Hill-Rom Holdings, Inc. F4Q08 (Qtr End 9/30/08) Earnings Call Transcript

| About: Hill-Rom Holdings, (HRC)
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Hill-Rom Holdings, Inc. (NYSE:HRC) F4Q08 Earnings Call November 11, 2008 8:00 AM ET


Andy Rieth - Vice President, Investor Relations, Communications and Global Brand Development

Peter Soderberg - Chief Executive Officer and President

Greg Miller - Senior Vice President and Chief Financial Officer


Ian Zaffino - Oppenheimer & Co.

Greg Halter – Great Lakes Review

David Bachman - Longbow Research

Steve O'Neil - Hilliard Lyons

Chris Cooley - FTN Midwest Securities


Good morning and welcome to the Hill-Rom conference call. (Operator Instructions)

Before we begin, I'd like to provide Hill-Rom's usual caution that this morning's call may contain forward-looking statements such as forecasts of business performance and company results and 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 today's press release. Also, you may reference the discussions under the heading Risk Factors in the company's annual report on Form 10-K for the period ended September 30, 2007 filed in December.

If you have not received today's release, it's available on Hill-Rom's website, www.HillRom.com.

On the call today will be Peter Soderberg, CEO and President of Hill-Rom, Greg Miller, Hill-Rom's Senior Vice President and Chief Financial Officer, and Andy Rieth, Vice President, Investor Relations, Communications and Global Brand Development.

Now I would like to turn the call over to Andy Rieth. Please go ahead, sir.

Andy Rieth

Thank you, [Cecelia] and good morning to everybody. I'd like to personally welcome you to our conference call and webcast for the fourth quarter of our fiscal year 2008.

Before we start, I hope all of you will join us here at Hill-Rom on this Veterans Day as we honor the men and women of our Armed Forces, both past and present. Their sacrifice is appreciated by all of us.

Now, as we have lots to discuss today, let's jump right in. First, some quick ground rules to make the call more efficient. We've scheduled about an hour for the call and plan to leave plenty of time for Q&A, and during that Q&A, please limit your inquiries to one question plus a follow up per person. If you do have additional questions, please rejoin the queue.

Along with our remarks, we are also displaying slides real-time on the webcast that will amplify our disclosures. I would encourage you to follow along with us. The slides are posted on the IR portion of our website. The slides will also be part of the archive of this call.

Now the telephonic audio replay of this call will also be available for a week. The webcast and the accompanying slides will be archived on our website for approximately one year.

Also, I want to note that our 10-K annual report for fiscal year 2008 will be filed later this month and will serve as a good complement to today's material.

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

Peter Soderberg

Thank you, Andy, and good morning to everyone. I'm very pleased to welcome you to this call.

It was just over five weeks ago that we held our very well-attended investor conference in New York. A lot has happened in that short time, but most importantly, we're now able to confirm a very strong close to our 2008 fiscal year.

We have spoken to many investors over the last five weeks as well. From these conversations, there are macro themes that are concerning to most of you which we will try to address on this call as well - first, the impact of tight credit markets and cost of credit on health care providers capital expenditures; second, the impact of deepening recessionary pressures on provider operating margins and cash flows; third, the headwinds or tailwinds of inflation; and fourth, the strengthening U.S. dollars' impact on our international sales and earnings.

In spite of these concerns, let me note at the outset that our fourth quarter results and strong momentum lead us to reaffirm 2009 guidance, reflecting our continuing cautious optimism for the year ahead.

Now let's take a quick look at our agenda for today's call. I'll begin with an overview of HillRom's fourth quarter business segment performance and their outlook. I'll also provide a brief update on our Liko acquisition integration status, and then I'll turn over the call to Greg for a more thorough financial review and discussion. After some brief concluding comments, we'll take your questions.

Let me start with revenue. I'm very pleased to report strong and accelerating growth for all reporting segments. Fourth quarter revenue was $424 million, up 14.1% and nearly 13% on a constant currency basis. We saw balanced growth between capital sales, which were up 11.8%, and rental revenues, which were up 19.6%. This level of growth, both as reported and on a constant currency basis, is unprecedented in Hill-Rom's recent history.

Revenue growth translated to strong improvements in profitability as gross margin increased, operating expenses grew at a rate slower than sales, and our operating margin as adjusted expanded by 410 basis points to 13.2%.

On a year-to-date basis, our consolidated revenue reached over $1.5 billion, which represents total organic growth of 11.1% and constant currency growth of 9%. This performance supports the conclusion that our goal of 6% to 8% compounded organic growth is achievable, and this quarter represents the sixth out of the past seven quarters where revenue growth fell in or above our targeted range.

Turning to our three reporting segments, let's begin with North America Acute Care, where revenue grew 8.7% to $273 million. The primary drivers of growth were a 40% plus increase in ICU patient support systems, a 30% plus increase in therapy support systems capital sales and rental revenue, and launch of the new all digital NaviCare Nurse Call platform late in the quarter. Offsetting these strong performances were softer sales of Med/Surge patient support systems and our Moveable Equipment Management Systems business, where we are beginning to see revenues stabilize.

