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Hill-Rom Holdings, Inc. (HRC)

F4Q13 Earnings Call

October 25, 2012 8:00 am ET

Executives

Blair A. Rieth – Vice President, Investor Relations

John J. Greisch – President and Chief Executive Officer

Mark Guinan – Senior Vice President and Chief Financial Officer

Analysts

Matthew S. Miksic – Piper Jaffray

Lawrence Keusch – Raymond James

Catherine Hu – Deutsche Bank Securities, Inc.

John Demchak – Morgan Stanley

Topher Orr – Goldman Sachs

Lennox Ketner – Bank of America/Merrill Lynch

Gregory W. Halter – Great Lakes Review

Gary Lieberman – Wells Fargo Securities, LLC

Operator

Good morning and welcome to the Hill-Rom conference call. At this time, all participants are in listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at the time. As a reminder, this conference call is being recorded and will be available for telephonic replay through November 1, 2012, see Hill-Rom’s website for access information.

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

I would now like to turn the call over to Mr. Andy Rieth, Vice President of Investor Relations. You may begin.

Blair A. Rieth

Thank you, Mimi. Good morning, and thanks for joining us on our fourth quarter fiscal year 2012 earnings call. Before we begin, I would like to provide our usual caution that this morning’s call may contain forward-looking statements, such as, forecasts of business performance and company results as well as expectations about the company’s plans and future initiatives. Actual results may differ materially from those projected.

For an in-depth discussion of risk factors that could cause actual results to differ from those contained in forward-looking statements made on today’s call, please see the risk factors in our Annual Report on Form 10-K and subsequent quarterly reports on Forms 10-Q. We plan to file our 10-K for the full year in November.

Joining me on the call today will be John Greisch, President and CEO of Hill-Rom and Mark Guinan, Hill-Rom’s Senior Vice President and Chief Financial Officer. The usual ground rules will apply to make the call more efficient. We’ve scheduled an hour in order to accommodate our prepared remarks and leave plenty of time for Q&A. During Q&A, please limit your inquiries to one question plus a follow-up per person. If you have additional questions, you may rejoin the queue.

As you listen to our remarks, we are also displaying slides that amplify our disclosures. I would encourage you to follow along with us. The slides were posted last night on our website and will also be part of the archive.

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

John J. Greisch

Thanks, Andy. Good morning, everybody, and thanks for joining us here today. We are pleased to report that we closed out a tough year with fourth quarter revenue and adjusted earnings per share that are ahead of our guidance.

Moreover, adjusted full-year EBITDA of $324 million was up from last year, despite the challenging environment. This reflects both the strong and sustainable cash flow capability of our portfolio, and the focus of this management team on delivering consistent cash flow.

As usual, Mark will cover our results in detail. But before I turn the call over to him, I’d like to cover several topics this morning, the external environment, progress on our key strategic initiatives, our outlook for 2013, and our plans to maintain a disciplined capital allocation strategy.

Let me start with a few comments on the external environment. Consistent with our communications of the last several quarters, the hospital capital spending environment remains extremely challenging, particularly in North America and Western Europe. In North America, our patient support systems revenue was up 7% sequentially and ahead of market performance, but down about 9% from 2011, excluding unusually large sale last year. We expect to see continued tough conditions in the hospital CapEx environment as we move into 2013.

Although we are encouraged by the fact that North American capital orders have been relatively steady throughout 2012, we entered 2013 with a backlog that is down 25% from the prior year. Internationally, we had a solid quarter, led by steady performance in Western Europe and strong growth in Australia and Latin America. For the full year, Western Europe has been relatively stable quarter-to-quarter.

Moving to our key strategic initiatives, as you recall, two years ago, we laid out several areas of focus, including leveraging our channel, international expansion, portfolio acquisitions, increased investment in innovation and improved financial performance across the portfolio. We’ve made good progress on all of these initiatives during 2012.

In addition, deploying our cash flow in a disciplined manner to drive shareholder value continues to be a strategic priority. We plan to continue to take a disciplined approach to deploying cash both for value enhancing M&A activity, and returning cash to shareholders. As an example of this approach, the Volker and Aspen acquisitions completed in 2012 were directed at several of our strategic focus areas, including leveraging our channel, international expansion, and improved financial performance.

Aspen moves us into a new hospital-based surgical product category, that provides us with a highly profitable, growing and recurring revenue stream, while Volker significantly expands our international footprint, and allows us to leverage our North American and other regional sales channels around the world. We also achieved strong growth in the Middle East and Asia Pacific during 2012, as a result of commercial investments made during the past two years.

We will continue to invest in markets, where profitable growth opportunities exist, and pursue strategically relevant acquisitions that leverage our channel strength, diversify our revenue profile, or provide us with international expansion opportunities. Continuing the comments on our portfolio, you’ve heard me discuss the fact that we have had businesses with approximately $100 million in revenue that were break-even at best.

We have taken several actions during 2012 to address this under performance. We recently streamlined our home care business, including the elimination of approximately 100 physicians. In addition during the year, we turned around two businesses, both of which are now profitable. These actions were all taken in addition to the restructuring we implemented in March. We will continue to aggressively pursue improved performance across the portfolio. At the same time we completed these acquisitions and portfolio actions, we also increased our R&D spending, for the third year in a row.

We launched several new products in 2012, and we remain committed to increased R&D spending, as we move forward. On the financial performance front, after two solid years of achieving our financial goals of accelerated revenue growth, margin expansion, leveraging our SG&A structure, and improved cash flow. 2012 proved to be a challenging year in several respects.

