Baxter International Inc (BAX) — Q3 2020 Earnings Call Transcript

Good morning, and thanks for joining us for our fiscal third quarter 2020 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 by reminding you that this presentation includes forward-looking statements that are subject to risks, uncertainties, assumptions, and other factors that could cause actual results to differ materially from those described, including any impact related to the COVID-19 pandemic. Please refer to today's press release and our SEC filings for more information 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. I would also like to mention that in addition to the press release issued this morning, we have posted a supplemental presentation, which highlights Hill-Rom's performance. These materials can be accessed on the Investor Relations page of our website. So, with that introduction, let me now turn the call over to John.

Thanks, Mary Kay, and good morning, everyone. Hope you're doing well. And thank you for joining the call. I'd like to start the call today by recognizing the dedicated, committed, passionate, and mission-driven team that we have here at Hill-Rom. It's truly extraordinary. And I do mean extraordinary. We were called to fulfill our mission to enhance outcomes for patients and caregivers, and as a team, we unequivocally executed to achieve. Ramping up and shipping two times the normal volume of smart beds, ramping up and delivering seven times the normal volume of non-invasive ventilators, securing our global supply chain, ensuring our workers' safety, involving five of our largest manufacturing sites in ramping up manufacturing to meet customer needs, continuing to engage our over 1,200 Field Service employees and rental employees and those involved in logistics and shipping, you name it, our overall operational team delivered excellently. This group of people, which consists of approximately 7,000 employees out of our 10,000 employees, really deserve special recognition. Next, we pivoted and accelerated our R&D pipeline during the pandemic, launching five new products and pivoting our programs towards innovations to help patients dealing with COVID. It doesn't stop there. We closed two acquisitions and supported our vision of advancing connected care in both patient monitoring and OR data integration. And if all that wasn't enough for you, we actually did this while all of our office workers moved to remote work-from-home, and we launched a new website for the company, as I said, extraordinary, incredible execution by the Hill-Rom team. The combination of our exceptional execution, financial strength, and diverse portfolio underscores our commitment to enhancing value for customers, caregivers, and our shareholders today and over the long term. Moving to financial highlights for the third quarter, we're pleased to report record results that exceeded our expectations on both the top and bottom line. Core revenue growth was 12%, reflecting the durability and strong value proposition of our critical care products and our category leadership in the markets we served. Core revenue includes a contribution of approximately 400 basis points from the Breathe acquisition and the benefit of more than $100 million related to other COVID-related purchases. We continue to be pleased with our ability to significantly expand margins, achieving a record adjusted gross margin of 53.8%. With disciplined cost management and expense leverage, we posted an operating margin of 23.7%. This resulted in adjusted EPS of $1.95 per diluted share, an increase of 59%. Before turning to performance by business, I'd like to highlight that growth from new products accelerated again this quarter, resulting in more than $440 million in new product revenue year-to-date, an increase of 40% versus the prior year. Importantly, this sets a solid foundation for achieving our $550 million in new product revenue, a key objective we set at the beginning of the fiscal year. I'm very proud of how we pivoted our R&D efforts and recently introduced five new products in the areas of remote monitoring, respiratory care, and surgical workflow. These were highlighted in the press release issued this morning. So given our limited time together, I won't walk through them individually, other than to note that they are all representative of how we're advancing our category leadership and plan to accelerate future growth through innovation. Geographically, international performance was strong with core revenue growth of nearly 40% due to a surge in demand for COVID-related products like ICU and med-surg beds, thermometry, and vital signs monitoring equipment. As expected, with the exception of Asia-Pacific, all regions generated positive growth, including significant double-digit growth from EMEA, Canada, and Latin America. In the U.S., growth of 2% reflects the various changes across our diverse portfolio. Patient Support Systems led the way with core growth of 12%, which was offset by lower revenues in Front Line Care and Surgical Solutions. Now, let me touch on our third quarter performance by business at constant currency rate. First, Patient Support Systems revenue increased 21%. Core revenue growth of 23% was driven by a global surge of demand for our ICU and med-surg bed systems as hospitals expanded capacity in the early phase of the COVID outbreak. The vast majority of the company's COVID benefit that I referenced earlier was from med-surg and ICU beds, which comprised approximately 30% of total company revenue in Q3. That's a full 10 percentage points higher than typical. During the quarter, we worked through a significant backlog in orders that accumulated during the months of March and April, particularly in the U.S., Canada, and EMEA. This resulted in revenue that was nearly two times the level of the prior year. In the U.S., we estimate that approximately 50% of the peak demand for beds was due to market expansion, while the other 50% was pulled forward from our fourth quarter funnel. Global demand for beds is now beginning to normalize. Due to the pull-forward effect and the surge in demand previously mentioned, we anticipate near-term transitory headwinds for our bed portfolio. That being said, we remain optimistic about recent customer commentary and prioritization around ICU beds as a top CapEx investment priority, as they balanced capacity needs to treat both COVID and non-COVID patients. We remain encouraged by the long-term growth prospects of ICU market expansion, which may help overcome some otherwise difficult growth comparisons in the coming quarters. While bed revenue was strong, it was partially offset by anticipated headwinds in other parts of the business including Care Communications, which was impacted by hospital access restrictions to complete installations. The good news is that access restrictions are starting to ease, installations and coding activity are accelerating towards pre-COVID levels, and we are currently building a robust funnel that we expect to benefit from in fiscal 2021. Turning to Front Line Care, third quarter revenue increased 4%, reflecting strength in international and one-time non-invasive ventilator orders of approximately $25 million to support U.S. stockpiles. While we experienced strong demand for vital signs monitoring equipment and thermometry, it was not enough to offset the impact of lower physician office visits in the U.S. on other patient exam and diagnostic tools, including cardiology and vision screening. Generally, physician offices are now resuming, and recovery towards pre-COVID levels is occurring across multiple areas of our Front Line Care portfolio. Lastly, Surgical Solutions revenue declined 37%, reflecting the surgical consumables divestiture last year. Core revenue declined 21% as a result of project timing and capital delays due to COVID-19. We expect recovery in the surgical business to be more gradual, as OR capital projects, as you can imagine, are currently being deferred by our customers. With that as a backdrop, I'd like to provide some additional perspectives on our results and visibility to the trends we're now seeing across the portfolio. As you may recall, we have portions of our business that have been favorably impacted and those that have been negatively impacted by the evolving market trends. The net impact to Hill-Rom in various regions and product categories will largely depend on the scope, intensity, and duration of the pandemic, as well as the shape of the recovery in demand for healthcare and access into acute care facilities. Given all these variables last quarter, we elected to suspend our previously issued guidance. And while we're not reinstating guidance today, as the situation remains very fluid, we're now through three quarters of our fiscal year and we have some visibility into our final fourth quarter. Given the strength of our financial results to-date, including core revenue growth of 8% and adjusted EPS growth of 28% and the evaluation of various scenarios for Q4, we're confident in projecting adjusted earnings of at least $5.40 per diluted share for fiscal 2020. Our confidence is based on various outcomes of the puts and takes across our portfolio. This includes the assumption of normalized demand for med-surg and ICU beds following the Q3 surge, continued growth across multiple product categories in Q4, and reflects no benefits from a second wave. In addition, we anticipate recovery across other areas of our portfolio that were negatively impacted by project delays, customer access, and reduced physician office visits. We are pleased with the speed of this recovery and expect double-digit sequential growth for these products as we exit our fiscal year. So, in summary, amid a challenging environment, our performance to-date demonstrates the advantage of our company's transformation into a diverse and more resilient portfolio of connected care solutions, and that is more important than ever. Looking ahead, we will continue to focus on our strategic priorities, advancing our mission and category leadership strategy, executing on our growth-oriented M&A strategy, and driving operational execution and strong financial performance in the years to come. Thanks, and I'll turn the call over to Barb.

