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HRC > SEC Filings for HRC > Form 10-K on 15-Nov-2012All Recent SEC Filings

Show all filings for HILL-ROM HOLDINGS, INC.

Form 10-K for HILL-ROM HOLDINGS, INC.


15-Nov-2012

Annual Report


Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Overview

We are a leading worldwide manufacturer and provider of medical technologies and related services for the health care industry, including patient support systems, safe mobility and handling solutions, non-invasive therapeutic products for a variety of acute and chronic medical conditions, medical equipment rentals, surgical products and information technology solutions. Our comprehensive product and service offerings are used by health care providers across the health care continuum and around the world in hospitals, extended care facilities and home care settings, to enhance the safety and quality of patient care.

Key Factors Impacting Our Business

Industry-wide Demand and Cost Pressures. We believe that over the long term, overall patient and provider demand for health care products and services will continue to grow as a result of a number of factors, including an aging population, longer life expectancies, greater access to medical insurance through government regulation and an increasing number of sicker patients across all care settings, including hospitals, extended care facilities and in the home. In contrast, however, health care providers across the care continuum are under continued pressure to improve efficiency and control costs, possibly reducing demand for our products and services. These pressures may occur for a number of reasons, including declining commercial third-party payor reimbursement rates and government regulation. In addition, an increasing number of our customers are purchasing through GPO agreements or other large contracts, where they may be able to purchase at lower prices than they would be able to individually. Moreover, general economic pressures have caused some governmental authorities to initiate various austerity measures to control healthcare spending, reducing direct spending in addition to governmental reimbursement rates. These factors may decrease demand for our products, decrease payments to us, or both. Although we believe that industry demand will increase over time, a lack of demand growth could impact our ability to grow revenues.

Growing Desire Among Developed and Developing Countries to Invest in Health Care. While industry growth rates in more mature geographic markets such as western and northern Europe and Japan have moderated, in many other geographic markets, where the relative spending on health care is increasing, we are experiencing increasing demand for medical technologies. New hospital construction and hospital refurbishments have continued in regions such as Latin America, the Middle East and many parts of Asia. These trends could increase overall demand for our products and services.

Mergers and Acquisitions. We have made several recent acquisitions, most notably the acquisitions of Aspen Surgical and Völker. In addition, our stated capital allocation strategy anticipates that we may make additional acquisitions in the future. Our past and future acquisitions (to the extent that we make them) will materially impact our results of operations, by increasing our revenue and revenue growth rates, increasing our ongoing operational selling and administrative expenses, adding incremental acquisition and integration related costs, and creating additional non-cash charges associated with the amortization of tangible and intangible assets resulting from purchase accounting. Moreover, to the extent that we acquire businesses that have financial drivers different than our current businesses, our future results of operations will be subject to additional or different factors impacting our financial performance.

Rising Acuities and Technological Impact. As a result of the growing population of the elderly and obese, health care systems are challenged to treat rising incidences of complex diseases and conditions such as diabetes, congestive heart failure and respiratory disease. Patients are being moved through the hospital faster and generally desire to rapidly move to lower acuity settings. We believe that this increases the demand for more sophisticated means to care for these patients, such as improved medical technologies, communication tools and information technologies. The increasing utilization of these technologies and our ability to meet changing demand with new differentiated products will impact our ability to increase revenue and improve margins in the future.

Increasing Operational Efficiency. We have and will continue to undertake initiatives to improve our operating efficiency, including business realignments, employee reductions in force, product rationalizations, lower sourcing costs and continuous improvement activities in our manufacturing facilities and back office functions. Throughout the year we gradually realized the efficiencies of these multiple actions and we believe our operating expenses and margins will continue to be positively impacted, but these activities may not produce the full efficiency and cost reduction benefits we expect, in a timely fashion or at all. Further, we may utilize savings produced to reinvest in (or fund) other business priorities.