Given the declines in hospital spending, particularly in North America, our organic revenue declined during 2012, for the first time in three years. As a result, the adjusted operating margin expansion of over 500 basis points that we achieved between 2009 and 2011 proved challenging to maintain in 2012, and we saw a decline of about 50 basis points for the full year compared to 2011.

This occurred despite the success we had driving our adjusted SG&A rates to below 30% for the full year. We remain committed to expanding operating margins through productivity improvements and SG&A leverage going forward, although the medical device tax and intangible amortization, from our recent acquisitions will challenge us in that regard in 2013.

Our cash flow performance was again outstanding in 2012 in line with our objective to drive consistent, sustainable cash flow across the portfolio. We achieved adjusted EBITDA of $324 million, up from last year. I’m proud of our ability to drive consistently strong cash flow in the last three years despite the ups and downs of our market cycles. So while we faced headwinds in our core patient support systems markets, we made significant progress on several of our key strategic focus areas.

As we move into 2013, we’ll remain focused on these strategic initiatives, and we will continue to be highly disciplined in deploying the strong cash flow we are confident we will continue to generate. Looking ahead to 2013, we expect a challenging top line environment in our core businesses.

Our 2012 acquisitions will drive the revenue growth of 7% to 8%, that we expecting. Operating margin will be burdened by the device tax, effective January 2013, and by intangible asset amortization from our 2012 acquisitions, both of which we expect to be accretive to earnings per share for the year. We also expect another strong cash flow year in 2013 with adjusted EBITDA roughly flat with 2012, after absorbing the device tax.

Turning to our capital allocation strategy, as Mark and I have mentioned in the past, we have a strategy that we have consistently followed. We plan to continue to selectively pursue acquisitions as we did in 2012, but at same time, return cash to shareholders, as we have done over the past two years.

We increased our dividend by approximately 10% in each of the last two years, and have repurchased over $150 million of our shares during the same period. In 2012, we returned nearly 30% of operating cash flow to shareholders. We plan to continue on this path.

As you saw on a recent press please, our Board increased Hill-Rom’s share repurchase to approximately 4 million or over $100 million at current prices. We are confident that we will continue to deliver consistent and sustainable cash flow in 2013 and beyond, and we will deploy our cash to drive improved shareholder value in the years ahead.

So in closing, this was a challenging year. But it was also year in which our management team demonstrated the ability to deliver strong cash flow and take the appropriate actions to improve performance in many areas. We are committed to continuing to do so.

With that, let me turn the call over to Mark before we open the call to Q&A. Mark?

Mark Guinan

Thank you, John and good morning to everyone on the call. Before we get started, I want to highlight that many of the figures we will discuss today are adjusted or non-GAAP measures. Reconciliations to our reported U.S. GAAP numbers are included in the appendix to our slide deck. In addition, all segment discussions reflect our previously announced realignment.

I also want to point out that starting this quarter and going forward, we will be highlighting adjusted EBITDA as one of our key metrics for discussion. Given our 2012 acquisitions and the associated purchase accounting, our P&L has changed enough that we feel this metric will be important in helping you evaluate our business performance versus prior years.

Now, let’s get started with revenue. On a consolidated basis, reported fourth quarter revenue increased 0.2% or 2.3% on a constant currency basis to $482 million. The increase was the result of incremental revenue from our fiscal 2012 acquisitions, which was mostly offset by declines in North America capital sales and enterprise wide rental revenue. Excluding acquisitions and currency, revenue declined 8.2%, compared to last year.

The capital sales increased 4.4% to $330 million or 6.7% on a constant currency basis. This was driven by increases in our surgical and respiratory care, and international segments. In both cases predominantly due to the 2012 acquisitions within each segment. This strength was partially offset by a 15.8% decline in our North America segment, primarily driven by lower patient support system sales.

Consolidated rental revenue also continued to come under pressure, decreasing 11.2% or 10.1% on a constant currency basis to $102 million. Revenue declines were reported across all segments on lower volumes and unfavorable pricing in select areas, with the largest percentage decline coming in our home care business. As you may recall, we previously announced the discontinuation of our frame rentals in home care, and we are now announcing a further narrowing of our scope in this business as John mentioned earlier.

Domestic revenue decreased 7.6% to $286 million, while revenue outside the United States increased 20.1% to $146 million, let by the addition of Volker and growth in Latin America and Australia. On a constant currency basis, revenue outside the United States increased 27.2%, and foreign exchanges rates continue trend unfavorably year-over-year.

Looking at revenue by segment, North America reported a decrease of 14.3% to $250 million, led by declines in our patient support system sales of 24.2%. Capital orders for the quarter were up sequentially and have been generally stable over the course of the year, falling into a rather narrow band quarter-to-quarter. While this lower order pattern is consistent with what we have been seeing in the industry and is in line with what we outlined last quarter, it is a significant deviation from our historical pattern of the fourth quarter being our strongest quarter of the year for both revenue and orders.

Additionally, compounding our tough comparable year-over-year was a single large sale, the second largest in the history of our company in last year’s fourth quarter. Excluding the effects of this large sale, our decline in patient support system sales would have been 9.3%, rather than the 24.2% outlined earlier.

North America rental revenue declined 10.5% in our traditionally weakest rental quarter of the year. We continue to experience pressure on rental volumes due to ongoing reimbursements and other cost pressures. The largest driver of the rental revenue decline is home care.

Moving to our new Surgical and Respiratory Care segment, revenue improved 63% to $56 million led by a strong increase in capital sales. This increase was driven by the addition of the Aspen Surgical business that we acquired early in the fourth quarter, generating incremental revenue of $23 million. Rental revenue declined 14.6%, as our respiratory care business encountered softer volumes and pricing pressures. On an organic basis, this segments overall revenue declined approximately 4%.

