Start Time: 08:30 January 1, 0000 9:33 AM ET
Hill-Rom Holdings, Inc. (NYSE:HRC)
Q3 2019 Earnings Conference Call
August 02, 2019, 08:30 AM ET
John Groetelaars - President and CEO
Barbara Bodem - CFO
Mary Ladone - SVP, Corporate Development, Strategy and IR
Conference Call Participants
Matt Taylor - UBS
David Lewis - Morgan Stanley
Rick Wise - Stifel
Larry Keusch - Raymond James
Bob Hopkins - Bank of America Merrill Lynch
Kristen Stewart - Barclays
Matthew Mishan - KeyBanc Capital Markets
Good morning and welcome to Hill-Rom's Fiscal Third Quarter 2019 Earnings Conference Call. During the presentation, all participants will be in a listen-only mode. At the end of management's prepared remarks, we will conduct a question-and-answer session. [Operator Instructions].
As a reminder, this call is being recorded by Hill-Rom and is copyrighted material. It cannot be recorded, rebroadcast, or transmitted without Hill-Rom's written consent. If you have any objections, please disconnect at this time.
I would now like to turn the call over to Ms. Mary Kay Ladone, Senior Vice President, Corporate Development, Strategy and Investor Relations. Ms. Ladone, you may begin.
Good morning, and thanks for joining us for our fiscal third quarter 2019 earnings conference call. Joining me today are John Groetelaars, President and Chief Executive Officer of Hill-Rom; and Barbara Bodem, Chief Financial Officer.
Before we get started, let me begin our prepared remarks this morning by reminding you that certain statements contained in this presentation are forward-looking statements and are subject to risks, uncertainties, assumptions, and other factors that could cause actual results to differ materially from those described. Please refer to today's press release and our SEC filings for more detail concerning risk factors that could cause actual results to differ materially.
In addition, on today's call, non-GAAP financial measures will be used. Reconciliations between GAAP and non-GAAP financial measures are included in our earnings release issued this morning.
As you know, beginning with our fiscal first quarter, we adopted the new revenue recognition accounting standard ASC 606 on a modified retrospective basis. The focus of our commentary this morning will be on our financial results under this new standard for the current and prior year periods, which will allow for comparability on an apples-to-apples basis as well as comparisons to our 2019 financial guidance.
With that introduction, let me now turn the call over to John.
Thanks, Mary Kay. Good morning, everyone. Hill-Rom delivered a fifth consecutive quarter of mid-single digit core revenue growth with improved gross margins and profitability on the strength of new production innovations and solid execution. We’re actively reshaping the portfolio through growth-oriented acquisitions and selected divestitures of low growth businesses.
The Hill-Rom team has been performing with determination to deliver financial results that have been above expectations on both the top line and bottom line each quarter during fiscal 2019.
In Q3, we delivered core revenue growth of 6% driven by growth across all three businesses and positive new product momentum. Our disciplined operational execution led to achieving a new record level of adjusted gross margin, above 50% and operating margin expansion of 100 basis points.
Adjusted earnings of $1.23 per diluted share increased 11% versus the prior year, our 16th consecutive quarter of double-digit earnings growth. Overall, our track record of delivering strong performance has provided flexibility to reinvest in our key growth initiatives and acquisitions in order to sustainably deliver both our short-term and long-term financial objectives.
Our category leadership strategy and four strategic priorities are delivering value to patients, caregivers and shareholders. Innovation remains our first priority to accelerate growth and new products continue to be a significant driver. New product revenue of more than $300 million so far this year is on track to exceed our expectations of $400 million for 2019.
Our new products are driving marketing expansion, share gains and incremental 300 basis points to top line growth. Supporting this performance are eight key products across all of our three businesses, which account for 90% of this revenue. Monarch Airway Clearance System, Integrated Table Motion and the Vision Care portfolio to name a few.
We have recently launched several new products in order to keep our momentum going including EarlySense, WATCHCARE and now the RetinaVue 700 Imager. We remain confident that these new products will continue to drive durable growth above our 2% to 3% weighted average market growth rate going forward.
Our second priority of penetrating emerging markets is focused on improving our commercial capabilities and execution. And while we’re still in the early stages of our investments, we are encouraged by mid-single digit growth in Latin America and Asia Pacific so far this year, including nice progress in China.
However, this strength was not enough to offset the weaker-than-expected performance in Europe and MEATI, which from now on we will refer to as EMEA going forward. While we expected better international performance overall in the third quarter, our results reflect transient headwinds, including capital project delays and budget approvals in select countries primarily within the EMEA region.
Our EMEA team is now under new leadership and a flattened organization structure that reports directly to me. I am optimistic that our international business will return to positive growth in the fourth quarter as a result of improved visibility into our funnel and easier comparisons.
Turning to our third priority, we are very encouraged with the actions we are taking to transform our portfolio through M&A and portfolio optimization initiatives. Our efforts here are directed at enhancing our category leadership, further diversifying the portfolio and driving sustainable mid-single digit top line growth.
Earlier this quarter, we closed the Voalte acquisition. Voalte is a pioneer and leader in mobile healthcare communications with a consistent track record of generating durable, double-digit revenue growth in an attractive fast growing $2 billion market. The integration is on track and Voalte is exceeding our expectations with strong revenue growth, record orders and a growing backlog.
