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

Morgan Stanley Healthcare Conference Call

September 11, 2012 1:30 pm ET

Executives

John J. Greisch – President and Chief Executive Officer

Mark Guinan – Chief Financial Officer

Analysts

David R. Lewis – Morgan Stanley & Co. LLC

David R. Lewis – Morgan Stanley & Co. LLC

My name is David Lewis, I’m the medical device analyst here at Morgan Stanley. It’s my pleasure to have all of us here, yet again for the second year. I’ll show two members of management, obviously John Greisch, as many of you know, as well as Mark Guinan, and Andy is in the audience as all of you know.

What I was going to have, may be do, I should have talked about this. But you want to give us a quick preamble of the business, and then we jump into Q&A?

John J. Greisch

Sure, thanks, David, great to be here. Just few quick highlights for those of you that aren’t familiar with the story. Hill-Rom market leading medical technology company global market leader in the hospital bed area, we’ve got about 70% installed base market share here in the United States. We’ve got a portfolio of products really focused on patient safety, enhancing patient outcomes, improving caregiver productivity, and caregiver safety in addition to beds, therapeutic surfaces, patient lifting, devices to help mobilized patients, get patients in and out of hospitals faster.

Many of you know, the hospital bed market particularly here in North America has been coming off to very strong years. Our fiscal 2011, we saw growth of over 20% in our core product category. We’ve really been focused since I got to the company about 2.5 years ago on optimizing our core business. We’ve driven significant margin improvements into the company, our operating margins from 2009 till today are up about 400 basis points, so we’ve achieved some very strong financial improvements over the past several years.

Here in fiscal 2012, we’ve really began to focus on diversifying the portfolio beyond our core patient handling products. We made a couple of acquisitions here this year, one in Europe, which represents, Europe broadly about 20% of the company.

We acquired one of the market leading bed manufacturers in Germany to solidify our market position in Europe and specifically in Germany. And most recently, we acquired company called Aspen Surgical, which is market leading provider of surgical blades, scalpels, wound care products, and other surgical accessories really to diversify our offering and strengthen our existing surgical platform with the Allen business, which again is about a $120 million business, very profitable, high margin operation, less cyclical than our patient handling portfolio.

So last couple of year’s lot of work to, as I said optimize the existing portfolio and here in 2012, made some moves to diversify the portfolio while continuing to remain focused on margin improvements, geographic expansion, and few other things, which I’m sure we’ll talk about with few questions.

David R. Lewis – Morgan Stanley & Co. LLC

Great, John. That was the perfect exact what we needed. I guess you would know this, but every August, and to help the comments, we sort of reevaluate, what’s happened with the stocks over last year? And congratulations, you were in more vital stocks certainly over the last year. So we set sometime in August trying to figure out, is there something wrong with our thesis on the stock? I want to spend time on this afternoon is, is the thesis still in tact as it relates to Hill-Rom and how investor see Hill-Rom?

I guess the first place, I think you would have thought a year-ago that the capital environment, what we expected to decelerate, there is no question the capital environment has decelerated dramatically faster than the investors, and I even think management front we would say. So the real question is, is what we saw, because we are seeing deceleration for several quarters, but what we saw accurately in the last quarter seem to be a further deceleration, which is let to a wide range of speculation on what’s going on in that quarter? Was it tied to hit the 5010, was it tied to some acute capital slowdown, or is this simply another cycle that we’re in? I guess what can you tell us in hindsight about what the rep saw in that particular quarter, about what may have caused a relative change of the deceleration pattern?

John J. Greisch

Yeah, I’ll give you my own, I guess personal perspective. I don't think it’s tied to any single event over the past three to six months. If you look at our, what we call our patient support systems product category, which is really the business that you are inquiring about, we have seen an accelerated decline in terms of year-over-year comps. However, we’ve seen a relatively stable sequential revenue performance throughout 2012.

So I think what my own view is, if you look at 2010 and 2011, where we came out of the trough of late 2008 and 2009, we clearly benefited from some pent-up demand spending for our product category with hindsight probably a little more pent-up demand than we knew at the time.

And as we came into 2012, you’re right, our expectations were that, we were going to see relatively stable patient support systems sales for 2012, and in fact, we’ve seen, I think in Q3, we had a decline of about 12%, Q2 was down about 8%, so little accelerated decline. Compared to last year, you’ll see an even comparable decline here in the fourth quarter, which as many of you know tends to be Hill-Rom’s strongest quarter, last year was particularly strong, where we had the second largest order in the company's history shipped in Q4.