International reported revenue increased 20.2% to $126 million or 28.4% in constant currency. Excluding the impact of the Volker acquisition on a constant currency basis, international revenue was up 8%, let by Latin America and Australia.

Despite continued concerns over the economic environment in Europe, excluding the effects of currency, sales and orders were relatively stable throughout 2012. Note that the uneven revenue growth we experienced in rest of world regions during the year was driven by several large projects and successful tenders. While we expect continued growth in these regions, the results are likely to be irregular quarter-to-quarter, and perhaps even year-over-year.

Moving to margins, we posted lower adjusted gross margin performance for the quarter at 47.0%, which represents a 170 basis point decline year-over-year. Both capital and rental adjusted margins were down with rental margins experiencing the larger decline. The capital margin decline relates primarily to a higher proportion of international revenue, and unfavorable product mix. This was partially offset by somewhat lower warranty cost in the quarter.

Commodity and fuel costs were relatively stable. The margin decline in our rental business relates primarily to the lower revenue discussed earlier and the resulting reduction in the leverage of our product fleet and field service infrastructure. Despite sequential revenue declines over the past two quarters, normalizing for the seasonably low rental revenue in the fourth quarter, rental margins have stabilized.

Regarding operating expenses, our R&D investment for the quarter increased 20.6% year-over-year driven by specific project time. As we have previously discussed, we expect to continue to increase investment in R&D over time, at a rate faster than our revenue growth.

Adjusted SG&A expenses for the quarter increased by 1% year-over-year to $127 million and were nearly flat as a percentage of revenue at 29.5%. Excluding the impact of the Volker and Aspen Surgical acquisitions, we delivered a reduction in adjusted SG&A expenses of 8.3% from the prior year quarter and lower personal costs, cost out initiatives from our restructuring and other activities, and the favorable effects of foreign exchange.

Sequentially, adjusted SG&A was up 7.3% from the prior quarter due primarily to the additional expenses of the newly acquired Aspen Surgical business. But as a percentage of revenue, was essentially flat. For the full year, adjusted SG&A came in just under 30% as a percentage of revenue.

Adjusted operating profit for the quarter was $57 million, representing a 13.2% operating margin, down 270 basis points versus last year’s comparable results. As noted previously, the drop was the result of lower gross margins, and higher R&D investment. The adjusted tax rate for the quarter was 35.7%, compared to 30.9% in the prior year. The higher rate in the current year was primarily the result of decreased international income in lower tax rate jurisdictions, certain international income, not being subject to tax in the prior year, and the expiration of the R&D credit.

It is also important to note that during the quarter, we recognized a one-time accounting gain of a $11 million, or $0.18 per share associated with international tax restructuring efforts. This benefit was excluded from our adjusted earnings. So to summarize the income statement, adjusted earnings per diluted share were $0.56 in the fourth quarter, representing a 22% decrease compared to $0.72 in the prior year.

One final comment on operating results, before I move on to cash flow and our guidance for fiscal 2013. During the quarter, we had four items, netting to $9.4 million of pretax expense, in our GAAP earnings that are reflected in our adjusted results. These are in addition to the international tax benefit referred to earlier, that was also excluded from our adjusted results. The most significant of these items relates to restructuring costs of $8.5 million for the completion of actions announced in the second quarter and new actions related to the planned exit from certain underperforming portions of our home care business.

Streamlining our home care business resulted in employee severance, lease disposition charges on dedicated products, and bad debt reserves. These actions are anticipated to deliver improved operating results for the home care business, but such results are not expected to reach their full potential until fiscal 2014, as runoff activities and business process changes continued through fiscal 2013.

The second item renewed from our adjusted earnings relates to acquisition and integration costs of $6.2 million, including inventory step up for the Aspen Surgical acquisition. These expenses are reflected in both cost of goods sold and SG&A. Additional integration costs are likely to be incurred in the coming quarters, related to recent acquisitions.

We also received a favorable legal settlement during the quarter of $3.6 million, net of legal expenses incurred in the quarter, which was adjusted out of operating income. The last adjustment items a continuation from the prior year, and one that was wrapped up this quarter was a $1.7 million benefit reflected in rental gross margin, related to a vendor product recall action.

As I mentioned up front, with the intent of providing visibility to the underlying strength of our cash flow, we will be including a new metric, adjusted EBITDA. With our capital sales subject to volatility from macroeconomic conditions and large tenders in rest of world regions, and our recent increase in merger and acquisition activities, our earnings can be somewhat volatile. Despite this, the cash generation of a respective businesses is much more stable.

We believe this metric provides insight into the underlying cash generating strength of our core business. Adjusted EBITDA for the full year was $324 million, compared to $318 million in the prior year.

Moving now to cash flow. Our full year operating cash flow was $262 million, in line with our guidance of $260 million to $270 million. Our full year operating cash flow increased 17.6% on slightly lower earnings, demonstrating positive working capital improvements over the course of the year and the increasing impact of non-cash expenses in our P&L related to M&A.

In the fourth quarter of 2012, we repurchased approximately 1.5 million shares of common stock for approximately $42 million. Also, during the quarter, the board expanded our share repurchase authorization by 3.5 million shares bringing our open share repurchase authorization to about 4 million shares.

As John mentioned previously, this affirms our commitment to our capital allocation strategy of returning a significant portion of our operating cash flow for shareholders as one of our key levers for creating value.

Now, let’s turn to our fiscal 2013 guidance. We are projecting full year reporter revenue growth of 7% to 8% and adjusted earnings of between 1.95 million and 2.05 million per diluted share. The 2013 guidance includes a reduction of $0.17 per diluted share for amortization of intangible assets associated with fiscal 2012 acquisitions, an increase of approximately $0.12 versus 2012 and a $0.17 reduction for the effects of the medical device tax.