Voalte contributed just over 100 basis points of growth to Q3. Combining Voalte with our clinical workflow solutions business builds on our leadership position and closes the loop from smart bed to smartphone to strengthen Hill-Rom’s connected solutions.
This morning, we announced the acquisition of Breathe Technologies, a developer and manufacturer of a patented nasal cannula technology that supports improved patient mobility. The acquisition of this differentiated and disruptive respiratory therapy provides an exciting growth platform that leverages our vertically integrated commercial model.
The company’s Life2000 Ventilation System is a volume-control, non-invasive mechanical ventilation system for a broad range of reimbursable conditions in the home and critical-care settings, including COPD, an underpenetrated and undertreated disease area with tremendous growth potential.
The Ventilator is wearable and only weighs 1 pound providing patients freedom of range inside or outside of the home. We expect this transaction to close during the fiscal fourth quarter. The transaction’s expected to be modestly dilutive during the first year and increasingly accretive thereafter.
The recent acquisitions of Breathe and Voalte are excellent examples of how we plan to strategically deploy capital with a disciplined approach towards higher growth, higher margin categories and adhering to our rigorous strategic and financial criteria to generate attractive returns.
I can also announce today that we have now completed the divestiture of our surgical consumables business. This sale underscores our strategic decision to exit a business that was a headwind to our growth aspirations and strengthens our ability to focus our resources and capital towards a future Hill-Rom.
From a financial perspective, this business was expected to generate annual revenue of approximately $100 million and contribute approximately $0.20 in adjusted earnings per share on a pro forma basis. As this divestiture does not quality for treatment as a discontinued operation, our historical sales and earnings results cannot be recast to reflect the divestiture. We want to ensure that investors and analysts take this into account when modeling the future projections.
All this considered, we are very pleased that our strong operational execution has positioned us well to absorb incremental dilution in the fourth quarter of approximately $0.05 related to the accelerated level of M&A activity, and in particular, the divestiture of our surgical consumables business. Therefore, we are raising our core revenue growth guidance to approximately 6% for the year and reaffirming our adjusted earnings guidance range of $5.03 to $5.05 per diluted share.
Our Hill-Rom team is engaged and passionate about our new branding and vision of advancing connected care, and I want to thank them for their determination and winning spirit to execute our strategy in pursuit of enhancing and improving lives for patients and caregivers.
With that, let me now turn the call over to Barb.
Thanks, John, and good morning, everyone. Our commentary this morning will focus on third quarter results on a comparable basis to the prior year period adjusted for ASC 606. Please use the supplemental schedules posted to our Web site to follow along.
For the fiscal third quarter, under revenue accounting standard ASC 606, we reported GAAP earnings of $0.48 per diluted share. These results include after-tax special items related to intangible amortization, acquisition and integration costs and other special charges.
Adjusted earnings of $1.23 per diluted share advanced 11% over prior year, exceeding our guidance range of $1.20 to $1.22 per diluted share. These results reflect accelerated core revenue growth, contribution from new products and continued margin expansion as well as strategic investments to drive future growth.
Now, let me walk through the P&L before turning to our financial outlook. Starting with revenue. For the fiscal third quarter, revenue was $727 million, it increased 3% on a reported basis and 5% on a constant currency basis. Core revenue grew 6% for the third consecutive quarter, exceeding our guidance range of 4% to 5%. Voalte contributed just over 100 basis points with revenue that exceeded our expectations.
Domestic revenue on a core basis increased 9% in the third quarter. We continue to benefit from portfolio diversification with double-digit growth across multiple product categories, including med-surg bed systems, clinical workflow solutions, vision, respiratory care and surgical tables.
Overall, international core revenue declined 2%. Latin America and Asia Pacific continued to show improvement with mid-single digit growth as we have stabilized our commercial operations and are in the early stages of setting a better foundation for sustainable growth.
As John highlighted, this performance was not enough to offset the decline in EMEA driven primarily by the timing of capital projects and lower performance than expected in the Front Line Care business.
Moving on to the business segments, I will address revenue growth on a constant currency basis. Starting with Patient Support Systems. Reported revenue of $375 million increased 7% and core revenue advanced 8%, consistent with what we have achieved all year.
This performance was driven by another quarter of double-digit growth in the U.S. with positive contributions from across our diverse and differentiated portfolio of connected solutions and services, including smart beds, clinical workflow solutions and Voalte, our new mobile communications platform.
Moving to Front Line Care. Revenue increased 3% to $244 million driven primarily by the contribution of new products resulting in double-digit growth in vision and respiratory care as well as strong growth of certain physical assessment and diagnostic tools.
Lastly, Surgical Solutions revenue of $108 million was flat to the prior year. Core revenue increased by 4% primarily driven by accelerated U.S. growth of 8% and record placements of Integrated Table Motion for the da Vinci Xi Surgical System.
Now, turning to the rest of the P&L. Adjusted gross margin of 50.3% reached a record level and expanded 140 basis points over the prior year, driven by improved performance across all three of our businesses.
Gross margin expansion continues to benefit from positive product mix, including impact of new products and Voalte as well as operational improvements. Collectively, these items more than offset tariffs and raw material inflation.