North America Acute Care capital sales grew 7% to $212 million. Within that number, sales of our hospital beds and proprietary therapy surfaces increased by high single digits. We believe the return on investment proposition for our frame and surface technologies is increasingly attractive to hospitals due to the growing number of bariatric and morbidly obese patients, mounting patient case complexity and co-morbidities, increasing emphasis on quality metrics, the CMS no pay rules for patient falls and pressure ulcers, which went into effect on October 1, and increasing focus on caregiver safety.

North America Acute Care rental revenue grew 15.1% to $60 million, led by therapy support systems revenue increase of over 25%. Continuing strong acceptance of our Envision e700 surface and Total Care Bariatric Plus rental products once again paved the way, along with a lack of any repeat in the rental receivable adjustments taken in the prior year.

Looking forward, our backlogs are remaining solid at this time and we have not yet seen a material change in order patterns. However, we are seeing customers take a more cautious approach in light of their economic uncertainty. Most new construction, which accounts for about 20% of our capital revenue, seems to be proceeding if it is fully funded and under way. However, we are learning of some isolated project delays or cancellations.

Replacement capital spending for our type of equipment seems to be more stable, despite a few examples of capital freezes or reductions. We estimate that only a bit more than onethird of our worldwide revenue is vulnerable to North America Acute Care capital spending reductions, and we continue to anticipate that total North America Acute Care capital sales and rental revenue should grow in the mid single-digit range before the impact of the Liko acquisition.

Turning to our North America Post-Acute segment, revenues grew to over $50 million, an increase of 29.6%. Like the last two quarters, both capital sales and rental revenues showed strong growth of 24% and 31%, respectively. While we are still in early innings here, we feel we will continue to be rewarded by our decision to focus resources on developing our business outside of our core hospital segment. Even when one accounts for the adjustments taken in 2007 to write down uncollectible rental accounts receivable, our Post-Acute Care business was up in excess of 17%.

Rental revenue strength again was driven by the Vest high velocity chest wall isolation therapy system and a 40% plus growth in our homecare therapy rental and capital products.

Our small but burgeoning direct-to-consumer business more than doubled versus the prior year.

Our extended care business was flat after accounting for the aforementioned accounts receivable adjustments.

Going forward, we expect to see continued low to mid teens revenue growth in this segment, while maintaining our strong profitability. Medicare is the largest payer for our Post-Acute rental products, and should represent in the near term a relatively stable source of revenue. Further, we expect new products launching in fiscal year 2009, some sales force additions we are currently making, and the Liko product line to provide continued momentum for the coming year.

Turning to our International and Surgical business, we have recorded another gratifying and balanced quarter. Total revenues of $103 million were up 23% or 18.2% on a constant currency basis. Mid teens to 40% plus sales growth in Europe, Latin America, Asia, and at Allen Medical, our surgical business, drove these results.

In Europe, our expanded focus on medicalized long-term care led to a doubling of sales, although we still have lots of opportunity to increase penetration within this product category, especially with the addition of new Liko channels. This growth, however, has come at lower margins than our other two segments, so improving profitability is the major 2009 priority for our International team.

Looking forward, we expect mid single-digit revenue growth in 2009 before the impact of Liko. This reflects considerable conservatism versus our recent performance in order to recognize the high penetration we have already achieved in Europe, more discipline in the low profitability tenders we will pursue, and the possibility that recessionary pressures, particularly in Europe, will negatively impact us. However, we believe we have pretty good visibility into revenue growth for the first half of fiscal year 2009 and have not seen a reduction in tender activity to date.

As for earnings, International divisional income is naturally hedged from a currency perspective in that much of our capital sales derived internationally are from products manufactured in France.

Let me now comment on our bottom line performance. Consolidated net income from continuing operations, adjusted for the one-time charges associated with our previously announced streamlining and cost saving measures, was $0.58 per fully diluted share compared to $0.38 per share in the prior year. While we still have much to do to ensure sustained and profitable growth, it feels as if we turned the corner in building a more balanced and profitable business, and our investments over the past two years are clearly bearing fruit.

On a full year basis, our adjusted earnings per share from continuing operations of $1.40 was up 23.9% over 2007 and is consistent with our previous guidance range of $1.33 to $1.43.

Free cash flow for the quarter was $18 million, brining our Hill-Rom year-to-date free cash flow to $115.4 million, up $84.2 million over 2007.

Turning to Liko, I'd like to provide a brief update regarding our progress on integrating this acquisition that closed on October 1. Liko affords us an ideal platform to accelerate expansion of our businesses across the care continuum and around the world. Liko products are used equally in both post-acute care and acute care to provide safe lifting and patient mobility solutions. There are strong adjacencies to our existing business and call points.

