Regarding the shelf that you have, who is going to maintain that?

Greg Miller

That would be maintained with the Hillenbrand, if you will, Hill-Rom companies, but as part of the capital structure, obviously we'll be looking at that for the spun-off companies with regard to setting up their capital structure as well.

Greg Halter - Great Lakes Review

One last one for Ken on the Batesville side, I think there's an operating income growth projection of 3% to 4% for the next couple years and then there were some costs related to the spin, I think of $4 million to $6 million. I'm just wondering if those costs are in that projection figure?

Greg Miller

I'm not sure I got the first part of your question.

Greg Halter - Great Lakes Review

Within the Form 10 there's an indication that the expectation for Batesville is to grow their operating income at a 3% to 4% pace over the next couple years. But then there are also some costs of $4 million to $6 million. I'm just wondering if those costs are included in that 3% to 4% or if those exclude those costs?

Greg Miller

In the Form 10, what we've got is historical financial statements and a pro forma financial statement for certain periods -- historical periods, though. They're not prospective. The $4 million to $6 million costs that you're seeing in there would be costs that you would have to add to those pro formas. It is an estimate of what those costs would be, to the allocated costs that are already in the pro forma for Batesville Casket to represent a stand-alone company.

I think if you look in the pro forma financial statement footnotes and the pro formas, you can build a pretty good bridge on the standalone Batesville Casket going forward. That's why we provided that extra note.

Peter Soderberg

Just one more thing on your CapEx question. When we gave you original guidance, we had not anticipated buying our Monterey, Mexico plant. So last year reflects a one-time fairly significant [bonus?] to purchase rather than lease that plant which we did because of very favorable returns we could get on that investment.

Greg Halter - Great Lakes Review

I found it on these statements now, it looks like your guidance for '08 on capital spending is about $135 million, which is about equal to what it was for fiscal '07. Any comment there?

Peter Soderberg

I'll comment that on the Hill-Rom side we continue to improve the currency of our rental fleets. We have a pretty strong new product flow. The Total Care bariatric product, as an example, is well exceeding our expectation which has led us to make investments in that product. We have another very exciting product that is highly differentiated. So we're backing the high return portions of that fleet, the technology intensive portions with appropriate level of capital.

The final thing I'll say is we have additional capital related to Monterey coming on as a completely integrated plant. It's going to be one of the most modern, sophisticated plants in the world. Finally, our new product surge has caused some increase in capital expenditure as well.

Greg Halter - Great Lakes Review

Relative to on the last call there was some discussion I believe of a competitor -- and I think it was Stryker -- that was mentioned roiling the market on the ICU side. I know you've made some comments about that, but just wonder how you see that playing out currently?

Peter Soderberg

I'm not sure we mention competitive names but you're approximately right. In the ICU, this is the kind of flux that happens when a major player in the industry introduces a significantly new product. The interesting thing is we thought this was going to happen earlier in the year but we're now in a situation of facing the early stages of a new product launch from them. Fortunately, in that period of time we've made tremendous enhancements to our products.

We really have a situation where customers contemplating a major purchase are going to take the time to evaluate both products. What you see is a stall in this market that will take a quarter or two to work through and it's exactly what happened when we brought our VersaCare product online in 2004.

Operator

We'll take our next question with Joe [inaudible] Partners, please go ahead.

Unidentified Analyst

Could you comment a little bit on some of the new product initiatives, particularly Tempur-Pedic, how that's rolling out, what kind of acceleration you're seeing, et cetera?

Peter Soderberg

Tempur-Pedic is an example of our desire to reach outside the four walls of Hill-Rom to people with technology and I'm just thrilled with the alliance we have with Tempur-Pedic. They have taken their technologies and redesigned very specific products for a variety of our stretchers and hospital beds. We began shipping our first products in July. We've had the incredibly wonderful anecdotes you would hope to hear of people not wanting to go home from the hospital.

It's early days, but we have a very significant opportunity pipeline right now on Tempur-Pedic. We've talked about the bariatric rental bed. I showed you pictures of the brand-new extended care and home bed. This is truly a revolutionary platform that will allow us to really reach people we haven't effectively reached with a sophisticated new offering.

In Europe, the results of the sales you saw in '07 were driven by a new value point or lower priced point acute care bed, but a very exciting thing is we've just gotten a French contract for medicalized long-term care. In Europe, the medicalized long-term care market is bigger than the hospital bed market. We now have a complete portfolio of beds and surfaces and furniture, so we're aggressively expanding into medicalized long-term care in Europe.

Andy Reith

I think there is time for one more question. Darryl, if you have anybody else in the queue, then we'll wrap it up.

Operator

No, sir. We don't have anyone else in the queue. I would like to turn it back over to management for any additional or closing remarks.

Andy Reith

Thank you, everybody for being on the call. I appreciate your interest. Lots going on here and we'll be happy to speak with you offline as you desire. Thanks for your interest and attention.

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