R&D spending for the quarter was $34 million, reflecting our ongoing commitment to innovation and the timing of investments in key programs to drive future growth. Adjusted SG&A of $202 million increased 5% due to strategic investments, primarily in emerging markets and the addition of Voalte.
Our adjusted operating margin in the third quarter was 17.8%, reflecting an improvement of 100 basis points compared to the prior year. The adjusted tax rate was 20.8%. Stock-based compensation had no impact in the current quarter but had a $0.02 benefit last year. The bottom line adjusted earnings for the third quarter of $1.23 per diluted share increased 11%.
Now, turning to cash flow. Cash flow from operations of $301 million was strong for the first nine months of 2019, advancing 21%. Capital expenditures on a year-to-date basis totaled $51 million, $21 million lower than the prior period due to project timing, and as a result free cash flow of $250 million is 41% higher than last year.
In terms of the balance sheet and financial leverage, our debt to EBITDA ratio at the end of June was 3.3x, and we have returned approximately $121 million to shareholders through dividends and share repurchases during the 2019 fiscal year.
Let me conclude this portion of the call with our guidance for the remainder of the fiscal year. We are raising our core revenue guidance and reaffirming our EPS expectations. Our strong operational performance positions us for continued strong financials, while offsetting Q4 dilution for recent M&A activity of approximately $0.05 per diluted share.
So specifically for the full year, we now expect reported revenue growth of approximately 2% and constant currency growth of approximately 3% reflecting the impact of the surgical consumables divestiture.
We now expect core revenue growth of approximately 6%, which includes the contribution of Voalte. Excluding Voalte, core revenue growth is expected to be 5%. Please note that with the closure of the surgical consumables divestiture, our prior period revenue will be reported as non-core beginning in the fourth quarter of 2019. The impact on 2019 core revenue guidance is immaterial.
There is no other change to non-core revenue which now totals approximately $210 million in 2018 and approximately $150 million in 2019. As a reminder, core growth guidance is calculated by excluding the non-core components in both and current and the prior-year period.
By business segment, on a core basis, we now expect Patient Support Systems revenue to grow in excess of 8%, driven by robust U.S. performance. We continue to project Surgical Solutions core growth of approximately 4%, given strong expected performance in Q4.
And finally, we now expect Front Line Care growth to be in the 2% to 3% range, driven by the more challenging international growth experienced year-to-date. We are also assuming an immaterial contribution from the Breathe acquisition, given the anticipated timing of the close.
From a profitability standpoint, we expect adjusted gross margin to expand approximately 80 basis points, reflecting mix and productivity improvements that more than offset incremental costs associated with tariffs and raw material inflation.
We continue to expect R&D spending to increase in low-single digits representing approximately 5% of sales and adjusted SG&A of approximately 26.5% to 27% of sales, reflecting recent M&A transactions and investment in key growth initiatives. As a result, we continue to expect adjusted operating margin expansion of 80 to 100 basis points.
We continue to expect other expense, including interest, of approximately $90 million, a tax rate of approximately 21% and a share count of approximately 67.5 million shares. This reflects an adjusted guidance range of $5.03 to $5.05 per diluted share.
From a cash flow perspective, we now expect operating cash flow of approximately $410 million including the impact of transaction-related outflows and capital expenditures of approximately $80 million. This translates into free cash flow guidance of $330 million which remains unchanged from our prior expectations.
For the fiscal fourth quarter, we expect revenues to be comparable to the prior year period on a reported basis and increase 1% on a constant currency basis. We expect core revenue to increase approximately 5%, including a positive contribution from international.
Our Q4 core revenue guidance adjusts for this surgical consumables divestiture. As we’ve previously highlighted, we also expect a decline in the Front Line Care business due to the challenging prior year comparisons driven by the U.S. Monarch launch.
With strong operational execution offsetting dilution from recent M&A, we expect adjusted earnings, excluding special items, of $1.64 to $1.66 per diluted share. Also, please recall that we recorded a significant tax benefit of $0.15 per diluted share in last year’s fourth quarter related to executive stock-based compensation.
Thank you. Now, I’ll turn the call back over to John.
Thanks, Barb. To summarize, we look forward to building on our store core growth and momentum heading into the fourth quarter of 2019 and we are well positioned for 2020 and beyond.
We are turning on our investments to enhance our international performance and expand our footprint in emerging markets, like China, and new products continue to be a significant driver to our top line performance with some exciting new products underway and an ongoing commitment to prioritize our R&D investments to drive our advancing connection care vision.
And finally, we were really excited about the recent M&A activity. Collectively, the recently announced acquisitions and divestiture helped position the company for sustained top line growth and future earnings accretion.
So with that, let’s open the call up for Q&A.
Thank you. We will now begin the question-and-answer session. [Operator Instructions]. I would like to remind participants that this call is being recorded and a digital replay will be available on the Hill-Rom Web site for seven days at www.hillrom.com. Our first question comes from Matt Taylor of UBS, your question please.
Thank you for taking the question. So, I just wanted to ask about Voalte and your acquisition strategy. It seems like the integration of Voalte is going well. Can you talk about how you expect to be able to grow that now that you’ve brought it in-house and maybe talk about how this new acquisition fits in more with your connected care strategies?