So revenue comps, you have seen some deterioration. However, as we look at the sequential performance of the bed business, I think hospital spending for our categories have been relatively stable this year albeit at a lower level than last year. And again, I don't think it's one particular event David, as much as it is the pent-up demand that we experienced and enjoyed in 2010 and 2011 has now slowed to a more normalized level. I got asked many times this morning, “have we troughed?” Honest answer is, I’m not sure we know the answer to that at this point in time. But we have seen more stability throughout this year even though the comps have been deteriorating, Q2 to Q3.

David R. Lewis – Morgan Stanley & Co. LLC

So, I mean do you have any ability of accessories, what do we call this? Do we call this just anniversarying a demand cycle that was created by 2008, 2009 shortfall than a positive 2010 or 2011 and that was to the inverse of that, or is there any information you could provide in terms of whether this is a quote cycle versus just what appears to be kind of a period of difficult comps, hard comps, easy comps, fall by hard comps?

John J. Greisch

Yeah, I think our view is, we don’t see any secular changes in terms of, investment levels from our customers. I think it is more of anniversarying the cycle of pent-up demand. As in the capital spending environment for our customers become more challenging, you bet. I think the reimbursement uncertainty, the payer mix changes that hospitals are looking at as they look forward, I think are putting a finer perspective on how much and where they deploy their capital.

And our challenge, which I think we’ve been doing well competitively is to continue to demonstrate that the improvement opportunities that our products bring hospitals and lowering their operating costs, improving patient outcomes, improving caregiver safety. So I don’t think we’ve seen a shift in the cycle. But I think we are coming off, as I said a higher level of pent-up demand that we probably appreciate it.

David R. Lewis – Morgan Stanley & Co. LLC

And you said you’re comfortable with your competitive position, I guess, we don’t have a lot of tools that are disposal. And we look at one of your key competitor’s performance in the last quarter versus your performance and we just do it on comp adjusted basis and try to have the best proxy for business of theirs just compared with yours. It actually look like you may have lost share, which is surprising to us, but you don't think you are losing share. What do you think the share dynamics are right now in the bed business?

John J. Greisch

Well, if I look at the last couple of quarters specifically relative to Stryker, year-over-year comps between the two of us, it’s a pyrrhic victory. But our sales declined in the patient support systems category was actually lower than theirs was, I don’t know how to adjust it other than just looking at the…

David R. Lewis – Morgan Stanley & Co. LLC

Sure.

John J. Greisch

…the raw data that we and they report. They’ve got stretchers, significantly more stretcher revenue than we do. We've got a couple of other things in our capital always. But I think the last couple of quarters and the last couple of years as we triangulate all the data that we do feel, we have stemmed the share loss that we have been experiencing, for the last five to seven years and began to close some of that back.

David R. Lewis – Morgan Stanley & Co. LLC

Okay. In the perception listed at the Morgan Conference here last couple of days that Stryker is being a little more bullish on their capital all of back half of the year and Hill-Rom maybe one-on-one today is being more cautious. And I can’t with regard frankly, as Stryker is being more bullish, because their product offerings are, [it’s got] a super important parts of that from a total revenue perspective, or you are being cautious, because it’s a significant portion of your company that prudent to do so. So is it possible they are seeing something else in the market that you are not seeing?

John J. Greisch

I don't like to comment on what they are seeing or what they are saying, to be honest with your David. Yeah, I think, we are communicating and articulating what we are seeing. I think we’ve been fairly consistent for the last couple of quarters in terms of the cautiousness based on, both the revenue comps that you mentioned and the order rates that we’ve been seeing.

I think competitively as I mentioned, I think we’re more than holding our own. So, has anything changed dramatically in our view over the past couple of months? No. And as I said, our caution towards capital spending outlooks as we look forward remains the same as well as on the last call.

David R. Lewis – Morgan Stanley & Co. LLC

John, when you came to this company, your goal obviously [if I would come as to] create shareholder value, okay. And I think you probably assume there was some level of revenue that was necessary to kind of execute your plan over a five-year period of time. It probably wasn’t double-digits, probably it was negative, somewhere between double-digits of negative.

So let’s say it was low single-digit. I guess in your time of the company, have you come to appreciate that the nature of this business and the cycles of revenue maybe more an impediment to the plan that you wanted to execute at Hill-Rom?

John J. Greisch

I think there is probably a little more cyclicality to the core bed business than I had a full appreciation of when I came in the door. That said, I think having driven the international growth, we’ve driven, improved our operating margins, the stocks actually up 30% from one IRI, which kind of gets lost in the volatility as you kindly described it over the past year.

David R. Lewis – Morgan Stanley & Co. LLC

Okay, that, okay. Yeah.