We are highlighting these items to add clarity in considering the year-over-year comparability of the results between years. Excluding these two items, adjusted EPS guidance would be $2.29 to $2.39. This full year 2013 financial outlook reflects an organic revenue decline of 1% to 2%. For the segments, a revenue decline of 2% to 3% in North America, approximately 70% revenue growth in surgical respiratory care due to the late 2012 acquisition of Aspen Surgical and mid to high single-digit constant currency revenue growth in our international segments, aided in the earlier comparables by the acquisition of Volker gross margin of approximately 47%, which is flat to2012, and R&D spending increase, in line with our growth in revenue, as we continue to invest in new and innovative products.

Continued operating leverage of our SG&A infrastructure, though more than offset in fiscal 2013 by the acquisition related amortization of intangibles and implementation of the device tax mentioned earlier, resulting in a net year-over-year deleveraging on our SG&A line.

An operating margin decline of approximately 200 basis points on the year, driven by the impact of the medical device tax and amortization expense. Positive earnings accretion from both the Volker and Aspen Surgical acquisitions, a tax rate of approximately 31% to 32% and the number of shares outstanding for the year to average $61 million.

We project 2013 operating cash flow to be in the range of approximately $265 million to $275 million. We also anticipate $75 million to $80 million of CapEx investments. And finally, we expect adjusted EBITDA to be in the range of approximately $315 million to $325 million.

Now, let’s turn to guidance for our first quarter. We are projecting reported revenue growth of 9% to 10% and adjusted earnings of between $0.33 and $0.45 per diluted share. Approximately, half of this decrease is related to acquisition related amortization expense with the remainder attributable to an increase in R&D spending, and a decrease in gross margin.

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

John J. Greisch

Thanks, Mark. The most important takeaway from the results we have shared with you today is that despite the ongoing volatility in our markets, we continue to grow and reshape our portfolio, while at the same returning cash to shareholders.

It is our strong cash flow performance that has positioned us well to do this. Our healthy cash flow is due in large part to managing our operating expenses and addressing the underperforming parts of our portfolio. We are committed to continuing on this path. Overall, I’m pleased we ended the year with results ahead of expectations and I am confident we will deliver on our priorities and commitments going forward.

One last item I would like to bring to your attention is that we plan to hold our next investor conference in May of 2013. We will communicate the specific date when we finalize the details.

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

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Our first question comes from Matt Miksic of Piper Jaffray. Your line is open.

Matthew S. Miksic – Piper Jaffray

Hi, can you hear me okay?

John J. Greisch

Yes, we can.

Mark Guinan

Hey, Matt. Good morning, Matt.

Matthew S. Miksic – Piper Jaffray

Hi, good morning. Great job on the quarter I should say I’m not pretty on an absolute basis, but certainly not as bad as a lot of folks, ourselves included had feared heading into the fourth quarter. I would like to get your sense as to you talked about your U.S. rather your OUS guidance. Could you talk a little bit about what your assumptions are for Europe in capital heading into next year? Particularly, if you could talk about it maybe ex-Volker, just to give us a sense of your expectations there, and I have one follow-up.

John J. Greisch

Yeah, I’ll take that Matt. This is John. As Mark said, Europe for 2012 excluding Volker was relatively consistent throughout the year. So we saw a pretty steady trend of order intake quarter-to-quarter throughout 2012. It’s down slightly from last year as we expected, but pretty steady.

Our expectation going into 2013 is pretty much more the same. So relatively steady, slight decline year-over-year, but no major disruptions really based on what we’ve seen throughout 2012, which I think is doing large parts of good execution in the markets on the top line and continuing to manage the costs structure there and in line with what’s clearly a challenging environment. But as we look to 2013, pretty steady slight decline in top line revenue in Europe, but nothing dramatic.

Matthew S. Miksic – Piper Jaffray

Okay. And then just one of the cost side; you mentioned it’s tightening that side of the business in a slowing environment. If you expand maybe a little bit on the progress you’re making there that was kind of another bright spot in the quarter, and maybe where your areas of focus are outside the U.S., how you’re doing and so on?

John J. Greisch

If you look at 2012 in total and not just a fourth quarter, we took out over 300 jobs during the year, while we added Aspen and Volker obviously on top of the existing base. So between the March restructuring and then the home care actions we took here in the fourth quarter together with constant management across the company throughout the year.

I think we managed our costs pretty effectively during 2012. For the full-year and for the quarter as Mark commented SG&A as a percent of sales even in a declining core revenue environment came in under 30% to revenue, which I think is pretty remarkable given the environment that we’re in.

If you look at next year, ex-device tax and ex-intangible amortization, we expect to be in that same ballpark. We are investing in some areas. We don’t want to short change the revenue opportunities that are out there for us, even in the challenging environment that were in. But we’re continuing to look at all areas where we can continue to take cost out.

Couple of the non-home care underperforming business is that I alluded to that have now turned profitable are in part due to taking cost out. One of our international operations, we shut a factor and changed the business model in that markets, which has taken that business from a loss maker to a profit generator and in our other business that I’ve alluded to in the past several quarters.

Same thing we took some cost out and turned a low $1 million loss business into a more attractive profitable business, not just through cost, but through efficiency improvements as well. So I think you’ll continue to see us address opportunities where we can. We don’t have any major restructuring actions plan for 2013, but we will continue to look across the portfolio.

Matthew S. Miksic – Piper Jaffray

Great, thanks for the color.

John J. Greisch

Okay, thanks Matt.