Sure. Thanks, Matt. Yes, so the Voalte acquisition, as we said in our prepared comments, the integration’s going extremely well in terms of retention of key talent bringing the two organizations together and the cultural fit that we’re seeing between the organizations. On a business side perspective, the 100 basis points of contribution in Q3 we expect that to continue in the fourth quarter. I think to summarize what customers are saying, I can read you a quote from the Chief Nursing Officer that kind of helps put in context the feeling from our customer base. Hill-Rom’s acquisition of Voalte validates our leaning towards Voalte over a competitor, who I won’t name. Our pipeline of activity, our pipeline of orders is exceeding our expectations. We’re building a backlog and our actual performance in Q3 was above our expectations as well. So we’re feeling really good about the strategic fit there, Matt, and its performance and feel very optimistic about our ability to continue that momentum as we bring the two organizations together in the sales organization more formally at the beginning of the new fiscal year. In terms of what it means to other acquisitions, I think the Breathe acquisition we announced today is a good example of another nice strategic fit of a product category that is very complementary to our current respiratory care offering and really fits in our commercial model where we are a DME and we have a large direct sales force of both in acute and home setting. So this Breathe Technologies really fits that category nicely and will help us drive incremental growth there. Our expectation on Breathe is that it will probably add 50 to 100 basis points of growth in the coming year. So we’re excited about bringing Breathe into the Hill-Rom family.
Thanks, John. We’re definitely seeing some of the fruit of your initiative to beef up BT and do more deals. Can you talk about your appetite to do more deals like this? And are we also seeing kind of end of your strategic divestitures with the surgical business?
Yes, good question. Let me answer the second question first. When it comes to core and non-core, probably the best way to answer it is we do intend to sunset the core, non-core definition at the end of 2020. So I think that helps put in context that we are at the end of winding down and divesting product lines in the case of our surgical consumables businesses. With that said, we’ll obviously always have an eye to reshaping our portfolio, but we feel with our intention to sunset, the core, non-core definition in next fiscal year that’s a good pretty good signal that we think we’re done on the divestiture side. As it relates to capacity to do more deals, if we assume a 4.5x leverage, we would have $700 million of dry powder remaining. We have a lot of activity because we have staffed up in each of our businesses and here with Mary Kay’s team at corporate to have more capacity to look at larger volumes of tuck-in and bolt-on deals. So our pipeline looks good. We’re pleased with the ability to execute on a couple of these in the last four months and certainly look to continue this strategy going forward.
Thanks a lot, John.
Your next question is from David Lewis of Morgan Stanley, your question please.
Great. Good morning. Barb, I know it’s early, but there’s a tremendous number of moving pieces for 2020 and I wonder if you could just help us in broad strokes. So a couple of pieces just for next year. Number one, maybe more for John, as you think about the activity on core and non-core and Centrella for next year, do you feel comfortable in kind of 4% to 5% or 5% type core growth number for 2020? And then, Barb, just on earnings just based on the divestiture, tariffs, tax; if you think about a consensus earnings number minus $0.20, so maybe that’s something like 4.50 or 5.50, how are those numbers relative to your expectations? Just looking for any broad strokes you can provide on 2020? Then I have a quick follow up.
Yes. Dave, thanks for the question. I can answer in terms of the context of this year. We’re not yet giving guidance for next year. But if you think about our areas of strength, all of our U.S. businesses, our new products are contributing once again 300 basis points in the quarter. The acquisition of Voalte is adding another 100 basis points. We expect Breathe in the future to add 50 to 100 basis points. So all those things have been, in the current year have allowed us to overcome less than expected performance in international, particularly out of EMEA. So we feel – on whole, we feel really good. We’re at the very high end of our initial guidance in the core, excluding acquisitions, and we’re above when you include the acquisition of Voalte. So we feel very good about our performance in 2019 despite some challenges. But that’s our job to overcome challenges with other opportunities. And we feel equally good that with the performance in international in 2019, it’s slightly more of a tailwind than a headwind as we look at 2020.
So following on to that, David, you’re absolutely right. There are a lot of moving pieces, and as John said, we are not giving 2020 guidance at this point in time. What I can say is I can give a little more clarity around the dilution in the $0.20 to make sure that everybody’s on the same page as we think about Q4 and going into next year. What we’ve said in Q4 is we have about $0.05 worth of dilution. As you back that back, we’ve also talked about how on a pro forma basis, the divestiture of the surgical consumables business is about $0.20 on a pro forma basis. Now that is net of a benefit from paying down debt. So if you take that $0.20 and you break it down for a full quarter, that’d be about a nickel for the timing of when we’ve closed in this quarter in Q4. That translates to about $0.04 of dilution in the current quarter. In addition to that, we have [indiscernible] this quarter which we’re – sorry, Breathe this quarter where we’re thinking about $0.01 to $0.02 of additional dilution in this quarter. As we look to next year with regards to the surgical consumables business, there will be the incremental $0.15, so $0.15 for next year over the $0.05 on a quarterly basis for this year. And then we are anticipating about another $0.05 worth of dilution related to the Breathe acquisition.
Okay, that’s very helpful. And then, John, maybe I’ll focus on one product question for you. Centrella headwinds are going to get more challenging in the fourth quarter but it actually appears that you’re jumping over them just given the strength in the backlog. Then you have offsets for Centrella harder comps next year. But if you just isolate Centrella on its own, John, is Centrella a headwind or tailwind to growth in 2020? Thanks so much.