In addition to the strategic rationale for the acquisition, I'd like to recap some of the financial reasons we pursued Liko. Liko has had a three-year trailing compounded annual growth of 11% in revenue and 12% to 13% in EBITDA. Gross margin and operating margin, not including any synergies derived, are both accretive to Hill-Rom immediately. We expect Liko to contribute up to $0.03 per share to Hill-Rom in 2009, even after including one-time integration costs. And finally, the internal rate of return for the Liko investment is above Hill-Rom's mid teens hurdle rate.

As we have pursued our integration activities and gotten to know Liko and their fine team of people better, we firmly believe this acquisition provides us a great opportunity to grow shareholder value.

In closing, it was an excellent year for Hill-Rom and I'm very proud of our organization for their many and considerable accomplishment. The Herculian task of completing the separation of Batesville Casket without missing a beat while successfully executing our business plan speaks volumes about our commitment to build a great company here. Add to this the $150 million of new revenue in 2008 and the identification and successful acquisition of a major new growth platform makes for a remarkable achievement by all our associates.

But this is a new fiscal year and we begin it facing headwinds. While we have not yet seen an impact of global economic challenges on our backlog or order patterns, we anticipate softening as we move through the year. Like most every business, our management team is taking what we believe to be appropriate steps to mitigate the impact of economic headwinds to our bottom line should demand slow significantly.

As we described during our investor conference and are reiterating here, our guidance for 2009 reflects a more conservative outlook on the revenue line, but by executing our gross margin improvement initiatives and potentially benefiting from moderating inflationary pressures and other expense disciplines in the G&A areas, we will strive to continue to deliver expanding operating margins and double-digit EPS growth.

Now I'd like to turn the call over to Greg Miller. Greg?

Greg Miller

Thank you, Peter.

As a reminder, as we completed the spin off of the funeral service business in the middle of the fiscal year on April 1, please note that all amounts presented in these slides are presented on the basis of our continuing operations. Therefore, these slides exclude not only the impacts associated with the former funeral service business but also most costs associated with its separation. In the fourth quarter, we had no separation-related costs in our continuing operations, however there are $10.6 million of separation-related costs included within our continuing operations on a year-to-date basis. All other separation-related costs are included within discontinued operations and are discussed in more detail in our Form 10-K that we filed at the end of November.

Now let's get started. As Peter has already covered revenues by segment, I will quickly walk through the next three slides, showing quarterly performance trends on a year-over-year basis. Overall, the ramp up of investment spending into R&D, global sales channel, and new product marketing during the last half of 2007 and in 2008 have resulted in the continued acceleration of revenues throughout 2008. In fact, fiscal 2008 total revenue growth rate at a constant currency basis was 9%, exceeding our long-term 6% to 8% targeted organic growth rate.

Looking forward to 2009, we expect total revenue growth to moderate given the economic pressures facing our customers and increase at a mid single-digit growth rate consistent with the initial guidance provided at our October 7 analyst meeting, and this excludes the impact of our Liko acquisition.

Looking at capital sales, fourth quarter capital sales increased 11.8% year-over-year or 10.6% on a constant currency basis, which was led by our International and Surgical segment and accompanied by solid increases in our other two segments as well. Fiscal 2008 growth rate for total capital sales was 11% or 8.5% on a constant currency basis.

Rental revenues were also higher in the fourth quarter, with 20.5% growth year-over-year or 19.6% on a constant currency basis. Rental revenue comparisons also benefited from the nonrecurrence of a prior year charge of $7.6 million taken to reserve for select uncollectible rental receivables. Excluding the impact of this prior year charge, rental revenues still grew 12.1% in the fourth quarter.

All business segments experienced double-digit rental revenue growth, driven by new products and investments into our sales channels. Our fiscal year growth was 11.5% or 9.9% on a constant currency basis.

Now let's move to gross profit and margins. During the fourth quarter, gross profit increased on a year-over-year basis 18.9% as both capital and rental gross profit showed growth. Gross margin measured as a percent of revenues increased 190 basis points compared to the prior year. Excluding the prior year $7.6 million nonrecurring rental receivable charge I mentioned above, overall gross margins still improved 70 basis points compared to the prior year.

This margin improvement is directly related to the higher rental revenue volumes leveraging our rental fleet and service cost structure, favorable rental mix, favorable capital product mix in the fourth quarter, and savings attained from both continuous improvement in our manufacturing service operations as well as sourcing activities. These improvements were partially offset by higher than expected inflation and unfavorable geographic sales mix towards international markets.

Year-to-date gross profit increased 11.1% while year-to-date gross margin remained flat from prior year at 44.4%, despite the significant pressure from inflation in the second half of 2008 and unfavorable sales mix towards International. As we have discussed in the past, our International gross margins generally provide relatively lower margins than those in North America.

Overall in the fourth quarter, commodity and fuel costs negatively impacted margins on a year-over-year basis by $6.6 million or approximately 160 basis points. Year-to-date commodity and fuel costs negatively impacted margins on a year-over-year basis by $11.5 million or approximately 80 basis points, with the majority of this inflation felt primarily in the last half of the year.