Operator

Our next question comes from Larry Keusch of Raymond James. Your line is open.

Lawrence Keusch – Raymond James

Yeah. Hi, good morning, guys.

John J. Greisch

Hi, Larry.

Mark Guinan

Good morning, Larry.

Lawrence Keusch – Raymond James

Good morning. I guess John is as you think about 2013 in the U.S., I’m assuming that again you’re sort of assuming the environment is roughly the same, but I’m wondering if you could just as you kind of finished out the year, help us understand again sort of what’s going on in the U.S. environment.

We’ve certainly seen a re-prioritization of capital spending? And I guess lengthening of the typical cycle for the replacements of frames? But again if you could provide some color on, as we exit the year kind of what you’re seeing as the dynamics from the U.S. market?

John J. Greisch

Sure. You’re absolutely right Larry. The environment is tough and whether it’s delayed decisions or re-prioritization of capital that is clearly affecting our business. I think we’ve been saying that for the last several quarters, not always in line with other people’s expectations. But we’ve been pretty clear and I think pretty open about the fact that our concerns around the U.S. market particularly relative to our patient support systems business were growing as 2012 progress.

Like the year played out pretty much as we expected, relative to our commentary starting back in January. And those conditions have not abated at all as we look into 2013. Our patient support systems business was down reported revenue nearly $50 million during the year as a result of the declining orders.

And I think that the operating margin that we’re able to deliver even on the back of a decline of our highest margin product category was one that I’m fairly pleased with for the year, our operating margin throughout the year was pretty steady at about 13% quarter-to-quarter with those conditions in the PSS business.

As we look into 2013, I don’t expect any change here Larry. I mean the uncertainty that our customers are facing, you guys have seen it with virtually every device company’s earnings report and limited outlook that have been presented by everybody else in the industry. If anything concerns around the uncertainty, we have increased here over the past month and again I think it’s pretty consistent of what we’ve been talking about for the last several quarter.

So we’re going into 2013 with a cautious outlook for North America. We have as I alluded to in my comments seen a relatively stable quarter-to-quarter order rate throughout 2012. We’re expecting more of the same is going to continue to be lumpy. But expectations as you’ve seen with our guidance are slightly down on an organic basis for our core business. But again reasonably consistent of what we’ve seen in 2012 and what we’ve been communicating for the last several quarters.

Lawrence Keusch – Raymond James

Okay. And then just to follow-up, I guess just one quick housekeeping one, which was on the device tax, what ultimately became of the rental business and the other part of the question really is it sounds like again deploying of cash flow to M&A as well as share repurchase. You did two deals in 2012, should we anticipate that you will seek to be active on the M&A front in 2013? And I guess Aspen deal was probably a bit bigger and more expensive than people have been anticipating kind of help us to frame how you’re thinking about the M&A activity?

John J. Greisch

Yeah, let me take the second part of your question, Larry, then I’ll let Mark address the device tax. Yes, we will continue to look for acquisitions along the lines in what we’ve discussed in the past. I think you coined the term strategically relevant in one year reports following some of our communication. We’re going to continue to look for those.

We’re not going to do deals for the sake of growing the company. Aspen and Volker are both accretive to 2013, in line with our expectations. Those are the kinds that we’re going to be looking for. If we do not find ones that fit our financial and strategic objectives, we’ll continue to deploy cash. It’s one of the reasons we increased the authorization.

And in the absence of any significant M&A activity, I think you can expect us to utilize that authorization over the next 12 to 18 months. But we are going to continue to pursue acquisitions, and to the extent we find attractive ones. We’re prepared to pursue them in the absence of those. I think you will see us increase our cash return to shareholders.

Mark Guinan

And Larry, on the device taxes, I’m sure you’re aware, the regs are still being finalized. At this point our interpretation which we feel pretty confident about is that on rental business, the device itself is taxed at one point upon placement into the fleet, and not there being an ongoing tax for each rental transaction. So those products will be subject to the tax. But kind of like a capital sale, it will take place at one point in time and we believe that point in time will be triggered when it’s place into the fleet.

Lawrence Keusch - Raymond James

Okay, terrific. Thanks, guys.

John J. Greisch

Just one follow-up Larry, just on the share repurchase just to clarify. The guidance that Mark laid out does not assume any 2013 share repurchases.

Lawrence Keusch - Raymond James

Okay, great.

Operator

Thank you. Our next question comes from Catherine Hu of Deutsche Bank. Your line is open.

Catherine Hu – Deutsche Bank Securities, Inc.

Hi, thanks for taking my question. I actually following up on the M&A question. Can you just kind of talk about how Aspen is tracking so far compared to your expectations? And then given the macro environment, do you think M&A is more or less important to your strategy?

John J. Greisch

As I commented, Aspen is tracking in line with our expectations, the accretion for 2013 is exactly what we had anticipated when we did the deal. More or less important, I think if you go back to our comments over the last year reshaping our portfolio with acquisitions that address some of the strategic focus areas that I commented on in my prepared comments, were and will continue to be an important part of our strategy.

So we are not going to panic into a heavier acquisition mode, because of the current challenging environments in our core businesses. But I think the importance of diversifying the portfolio and reshaping the portfolio continue to be important, and will continue to be an important part of our strategy.

Catherine Hu – Deutsche Bank Securities, Inc.

Okay. And then quick one on the med tech tax as well, the impact for this year, considering it’s only three quarters seems a little higher than I would have thought when I think comments, just talking to you guys in the past, has anything changed or come up in the past couple of months that may have changed that?