Thanks, John, and good morning, everyone. Let me briefly walk through the P&L before commenting on trends we are seeing as we close out fiscal 2020. For the third quarter, global revenue of $768 million increased 6% over prior-year revenue of $727 million. On a constant currency basis, revenue increased 7%. Core revenue advanced 12%, reflecting a benefit from COVID-related purchases of more than $100 million, new product contributions, as well as approximately 400 basis points from the Breathe Technologies acquisition, which will anniversary in August. Adjusted gross margin expanded 350 basis points versus the prior-year and peaked at 53.8%, a new record level. This reflects favorable product mix, particularly from higher-margin one-time COVID purchases, as well as the impact of new product and portfolio optimization initiatives and the benefit of lower manufacturing and service costs. R&D spending of $34 million was comparable to the prior-year. Adjusted SG&A of $197 million decreased 3% primarily as lower discretionary spending, like travel, meetings, and certain marketing expenses more than offset strategic investments to drive future growth. Given strong adjusted gross margin expansion and expense leverage, adjusted operating margin of 23.7% improved 590 basis points compared to the prior-year, setting a high watermark for the fiscal year. Interest and other non-operating expenses for the quarter totaled $17 million, and the adjusted tax rate was 21%. This translates into adjusted earnings for the fiscal third quarter of $1.95 per diluted share, which is an increase of 59% from $1.23 per diluted share in the prior year. Excluding the diluted impact of the Surgical Consumable divestiture which contributed $0.07 per diluted share last year, adjusted earnings per share increased 68%. Now, turning to cash flow, cash flow from operations for the first nine months of 2020 was $315 million, a 5% increase over the prior year. Capital expenditures on a year-to-date basis totaled $72 million, $21 million higher than the prior-year, driven by IT transformation costs and capitalized software costs related to R&D investments. As a result, year-to-date free cash flow totaled $243 million. Our balance sheet and overall financial position remains very strong. To date, we returned $114 million to shareholders through dividends and share repurchases during fiscal 2020. We ended the quarter with $332 million in cash and our debt-to-EBITDA ratio at the end of June was 2.9 times. The first time it's been below three times since the Welch Allyn acquisition. We continue to operate well within our debt covenants and we have no material debt maturities until 2024. Lastly, given our refinancing efforts last year, we have access to a revolving credit facility of up to $1.2 billion to address any capital needs as necessary. Now, before turning the call back over to John, let me expand on the current business trends as we continue to actively monitor the evolving landscape and track potential implications geographically and within each of our three businesses. As John mentioned, Q3 reflected peak demand overall for 60% of the portfolio, which translated into actual growth of more than 40% for this category of products. As demand for certain products like ICU and med-surg beds begins to normalize, we do expect double-digit growth for other products in this category like thermometry, vital signs monitoring, and respiratory products as we exit the year. Collectively for the 60% revenue category, we expect Q4 revenues to be comparable to the strong fourth quarter last year, resulting in growth of nearly 20% for the second half of 2020. This reflects the current backlog and visibility to orders and no benefits from a second wave. The other 40% of our revenue is now showing signs of recovery and is expected to show sequential double-digit revenue growth as we exit our fiscal year as customer access and physician office visits improve. We continue to expect second half revenue for this portion of the portfolio to decline by about 25%. This is in line with the expectations we shared with you last quarter. Given the ongoing uncertainty, scope and evolving nature of the pandemic, we're not reinstating formal guidance. We would also not recommend extrapolating our recent results into projections for the remainder of the fiscal year. However, given our results today, and disciplined management of the business, we can say that we expect full-year adjusted earnings of at least $5.40 per diluted share. We look forward to providing you with additional updates in the future. Thank you. And with that, I'll turn the call back over to John.