Yes, I can say like you expect what it is. It continues to be a tailwind for us in Q4. We had a really strong Q4 last year and we’re able to overcome it with incremental growth this year. We haven’t yet finalized our plan at that level of detail. We’re in the middle of doing that right now. We certainly like the momentum that we see in the product category. There’s a tremendous number of existing installed base. We’re 500,000 med-surg beds, we’re well under 10% penetrated into that base of existing products that are out in the field, we’re nowhere capturing some gain share but more importantly we’re replenishing and activating a replenishment cycle in the med-surg category as a whole. So we don’t have specifics for 2020 but optimistic that we’ll see this momentum carry on.
Great. Thanks so much.
Your next question is from Rick Wise of Stifel, your question please.
Good morning, John. Let me start off with some of your comments about EMEA and some of the emerging market issues and maybe I’ll throw a bunch of things into it. The new leadership, what have you charged them with reporting directly to you, why so confident that it will so quickly return to growth in the fourth quarter? And I assume if it’s doing that it’s going to be a good setup to 2020. And how do we think about what it should grow or what is your – is the right growth rate there?
Yes, thanks for the question. So let me start with a couple of areas of consistent strength. Asia Pac and LatAm all year have been delivering mid-single digit growth and in fact in the most recent period we’ve got double-digit growth coming out of China. So we’re pleased with those components of emerging market growth. In EMEA, the Q3 performance was really largely driven by shifts in timing of orders that are going to happen in Q4. Some will bleed over into 2020, but most of it will happen in Q4. And having just come back from our meeting with our European team with Barb and I last week, we feel really good about our ability to see that occur and happen in Q4 and we’re anticipating nice growth out of international in Q4, which we’ll catch them up for weak performance year-to-date and get them back to a low-single digit growth for the year. That said, we’re not happy with the way things kind of played themselves out this year. It wasn’t want we expected. We’re working on making sure that we can get better consistency out of the EMEA region and all of international, but particularly within EMEA. We had, as we discussed a few months ago, made some organizational changes to flatten the organization and have two regions reporting into me; one for EMEA and one for Asia Pacific. That’s giving me a direct line of sight into those regions and giving those regional leaders direct access to the executive leadership team and resources that we can all pull together to improve performance and consistency. The formula for success there, Rick, really revolves around new products and focusing on strategic categories. We can do better with our new product performance and new product launch success in EMEA and all of international for that matter. And we can certainly stay more focused on our higher priority areas to make sure that our international efforts are aligned with our new product R&D efforts more synergistically to allow for consistent performance quarter-over-quarter. So with those things said, because there’s clearly a shift from Q3, we feel really confident about Q4 and our ability to drive growth in international in Q4 and in EMEA in particular. And given the lower than expected performance in '19, we would expect international to be certainly more of a tailwind for 2020 given the easier comps.
That’s great. And maybe for my second question here, just going back to new product – the very positive new product momentum, you highlighted with the eight key products 90% of the new products are from those eight key products. Maybe you could talk to us about these three new products you highlighted in more depth? And I don’t know whether the Welch Allyn RetinaVue 700 Imager is the most important, but how do we think about these new three? Are these as big a compelling incremental opportunity and maybe just to flush that out with how should we think about the rollout of new products, just a steady flow as we’ve seen over the last 12, 18, 24 months or just help us think about the future from a new product momentum rollout kind of basis? Thank you so much.
Great. Thanks, Rick. Yes, a good question. The three new products that are in flight in terms of their early launches are EarlySense, WATCHCARE and the new Welch Allyn RetinaVue 700 Imager. The most recent one which we have literally just launched a week ago is the RetinaVue 700 Imager, it’s simple to use, point and click device with some nice video on our Web site and social media that kind of walks through it. It’s a pretty slick device that’s point and click. Takes an image of both eyes. It’s a lot more user friendly and human factor proof in terms of learning how to use it. So we think that’s going to be a real game changer in our vision care, vision screening business for diabetic retinopathy and would expect to see that growth continue consistently quarter-over-quarter going forward. Next, in reverse order again is WATCHCARE. This is the incontinence detection device that picks up on the sensitivity of moisture either from urine or fecal incontinence. And really the purpose of this is to avoid bedsores. I can tell you from a recent experience that a personal family member who had been admitted to the hospital, been in hospital for a week didn’t have this kind of technology in place, and sure enough, after a week in hospital ended up with a bedsore. So the purpose of WATCHCARE is to avoid those kind of complications and really ensure that caregivers are alerted to incontinence events and can be proactive in doing a change of the surface blankets for the patient. And then finally, EarlySense, we’ve talked quite a bit about our pending digital offering in the area of patient deterioration and EarlySense which is the heart rate, respiratory rate monitor that monitors twice per second without any contact to the patient. We think this has got a real nice opportunity to connect in with our ecosystem of the smart bed and smartphone and drive real-time actionable insights to caregivers on their mobile phone to alert them to changing patient deterioration signal from those two vital signs. So EarlySense and WATCHCARE, a lot more market development and KOL development and developing reference sites and really building up the evidence. So I think as we look to the launch of those, we would have initially as we’ve seen this year a modest expectation but we would certainly as we go into 2020 expect to see that ramp up more significantly. And RetinaVue, given the installed base of people using the current RetinaVue product, our expectation on the RetinaVue 700 is that it will be a much more rapid uptake of the product in that base of customers. So I hope that helps you, Rick. I think one other thing to keep in context is for five quarters now new products have delivered greater than 200 basis points of growth for Hill-Rom overall. The last couple have been at 300 basis points of growth. So given the product portfolio and what’s in our pipeline that we’ve both discussed and not discussed, certainly we feel confident we can keep up that type of growth rate of somewhere between 200 and 300 basis points on a go-forward basis.
