Overview
The following discussion and analysis should be read in conjunction with the accompanying interim financial statements and our 2020 Form 10-K.
Hill-Rom Holdings, Inc. ("we," "us," or "our") is a global medical technology leader whose approximately 10,000 employees have a single purpose: enhancing outcomes for patients and their caregivers by Advancing Connected Care™. Around the world, our innovations touch over 7 million patients each day. Our products and services help enable earlier diagnosis and treatment, optimize surgical efficiency and accelerate patient recovery while simplifying clinical communication and shifting care closer to home. We make these outcomes possible through connected smart beds, patient lifts, patient assessment and monitoring technologies, caregiver collaboration tools, respiratory health devices, advanced equipment for the surgical space and more, delivering actionable, real-time insights at the point of care.
The Impacts of COVID-19 on Hillrom
COVID-19 has impacted global economies as travel, leisure and discretionary consumer spending has reduced significantly causing companies to make commensurate changes to their investments, human capital, and financial outlooks.The United States and countries around the world continue to take precautionary and preventive measures to reduce the spread of COVID-19. Recently, prospects for an eventual path out of the crisis have improved as COVID-19 vaccines were authorized for use globally and governments began executing plans to distribute the vaccines to the public as supplies become available over the course of fiscal 2021. However, near-term outlook remains uncertain due to external factors such as policymaker decisions to remove certain restrictions, availability and distribution of vaccines and people's willingness to take the vaccine.
Revenues and Customers
Hillrom continues to experience fluctuations in demand across its portfolio of products as health care customers manage the treatment of patients diagnosed with COVID-19. Due to an increase in COVID-19 confirmed cases and hospitalizations that were attributed to holiday travel, we experienced higher demand for select products within Patient Support Systems such as intensive care unit and med-surg beds and specialty surfaces, including our rental portfolio. We also experienced higher than expected recovery in portions of our remaining portfolio that had previously been limited due to hospital access and doctor office restrictions. For the remainder of fiscal 2021, we expect hospitals and physician practices to advance toward more normal operating activities as efforts continue across the world to control the spread of COVID-19 through improved testing and contact tracing and the availability and distribution of an effective vaccine.
Operations and Workforce
We have experienced no significant supply chain constraints nor significant increases in supply costs, and we were able to secure raw materials and components for manufacturing products in high demand due to COVID-19.
Our production facilities have remained open and employment levels have remained consistent. Many employees in our administrative functions have effectively continued to work remotely sincemid-March 2020 . We have implemented the necessary precautions to allow our employees to work safely and effectively in our manufacturing and service facilities. In other areas of the business, we have adapted our processes and used technology to continue to effectively execute on our strategic priorities as well as daily operating activities.
We will continue to assess our workforce requirements in response to evolving customer demand related to COVID-19.
As disclosed in Note 1. Summary of Significant Accounting Policies, we have benefited from government programs within the various jurisdictions in which we operate in the form of subsidies, incentives, cost relief and payment deferrals. Management will continue to evaluate these opportunities as well as the related requirements or restrictions to support our operations and workforce in a manner that allows us to continue to operate efficiently and effectively. 24 -------------------------------------------------------------------------------- Table of Contents For further discussion, see the risk factor within PART I, Item 1.A Risk Factors, entitled "Our business, results of operations, financial condition and prospects could be materially and adversely affected by the ongoing COVID-19 pandemic and the related effects on public health." within the 2020 Form 10-K.
Use of Non-GAAP Financial Measures
The accompanying Condensed Consolidated Financial Statements and related notes are presented in accordance with GAAP. In addition to the results reported in accordance with GAAP, we routinely provide operating margin, income before taxes, income tax expense and earnings per diluted share results on an adjusted basis as we believe these measures contribute to the understanding of our financial performance, provide additional analytical tools to understand our results from core operations and reveal underlying operating trends. These measures exclude strategic developments, acquisition and integration costs and related fair value adjustments, gains and losses associated with disposals of businesses or significant product lines, regulatory costs related to updating existing product registrations to comply with the European Medical Device Regulations, Special charges as described in Note 8. Special Charges of this Form 10-Q, the changes in tax accounting methods, and other tax law changes as described in Note 11. Income Taxes within the 2020 Form 10-K, expenses associated with these tax items, the impacts of significant litigation matters, certain impacts of the COVID-19 pandemic and other unusual events. We also exclude expenses associated with the amortization of purchased intangible assets. These adjustments are made to allow investors to evaluate and understand operating trends excluding their impact on operating income and earnings per diluted share. Management uses these measures internally for planning, forecasting and evaluating the performance of the business. Investors should consider these non-GAAP measures in addition to, not as a substitute for, or as superior to, measures of financial performance prepared in accordance with GAAP. In addition, we present certain results on a constant currency basis, which compares results between periods as if foreign currency exchange rates had remained consistent period-over-period. We monitor sales performance on an adjusted basis that eliminates the positive or negative effects that result from translating international sales intoU.S. dollars. We calculate constant currency by applying the foreign currency exchange rate for the prior period to the local currency results for the current period. We believe that evaluating growth in net revenue on a constant currency basis provides an additional and meaningful assessment to both management and investors. 25 -------------------------------------------------------------------------------- Table of Contents Results of Operations In this section, we provide an overview of our results of operations. We disclose segment information that is consistent with the way in which management operates and views the business. Our operating structure contains the following reportable segments: •Patient Support Systems - globally provides an ecosystem of our digital and connected care solutions: devices, software, communications and integration technologies that improve care and deliver actionable insights to caregivers and patients in the acute care setting. Key products include care communications and mobility solutions, connected med-surg and ICU bed systems, sensors and surfaces, safe patient handling equipment and services.