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Patient and Caregiver Safety and Quality. An increasing emphasis is being placed within hospitals to assure quality of care through increased accountability and public disclosure. At the same time, caregiver shortages, worker related injuries, the aging workforce and other staffing requirements have led to increasing emphasis on caregiver injury prevention. Several pieces of legislation have been enacted over the past few years to address these areas including the "pay for performance" initiative by the Centers for Medicare and Medicaid Services ("CMS") which aims to better align reimbursement with improved patient outcomes and the reduction of adverse events including bedsores (or pressure ulcers), ventilator associated pneumonia, patient falls, deep vein thrombosis and patient entrapment. Hospitals may experience reduced reimbursement for hospital acquired adverse events, making a stronger connection with these adverse events and revenue levels. A number of the top adverse events and preventable medical errors in U.S. hospitals, including those listed above can be mitigated in part by our technologies, processes and services. We are well positioned to benefit from the emphasis being placed on patient safety due to our products and technologies that are designed to assist providers in materially improving outcomes associated with patients confined to beds across all care settings.

Related to caregiver safety, certain countries in Europe have established legislation that has mandated that patient lifts be available in hospitals. In the U.S., several states have enacted or introduced legislation and, most recently, The Nurse and Health Care Worker Protection Act of 2009 was introduced in Congress aimed at eliminating manual patient lifts and transfers. We believe that our products and services seek to address these concerns through novel application of technology, clinical and ergonomic science, and customer feedback. Overall increasing emphasis on patient and caregiver safety and quality could increase demand for our products and services.

Use of Non-GAAP Financial Measures

The accompanying consolidated financial statements, including the related notes, are presented in accordance with accounting principles generally accepted in the U.S. ("GAAP"). We provide adjusted income before income taxes, income tax expense and diluted earnings per share results because we use these measures internally for planning, forecasting and evaluating the performance of the business.

In addition, we analyze net revenues on a constant currency basis to better measure the comparability of results between periods. We believe that evaluating growth in net revenues on a constant currency basis provides an additional and meaningful assessment to both management and investors.

We believe use of these non-GAAP measures contribute to an understanding of our financial performance and provide an additional analytical tool to understand our results from core operations and to reveal underlying trends. These measures should not, however, be considered in isolation, as a substitute for, or as superior to measures of financial performance prepared in accordance with GAAP.


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RESULTS OF OPERATIONS

The following table presents comparative operating results for the years discussed within Management's Discussion and Analysis:

                                                                                            Years Ended September 30
                                                                         % of Related                    % of Related                    % of Related
(In millions except per share data)                          2012          Revenues          2011          Revenues          2010          Revenues
Net Revenues
Capital sales                                              $ 1,198.2              73.3 %   $ 1,119.0              70.3 %   $   996.6              67.8 %
Rental revenues                                                436.1              26.7 %       472.7              29.7 %       473.0              32.2 %
Total Revenues                                               1,634.3             100.0 %     1,591.7             100.0 %     1,469.6             100.0 %
Gross Profit
Capital sales                                                  507.8              42.4 %       512.2              45.8 %       448.0              45.0 %
Rental revenues                                                246.9              56.6 %       269.1              56.9 %       268.6              56.8 %
Total Gross Profit                                             754.7              46.2 %       781.3              49.1 %       716.6              48.8 %
Research and development expenses                               66.9               4.1 %        63.8               4.0 %        58.3               4.0 %
Selling and administrative expenses                            496.4              30.4 %       502.0              31.5 %       474.6              32.3 %
Litigation (credit) charge                                      (3.6 )            -0.2 %        47.3               3.0 %       (21.2 )            -1.4 %
Impairment of goodwill and other intangibles                     8.0               0.5 %           -                 -             -                 -
Special charges                                                 18.2               1.1 %         1.4               0.1 %        13.2               0.9 %
Operating Profit                                               168.8              10.3 %       166.8              10.5 %       191.7              13.0 %
Other income (expense), net                                     (5.3 )            -0.3 %        (7.1 )            -0.4 %        (8.8 )            -0.6 %
Income Before Income Taxes                                     163.5              10.0 %       159.7              10.0 %       182.9              12.4 %
Income tax expense                                              42.7               2.6 %        26.2               1.6 %        56.9               3.9 %
Net Income                                                     120.8               7.4 %       133.5               8.4 %       126.0               8.6 %
Less: Net income attributable to noncontrolling interest           -                 -           0.2                 -           0.7                 -
Net Income Attributable to Common Shareholders             $   120.8               7.4 %   $   133.3               8.4 %   $   125.3               8.5 %