Excellent. Thank you so much.
Your next question is from Larry Keusch of Raymond James, your question please.
Good morning, everyone. John, I want to just come back to international and I guess where I’m going with this is I feel like international has been a chronic issue for the company for many years and there have been some fits and starts, but I’m just really trying to understand has it been a leadership issue, is it a structural issue over there, is it local competitors and really what do you think you can do to kind of get this to be more consistent growth? And I know you talked about some of the factors that you’re thinking about, but what should this be in terms of a consistent grower?
Yes, Larry, it’s a fair question. First of all, let me talk about emerging markets. This is where we’re making investments. We think there’s a lot more growth opportunity here that we have untapped. So that was the initial focus. We like the way things are shaping up in Latin America and Asia Pac. We’ve always had a pretty nice business that had critical mass in the Middle East. And given this year’s performance we would expect better growth outlooks for next year at the Middle East. So in total, feel good about emerging markets quite frankly and how that’s progressing and the opportunity for our portfolio to have a bigger impact. And then our investments will begin to show fruit as we’re starting to see in the early days in China and Asia Pac and LatAm. When it comes to the more established markets; number one, we’re probably over indexed into those established markets whether that’s Canada, Australia or Western Europe. Relative to our total international business that represents the vast majority of our international portfolio, probably 90% given that emerging markets are 9%. So we’re heavily indexed there. I think across the sector, the med tech sector, if I look at our peers results, I do see a pretty significant gap between U.S. growth and established international market growth at least as far as I can read through and see those comments. So it seems to be not a Hill-Rom alone issue but it’s certainly an industry-wide differential issue that is part of the explanation. I would also reflect and say that the variability that we’ve been able to see in our international business in the last five quarters has certainly been less than it has in the past. It’s something we’re focused on and getting better predictability and performance out of our international business and that’s really reflective of the operating model and the management system that I’ve brought over to get better ongoing visibility into our development there and around the business for that matter. So I think those are all kind of foundational issues, but it gets back to how do we turn this around and get it growing at a higher level and contributing to growth in the more established international markets. And that does get down to making sure that we fundamentally have strong alignment between the businesses and the R&D portfolios and those international regions and making sure we have the best leadership we can possibly get in the company. Again, having just come back from Europe, feel really good about the EMEA leadership team that we have in place and are looking to lead us into 2020. And leadership always makes a pretty significant difference in terms of the long-term performance. The new leader we had in EMEA is someone who’s been with Hill-Rom a long time, Francisco Canal. He’s a former leader of our GSS business. And actually when he first joined Hill-Rom, he led Europe for us during a pretty strong period of performance. So we’re very pleased to have him back in the regional leadership role and our expanded capacity, including our former MEATI region to form EMEA. So very confident in him and his leadership and the team around him to turn around this performance into 2020.
Okay, that’s definitely helpful. And then just one other question. It seems to me that despite all the benefits that you’ve gotten on operating margin expansion and you guys continue to focus in on that. There could be more leverage but clearly you are investing back into the business at this point. So again, just curious as to sort of high level the areas of reinvestment and is that multiyear reinvestment or more like a year out, just trying to get calibrated how we should be thinking about that?
Thanks, Larry. I’ll turn that one over to Barb.
Yes, I’m happy to take that. Hi, Larry. When we think about 2019, the primary areas of reinvestment when you think about total operating expense would be into three buckets. We’ve talked quite a bit about our efforts in the digital space and preparing for new offerings in that area. So clearly that’s been a driver of our investment in 2019. From an SG&A and commercial perspective, we also have talked about the investment that we have now turned on in China. And in Q3 that’s really the first quarter that we’ve started to see – that’s going to follow along into Q4 and continue to grow as we look at 2020 as well. And then the last area of investment that you’re starting to see and will continue to see is going to be around the M&A work. So we’ve got investments in both. As Breathe comes in we will have investments in Breathe as well both on the SG&A as well as on the R&D line as we make sure that those businesses are set up to drive the sustainable mid-digit top line growth. And we believe that we can do that because we’re seeing such strong gross margin expansion affording the investments and allowing us to continue to deliver double digit EPS growth.
Perfect. Thank you very much.
Your next question is from Bob Hopkins of Bank of America, your question please.
Thanks and good morning. Just a couple of quick clarifications. First on the guidance for this year for core revenue growth. Definitely heard your comments that excluding M&A in the fiscal third quarter, you grew 5%. I’m just curious and I’m sorry if I missed it. For your fourth quarter core revenue growth guidance, what are you guiding to for the fourth quarter excluding any contribution from the deal that you’ve announced? Just want to make sure I understand that.