Mark Guinan

No. We really have not commented specifically on any amount previously. So, this is about within the ballpark of what we have been estimating for a while. There is nothing that’s developed as we have spent time understanding and interpreting the regulations that deviates significantly. So, yes, it’s three quarters, but this is our belief a majority of it coming from our capital sales in North America and then a chunk of it coming from rental placements in the fleet, as I mentioned earlier.

Catherine Hu – Deutsche Bank Securities, Inc.

Okay, great. Thank you.

John J. Greisch

This is our best estimate, as many of you know. The specific regulations from the IRS are yet to be released. So for all of us in the industry this is still a bit of a moving target. But as Mark said, there has been no change to what we expect the legislation to look like, but they are yet to be released in specific form. And as I think everybody on this call knows, there is still a fairly active effort underway to have the tax repealed or delayed, and those activities continue.

Catherine Hu – Deutsche Bank Securities, Inc.

All right, great. Thanks.

Operator

Our next question is from David Lewis with Morgan Stanley. Your line is open.

John Demchak – Morgan Stanley

Hello. This is actually John Demchak in for David.

John J. Greisch

Hey, John.

Mark Guinan

Hey, John.

John Demchak – Morgan Stanley

So I wanted to ask a question on operating margin guidance. I believe you guys guided was down 200 basis points for the year, which I mean looks pretty consistent with what we saw this year, where I guess it dropped almost that amount, not fully. But I mean understandably some of that involves mix, some of it involves profitability.

But when half of that, I guess would come from the med tech tax and then the other from amortization, it doesn’t really sound like you are expecting the true I guess the margin profile of the business to get any worse. Given just the commentary about the overall tough environment, and that it doesn’t sound to be getting much better. I’m just wondering what assumptions you guys are kind of including into this margin assumption?

Mark Guinan

Well, the business actually in 2012 declined about 50 basis points in terms of operating margin, not a couple hundred basis points. But our assumptions for 2013 are really that given the fact that we are entering this year with a difference portfolio mix than we entered 2012, obviously, the PSS business is smaller as a proportion of our total portfolio, that’s a very high margin profitable business as John pointed out and then we’ve got the acquisitions as part of our portfolio that change the mix as well.

As we look at that, as I said earlier, we assume we can hold gross margin flat. So obviously within that, there is a lot of moving pieces, including some mix dilution offset by productivity improvements, that we’ve talked about that we will continue to work on. But the net there is a flat gross margin year-over-year. We talked about growing our R&D dollars.

In proportion with our revenue growth, it continues to invest in the long-term. And then, really what it comes down to on operating margin is deleveraging on the SG&A line. Without the device tax and the amortization expense, we would not be delivering any leverage, but we would be holding SG&A pretty flat year-over-year. So really the operating margin decline is driven in fact by the device tax and by the amortization expense that runs through SG&A.

John J. Greisch

Okay, John. Just to add to Mark’s comments, I think three important points just to repeat some of what Mark said. For the full-year, operating margin was down 50 basis points. I think you may be referring to the fourth quarter decline.

As I said in an earlier response to the question, throughout the year, our operating margin has been plus or minus 13% on a quarter-to-quarter basis. The fourth quarter was actually the strongest operating margin quarter for the year. In 2012, it’s just over 13%, but it’s hovered around 13% for the full year. And you are absolutely right, the 200 basis point decline for 2013 is entire driven by the device tax and the intangible amortization and the core business margin maintenance in again, a challenging revenue environment is one that we are guiding to for next year.

John Demchak – Morgan Stanley

Thank you. And you are absolutely right, I think I was looking at the gross profit change when I went to that...

John J. Greisch

Correct.

John Demchak – Morgan Stanley

So I apologize that.

John J. Greisch

No problem.

John Demchak – Morgan Stanley

And just looking at an organic basis kind of sequentially into the start of next year, I mean it sounds like this is the kind of start up when you guys start to thinking of maybe sequential stabilization going forward. And I just wanted to kind of making sure that I am reading that right?

Mark Guinan

Yeah, I believe that, it’s correct. We talked about a couple of areas North America although we’ve had a lower level than it was in 2011, once it took that downward turn, we’ve seen pretty stable level of orders consistently throughout this calendar year and the balance of Q2 through Q4. We also talked about Europe being fairly stable, and it really goes beyond in fact, beyond this fiscal even though revenues were down, because we had a really strong backlog at one point for the last six quarter approximately, we’ve seen pretty stable order rates coming out of Europe.

So as a very fair statement that we are looking for a good degree of stability with slight erosion both in the North America business in Europe, but nothing fo significance relative to what we’ve been seeing for quite sometime now.

John Demchak – Morgan Stanley

Thank you, very helpful.

Operator

Thank you. Our next question comes from Topher Orr of Goldman Sachs. Your line is open.

Topher Orr – Goldman Sachs

Yeah, thanks for taking the question, guys.

John J. Greisch

Topher, good morning.

Topher Orr – Goldman Sachs

So I guess my first question is just one more following on the string of M&A relating questions here. And it really relates, the last couple of acquisition you guys have done especially Aspen from a technological diversification standpoint appear to be doing quite well. And I was just wondering going forward, are you guys more inclined to go with new technology type acquisitions? If so, are there any areas that you are geared towards? Or do you think it’d be more geographic dependent in terms of expanding your footprint? And so on that side what specific areas globally look at?

John J. Greisch

Topher, as you might suspect, I would rather not comment specifically on any particular technologies or areas. I think that the three things that I commented on in my prepared comments leveraging our existing channels here in the U.S. and internationally diversifying the portfolio for expanding our international footprint in those of the areas that that broadly we’re focused on about specific products, technologies or geographies. If I threw one or two out, I’d probably be wrong relative to whatever our next acquisition is, so I’d prefer not to comment on those specifically at this point in time.