Thanks Barb. In closing, we remain confident in the durability of our diverse portfolio of differentiated healthcare solutions. As we move beyond heightened COVID demand and the transitory benefits, we believe our value proposition got even stronger and remains attractive in the post-COVID environment. And the multi-year growth platforms we've previously discussed can contribute meaningfully to future performance. Our company is better positioned today than during the last period of economic instability. Our core investment thesis remains intact. Our financial strength, consistent cash flow generation, and the execution of our strategic priorities is positioning Hill-Rom for sustained success. As I mentioned earlier, the strong foundation we've built is due to the amazing work and dedication of our Hill-Rom team. Their commitment both to our company and the patients and caregivers we serve is truly an inspiration. Our employees around the world bring our mission to life every day. I feel fortunate to work with such a great team and together we will continue to build on our momentum as we aspire to deliver on our long-term objectives and create value for our shareholders. With that, let's open up the call for Q&A.

Good morning, John, and Barb and thanks for all the excellent detail and performance in the quarter. So many questions. Maybe I'll start with patient support. John, you can give details about the quarter. But I'm sort of intrigued with your views around market expansion here. I can imagine why you might argue for market expansion. But as part of this question, how does that market expansion characterize in your mind? What's it due to growth? How does this play out over the next couple of years? And maybe you can help us understand on a sustainable basis what this might mean to more normalized go-forward growth for this business?

Thank you, Rick. Regarding our PSS business, specifically the bed segment for both med-surg and ICU beds, we observed market expansion in Q3, as highlighted in our comments. We detailed that the additional $100 million of COVID-related business included approximately half attributing to market expansion. Notably, this growth was seen not just in the U.S. but also internationally. For instance, in Canada, we sold over $25 million in ICU and med-surg beds, largely ICU, which were not replacements but rather new additions to capacity. This demand arose quickly and was widespread across the country, allowing us to effectively meet those urgent customer needs. Our ability to respond swiftly to the immediate healthcare demand facilitated significant market expansion in Q3. As mentioned before, we anticipate a nonlinear recovery for this business segment, and we are currently experiencing nonlinear expansion. The urgent healthcare requirements have positioned Hill-Rom to effectively address those needs, resulting in immediate market growth. While this surge has accelerated some sales anticipated for Q4, we maintain a positive outlook for the long-term expansion of ICU beds and med-surg beds capable of adapting to ICU functions temporarily. We are promoting a new Centrella Bed that can transition to an ICU bed, supporting this growing need. We feel well-equipped to capitalize on this global trend as many countries acknowledge the necessity for increased ICU capacity. The recent experiences have prompted a more thoughtful approach from healthcare systems, and we have gathered significant feedback and conducted thorough research, which boosts our confidence in continued market expansion for the ICU bed sector in the coming years.