•Front
•Surgical Solutions - globally enables peak procedural performance, connectivity and video integration products that improve collaboration, workflow, safety and efficiency in the operating room, such as surgical video technologies, tables, lights, pendants, precision positioning devices and other accessories. Net Revenue (In millions) U.S. OUS Three Months Ended December Change As Constant Change As Change As Constant 31 Reported Currency Reported Reported Currency 2020 2019 Net Revenue: Product sales and service$ 652.5 $ 614.3 6.2 % 4.4 % (2.8) % 25.7 % 19.9 % Rental revenue 88.6 70.7 25.3 % 24.3 % 28.1 % 6.5 % (1.1) % Total net revenue$ 741.1 $ 685.0 8.2 % 6.5 % 1.2 % 24.8 % 18.9 % Net Revenue: Patient Support Systems$ 377.4 $ 344.2 9.6 % 8.0 % 0.9 % 39.8 % 32.7 % Front Line Care 269.9 254.6 6.0 % 5.0 % 3.6 % 11.6 % 8.2 % Surgical Solutions 93.8 86.2 8.8 % 4.4 % (7.8) % 21.4 % 13.6 % Total net revenue$ 741.1 $ 685.0 8.2 % 6.5 % 1.2 % 24.8 % 18.9 %
OUS - Outside of
Three Months Ended
Consolidated Revenue Product sales and service revenue increased 6.2% on a reported basis, and 4.4% on a constant currency basis, for the three months endedDecember 31, 2020 compared to the three months endedDecember 31, 2019 due to higher demand across all reportable segments outsidethe United States including market expansion of med-surg and ICU bed systems acrossEurope and other International markets. Rental revenue increased 25.3% on a reported basis, and 24.3% on a constant currency basis, for the three months endedDecember 31, 2020 compared to the three months endedDecember 31, 2019 . The increase was primarily due to increased deployment of beds within the Patient Support Systems rental portfolio for COVID-19 patients inthe United States . 26 -------------------------------------------------------------------------------- Table of Contents Business Segment Revenue Patient Support Systems revenue increased 9.6% on a reported basis, and 8.0% on a constant currency basis, for the three months endedDecember 31, 2020 compared to the three months endedDecember 31, 2019 . The increase was driven primarily by sales growth outsidethe United States due to customer demand for intensive care unit and med-surg beds as well as higherU.S. rental revenues related to COVID-19 demand. The increase was partially offset by lowerU.S. demand and project delays for care communications products. FrontLine Care revenue increased 6.0% on a reported basis, and 5.0% on a constant currency basis, for the three months endedDecember 31, 2020 compared to the three months endedDecember 31, 2019 . The increase was driven by global sales of patient monitoring and thermometry products to hospitals. Surgical Solutions revenue increased 8.8% on a reported basis, and 4.4% on a constant currency basis, for the three months endedDecember 31, 2020 compared to the three months endedDecember 31, 2019 primarily due to higher revenues inEurope , including the new acquisition. Gross Profit (In millions) Three Months Ended December 31 2020 2019 Gross Profit 1 Product sales and service$ 328.3 $ 308.0 Percent of Related Net Revenue 50.3 %
50.1 %
Rental 50.9
33.7
Percent of Related Net Revenue 57.4 %
47.7 %
Total Gross Profit$ 379.2 $
341.7
Percent of Total Net Revenue 51.2 %
49.9 %
1 Gross Profit is calculated as net product sales and service revenue and rental revenue less the related cost of goods sold or rental expenses as disclosed on the face of the Condensed Consolidated Statements of Income. Product sales and service gross profit increased by$20.3 million or 6.6% for the three months endedDecember 31, 2020 compared to the three months endedDecember 31, 2019 . The increase in gross profit was primarily driven by increased sales volume outsidethe United States and favorable product mix. The increase in gross profit is also attributed to cost efficiencies within our supply chain operations. Rental gross profit increased by$17.2 million or 51.0% for the three months endedDecember 31, 2020 compared to the three months endedDecember 31, 2019 , primarily driven by higher volumes and lower costs associated with servicing the Patient Support Systems rental portfolio due to increased rental durations related to hospital needs for COVID-19 patients. Operating Expenses (In millions)
Three Months Ended
2020 2019 Research and development expenses $ 34.8$ 31.5 Percent of Total Net Revenue 4.7 % 4.6 % Selling and administrative expenses$ 209.0 $ 196.8 Percent of Total Net Revenue 28.2 % 28.7 % Acquisition-related intangible asset amortization $ 25.9$ 26.7 Percent of Total Net Revenue 3.5 % 3.9 % 27