All in all, we are quite pleased with our margin achievement given the significant unexpected inflationary pressures we have encountered and the geographic mix issues we faced during the year. Looking forward to 2009, our guidance includes overall gross margin expansion of 60 to 190 basis points, reflecting the benefits from volume increases, price realization, productivity gains, including the tailwind from our Mexico manufacturing facility, and the accretive effect of our higher Liko margins, partially offset by estimated inflation that primarily reflects continued pressure on metal-based products.

Now let's take a quick look at capital and rental gross profit margins. Fourth quarter capital gross profit increased 11.7%, with all three business segments reporting higher gross profit. Overall, fourth quarter capital gross margins as a percent of sales remained flat year-over-year at 41.4% as higher North America acute price realization and favorable product mix, driven primarily by the accelerated sales of our new Total Care Connect ICU platform, were offset by inflation and an increasing sales mix towards lower-margin International sales.

For the full year fiscal 2008, capital gross profit increased 8%, related primarily to the higher volumes. The full year capital gross margin rate of 40.7% reflects a decrease of 120 basis points from fiscal 2007.

As we have discussed in past conference calls, this decrease was largely due to the increase in percentage of our overall revenues coming from International segment, a number of one-time items in our International segment related to inventory and distributor items, cost associated with the ramp up of production in Mexico and inflationary cost increases experienced during the last half of the year. In fact, inflation alone accounted for approximately 100 basis points of downward impact on capital margins.

As mentioned above, these negative effects were partially offset by price realization, productivity and sourcing improvements, and improved margins from new product introductions.

Rental gross profit increased 37.5%. Despite fuel inflation experienced by our field service organization, fourth quarter gross margin improved 660 basis points year-over-year to 53.6%. Excluding the impact of the prior year adjustment of $7.6 million, fourth quarter rental gross margins would have improved an incremental 260 basis points. This incremental improvement results from the increased rental volumes which continue to increase the leverage of our rental asset fleet and field service cost structure, the continued rollout of new, higher-margin products, and the effects of various continuous improvement activities in our field service organization.

For fiscal 2008, rental gross profit increased 17% from the prior year, with gross margins improving 240 basis points to 52.6% for the same reasons I just covered.

Now I would like to move on to operating expenses. For the quarter, we saw an overall increase of 6.1% to $133.4 million. As we had indicated in our previous calls, the fourth quarter reflects a declining year-over-year rate of increase and an improvement in our leverage of operating expenses. As a percent of revenues, operating expenses have improved from 33.7% in the prior year fourth quarter to 31.4% in the fiscal 2008 fourth quarter.

The primary reason for the year-over-year increase in operating expenses was an 8.8% increase in sales and marketing expenses. This was in line with our expectations and consistent with our initiatives related to sales channel expansion and the higher level of new product launches over the past year and a half. In addition, this increase also reflects higher sales commissions, in line with the higher revenues experienced during the quarter.

Year-to-date operating expenses increased 11.5% as we continued to execute on our strategic plan investing in the development of new products, expanding our sales channels, and marketing new products.

Looking forward, while we continue to make prudent investments in select areas of our sales channel and in new product development, the overall rate of our investment spending will continue to decline in fiscal 2009 and be more in line with our overall increase in sales performance.

Before leaving operating expenses, let's take a quick look at R&D spending. The decline as a percent of revenue in the fourth quarter - the 3.1% - was based primarily on the strong revenue performance and project timing as actual spending was slightly down year-over-year in the fourth quarter. For fiscal 2008, year-to-date R&D spending increased 19.6% or as a percent of revenue, increased from 3.5% to 3.8% compared to the prior year.

In addition to operating expense, R&D spending related to software development in our health information technology solutions business is included within capital expenditures. During fiscal 2008, we spent and capitalized almost $11 million or 46% more than in 2007 on the development of new software products.

In September we launched our new NaviCare Nurse Call technology platform, and we have other projects in process for 2009 launches. As we have discussed in the past, developing these technologies provides Hill-Rom with competitive advantages in real-time connected care environments.

On an as-adjusted basis, excluding the effects of separation-related costs and special charges, operating profit for the fourth quarter increased to $56.2 million, up over $22 million from the prior year. Not only have we executed on our investments to improve our billing system and receivable collections, thus avoiding the repeat of prior year's $7.6 million receivable reserve, but we are now seeing the overall improvement in our operating profit from the strategic investments we've made over the past year and a half, even despite the unexpected pressures from inflation. We have previously stated that 2008 would be an [inflection] year, and I think you can see this in our second half performance.

As we progress as a separated company, we will continue to challenge the way we do business. As part of this, during the fourth quarter we incurred special charges related to two separate actions. First, on August 15 we implemented actions to streamline and delay or organizational structure. As a result, the company incurred a special charge of $6 million for severance costs which will provide an annual benefit of approximately $14 million. This benefit has been fully reflected in our 2009 guidance.