Great. John, you discussed the Care Comm business. I'm not surprised that, during the period, there were access limitations for installations. However, I'm pleased to hear that you're building a backlog and optimistic about the impact on fiscal 2021. Can you share if you have any numbers regarding the backlog and discuss the potential incremental benefits we might expect from the turnaround in Care Comm as we look ahead to fiscal 2021?

Yes, so our outlook for Care Comm remains really bullish. It's more relevant now and in the future than it has been. We because our Care Comm business is constituted of conventional nurse call and the mobile platform offering, the access into rooms to wire in the systems and install systems and recognize revenue as a result was severely impaired in Q3. As we exited the quarter, things got better. Our outlook in Q4 continues to show a nice route. We believe a very nice recovery as we saw the trend play out in Q3. So we're quite optimistic that that recovery curve is one of the quicker steeper ones to come back partly because of the relevance and the importance of these communication tools to healthcare providers and the expanded feature set that we now provide with everything as we mentioned in some of our presentation materials a new partnership with hands-free voice-activated feature on our Volt mobile nurse call system, as well as the earlier acquisition of Excel Medical which brings medical device integration and live waveforms, our comprehensive solution set in that, the mobile building around this business continues to provide a fairly dynamic growth vehicle for the company going forward. So the recovery is coming, it feels like it's one of the quicker businesses that will recover because of the importance of it. And the long-term growth outlook continues to be one of our brightest opportunities in the future.

And just last from me, debt now is 2.9 times. Maybe just talk to us about your thinking about M&A. You feel like just because of all the craziness in the world that there are more businesses available or more of the kind of acquisitions that you're interested in available now? And maybe talk through with the help of your outstanding business development strategic team, where are your priorities as we think about the portfolio? Thanks so much, John.

Thanks, Rick. Yes, so we continue to be very active in M&A. As we're working through the last quarter and the craziness of the pandemic, we were able to remain very focused with our teams on M&A and continue making good progress. As you heard in this announcement, we closed two small tuck-in acquisitions; one around video integration in the OR, and the other around an emerging market connectivity solution for our vital signs business, which we're really happy with. Both of those strategically fit into our strategies very nicely. They both support international as well as U.S. opportunities in the case of the OR integration one. So we remain very active from a valuation point of view and our rigor around the financial discipline. Smaller privately held companies probably represent better near-term opportunities. It's really difficult for larger and certainly larger public companies to meet our financial criteria in today's environment. But it's not that we're not looking. But I think our strategy around tuck-in and bolt-on M&A is a more likely set of expectations in the near term. And maybe, Barb, if you want to touch on capital allocation priorities, I think it was also part of this question.

You know, I think you've covered it really well, John. Our capital allocation priorities remain the same. First and foremost, we're looking to support the growth of the business, and finding the right M&A deal is at the top of our list. Absent the right M&A, we will continue to support our dividend. We'll continue to look at share repurchases as a lever to offset dilution wherever appropriate. But absent the right M&A beyond our supportive dividends and share repurchases, we're going to continue to pay down our debt. We're really pleased in this environment to see our debt ratio decline to 2.9, which is a historically low number for us. So we're going to continue to stay disciplined and look for the right deals and the deals that are going to drive our top and bottom-line growth over time.

Thanks and good morning, everyone. Just a couple here. John, I'm wondering if you can perhaps talk a little bit about sort of the trends that you're seeing in the business through the fiscal third quarter and sort of how you're thinking or how July progressed?