But I think you can count on us staying pretty close to our core channel that we’re in today, and maintain a high degree of financial discipline. As I said, we’re going to panic because our core business is under stress right now. But we’re going to stay with what we do well in the channels where we have success and great customer relationships.

Topher Orr – Goldman Sachs

Well, I figured, I would try on that one. My second question actually, if I could shift over to gross margins. I was just wondering, it looks like if you look at the capital side of the business that gross margins, you know it should be pressured by the great percent of international continuing at least for 2013 and probably thereafter.

But on the rental side of the business, in light of a weak volume environment, are there any steps that you guys can take to get that portion of the margin going back up again? I know a couple of years ago, you guys had rationalized a number of service centers you had out in the field. You had taken steps there. Is there anything else that you guys are looking at this point to get the margin backup?

John J. Greisch

There is a couple of things that we have and we’re continuing to do one of which you mentioned. Reducing the footprint of our service centers, we’ve done more of that in 2012. Also the portfolio of products that are in the rental fleet we’re both adding product that we think will be margin accretive over time and we’ve also been reducing products domestically and internationally to take products out of the fleet, where margins were not attractive. Those efforts will continue going forward.

On the first point, you’re right. If you look at 2012, the international growth to some degree has diluted our margin. It’s mostly been Volker driven though, which again as we communicated when we did deal was a lower margin business over time. We expect that to improve, 2013 that will be accruing.

With Europe, relatively flat and the rest of our international growth coming from non-European regions, the dilution from those regions actually is not apparent at all. Those regions have been attractively profitable for us and the growth we’ve seen coming out of some of those regions, particularly at the operating margin line have helped us maintain the 13% operating margin here in 2012.

Mark Guinan

I would add that beyond the number of service centers we have, we’re also driving and adopting new technology to help optimize the efficiencies of those operating expenses we’ve got over 700 trucks that are going in and out of hospitals everyday certainly the effectiveness of both utilizing those assets as well as the rental fleet itself, the more we can drive efficiency there that the more we can improve the margins within our rental business.

That’s something we’re very focused on as well. We’ve talked about that a couple time in the past and we’re feeling very good about that contribution. So everything from monitoring fuel consumption and the logistics of planning out how our delivery schedule gets done, and making decisions about are certain deliveries profitable or unprofitable as John referenced our certain assets, profitable was driving us to rationalize some of our rental asset business as well. So there is a lot of things that we’re driving with the rental to address the margin issues.

Topher Orr – Goldman Sachs

Okay. Well, thanks again.

John J. Greisch

Thanks.

Operator

Thank you. Our next question comes from Lennox Ketner of Bank of America. Your line is open.

Lennox Ketner – Bank of America/Merrill Lynch

Hi, guys. Thanks so much for taking my questions. I guess first just to follow-up on the margins, but just returning to SG&A. Either for John or Mark, I’m trying to understand what I’m missing in terms of SG&A expected to be up 200 basis points or so year-over-year. I guess obviously you have the device tax, which it sounds like from the $0.17, how about a 100 basis point impact on your SG&A? But you have guys the restructuring from 2012, which I believe it was expected to add $18 million or so cost savings on an annual basis. So that should really offset the tax.

And then on the last call, I believe you said that Aspen was expected to be neutral the margins, even including amortization. So all of those to me would suggest that SG&A should be relatively flat over year, so I’m just trying to understand what I missing in terms of that deleveraging?

Mark Guinan

Yeah, a couple of things, Lennox, I appreciate the question. First off on the restructuring savings, I’m sure you’re aware of that we actually benefited from a proportion of that in the current fiscal year, at the past fiscal year 2012. So $0.18 you referenced is not an incremental year-over-year benefit that we used to fully offset the device tax. We got approximately half of that, not quite, but in that ballpark in 2012. So the year-over-year benefit is less than the $0.18.

In terms of Aspen, I think our comments were that the margins were not dilutive excluding any sort of acquisition accounting. So in fact as you would typically assume, when you do an acquisition of that size, there is a fair amount of purchase accounting and ends up diluting report EPS, but obviously does not takeaway from the cash generating ability of the business, which is very, very helpful for Aspen.

So really when you look at the incremental benefit that we get from the restructuring. There are some investments that we need to make that John talked about earlier in order to insure that we can pursue some of the revenue opportunities certainly in the international areas, we’re investing in some SG&A, and there are some other things within the core business that we feel are essential.

So we as I said earlier, pretty much holding SG&A holding SG&A flat as a percent of sales year-over-year, we think that’s the right thing to do for the business other than the two items we mentioned, which is the incremental amortization and the device tax.

Lennox Ketner – Bank of America/Merrill Lynch

Okay. I’ll go back and look at the Aspen. I thought that was supposed to be accretive before amortization and neutral after…

John J. Greisch

Lennox, just to clarify, Aspen is accretive after intangible amortization in the $0.15 to $0.20 range. So after amortization, it’s exactly where we thought it would be with that level of earnings accretion.

Mark Guinan

On EPS…

Lennox Ketner – Bank of America/Merrill Lynch

Okay.

John J. Greisch

Correct, on EPS.

Lennox Ketner – Bank of America/Merrill Lynch

Okay, great. That’s very helpful. And then just second one, Mark you talked about adjusted EBITDA being an important metric going forward. Sorry, if I missed that, what are you guys adjusting for there? Is it excluding the device tax or what adjustments are being made?

Mark Guinan

No, it’s building, it off of adjusted earnings. So that’s why we’re referring to it appropriately as adjusted EBITDA. So we have reconciliation within the slide deck. As you can see, there’s nothing unusual and in fact in that range the guidance range of 3.15 to 3.25 is not excluded to device tax. It is included in that figure.