Hi, Bob. It’s Barb. When you look at fourth quarter, we are guiding to a 5% core revenue growth overall. We do anticipate that Voalte will contribute about 100 basis points of that in the quarter.
Okay. And then any contribution from – I’m sorry, I didn’t see when you expect the other deal to close.
No. So when we talked about Breathe, we did mention that for the year Breathe is not expected to have a material impact on either our core revenue or the overall picture. It’s going to be mildly dilutive, maybe a penny or two on the bottom line but on the top line no material impact on our core revenue growth.
Okay. And then maybe you could talk a little bit about this acquisition in a little more detail, talk about how you view growth prospects for this business, how you view kind of the margin prospects for this business, just would love a little more detail on what we can expect from this deal in terms of this contribution over the course of the next, call it the next two years and then long term?
Yes, Bob, I’ll take that. Thanks for the question. We’re excited about getting into this category. It’s really complementary to our current product offering and our current sales team. As you know, COPD patients are frequently going to be picked up in the acute care setting coming in through the ER and this is a product that can be used both in that setting and then taken home with the patient where appropriate. This non-invasive ventilation category is a significant size, it’s growing at about 5% a year and this technology is really unique and differentiated in the fact that it has a nasal cannula. All other ones are mask-based non-invasive therapy. And I can always go back to a recent family episode where I had a family member in hospital on respiratory therapy using a mask and it wasn’t well tolerated by this individual and I think the compliance level of a nasal cannula is really what makes this differentiated and much more comfortable. And then if you think about the ability to ambulate and be mobile in the home without being tethered to a short hose or tube, this really makes a big difference. So we’re optimistic, Bob, that this will be many years of incremental growth contribution coming out of this product offering. I think we said it’s about $10 million current revenue base, so we’re not starting from zero. It’s roughly around 10 million of revenue today. In our hands, we think we can really drive a tremendous amount of growth as we ramp this thing up. In its first year, somewhere between 50 basis points and they’re ramping up towards 100 basis points as we get towards the end of the first 12 months.
Bob, the only other thing I would add is as we look at any of the M&A, we’ve talked about the criteria of what we’re looking for and we’re looking for acquisitions that are going to be accretive to our top line growth as well as to our margin profile, and Breathe is no different to that. So just as with Voalte we expect that Breathe not only is going to drive top line growth but it’s also going to help from an operating margin and from a gross margin perspective.
Yes, as you may recall and I know you do, Bob. As you know, our respiratory care business is our highest margin business in our whole company. So the gross margin profile of Breathe fits into that pretty nicely.
Okay, that’s helpful. And then just really quickly back on the 2020 question. You’ve got this $0.20 of dilution, maybe just talk qualitatively relative to your normal sort of double digit earnings growth, are there offsets to that $0.20 of dilution that are possible as you think about next year? Thank you.
So, Bob, we’ve talked about how we’re not going to be giving specific guidance on 2020 next year. I think John did a great job earlier of highlighting all the reasons why we feel good going into 2020 next year, the momentum at our core business which is really being driven by our new product launches. As we think about international, we think international has the ability to become a real tailwind for us next year as we see really easier comps from this year. And then as we think about the additions from Voalte and Breathe, all of those things are going to be sort of added to this, as we think about 2020. What we have done at this point in time is just try to be very clear about what the dilution impact will be from the divestiture of the surgical consumables business as well as to remind folks that for the first 12 months we do think that the Breathe acquisition is going to be modestly dilutive before turning accretive. That’s about as far as we can provide insight as you think about your projections for next year.
And obviously at a high level, Bob – and thank you, really appreciate this. We’re monetizing an asset that wasn’t growing for us and really the margin profile of that business wasn’t like the rest of Hill-Rom and certainly wasn’t where we aspired our P&L to be on the margin side of things. So for us to monetize that asset – yes, there are some dilution that comes with it. But for us to monetize that and then redeploy the capital towards growth-oriented assets and provide top line durable growth, that’s what we’re doing here. And I think the combination of the moves and frankly the fortunate timing of having our divestiture close almost in the exact same day and time as the Breathe acquisition is announced is fortunate. It wasn’t planned necessarily that way. But Mary Kay did a nice job of landing these items both within 24 hours of themselves. So we like the combination. We think it’s the right portfolio moves to make for the company and position us for ongoing accretive growth going forward.
Good, makes sense. Thank you.
Your next question is from Kristen Stewart of Barclays, your question please.
I guess just following on with Bob’s commentary, can appreciate you don’t want to give 2020 guidance, but you have always talked about this 50 million in cost savings that you could always look to monetize, I guess. What would be preventing you from looking to implement something on the lines of a restructuring program or something like that that could help maybe fill in some of the dilution for next year?
Hi, Kristen. It’s Barb. So it’s a great question around our ongoing efforts from the business optimization. We’ve talked about the fact that we embarked on a plan that we think is going to generate about $50 million with the benefit over a multiyear period. We are executing against that and tracking well against our $50 million. One way to look at our 2019 results is one of the reasons why we’re able to absorb some of that dilution in Q4 while still investing is the fact that we are seeing improvements from the optimization. But what we have also said is that the optimization is to help fuel future investments and those future investments are to be driving – in future top line growth. So as we focus, our priorities are really around making sure that we have that mid-single sustainable growth on the top line while continuing to deliver double digit bottom line. And we’re going to look at the results from the business optimization as well as the improved performance in other areas of the business and look at what sort of investments we can continue to turn on to drive that growth.