Yes, let me address that in two ways, Larry, one focusing on capital expenditures and the other on the segments of our business that were negatively affected, specifically the 40% of our portfolio. Starting with the latter, this 40% of revenue impacted by COVID can be categorized into three main areas: first is Care Comm, which we touched on earlier. The second area is our physician office businesses within Frontline Care, including vision care and various physical assessment tools, excluding thermometry, which falls under a different category. The third area pertains to our surgical business and certain safe patient handling equipment within our PSS portfolio. Each of these segments is experiencing a distinct recovery trajectory. Care Comm is rebounding more swiftly than the others, and we saw an encouraging trend as we concluded the quarter. Our expectations for Q4 indicate we might achieve some growth in that category, or at least get very close to it. In our Frontline Care segment, primary care visits were deprioritized compared to elective surgeries and the general return of healthcare needs, leading to a slower recovery in Q3. However, we've observed progress starting in June, and that momentum appears to be continuing into July, suggesting that this area is also heading back towards pre-COVID levels. Regarding the surgical segment and safe patient handling, which often involves installing infrastructure in hospitals or operating rooms, the recovery here is anticipated to be slower due to the ongoing backlog of elective surgeries. We do expect these product lines to regain traction in the new fiscal year beginning in October, and we are confident about their recovery despite the slower pace. On the topic of capital expenditures, particularly in the U.S., our international CapEx remains largely unaffected and in fact, has benefitted from increased demand for additional bed and ICU capacity in certain markets. However, there is more uncertainty in the U.S. healthcare landscape, reflected in the comments from providers and other industry players. Despite this, our positioning remains strong; workflow and clinical communications between caregivers and patients are top priorities for our customers, which enhances the relevance of our Care Comm business. The need for critical care equipment, such as vital signs monitors and ICU beds, also maintains high priority even in a tight capital environment. We foresee challenges in the coming quarters until hospitals fully benefit from government stimulus, of which approximately $125 billion out of the allocated $175 billion has already been distributed, with potential for additional funding in future packages. Normalizing elective surgeries and acute care consumption will also provide financial stability for hospitals. We believe that these factors will lead to a significant improvement in financial certainty regarding CapEx in the U.S. over the next few quarters, positioning our portfolio well for the urgent requirements of our clients.

Okay, terrific. That was really helpful. And then just two for Barb. I guess one thing I was thinking about was certainly the record margins that you set this quarter, but as you start to ramp down some of that manufacturing that was flexed up to meet COVID-related demand, how should we think about kind of margin in the fourth quarter? And I assume that that'll trend back down a bit, so some thoughts around that? And then on the cash flow from Ops, which was up, as you mentioned 5% year-to-date, looks like your GAAP net income was up significantly more in the year-to-date and it feels like at least as I looked at it quickly, it looks like there's a fairly meaningful increase in inventory. So again, how do we think about kind of inventory levels going forward and improvements in cash flow from Ops? Thanks.

Hey, Larry, thanks for the question. I hope you're doing well. Let me start with gross margin. So gross margin for Q3 was at record levels 53.8% and we're really pleased with that. As we highlighted in our presentation that's online, about 180 basis points of that really is related to the one-time COVID sale that we saw in Q3. On a year-to-date basis, if you look at our performance, we're year-to-date for the first nine months at 51.7%. And one-time, we're tracking really well for the full year. In fact, if you go all the way back to sort of our aspirations at the beginning of the year for our gross margin expansion, we're tracking well against that. As you think about Q4, there are probably two things that you want to consider. One is that, we won't have the one-time COVID benefit. But the second thing to keep in mind is that the benefit that we've been receiving from the divestiture of the Surgical Consumables business has given us about a 50 basis points lift each of the quarters so far this year, that's going to anniversary in August. So we will not see the same level of benefit in Q4. So you want to keep in mind those two pieces. But overall, in terms of the expansion of gross margin, we continue to be really pleased with it. It's tracking along our long-term aspiration. Volumes and manufacturing variances to-date and in our expectations are going to have an immaterial impact on the full year. This is really coming down to our efforts in portfolio optimization, our M&A, our new product launches, and the overall portfolio mix that's driving the bulk of the improvements supported by ongoing productivity improvements from our outstanding operations team. So that's how we think about gross margin. As we turn and we talk about cash flow, and we look at inventory, we did have a significant build of inventory in Q3. And really, that was driven by a couple of different things. One of it was sort of a reaction or the result of the fact that we did see parts of our portfolio that 40% of our portfolio we saw softness in demand in the quarter. And we saw that demand. It takes time for the supply chain to match up with that demand. The other part of the build was a conscious build to make sure that we have the flexibility to continue to meet customer demands. And given how fluid the market is, we've deliberately held a little bit more to make sure that we're in a position to meet demand as it moves. As you think about Q4, I wouldn't expect a substantial change in our inventory levels, as we think about Q4, but we expect as we head into the next year, those things will all start to normalize more as we go into 2021. I hope that answers your question.

Yes, that was terrific. Thanks to both of you. Appreciate it.