Second, on October 6 we announced a restructuring of our MEMS rental business, resulting in a fourth quarter special charge of $14.5 million. Of this amount, approximately $1 million relates to severance and lease termination costs, while the remaining amount relates to product rationalization costs and will be non-cash in nature. We expect the annual benefit of approximately $4 to $5 million as a result of this action, with a portion of that impacting 2009.

Moving to our tax rate, the effective tax rate for the company's continuing operations for the fourth quarter was 27.4% compared to 26.4% in the prior year. The higher rate in the current quarter is due principally to the 2007 rate reflecting the R&D tax credit, whereas 2008 did not reflect such credit following the expiration of the R&D credit on December 31, 2007.

The Q4 2008 tax rate does reflect favorable discrete period tax benefits of approximately $1.5 million primarily related to the expiration of certain state statutes. Discrete tax periods recorded in the prior year were less than the current year.

The effective tax rate for the company's continuing operations for the full year 2008 was 27.3% compared to 33.7% for 2007. The lower rate for the year-to-date period is due principally to $8.3 million of favorable discrete period tax benefits recognized throughout the year, including a significant $7.8 million benefit in the third quarter. These tax benefits related primarily to the net release of valuation allowances on our foreign tax credit carryforwards and recorded liabilities associated with the completion of the federal audit of the company's fiscal 2004 through 2006 tax years, along with the expiration of certain state statutes. Discrete tax benefits recorded in the prior year are approximately $1.2 million.

The full year effective tax rate without discrete tax items would have been 36.2% in 2008, with the main difference from 2007's rate of 35.2% being the reduced benefit of the R&D tax credit which expired upon the completion of our first quarter on December 31, 2007.

Looking forward, with the reinstatement of the R&D tax credit in October, the benefits from the restructuring of the Liko acquisition and a number of other initiatives, we expect our effective tax rate, excluding discrete tax items, to improve to 34% in fiscal 2009.

Adjusted earnings per share were $0.58 per fully diluted share in the fourth quarter of fiscal 2008 compared to $0.38 per share in the prior year. The increased earnings per share results related to the improved operating results discussed above. A reconciliation of these amounts to GAAP earnings per share is provided in the appendix of the earnings release slide deck and in the earnings release itself.

Moving on to cash flows, our fourth quarter cash flows were lower in the current year as higher levels of adjusted earnings could not fully offset movement in working capital. While inventories and accounts payable both reflected favorable improvements in cash flows, the substantial increase in our fourth quarter revenues resulted in a temporary build in accounts receivable. With this higher year end receivable position and the continuance of our strong collection efforts, we would expect this to result in strong cash flow performance in the first quarter of 2009.

Full year 2008 free cash flows for Hill-Rom improved $84.2 million from the prior year to $115.4 million, primarily related to, first, increased operating profit after considering the accrual of special charges incurred in the fourth quarter of 2008 - which only approximately $7 million of the $20 million special charge will impact cash and not until 2009 - improvements in working capital, and a reduction of capital expenditures related primarily to the 2007 Mexico plant acquisition of approximately $15 million.

Taking a look at our liquidity and capital resources, we continue to maintain a strong financial position from which to carry out our strategic plans. We had cash and cash equivalents of $221.7 million on hand at year end, including associated with $90 million of borrowing from a revolving credit facility in anticipation of the Liko acquisition. As you know, the next day, on October 1, we completed the acquisition of Liko for a purchase price of approximately $183 million from this total cash amount at year end.

After this transaction, we still have borrowing capacity of approximately $400 million on our line of credit. In addition, with the fourth quarter or, more specifically, September being our highest revenue period during the year, we anticipate seeing significant cash inflows from the collection of related receivables during the first quarter of 2009. Based on our view today, we are comfortable with our liquidity position and our ability to continue to execute on our strategies to grow the business.

As mentioned above, our primarily working capital as a percentage of revenues improved to 26.2% from 31.2% in the prior year comparable period. This includes improvements in DSO and in inventory turns. Our debt-to-capital ratio of 17.1% compared to the prior year of 21.9% also showed improvement.

Now let's finalize our 2009 guidance. As Peter mentioned, we are reaffirming full year 2009 guidance initially provided on October 7, 2008 in conjunction with your New York investor conference. This guidance includes the result from our Liko acquisition for the full year. We believe this guidance is appropriately cautious given the current economic uncertainties outlined by Peter in his comments.

Overall, consolidated revenue is expected to be in the range of $1.633 billion to $1.683 billion, which represent year-over-year growth of 8.3% to 11.6%. Earnings per fully diluted share from continuing operations are expected to be in the range of $1.40 to $1.64. This compares very favorably to the final 2008 adjusted earnings per share of $1.40 or $1.28 if you consider the third quarter's large benefit from discrete tax items. Discrete tax items are not included within our guidance for 2009. Additional details of our updated guidance are provided in our slides and in our press release.