Net Income Attributable to Common Shareholders
per Common Share - Diluted                                 $    1.94                       $    2.09                       $    1.97

Note: Certain percentage amounts may not add due to rounding.

Fiscal Year Ended September 30, 2012 Compared to Fiscal Year Ended September 30, 2011

Consolidated Results of Operations

In this section, we provide a high-level overview of our consolidated results of
operations. Immediately following this section is a discussion of our results of
operations by reportable segment.

Net Revenues

                           Years Ended September 30              Percentage Change
                                                                                Constant
 (Dollars in millions)       2012              2011         As Reported         Currency
Revenues:
Capital sales            $     1,198.2       $ 1,119.0               7.1              8.9
Rental revenues                  436.1           472.7              (7.7 )           (7.0 )
Total Revenues           $     1,634.3       $ 1,591.7               2.7              4.2

Capital sales increased, primarily as a result of incremental sales due to our Völker and Aspen Surgical acquisitions. Sales in our International segment also increased due to strong growth in the Middle East and Eastern European regions, partially offset by lower Western European revenues. North America capital sales declined for the year, where patient support system sales decreased 9.7 percent on lower volumes and hospital spending pressure.

Rental revenues declined in all segments on lower volumes and unfavorable pricing in select areas. In our North America segment, revenues were down in all lines of business, with the largest percentage decline coming in our home care business where certain restructuring actions were taken in the current year. Rental revenues in Surgical and Respiratory Care decreased on lower volumes and pricing pressures in our respiratory care business. International rental revenues were also down, primarily on unfavorable currency effects.


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Gross Profit

                                     Years Ended September 30
                                                         Percentage
(Dollars in millions)           2012          2011         Change
Gross Profit
Capital sales                 $   507.8      $ 512.2            (0.9 )
Percent of Related Revenues        42.4 %       45.8 %

Rental revenues               $   246.9      $ 269.1            (8.2 )
Percent of Related Revenues        56.6 %       56.9 %

Total Gross Profit            $   754.7      $ 781.3            (3.4 )
Percent of Related Revenues        46.2 %       49.1 %

Capital gross profit was down only slightly on higher revenues, while gross margin (as a percentage of revenues) decreased 340 basis points. The decline was due to a number of factors, most notably an unfavorable field corrective action of $16.0 million, unfavorable geographic and product mix, higher commodity and fuel pricing, unfavorable acquisition costs associated with the step-up of acquired inventories and generally lower margins associated with Völker products.

Rental gross profit decreased 8.2 percent and gross margin declined 30 basis points, due to lower revenues and the resulting reduced leverage of our fleet and field service infrastructure as revenues declined quicker than our costs. Partially offsetting this decline was the recognized gain of $6.5 million related to a completed vendor product recall matter, which exceeded the gain of $2.3 million for the same product recall in the prior year.

Other

                                                      Years Ended September 30
                                                                          Percentage
(Dollars in millions)                            2012         2011          Change

Research and development expenses              $    66.9     $  63.8              4.9
Percent of Total Revenues                            4.1 %       4.0 %

Selling and administrative expenses            $   496.4     $ 502.0             (1.1 )
Percent of Total Revenues                           30.4 %      31.5 %

Litigation (credit) charge                     $    (3.6 )   $  47.3              n/a
Impairment of goodwill and other intangibles   $     8.0     $     -              n/a
Special charges                                $    18.2     $   1.4              n/a

Interest expense                               $    (6.5 )   $  (8.5 )          (23.5 )
Investment income and other, net               $     1.2     $   1.4            (14.3 )

Research and development expenses increased 4.9 percent as we continue to increase our organic investments in new products. Selling and administrative expenses declined as a percentage of revenues by 110 basis points as the incremental expenses added with recent acquisitions and the associated acquisition and integration costs were more than offset by lower personnel costs, including lower incentive compensation costs, and lower legal costs.