John J. Greisch

But we have accomplished a lot of what we had said out to accomplish a couple of years ago, a lot of work still ahead of us. More challenging end markets today than probably we saw 2 to 2.5 years ago, that’s not unique to Hill-Rom by any means. But I’m pleased with the progress that we’ve made and probably have a better appreciation of some of the headwinds that we’re facing that clearly changed over the past couple years in any event.

David R. Lewis – Morgan Stanley & Co. LLC

Sure.

John J. Greisch

But we are making the progress that we hope to.

David R. Lewis – Morgan Stanley & Co. LLC

Just really the kind of second part of our thesis, which was, we were, it’s not like you have negative revenue growth, you are looking for something like low single-digit revenue growth, but I felt that low single-digit revenue growth, you could execute your margin expansion plan and create a dramatic amount of value.

On the last quarter what was encouraging was, international business was encouraging on a relative basis and your rental margin business, which had been a issue year ago at this time, is still kind of hanging in there at a reasonable margin. So I guess going back to our central thesis, which was low single-digit European margins, the ability to get back to 10% that can create a lot of value. And so help us understand the progress you are making to making the international business a more profitable business?

John J. Greisch

Yeah, I’ll answer that not just relative to international, but maybe a little more broadly as well. We’ve continued to take cost out of the company’s cost base as you all know. I think every said out last spring, spring of 2011 with a goal of operating margin expansion continuing, SG&A getting down into the high 20s as a percent of sales. We took actions in March to take some costs out a couple of hundred people in addition to what we did a couple of years ago. SG&A is now below 30%, so we’ve accelerated that objective even in the context of a tough revenue environment across the Board.

So I think from a cost management perspective, we've reacted to some of the external challenges that we are seeing, and as I said haven’t achieved a number of our objectives there. Internationally, last quarter we saw very strong growth outside of Europe and relatively stable environment within Western Europe, which I think has been a little surprising to some folks. But as we progressed to 2012, Europe is pretty much on track from our expectations and has been relatively stable as it is throughout the year.

Profitability, we continue to attack margin both on the gross and operating margin side internationally, still have a lot of work to do there. We’re not and/or near where we want to be. We saw some good gains early on and are combating some of the revenue challenges that we’re seeing in Europe with as aggressive cost actions as we can.

David R. Lewis – Morgan Stanley & Co. LLC

And so, what do I say to investors who say your thesis is predicated on your international or European margin expansion right into the Bally of European austerity. So how is it possible? How can you convince investor to provide visibility, you can execute your plan in some of these markets that are single payer systems going to significant budgetary challenges?

John J. Greisch

Well, the best we can do is, put up some results that deliver again some of those objectives. And again if you look at international broadly, I think we did that reasonably success over the last quarter. We had very strong growth in the Middle East, Eastern Europe region, as well as in Asia-Pacific, while again at the same time managing as aggressively as we can within Western Europe. On the back of the Volker acquisition that we made back in February, we’ve consolidated our German infrastructure and taken our costs here over the past few months and gotten some leverage out of that acquisition as we go forward.

David R. Lewis – Morgan Stanley & Co. LLC

Okay.

Mark Guinan

If I can add a couple of things David, certainly growth enables some of the margin improvements to leverage. But there is a number of things that we’re working on and then people would typically go after, that really aren’t dependent on revenue growth. Just give you two examples, one of them is, our focus on the area of indirect procurement, we are really just starting to adopt some of the industrywide best practices in terms of preferred providers, spend visibility, certain tools to monitor spending, ensure compliance with providers and pricing and things like that.

So that is completely independent sort of revenue growth, and other one is the adoption of technology. If you look at our Rental business, we’ve moved some technology out into our field that help us better enable the optimization of our truck fleet of our service employees time, et cetera, it’s a very complicated algorithm to try to get these assets in and out of hospitals on a day in and day out basis both in Europe and North America.

So that again that’s independent of volume, you can do those things and take cost out, in a flat business or even in a declining business.

David R. Lewis – Morgan Stanley & Co. LLC

Okay. Questions for John and Mark. Yeah one that – I’m sorry got excited for a second. I want to comment one thing before I move on maybe to some of the balance sheet activities. I still [steering] at the model last night and I’m looking at the fourth quarter number, Bristol Motors, they got pushed out of the fiscal third quarter, I think about your guys and looking at the fourth quarter, it implies 10% to 12% organic growth declines, that’s a top number. It just seems overly conservative to me, but again I am not really getting a read today that, you guidance is overtly conservative and how is that possible that with orders pushing out, the business really can be done 10% to 20% in the fourth quarter?