As we have discussed with many of you, 2008 has been an inflection year with the benefits from our strategic investments beginning to pay off in the second half of 2008. With that, we are cautiously optimistic with respect to our fiscal 2009 guidance, despite the unprecedented turmoil in the credit markets and the global economy overall. Despite these pressures, we continue to believe we have sufficient actions that can be taken to deliver on our promises.

With that, I'll turn the call back over to Peter. Peter?

Peter Soderberg

Thank you, Greg. Let me quickly wrap up the prepared portion of our remarks with a few observations, leaving plenty of time for Q&A.

First, I want to thank once again the 6,600 associates of Hill-Rom for the great job they did in 2008. They delivered financial performance that met or exceeded our expectations, completed the successful separation of the medical technology and funeral services businesses, and identified and successfully consummated a major acquisition.

Let us assure you that I, along with my management team, are well aware that what matters now is performance going forward. We believe that we are well positioned to continue to successfully execute the strategies and the initiatives that will provide continued revenue growth and margin expansion.

In spite of turbulent economic times, as Greg said, we have a variety of levers we can pull in order to help mitigate pressure on our sales and profit growth goals, and we are not hesitant to pull them.

We're pursuing a straightforward med tech strategy, identifying solid growth markets that leverage our brand and capabilities, invest in innovation in product and service differentiation, build and maintain comprehensive sales and distribution channels that meet our customers' expectations, and drive operating efficiencies through the P&L. We are steadily improving our stewardship of the balance sheet, and we'll use it strategically to generate value for shareholders. I hope our results in 2008 give you confidence that we are on the right track.

Thanks for your interest and we will now be pleased to take your questions.

Question-and-Answer Session


(Operator Instructions) Your first question comes from Ian Zaffino - Oppenheimer & Co.

Ian Zaffino - Oppenheimer & Co.

As far as the guidance, you're assuming gross margin expansion in your guidance. How much of that's related to actually revenue growth versus the levers that you could pull that you'd mentioned?

Greg Miller

I don't have the benefit of the slides that we had in our October 7th meeting, but I would tell you that the majority of our gross margin improvement - well, actually, it breaks down into our revenue growth, which is a big portion of that, as well as some of the initiatives that we have been talking about for the last year in regards to improved operations, which include not only continuous improvement in our current plants and low-cost region sourcing, but also this year in Mexico we should be able to see benefits from our Mexico plant where this past year it's been primarily providing some headwinds.

So if you were to refer back to that, it actually breaks it down by area for gross profit reconciliation.

Peter Soderberg

I'd just point out that we said all along the Monterey investments will go from a headwind to a tailwind, so that plant is now pretty vertically integrated. The supply base is being converted. Our plant in France has received the benefit of a significant investment in automation, so we are pretty much online with a mixed model assembly line that's highly automated, and we have a number of productivity initiatives.

So the very biggest improvement I would group as productivity.

The other thing I think you'll see, as we talked about this a lot, is mix. If you look at our guidance, the matching growth in North America in acute care, where we've consistently improved our margins with growth in International means the mix impact should moderate very significantly.

Ian Zaffino - Oppenheimer & Co.

Breaking down the $20.5 million pre-tax charge, what was it, $13.8 was non-cash related to MEMS and then the other $7.7 was cash related to 160 positions that you had looked to eliminate. Is that how to think about it?

Greg Miller

Well, you've got the general numbers right from a cash and non-cash perspective, but actually the streamlining was about $6 million of cash and about $1 million of that $7 million related to the MEMS, related to lease termination costs and some severance. So overall it's about a $7 million cash impact and a $14 million non-cash impact.


(Operator Instructions) Your next question comes from Greg Halter – Great Lakes Review.

Greg Halter – Great Lakes Review

I'm wondering if you could update us on your shell filing status?

Peter Soderberg

Yes. Our shell filing is actually coming due in the first half of this next year. As you know, it was up to - how big was that?

Greg Miller

A billion - $750 million?

Peter Soderberg

$750 million left on that. And so that's still available, but we'd have to be renewed this next year.

Greg Halter - Great Lakes Review

And if you could comment on what you've seen so far from the CMS directive, which is effective October 1 that you've comment on, and then the status of the other that may be put in place here in '09. I guess your fiscal year or the government fiscal year, I should say. What kind of successes or, I guess, lack of have you seen from that directive?

Peter Soderberg

Well, I think we were pretty explicit in my remarks about some of the growth drivers, but it certainly has been a very significant impact, I think, particularly on wounds, pressure ulcers. I think that you're seeing the growth in our therapy rental and capital business that's in no small part generated by some of the new technologies even on the ICU business, which grew over 40%. That product has a brand-new surface with special technology, micro climate management that manages the humidity and the heat on the skin. You know, ICU patients can be very vulnerable, bariatric ICU patients in particular.

And so I would say that the good thing that we were able to do a couple of years ago is starting investing in surface technology, and I think the kind of numbers we're putting on the board in rental growth, where that's the first place we've been able to get this new technology into play and now you're seeing it on some of the capital projects, has been a meaningful reason why our numbers are so much improved.