Kristen, to your question and to Bob’s just to be really clear, we are still committed to double digit EPS growth in the quarter, right. As we look forward that is still our ongoing commitment to drive double digit EPS growth in the core business. So we will look for ways to offset dilution, but at the same time turning on investments that provide that durable growth profile that we’re looking for.
Okay. And you guys -- the way you think about core will be looking at the business excluding basically the impact of the divestiture effectively in all of 2019 versus what you will ultimately have for 2020 and looking at it more on a normalized apples-to-apples basis?
That is correct.
Okay. And then for core growth, again sorry to hammer on the core, when you guys ultimately do give guidance for 2020, will you be thinking of Voalte and Breathe within the core business since Voalte is core this year even though it’s acquired? In other words, you’re looking for like 4% to 5% LRP type growth. I guess is that inclusive of the benefit of Voalte and Breathe to kind of get you to those levels or should we think of Breathe and Voalte as being additive?
So, Kristen, a couple of different questions in there, so let me make sure I take them in turn. As we think about 2020 and we talk about our guidance and we talk about core revenue, we will be including Voalte as well as Breathe in our core revenue, okay. So that will be part of it. But our intention would be just as we have done so far this year is to be clear on what they’re adding as part of that core and what the underlying portfolio is driving on. So we’ll make sure that there is transparency around how those acquisitions are adding to. As you think about our long range plan and the guidance that we gave over the 2018 to 2020 time period, we’re coming towards the end of the second quarter and it’s great to see that on all of the metrics that we outlined, we are on track or ahead of each of those. And when we think about the core revenue growth guidance of that 4% to 5% in particular, we are tracking ahead of that and ahead of that is being helped, yes, by new product performance but also by Voalte. And so we are not looking to supplement, if you will, or offset with the new acquisitions to get to that 4% to 5%. We feel pretty good about where our performance is and how this is going to be additive over time. I hope that helps.
Yes, it does. Thank you so much.
We have time for one more question. Thank you.
Our final question comes from Matthew Mishan of KeyBanc, your question please.
Thank you for taking the questions. John, you look at some of these assets that you’re now selling, they were previous acquisitions, like Volker and Aspen. How do you kind of change your M&A process since you’ve been there? And what should we be more confident in your guys succeeding in acquisitions, like Voalte and Breathe?
Yes, it’s a great question. I think a couple of key differences. One, the overall strategy is around category leadership. And we play in multiple categories that are large in size and some grow faster than others, but we want to look at within those categories where can we play with innovation that is a meaningful, durable, long-term growth profile to them. So, number one, does it fit with category leadership? Does it fit inside of our portfolio? Is it in our market segment that’s growing above our growth rates for the company? Does it have a margin profile that is above – either initially above or can be above our margin profile in our ownership? And I think the most important additional criteria there is what I just kind of talked about and underscores, is the ability for that acquisition target and asset to grow on a sustained basis over time. I think under the prior leadership, the mandate at that time was to diversify the business and to diversify away from hospital beds. I think we’ve successfully done that. Now it’s time to supplement and drive growth within the categories that we’re in and to utilize the assets that we have in the company whether that’s R&D assets, manufacturing or our commercial footprint. So really looking to drive that type of profile in the targets that we’re looking at. Not that we won’t look at adjacencies and larger acquisitions, but as I think we all know those are – the evaluations on those can be pretty challenging in today’s environment. This bolt-on and tuck-in strategy certainly will bring a lot of synergy and a lot of value to the transaction, then it allows us to get to our ROIC requirement in the three to five-year period.
Okay. Perfect. And then just a follow up on international. I can get volatility in Patient Support and in Surgical given the capital component to it. But what I’m struggling with is Front Line Care, because I thought that was more of a penetration story with kind of Welch Allyn being underpenetrated internationally and I’m not quite sure about why that story hasn’t played out more consistently?
Yes, the Front Line Care business is being masked by a tough comp in the Middle East last quarter, last year. We actually do see nice consistent growth in our Front Line Care business internationally. But due to some large orders that came in from some of those customers in that region, it’s masking it in the third quarter. It’s a great point you are making because that’s an example of what I was talking about earlier that we’ve got to make sure that all of our international regions are really driving on a strategic platform like the Front Line Care portfolio, so thanks for bringing that up.
All right. Thanks, John.
Okay. Thank you. All right. Let me just close out with a few comments. Look, I think our playbook around category leadership and our strategic priorities I think they’re really working. We’re seeing that in our consistent mid-single digit performance for five quarters in a row. We’re really pleased that we were able to raise guidance in this last quarter to 6% core growth, including Voalte, and then offsetting the $0.05 of dilution that came with acquisitions as well as the divestiture.
So really pleased with our M&A progress and positive contribution from all three deals to sustaining our top line growth and driving double-digit EPS growth in our core. Super confident in our ability to execute against our guidance in Q4. And I’ve said it once before and I guess I’ll say it again. Times have never been better at Hill-Rom. So thank you very much for the call.
Ladies and gentlemen, this concludes today’s conference call with Hill-Rom Holdings, Inc. Thank you for joining.