Yes, maybe just one clarification on that excess inventory of componentry. We don't see any risk to obsolescence in that kind of inventory build of our supply chain.

Really good clarification. This is deliberate choices about volume, not about any risk of obsolescence.

Thank you and good morning. So had some

Good morning.

Good morning. I understand it's a confusing time with a lot happening. I would like to clarify the guidance and address some longer-term questions. First, can you clarify what you mean regarding the fourth quarter in terms of absolute dollar revenues?

I will start with that and then turn it over to Barbara. We haven't specified explicitly. The best we can convey is on Page 20 of the slide presentation, where we indicate that 60% of the revenue is resilient and 40% is impacted, outlining our overall outlook for the second half. You can do the calculations to estimate what the fourth quarter looks like. However, when you do that, you'll see we project a decline in fourth quarter revenue overall, primarily driven by the surge in bed volume we experienced and delivered in Q3. As you know, customers were eager to get this product delivered immediately, and we were able to meet those demands. Consequently, we face a nonlinear transition between Q3 and Q4 regarding our resilient products because we delivered over $100 million in benefits financially from beds, along with another $25 million from non-invasive ventilators, which will be a one-time stockpiling order in Q3. Those figures will not repeat, and our goal is to smooth out that transition over the second half of the year, suggesting how the second half would appear if you average both quarters.

I understand that there are many moving parts right now. I'm trying to clarify for everyone because we're receiving a lot of questions. I realize we have some figures to work with, but it appears that the fourth quarter might be in the low $700 million range when you calculate everything. Is that approximately correct?

No, I think what we try to do is underpin it with the $5.40 on the EPS side because there are many variables on the revenue line. Quite frankly, it's quite difficult for us to provide guidance; we don't have the ability to give an accurate outlook on the top-line. However, there are enough other factors in the P&L that we feel confident saying $5.40 EPS for the full year is the floor. Excluding the Surgical Consumables divestiture last year, that represents 11% growth year-over-year. So again, our ability to deliver double-digit EPS for our fiscal year in highly uncertain times is something we're quite proud of.

Yes, and that makes total sense. It's just that you are providing information in the slide deck. And I'm just trying to understand what that information implies about the fourth quarter and it looks like to me it's kind of very low $700 million. And I just wanted to see if we were kind of doing the math right.

Barb?

Well, just to reiterate, when we look at suspended guidance last quarter, it was because it's very difficult to pinpoint the exact net impact on the portfolio of all the puts and takes. As John has highlighted around the bed orders in Q3 and our ability to deliver on that in Q3 and the subsequent impact on Q4, it's not just about the net impact; it's the timing of the net impact that becomes challenging. And so we obviously are running loads of scenarios looking at where things could be and as we were preparing for today, wanted to make sure we are providing as much clarity as we could. So again, where we came back to was this floor. And it really is a floor on the EPS of the $5.40. Where do we feel confident that we can deliver there? And then providing the thoughts about what the second half will look like on the 60 and 40. And as you're doing the math back, that will give you sort of the range, if you will, and the floor that you can work that to from a revenue standpoint of what we think the quarter is going to look like. But remember that the timing, the timing in particular, it's the net impact of the puts and takes. But it's also the timing and how that’s falling within our quarters; there's more fluid nature to it than what we've traditionally seen.

Okay, and that's fair. Let me just follow-up on that.

Bob, I want to clarify that I'm not going to express any objection or support for your figure of $700 million for the quarter. However, I want to remind you that in previous quarters, we've advised against making any conclusions based solely on quarterly results, including this past quarter. Regardless of what our outcomes are for Q4, we will likely reiterate that same guidance. So, even if you arrive at a number for Q4, it shouldn't be used as a basis for extrapolation.

No, I understand that. Let me take a moment to ask one additional question. Regarding the $5.40, I'm curious about where the conservative estimates are reflected in that figure. Could you share some insights into the assumptions that inform that number and where there might be some caution? I know it's a challenging time, but John, could you provide your perspective on the growth outlook for the business once we move past this? Based on current knowledge, what are your thoughts on the long-term growth potential in terms of revenue and earnings, considering the insights gained over the past few quarters? I'll stop there. Thank you.

Yes, thanks Bob. I'll turn the first part of that question over to Barb on the $5.40 and the puts and takes.