I think that not every hospital has drunk the Kool-Aid yet, so they're waiting to see and quantify their internal costs. But it is a source of real encouragement for us that this, I think, has helped move the ROI of our kind of products up the food chain as hospitals consider how to deploy their limited CapEx.

What's next? I think obviously the talk of ventilator acquired pneumonia, of hospital acquired infections are all areas that we have capabilities in and are working on. So I think the whole movement you're hearing about from the new administration for the duality of quality and efficiency really works very nicely into where we're headed.


Your next question comes from David Bachman - Longbow Research.

David Bachman - Longbow Research

Just a quick question on your revenue - top line guidance for next year. Can you give a little color on, when I look at the low and high ends of that range, sort of what might move the needle one way or the other. You mentioned, I think at the beginning of the call, that about 20% of capital revenue is sort of tied potentially to new construction, and I just sort of wondered what's in that range and how you're thinking about next year.

Peter Soderberg

I think the best way to think about this is down at the segment level, so as I was going through my remarks and kind of gave you an insight in '09, we hear a lot in the last five weeks that a lot of you think we've sandbagged the year in light of the very strong performance which now we confirm with the fourth quarter, but I think you have to reflect on the uncertainty out there.

So we have taken down significantly our North America Acute Care revenue growth down to the kind of mid single-digit levels, and that's a little bit different rental versus capital. We think the rental is going to be quite stable, and the capital is clearly going to be more volatile. Post-Acute, we think of the three business segments it's the least volatile. It's heavily rental oriented and people have argued to us that rental might even increase is CapEx is impacted. But that isn't really reflected in our guidance.

On International, I think that there's the biggest change from the experience we put on the board versus next year. Our underlying growth in Europe, we think is going to be virtually flat versus the prior year's plus 20% performance. And again, that reflects both concerns about the recessionary environment and also a bit more discrimination on the margins we're going to accept on some of the tenders we go after.

So I can't be super scientific on how the numbers fall on the MEMS and the [MAXES], but I think that range is fairly consistent with what we've done in the past.

Finally, there's a big wild card, as you know, on the flu season. The flu season gave us a lot of tailwind last year and we're just not sure what to expect this year as it relates to our revenues on rental.


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

Greg Halter - Great Lakes Review

First off, relative to the Liko being completed early in October, can you comment on what your current debt structure looks like in terms of what the amount of debt is as well as your cash position after the acquisition's completion?

Greg Miller

Yes, I mean, if you take a look at the script or what we talked about was we had $221 million, which $90 million of that was borrowed at the end of the fiscal year, so that's what you'll see on our balance sheet. But of course that has borrowings that we had anticipating, you know, an international acquisition, so there's a little bit of a timing there. So then the next day, on October 1, out of that $221 million we spent $183 million, which $90 of it we initially borrowed and $93 of it we ended up spending on the acquisition. So the difference then would be the cash that we have coming in to the current year.

The debt that we have was the original $134 million of debt, approximately $134 million worth of debt, at the beginning of the year plus the $90 million that we borrowed afterwards, so about $223 million.

Greg Halter - Great Lakes Review

And I wondered if you could comment on your thoughts relative to corporate share repurchase?

Peter Soderberg

Well, I think you know that we have approval from the Board to repurchase up to 3 million shares, and we have indicated and intend to look at share repurchases and use our excess cash to do so.

Greg Halter - Great Lakes Review

And one last one if I could - I wonder about your thoughts on the merger and acquisition front, given the integration of Liko here would, I presume, take some time to look at. But just wondering what you're seeing in terms of M&A given the price declines - I presume price declines  for companies that are out there.

Peter Soderberg

Yes. The Liko acquisition, I hope you're all sensing, is a very exciting one in that it touches almost every nook and cranny of the business. I mean, this is unlike many that I could have thought of. This one affects Acute Care capital and rental, Post-Acute Care capital and rental, and International.

It is going to take a lot of focus and a lot of energy to get full value out of this acquisition, and we are absolutely dedicated to making sure that we have the bandwidth to get that done. So this clearly is the major acquisition we will do for awhile.

Having said that, we've long maintained that small differentiated technology companies are also of a high interest and you could reasonably expect that at any one time we'd be looking at three, four or five of those. But if one were to pass, it would be more isolated in its impact, more digestible, and certainly have a much smaller impact on our liquidity.


Your next question comes from Steve O'Neil - Hilliard Lyons.

Steve O'Neil - Hilliard Lyons

Just a quick question on R&D; flat in the fourth quarter. Just wondering if you'd discuss that and then talk about the outlook for R&D spending in 2009 as a percentage of revenue?

Peter Soderberg

The fourth quarter as a percent to revenue, of course, given the strong revenue spike in the fourth quarter, it looks optically like it's down, but R&D bumps around as we have outside expenditures on selected projects. I think we have been fairly clear that the notional target of 5% to 6% of revenue is still out there; however, I think we're going to slow the flight path to get there a little bit. So our '09 guidance reflects a relatively flat performance as a percent of sales versus '08.