-------------------------------------------------------------------------------- Table of Contents Research and development expenses increased by$3.3 million or 10.5% for the three months endedDecember 31, 2020 compared to the three months endedDecember 31, 2019 and remained consistent as a percentage of revenue. Selling and administrative expenses increased$12.2 million or 6.2% for the three months endedDecember 31, 2020 compared to the three months endedDecember 31, 2019 primarily due to increased variable compensation linked to performance, increased marketing spend and an increase in costs related to our IT transformation efforts. These increases were partially offset by lower travel expenses and decreased compensation costs resulting from the Workforce Reduction Plan. Acquisition-related intangible asset amortization decreased$0.8 million or 3.0% for the three months endedDecember 31, 2020 compared to the three months endedDecember 31, 2019 primarily due to a scheduled decrease in asset amortization of customer relationships, which was partially offset by amortization of intangible assets acquired in business combinations executed in fiscal 2020. See Note 3. Business Combinations within the 2020 Form 10-K for further information. Special Charges and Other (In millions)
Three Months Ended
2020 2019 Special charges $ 27.1$ 7.8 Interest expense $ (17.8)$ (19.4) Loss on extinguishment of debt $ -$ (15.6) Investment income (expense) and other, net $
7.0
In connection with various transformative initiatives, exit activities, and organizational changes to improve our business alignment and cost structure., we recognized Special charges of$27.1 million for the three months endedDecember 31, 2020 compared to$7.8 million for the three months endedDecember 31, 2019 . These charges related to the initiatives described in Note 8. Special Charges. Interest expense decreased$1.6 million or 8.2% for the three months endedDecember 31, 2020 compared to the three months endedDecember 31, 2019 due to lower borrowings outstanding, lower borrowing rates from the refinancing of senior unsecured notes of$425.0 million inSeptember 2019 , declines in LIBOR impacting our variable rate debt under the Securitization and Revolving Credit Facilities and a reduction of$0.5 million in fiscal 2020 as we did not incur duplicative interest costs with respect to the refinancing. See Note 4. Financing Agreements for further information.
Loss on extinguishment of debt for the three months ended
Investment income (expense) and other, net for the three months endedDecember 31, 2020 increased by$8.3 million primarily due to the receipt of an insurance settlement of$5.3 million related to covered losses in prior periods and higher investment income of$1.8 million .
Income Tax Expense
The effective tax rate for the three months endedDecember 31, 2020 was 17.9% compared to 6.6% for the comparable period in the prior year. The rate was lower in the prior year period primarily due to the favorable impact of excess tax benefits on deductible stock compensation compared to the current year period. The effective tax rate for the three months endedDecember 31, 2019 was also favorably impacted by the reduction of the contingent consideration accrual of$8.4 million , that was not subject to tax. The adjusted effective tax rate for the three months endedDecember 31, 2020 was 20.5% compared to 16.6% for the comparable period in the prior year. The adjusted rate was lower in the prior year period primarily due to the favorable impact of excess tax benefits on deductible stock compensation compared to the current year period. 28
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Earnings per Share
Diluted earnings per share increased from$0.59 to$0.88 for the three months endedDecember 31, 2020 compared to the three months endedDecember 31, 2019 primarily due to higher operating profits, the loss on extinguishment of debt recognized in fiscal 2020 and the increase in Investment income (expense) and other, net, which was partially offset by higher income tax expense. Business Segment Divisional Income (In millions) Three Months Ended December 31 2020 2019 Change As Reported Divisional Income: Patient Support Systems $ 87.3$ 58.4 49.5 % Front Line Care 81.9 73.5 11.4 % Surgical Solutions 17.5 12.8 36.7 %
Refer to Note 11. Segment Reporting for a description of how divisional income is determined.