Happy to address that. We previously discussed gross margin expectations for Q4, and you shouldn't anticipate a repeat of 53.8% in that quarter. However, our overall trend towards gross margin expansion remains in line with the goals we set at the beginning of the year. We continue to focus on this expansion. Regarding operating expense leverage, we experienced good leverage in Q3, with expenses decreasing year-over-year due to the shift to remote working. In Q4, we will see some changes in operating expenses. As John mentioned, activity has increased, and our spending is expected to rise as we engage more with customers in the marketplace. This reflects a different level of activity compared to previous quarters. Additionally, the investments initiated in Q3 will continue into Q4. Nonetheless, our commitment to growth and operating margin expansion is strong, and we believe we're on the right track to achieve our goals for the year. The uncertainty for Q4 and how it relates to the $5.40 depends on the various factors affecting the portfolio and their timing. This is why we are refraining from providing specific guidance, as there are many variables at play.

So let me then answer the second part of that question, and I'll point to our actual results first, and say the Hill-Rom today is not the Hill-Rom of yesterday. And the results year-to-date and what we're now projecting for the full year illustrate that, right. The diversity of our portfolio, the resiliency of our portfolio, and our ability to navigate through this pandemic and the financial uncertainty that go with it and still deliver double-digit EPS growth and revenue growth at some level, we'll know in the next quarter what that full-year performance looks like. It's pretty remarkable especially compared to our peer group. Long-term, our vision and our direction of going towards a connected care and advancing connected care environment has become more relevant than it ever has been. And the growth vectors will be driven-off of new products which we continue to see nice acceleration in the current quarter. It'll be driven by select investments in emerging markets, and then driving off of four key product category areas: respiratory health, Care Communications, our smart bed and ICU market expansion opportunities, including flexible ICU offerings, and then patient monitoring and the application for patient monitoring and Telehealth and remote patient monitoring, and really connected care in both the hospital and the home for the physical assessment tools as an example. So the long-term growth vectors and growth vehicles are in our portfolio today, I think we're showing that resilience in our current results and our aspiration that we outlined in our LRP or three-year plan from earlier this year; that aspiration still holds to be consistent mid-single-digit grower and provide double-digit EPS growth over the long period of time, and we think we're very well positioned to do that.

Hi, good morning. I have a few follow-up questions. I feel compelled to revisit Bob's question. For the fourth quarter, the guidance in your presentation mentions a range of $6.95 to $7.10. Your earnings guidance suggests margins around 17% for that figure. Are you indicating that $6.95 to $7.10 is not the range suggested by those slides? Or are you saying that while there is more confidence in the earnings, revenue projections are less certain? I’m still a bit confused and want to ensure we have clear expectations before we finish the call.

Yes, as I mentioned, we are not providing explicit guidance, but we have tried to give as much context as possible. You are on the right track with the numbers you're estimating. While we won't confirm anything directly, you are certainly in the correct ballpark. We aim to be transparent with our current results and expectations for the second half of the year, so you can determine the range you are referring to. If you have a strong belief in our ability to influence the various aspects of our financial performance, then we can establish a firm estimate for EPS.

Okay, that gives us a range to work with. Thank you. Related to that, I believe investors are concerned about the current business cycle dynamics. You've probably been asked about this frequently, and the fourth quarter seems to illustrate this as various factors influence performance each quarter. For the second half of the year, core gross is around 2%. Is that a reasonable estimate for the business floor or a good indicator for the first half of next year? Or are there reasons to think that this average of 2% during the peak and trough of the third and fourth quarters isn't a reliable figure?

Yes.

You want me to take that, John?

I want you to start, Barb sure, go ahead and start.

So I think that it's difficult, and as we talk about it, we would not extrapolate purely off of Q3. And as John commented earlier, we wouldn't extrapolate off of Q4. Even taking the average of those two, David could present some challenges. You really have to think about the shape and the speed of the recovery that we're seeing in the underlying portfolio. Much as John talked about it earlier, we're seeing different speeds based on whether you're in care homes versus physical diagnostics versus safe patient handling and surgical. And then we're going to have in the near-term, some of the lumpiness around the U.S. capital market and the impact on the bed sales as a result of the really phenomenal volumes that we had in Q3. So there's a lot of moving lines that are moving at different speeds. And therefore I think even taking just a second half is a troublesome sort of extrapolation; I wouldn't advise doing that. I think that you're going to have to bear with us a little longer as the pandemic rolls out. And we have clear trajectories on where 2021 will be. And the next time we're together, we'll have more information; we will be able to talk more about that then.

Okay. And just two, two more quick questions for me, I apologize. You mentioned Barb 40% of the business can exit fiscal 2020 with double-digit growth which is encouraging, any sense of a range or floor for sort of the other 60% of the business?

So we've talked about the 60% growth we expect in the second half of the year, which should be around 20%. We've also mentioned that within that 60%, we are seeing double-digit growth in specific areas, particularly in patient monitoring. We expect these areas to continue expanding as we approach Q4.