As Greg pointed out, for the first time in our script we've shared with you a little bit about the other R&D that's sitting in CapEx, which is our capitalized development of software, and I think we all should be thinking about total R&D commitment as the total of both those spending. And we're very optimistic that the money we're plowing into our heath IT business, particularly in these times, will see a high return.

So we plan to make that reasonably constant as well.


Your next question comes from Chris Cooley - FTN Midwest Securities.

Chris Cooley - FTN Midwest Securities

Could you maybe touch base briefly on how the company plans to kind of re-approach the home market with Liko? You've basically dipped your toe in that market I guess now twice over the course of time. Help us understand how Liko basically helps you get into that space, what you might do a little bit differently as you think about it, this juncture versus the past.

And then similarly, from a competitive dynamic, do you think the window of opportunity that you have there with Liko now in your bundle, help us kind of frame that window of opportunity. I mean, I guess what I'm trying to be very specific about is do you think a competitor makes a move similarly, to buy another lift company to try and counterbalance that advantage that you have in the nearer term? A couple of different questions there.

Greg Miller

Just to give a little historical perspective that you certainly have is the fact that in the past HillRom has gone into the home care market and tried to succeed. They haven't in the most recent - prior management actually got out of the home care area - and historically we have tried to compete, when we were in it, with products directly out of Acute Care. And I will tell you and what we've shown you, even with pictures, some of the products that we're taking to that market now are really products that are aligned with that market and the price points that that market demands, including some of the products that we have in the Acute Care area.

So that's a little bit of the history. Now, we decided it's a great opportunity, growth area for us, with the right investments and so far it's proven out to be that.

Peter Soderberg

And I will add to that I've got personal experience with lifts with my dad. We removed him from the nursing home and put him in the home, and it took us two lifts and eight slings or six slings to get it right, so this is not a piece of furniture. This takes some clinical assistance to get the right product into the home. And the good news is we have a direct sales force of 65 principally nurses servicing the home, so we're pretty optimistic that we will find a way to exploit this and potentially even as a part of our direct-to-consumer business, but certainly in the rental.

Having said that, I think our model is pretty conservative and we're going to be sure that we understand how to profitability enter that space before we make the kind of fleet investments that will be necessary.

Andy Rieth

Chris, you'd also asked about competitive moves into that space. Again, I can't speak for any of our competitors. We're certainly very impressed with what we're seeing today with respect to Liko's product line. They are innovative and so forth and seem to be quite differentiated. We certainly like what we have to add to our portfolio. But I won't speak for any knowledge of any competitive countermoves at this time.


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

Greg Halter - Great Lakes Review

I don't know if you provided this or not, but did you give a figure for total capital spending in 2008 and also what your depreciation and amortization was in '08?

Greg Miller

Yes, 2008 we ended up, I think, just under $100 million. And our CapEx for 2009 ranges from $100 to $110 million. And I believe our depreciation expense for 2008 was around $104 million. That is in the press release, by the way, on the back sheet of the press release, so you can get it by quarter as well.

Greg Halter - Great Lakes Review

And relative to your direct-to-consumer business, what kind of size is that and what kind of growth are you seeing there and what kind of products are being sold and how they're being sold, is that through that direct sales force that you alluded to?

Peter Soderberg

The size is still what I would call an entrepreneurial business; we'd just as soon not disclose it, but I will say it doubled during the quarter versus prior year and it's interesting.

Sales, we have come in over the transom many, many calls a day. They come into a call center. Some come over the Internet. We have a team of people who act as consultants to figure out what the patient or the family wants. Sometimes we get leads from our direct people in the field. Sometimes the outcome of those conversations is a rental product funded by Medicare or a third party is a better solution. But in almost cases they are clinical grade beds. They are VersaCare or even a Total Care or a Care Assist, beds and surfaces that the patient had in the hospital and they insist on having at home. As the product funnel builds more custom products for post-acute care, nursing homes, we're seeing those kinds of requests accelerate.

And they're delivered through that same very large distribution system that supports our rental business across the care continuum.

Greg Miller

The other interesting thing is the call points in that space are quite diverse. They range from discharge planners who sit physically oftentimes within the hospital confines all the way out to home nursing care facilities, hospice and so forth. So there is an interesting set of call points that can generate that kind of potential sale at any point in time.

Chris Cooley - FTN Midwest Securities

And this, again, is a sale, not a rental?

Peter Soderberg

It's a sale.


And with no further questions in queue, I'd like to turn the conference back over to Andy Rieth for any additional or concluding comments.

Andy Rieth

Well, thank you, Cecilia, and thank you folks on the call. I appreciate your interest. Thanks for your continuing support, and let us know if you have any questions or anything with which we can follow up on. That will conclude the call at this time.


This does conclude today's call, ladies and gentlemen. Again, we appreciate your participation today and you may disconnect at any time.

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