During the fourth quarter of 2012, we reached a favorable litigation settlement of $3.6 million, net of legal fees, related to a patent litigation suit. During fiscal 2011, we recorded a litigation charge of $42.3 million in conjunction with reaching an agreement to settle a United States Office of Inspector General's ("OIG") investigation. Also during fiscal 2011, we reached a settlement with Freedom Medical, Inc. with respect to an antitrust matter resulting in a litigation charge of $5.0 million.


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During the second quarter of fiscal 2012, we recorded a non-cash impairment charge of $8.0 million related to a previously acquired trade name whose assessment was triggered by strategic changes in how the asset would be utilized on a go forward basis. Also at that time, we announced a plan to improve our cost structure and streamline our organization by, among other things, eliminating approximately 200 positions across the Company resulting in a special charge of $9.3 million, net of reversals, primarily related to severance and other benefits provided to the effected employees. We also recorded an impairment of certain tangible assets for which the carrying values could not be fully recovered as a result of various strategic decisions, which resulted in a non-cash charge of $3.2 million. These actions and the related cash expenditures were substantially complete by the end of fiscal year 2012, but some will be paid in fiscal 2013. The actions are anticipated to yield annualized cost savings of approximately $18 million after full implementation.

During the fourth quarter of fiscal 2012, we recorded a non-cash impairment charge of $4.7 million for certain tangible assets for which the carrying values could not be fully recovered as a result of strategic decisions made relative to the exiting of underperforming portions of our home care business. Also associated with this action was the elimination of approximately 100 positions and the related charge of $1.0 million, primarily related to severance and other benefits to be provided to the effected employees. These actions and the related cash expenditures are expected to be completed by the end of fiscal year 2013.

During fiscal 2011, we recorded net special charges of $1.4 million primarily related to a combination of severance activities associated with our 2010 restructuring activities and additional write downs of assets held for sale related to our aviation assets.

Interest expense was lower for the year on lower interest rates and borrowings for most of the year. During the first quarter of fiscal 2012, we repaid $47.5 million of unsecured debentures carrying an interest rate of 8.5 percent, lowering our outstanding borrowings. Then during the fourth quarter in conjunction with the Aspen Surgical acquisition, we borrowed an additional $260 million at more favorable rates, however given the interim period in between with reduced borrowings, our total amount of interest expense was reduced for the year.

GAAP and Adjusted Earnings

                                                                                                       Years Ended September 30
                                                                                    2012                                                      2011

                                                                                                                        Income Before
                                                            Income Before       Income Tax                              Income Taxes         Income Tax
(Dollars in millions, except for per share amounts)          Income Taxes         Expense        Diluted EPS (1)       and NCI (1) (2)       Expense (1)       Diluted EPS

GAAP Earnings                                              $          163.5     $      42.7     $            1.94     $           159.7     $        26.2     $        2.09
Adjustments:
Vendor product recall                                                  (6.5 )          (2.5 )               (0.06 )                (2.3 )            (0.9 )           (0.02 )
Acquisition and integration costs                                      11.7             2.9                  0.14                   1.0               0.4              0.01
Special charges                                                        18.2             6.8                  0.18                   1.4               0.5              0.01
Impairment of other intangibles                                         8.0             2.1                  0.09                     -                 -                 -
Field corrective action                                                16.0             5.9                  0.16                     -                 -                 -
Litigation (credit) charge                                             (3.6 )          (1.3 )               (0.04 )                47.3              14.2              0.52
International tax reorganization and recognition of
unrecognized tax attributes                                               -            11.0                 (0.18 )                   -              21.5             (0.34 )

Adjusted Earnings                                          $          207.3     $      67.6     $            2.24     $           207.2     $        61.8     $        2.27

(1) May not add due to rounding.
(2) NCI refers to our noncontrolling interest in our former Encompass joint venture.