Patient Support Systems divisional income increased$28.9 million or 49.5% for the three months endedDecember 31, 2020 compared to the three months endedDecember 31, 2019 primarily due to increased revenue related to intensive care unit and med-surg beds sales outsidethe United States as well as bed rentals inthe United States as a result of higher demand due to COVID-19, and expanded gross profits due to longer rental durations and operational efficiencies. These increases were partially offset by an increase in investments to support growth initiatives. FrontLine Care divisional income increased$8.4 million or 11.4% for the three months endedDecember 31, 2020 compared to the three months endedDecember 31, 2019 primarily driven by global sales growth for patient monitoring and thermometry products to hospitals. Surgical Solutions divisional income increased$4.7 million or 36.7% for the three months endedDecember 31, 2020 compared to the three months endedDecember 31, 2019 primarily due to increased revenues inEurope , including a recent acquisition, which was partially offset by inventory reserves for discontinued products.
As Reporting and Adjusted Earnings
Operating margin, income before income taxes, income tax expense and earnings attributable to common shareholders per diluted share are summarized in the tables below for the three months endedDecember 31, 2020 and 2019. As Reported amounts are adjusted for certain items to aid management in evaluating the performance of the business. Investors should consider these measures in addition to, not as a substitute for, or as superior to, measures of financial performance prepared in accordance with GAAP. Income tax expense is computed by applying a blended statutory tax rate based on the jurisdictional mix of the respective before tax adjustment. 29
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Three Months EndedDecember 31, 2020 Three
Months Ended
Income Income Before Before Operating Income Income Tax Operating Income Income Tax Margin Taxes Expense Diluted EPS Margin Taxes Expense Diluted EPS As Reported 11.1 %$ 71.6 $ 12.8 $ 0.88 11.5 %$ 42.6 $ 2.8 $ 0.59 Adjustments: Acquisition and integration costs - % (0.1) - - (1.0) % (6.6) 0.3 (0.10) and related fair value adjustments 1 Acquisition-related intangible asset 3.5 % 25.9 6.3 0.29 4.0 % 26.7 6.4 0.30
amortization 2
Regulatory compliance costs 3 0.5 % 4.1 1.0 0.05 0.6 % 3.9 0.6 0.05 Special charges 4 3.7 % 27.1 6.2 0.31 1.1 % 7.8 1.2 0.10 Debt refinancing costs 5 - % - - - - % 16.1 3.7 0.18 Loss on business combinations 6 - % - - - - % 0.5 0.1 0.01 COVID-19 related costs and benefits, - % (0.1) - - - % - - - net 7 Adjusted Basis 18.8 %$ 128.5 $ 26.3 $ 1.53 16.2 %$ 91.0 $ 15.1 $ 1.13 1 Acquisition and integration costs and related fair value adjustments include legal and professional fees, temporary labor, consulting and other costs related to the closing and integration of acquired businesses, including purchase accounting adjustments for deferred revenue and other items, and contingent consideration. For the three months endedDecember 31, 2020 and 2019, a net benefit from fair value adjustments of$1.6 million and$7.5 million , respectively, represents purchase accounting adjustments for deferred revenue and contingent consideration associated with our business combinations in Note 3. Business Combinations. 2 Acquisition-related intangible asset amortization relates to the amortization of intangible assets associated with our business combinations.
3 Regulatory compliance costs relate to updating existing product registrations to comply with the European Medical Device Regulations and the impacts of current period tax law changes. These costs are included in Selling and administrative expenses. 4 Special charges represent a variety of costs associated with restructuring actions, including severance and related benefits, lease termination fees, asset write-downs and temporary labor on shutdown of operations. It also includes costs related to a global information technology transformation, including rationalizing and transforming our enterprise resource planning software solutions and other complementary information technology systems. See Note 8. Special Charges for further information.
5 Debt refinancing costs are expenses related to the costs incurred between the issuance and redemption of our senior unsecured notes due 2027 and 2023, respectively, as discussed within Note 4. Financing Agreements as well as duplicative interest costs. 6 Loss on business combinations relates to the sale of our surgical consumable products business inAugust 2019 recorded in Investment income (expense) and other, net. 7 COVID-19 related costs and benefits, net primarily represent incremental non-recurring costs incurred to prepare our facilities for workforce reintegration to ensure the safety of our employees, partially offset by the recognition of funding associated with government programs created in response to COVID-19. See Note 1. Summary of Significant Accounting Policies for further information. 30
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