Okay. But that 60%, a view that 60% of the business can exit this year kind of flat. Is that too aggressive?

We spoke about how we think that year-over-year collectively that growth is going to look very similar to what we saw in Q4 of last year.

Really, the wildcard there, Dave, the wildcard there, David, is the bed business, right. Maybe it was such a surge in Q3, it's relative to last year in Q4, obviously showing the decline in the math that we're providing here. It's that that is the piece, as we talked before that is going to be nonlinear. It's generally positive over a multi-quarter period of time. But quarter-to-quarter in this kind of environment is going to show some positive and some negatives, quarter-to-quarter and just going to be nonlinear. And that's just unfortunate the nature of the pandemic that we're in.

Yes, totally understand. And just lastly John, on the LRP just more specifically, I mean you've expressed some confidence recently in the LRP. And the first half of the LRP, if you assume that guidance range for the fourth quarter is correct. It's kind of maybe 3.5% core growth here in 2020, did closer to 7% in 2019. So you kind of get 5% growth in the first half of the LRP, to deliver your LRP have to do 5% growth in the back half of the LRP, so if we think about 2021 and 2022, are you now feeling that you can do 5% in the back half of the LRP or it's now just looking like it's more likely you can do that 5% for the next two years, if 2021 comes in lower?

Yes, I would comment this way. One as we just said, the quarter-to-quarter variability in some elements of our business, namely the bed business, quarter-to-quarter financials and volatility right, so over a longer period of time and because of the environment we're in right now, the end of this year and likely beginning of next fiscal year, it's going to give us some interesting comps to deal with in fiscal 2021. That said, the long-term growth trajectories, the long-term growth vehicles in our business that are shining through in Q3 and will rebound in Q4 for the parts that have been impacted. We feel very confident that those aspirations can be achieved over a multi-year period.

Hi, thank you for taking the question. So I just wanted to ask one about the guidance for the 40% of the portfolio that seems COVID pressure. So I'm having trouble understanding the guidance relative to your comments, because you talked in the script about the Care Comm activity picking up and physician office visits improving. So why would it still be down 25% in the second half, the same as Q3? Why wouldn't you see any improvement in Q4?

Yes, that's a good question. The straightforward answer is that we are facing challenging comparisons from last year. Typically, we experience a strong Q4. However, in the current environment, we do not anticipate the usual seasonality or quarterly trends in our business due to our current circumstances. This is why we expect a sequential improvement of about 10%. We forecast around 10% sequential growth between Q3 and Q4 overall. Additionally, the safe patient handling and surgical segment, which accounts for about 15% of total revenue, will likely recover more slowly due to difficulties in accessing installation infrastructure.

Okay, okay. And one follow-up on the longer-term ICU opportunity. So Philips has commented for example they think there could be a doubling of ICU capacity over time. Is that a number that U.S. is balanced as well? Do you think it could be greater or less than that?

Yes, we're honing that number as we speak and doing a lot of research. We do believe that it's a well over $200 million incremental opportunity over the next four years. And in terms of the TAM that will be available. So that's on an incremental basis, that's kind of a preliminary number that we're seeing.

Thank you for squeezing me in. Just on the $200 million incremental opportunity that you're talking about. There's a big difference in ICU bed for Tampa and that TAM, is with you are talking about developed European countries versus also including emerging markets like India and China, how do you think about the differences? And are those included in that TAM as well?

Yes, that's exactly the kind of thing we're doing to quantify it because in some of those emerging markets, they'll be happy using a lower-end med-surg bed as an ICU bed and can have very different practices. So that that is the work, we need to finalize, but the number I gave you, over roughly $200 million or better over the next four years does incorporate that thinking in terms of market dynamics.

And just to put it all in context, where are you at on Centrella penetration of the existing base? And did that seriously accelerate over the last quarter or is it still fairly low?

It’s still fairly low; it's around 15% mark the last quarter will probably give it an uptick of a percent or two, but it's still below 20%, easily below 20% of our Hill-Rom base of business in the United States. So we have a long way to go in terms of penetrating that base and then building our connectivity story of smart bed to smartphone and digital product offerings around that as we go into the future. Okay, thank you. Well, with that, I will turn it back over to Mary Kay and say thank you for the call. We went over a little bit, but given the climate, hopefully everyone hung on to the call. And really want to thank you for your questions today. And I'll turn it back over to Mary Kay.

Thanks, John. Just wanted to say thanks for everyone sorry, we ran a little late today, but happy to answer any follow-up questions during the day. Thanks so much, and have a great weekend.