Lennox Ketner – Bank of America/Merrill Lynch

Okay, great. Thanks very much.

John J. Greisch

All right, thanks.

Mark Guinan

You’re welcome.

Operator

Thank you. Our next question comes from Gregory Halter of Great Lakes Review. Your line is open.

Gregory W. Halter – Great Lakes Review

Yes, good morning and thanks for taking my questions. Relative to the discussion on R&D, which again you indicated has been up several years and expected to be up again this year. Just wondering if you could maybe mention a few of those new products that are out there?

John J. Greisch

Yeah, we’ve launched some new products in our surgical portfolio out of our Allen Medical business, which had a modest impact in 2012 and expected to have a more significant impact of that business in 2013. We also released some new therapeutic surface products during 2012 as well as a number of new products within our healthcare IT business.

As we look ahead, we’ve got some significant investments in refreshing some of our ICU and over the coming years, our med surge portfolio as well. And during 2012, in fact internationally we released a new med surge platform in our international markets on the back of some of our increase investment, so most of the investment is directed towards next-generation products along the lines that I mentioned as well as in some cases refreshing and enhancing the existing portfolio.

Mark Guinan

I would just add one more product. We had introduced a powered stretcher earlier in the year as well. That was an important addition to our stretcher portfolio.

Gregory W. Halter – Great Lakes Review

And relative to the rental business, just wanted to gauge the prospects for that business going forward, given what you mentioned pricing and I think competition as well. How that business is changed and how it may hopefully comeback to where it has been if that is the case?

John J. Greisch

Yeah, let me take that first Greg. I think we started talking almost two years ago about the pressures we were seeing in the rental business as hospitals began a more intense focus on their supply chain costs. And we do seeing the excess rental expense that they may have been incurring by carrying assets of few extra days for example.

Those pressures have obviously continued, and I think are going to continue. So that part of the portfolio is certainly under stress, and it has been for the last couple years. I think as Mark mentioned, we have addressed a number of issues in that business to stabilize the margins, which we’re very pleased with.

But from a top line revenue growth perspective, some of the new product introduction that we made last year, some of the ones we’re looking at next year and I would had a respiratory care business of that that area as well, where we’ve introduced a couple of new products over the last year is really going to be critical to maintaining some growth of that business. So it’s certainly under pressure on a top line basis and new product introductions and managing the heck out of our service cost infrastructure are both going to be critical to driving improvement in that business.

Gregory W. Halter – Great Lakes Review

All right. Thank you.

John J. Greisch

Okay.

Operator

Our final question comes from Gary Lieberman of Wells Fargo. Your line is open.

John J. Greisch

Hi, Gary.

Gary Lieberman – Wells Fargo Securities, LLC

Hi, it would appear that over the course of 2013, the environment for the North American capital business could improve substantially, with the shift in hospital CapEx maybe a way from healthcare IT and back towards regular maintenance CapEx as it’s been historically that’s been put off. But and also benefit because the implementation of healthcare reform and maybe the expectation of a boost in volumes by hospitals, because of that.

So I guess my question is do you think Hill-Rom benefits from that as much as we would have expected historically or are there other changes that you guys are aware of that that are keeping you kind of more conservative as you head into that environment?

John J. Greisch

Gary, this is John. Despite being an optimist at heart, I’m not looking at 2013 as a year of big recovery in the capital in environment. I think there has been some crowding out of capital for equipment like ours, from the IT investments that hospitals have made. But I can tell you every single hospital system that I meet with is looking to reduce their capital, in total. And again, we have talking about that for the last year.

So, capital expenditures overall, I think are going to continue under pressure at the hospital and hospital systems levels, IT investments again I think you’ve heard me use that as an excuse, as to why our products have been reduced this year, I think it’s the environment more than the prioritization, to be honest with you. The environment includes the uncertainty, as you mentioned from healthcare reform, as that gets clarified. Whenever that happens, I think that uncertainty factor will at least be somewhat removed.

But I personally I’m not looking at 2013 as a year when we are going to see a big snapback in that business. I hope you are right, but I think you would be imprudent for us to be banking on that, at this pointing time for 2013.

Gary Lieberman – Wells Fargo Securities, LLC

When you talk to hospitals do you hear anything from them in terms of gearing up for 2014, assuming healthcare reform is implemented because of the potential for at least marginally improved volumes?

John J. Greisch

To be honest with you, no, I mean I think the one thing I hear consistently from hospitals is, you know, concern over their margin profile which as you all know, most of them are operating at low single-digit operating margins as of today, the better ones are.

And I think if there is any perspective towards 2014 and beyond it’s concerned over their ability to maintain those margins, which again I think is a big factor in their conserving capital where they can. Despite that environment, I feel very good about our competitive position, the growth we’ve seen as I mentioned here in the fourth quarter sequentially, I think is stronger than certainly than any of our other publicly reporting competitors, and I think we are holding our own quite well in the environment as it is, one, on the back of our product portfolio and the strength of our channel here in the U.S. and across the world. So I feel good about the position that we’ve been able to maintain, but I think the capital environment is going to continue to be challenging at least for the foreseeable future.

Gary Lieberman – Wells Fargo Securities, LLC

Okay. Thanks a lot.

John J. Greisch

All right, thanks, Gary.

Operator

Thank you. I’m showing no further questions in the queue. At this time, I will hand the call back to management for closing remarks.

Mark Guinan

Thanks, Mimi, and that’s it for this morning everybody, and thanks for joining us. Take care.

Operator

Thank you. Ladies and gentlemen, this concludes the conference for today. You may all disconnect, and have a wonderful day.

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