John J. Greisch

Yeah, the biggest factor is what I mentioned earlier, the second largest order, which is about $25 million…

Mark Guinan

Yeah.

John J. Greisch

That shipped in the fourth quarter of last year, second largest order in the company’s history, not in the last couple of years. That’s a tough one to offset.

David R. Lewis – Morgan Stanley & Co. LLC

Okay.

John J. Greisch

And then when you look at the order level declines year-over-year, which pile on the single order comp challenge. The one thing that I guess is different this year relative to previous years for our company, our fourth quarter 2010, which is the quarter we’re now ending September 30th, tend to be historically by far the strongest quarter of the year for us. A lot of that is sales incentive driven and sales guys driving towards their commission targets what have you.

Our ability to drive capital spending decisions in the industry today is certain more challenging than it has been in the past, which I think again as a reflection of the environment that we’re in from a macro perspective. So, certainly I’m not going to sit up here and say, our guidance is conservative for this quarter. I think there is a number of factors both in macro environment that we’re seeing throughout the year and the one order that we had a big impact in 2011.

David R. Lewis – Morgan Stanley & Co. LLC

Okay. And your acquisition of Aspen Medical, although we initiated coverage of the company, clearly using the balance sheet as new capital deployment buying back stock, was obviously a part what we were expecting. So I can’t say that you’re doing deals was very surprising, you said that first you’ve done under your watch, large deal.

And I guess the question that really concern investors and I’ll be honest myself as well. For the mix of business, the multiple pay seemed a little high to us, better on EBITDA basis, it’s a very profitable asset. But our revenue basis, you did seem a little high and a lot of investor were concerned about the timing of Aspen, as well as the delivering of the quarter that perhaps you stretched on evaluation to get that deal done in conjunction with the quarter, maybe sort of help us understand process in timing whether that’s true or not true?

John J. Greisch

Happy to answer that. For the last year or so, I’ve been communicating relatively consistent we had hoped that after the first year, year and a half of my assembling the team, we’re going to start looking at acquisitions. And we had an objective of diversifying the portfolio away from such capital intensive category as patient support systems, specifically target of our respiratory care and surgical, that’s being two businesses that we are already in and we are looking for adjacent assets to complement those businesses.

We've had our eye on Aspen for sometime actually and have been in negotiations for the acquisition for a number of months. It was not an auction process, so there was no gun to our head on either value or process. And it was a company as I said, we had targeted well over a year ago as they good fit and complimentary addition to our surgical business, which was more capital intensive around patient support systems equipment and accessories for operating procedure.

So the complementary nature of disposable consumable business, EBITDA margins well north of 30% of sales, so margin expansion opportunity for us, across the enterprise made it a very attractive asset for us. As you know, we’re very disciplined around return on invested capital. The large part of our incentive system is driven towards ROIC and even larger part towards total shareholder return. So the price we paid, where confidence is going to be a value creating acquisition for us. It's not at the low-end of multiples in the device field, it's not off the charge high, but it was a full price recognize that, but it certainly was not a deal that we stretched to close or stretched to pay outside of our zone in terms of valuation.

David R. Lewis – Morgan Stanley & Co. LLC

Probably I’ve got a minute left, so I want to give you some transition time, you tell, it was your comp in ROIC, but heard it was a lot of capital, you don’t get to spend that kind of capital that often, because you don’t have that kind of balance sheet, so what are the two things about this transaction that said this is where you want to spend, maybe the biggest chunk of capital we’re going to spend the next few years?

John J. Greisch

Yeah, couple of things, one that the high margin accretive profile of the business to our margin profile is very attractive from a financial perspective. And as I said, I think the value creating opportunity for us with the acquisition we’re very confident. And secondly, from a customer relationship perspective, it broadens our portfolio that we bring into the acute care channel and gives us a stronger portfolio to build and really leverage our channel relationships with the acute care hospital network and is more buying decisions whether it’s capital or disposable products are moving upstream into the suites of the hospital networks, the more we can bring to the party, I think the more value to our relationship with customers are. So customer leverage, channel leverage, they’ve got very, very strong market positions with their products, in addition to the margin accretion and margin expansion opportunities as far as we really one attracted as to the company.

David R. Lewis – Morgan Stanley & Co. LLC

Okay. With that, I’m going to cut it off. But John and Mark, thanks so much for being here with us today.

John J. Greisch

Okay. Thanks for being here.

Mark Guinan

Okay.

David R. Lewis – Morgan Stanley & Co. LLC

Okay.

John J. Greisch

Thanks everyone.

Question-and-Answer Session

[No Q&A session for this event]

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