The tax rate for fiscal 2012 was 26.1 percent compared to 16.4 percent in the prior year. The effective rates for both fiscal 2012 and 2011 were favorably impacted by the recognition of discrete period tax benefits. The effective tax rate for 2012 was favorably impacted by the $11.0 million of tax benefits related to the international tax reorganization efforts in the fourth quarter. The lower rate in 2011 is due primarily to the fourth quarter recognition of $21.5 million of previously unrecognized tax benefits associated predominantly with international operating loss carryforwards, as well as higher earnings in lower tax rate jurisdictions and the reinstatement of the research and development tax credit.


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The adjusted effective tax rates were 32.6 and 29.8 percent for fiscal years 2012 and 2011. The lower rate in 2011 is due primarily to the benefit of higher earnings in lower tax rate jurisdictions as well as the benefit and reinstatement of the research and development tax credit. For fiscal 2011, we entered the year with no allowable credit, but its reinstatement in the first quarter allowed for a full year's benefit in 2011 as well as required a retroactive "catch up" of previously unrecognized credits. For fiscal 2012, the credit expired at the end of our first quarter.

Net income attributable to common shareholders was $120.8 million compared to $133.3 million in the prior year period. On an adjusted basis, net income attributable to common shareholders decreased $5.5 million, or 3.8 percent. Diluted earnings per share decreased from $2.09 in the prior year to $1.94 in the current year on a reported basis and on an adjusted basis decreased $0.03 to $2.24 per diluted share.

Business Segment Results of Operations

During the fourth quarter of fiscal 2012, we changed our segment reporting to reflect changes in our organizational structure and management's view of the business. As part of these changes, we combined the North America Acute Care and components of the North America Post-Acute Care segments into a new North America segment. At the same time we created the Surgical and Respiratory Care segment which contains the surgical reporting unit (formerly part of the North America Acute Care segment), the respiratory care reporting unit (formerly part of the North America Post-Acute Care segment) and the recently acquired Aspen Surgical business. There were no changes to the International segment. The prior year segment information included below has been updated to reflect these changes.

                                             Years Ended September 30              Percentage Change
                                                                                                 Constant
(Dollars in millions)                          2012              2011         As Reported        Currency
Revenues:
North America                              $       998.2       $ 1,057.2              (5.6 )          (5.5 )
Surgical and Respiratory Care                      153.2           132.9              15.3            15.3
International                                      482.9           401.6              20.2            25.8
   Total revenues                          $     1,634.3       $ 1,591.7               2.7             4.2

Divisional income:
North America                              $       198.9       $   230.6             (13.7 )
Surgical and Respiratory Care                       38.1            40.0              (4.8 )
International                                       18.6            27.9             (33.3 )
Corporate expenses                                 (64.2 )         (83.0 )           (22.7 )
   Total divisional income                 $       191.4       $   215.5             (11.2 )

North America

North America capital sales were down 4.5 percent related primarily to volume declines in our patient support systems sales, which were down 9.7 percent in a difficult North American healthcare environment with continued pressure on capital spending. This decline was partially offset by stronger sales from our healthcare information technology business. Rental revenues declined 7.9 percent, with declines in all care settings and in our two product groupings of therapy and movable medical equipment. Volume declines in these product groupings are attributable to the lower indications of flu, continued initiatives by hospitals to control operating costs and competitive pressures. The largest percentage decline in rental revenues came from our home care business where certain restructuring actions were taken in the current year.

North America divisional income decreased due primarily to the lower operating income generated in response to the lower revenues, along with the impact of a field corrective action of $16.0 million. This decline was only partially offset by operating expense favorability. Capital margins declined, impacted by the field corrective action, while rental margins remained flat despite the impact of declining revenues due to gains recognized in connection with a vendor product recall of $6.5 million in the current year compared to $2.3 million for the same product recall in the prior year. Operating expenses were favorable . . .

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