UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

FORM 10-Q

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.

HILL-ROM HOLDINGS, INC.

INDEX TO FORM 10-Q

 

Basis of Presentation and Principles of Consolidation

Unless the context otherwise requires, the terms “Hill-Rom,” “the Company,” “we,” “our,” and “us” refer to Hill-Rom Holdings, Inc. and its wholly-owned subsidiaries. The unaudited Condensed Consolidated Financial Statements appearing in this Quarterly Report on Form 10-Q should be read in conjunction with the audited Consolidated Financial Statements and notes thereto included in Hill-Rom’s latest Annual Report on Form 10-K for the fiscal year ended September 30, 20162017 (“20162017 Form 10-K”) as filed with the United States (“U.S.”) Securities and Exchange Commission. The September 30, 20162017 Condensed Consolidated Balance Sheet was derived from audited Consolidated Financial Statements, but does not include all disclosures required by accounting principles generally accepted in the U.S. In the opinion of management, the Condensed Consolidated Financial Statements herein include all adjustments, consisting only of normal recurring adjustments, necessary to state fairly the financial position, results of operations and cash flows for the interim periods presented. Quarterly results are not necessarily indicative of annual results.

The Condensed Consolidated Financial Statements include the accounts of Hill-Rom and its wholly-owned subsidiaries. In addition, we also consolidate variable interest entities ("VIEs"(“VIEs”) where Hill-Rom is deemed to have a controlling financial interest. Intercompany accounts and transactions have been eliminated in consolidation, including the intercompany transactions with consolidated VIEs. Where our ownership interest is less than 100%, the noncontrolling interests are reported in our Condensed Consolidated Financial Statements.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the U.S. requires management to make estimates and assumptions that affect the reported amounts of certain assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expense during the period. Actual results could differ from those estimates and such differences could be material. Examples of such estimates include, but are not limited to, income taxes (Notes 1 and 9), accounts receivable reserves (Note 2), accrued warranties (Note 12), the impairment of intangibles and goodwill (Note 4), pension expense (Note 6), and commitments and contingencies (Note 14).

Fair Value Measurements

Fair value measurements are classified and disclosed in one of the following three categories:

We record cash and cash equivalents, as disclosed on our Condensed Consolidated Balance Sheets, as Level 1 instruments and certain other derivatives and investments as either Level 2 or 3 instruments. Investments measured at Net Asset Value as a practical expedient are not categorized in the fair value hierarchy. There have not been significant changes in our classification among assets and liabilities during the fiscal year.quarter. Refer to Note 5 for disclosure of our debt instrument and interest rate swap fair values.

Taxes Collected from Customers and Remitted to Governmental Units

Taxes assessed by a governmental authority that are directly imposed on a revenue producing transaction between us and our customers, including but not limited to sales taxes, use taxes and value added taxes, are accounted for on a net (excluded from revenue and costs) basis.

Income Taxes

Hill-Rom and its eligible domestic subsidiaries file a consolidated U.S. income tax return. Foreign operations file income tax returns in a number of jurisdictions. Deferred income taxes are computed using an asset and liability approach to reflect the net tax effects of temporary differences between the financial reporting carrying amounts of assets and liabilities and the corresponding income tax amounts. We have a variety of deferred tax assets in numerous tax jurisdictions. These deferred tax assets are subject to periodic assessment as to recoverability. If it is determined that it is more likely than not that the benefits will not be realized, valuation allowances are recognized. In evaluating whether it is more likely than not that we would recover these deferred tax assets, future taxable income, the reversal of existing temporary differences and tax planning strategies are considered.

As of March 31, 2017,2018, we had $27.5$60.0 million of valuation allowances on deferred tax assets, on a tax-effected basis, primarily related to statecertain foreign deferred tax credit carryforwardsattributes that are not expected to be utilizedutilized. The valuation allowance total was not materially impacted by the Tax Cuts and foreign operating loss carryforwards and other tax attributes.Jobs Act enacted in December 2017. We believe that our estimates for the valuation allowances recorded against deferred tax assets are appropriate based on current facts and circumstances.

We account for uncertain income tax positions using a threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The difference between the tax benefit recognized in the financial statements for an uncertain income tax position and the tax benefit claimed in the tax return is referred to as an unrecognized tax benefit.

Dispositions

During the firstsecond quarter of fiscal 2018, we entered into an agreement to convey certain net assets related to the Company’s third-party rental business, which is comprised of purchased moveable medical equipment that can be rented to customers, to Universal Hospital Services, Inc. (“UHS”) in exchange for UHS's agreement to dismiss its previously disclosed litigation against the Company subject to satisfaction of customary closing conditions (“Settlement Agreement”). We recorded a loss of $23.4 million in special charges, which includes approximately $20.4 million related to the non-cash loss reserve for the assets to be conveyed, and other Settlement Agreement related costs of approximately $3.0 million. The third-party rental business is part of our Patient Support Systems segment. The transaction is expected to close during our fiscal third quarter.

Recently Issued Accounting Standards

In May 2014, the FASB issued ASU 2014-09, “Revenue from Contracts with Customers,” which provides guidance for revenue recognition. The standard’s core principle is that a company will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. In August 2015, the FASB issued ASU 2015-14 which delayed the effective date of the new revenue guidance by one year, while permitting companies to early adopt the new standard as of the original effective date. As a result, the provisions of ASU 2014-09 and subsequent amendments, are effective for us in the first quarter of fiscal 2019 using either of the following transition methods: (i) a full retrospective approach reflecting the application of the standard in each prior reporting period with the option to elect certain practical expedients, or (ii) a modified retrospective approach with the cumulative effect of initially adopting ASU 2014-09 recognized at the date of adoption. We plan to adopt the new standard effective October 1, 2018 and are continuing to evaluate the impact of adoption on our Consolidated Financial Statements and the implementation approach to be used.

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). From the lessee’s perspective, the new standard establishes a right-of-use ("ROU"(“ROU”) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement for a lessee. From the lessor’s perspective, the new standard requires a lessor to classify leases as either sales-type, finance or operating. A lease will be treated as a sale if it transfers all of the risks and rewards,

Except as noted above, there have been no significant changes to our assessment of the impact of recently issued accounting standards included in Note 1 of our Consolidated Financial Statements in our 20162017 Form 10-K.

Note 2. Supplementary Balance Sheet Information

Note 3. Acquisitions

Mortara Instrument

On February 14, 2017, we completed the acquisition of Mortara Instrument, Inc. (“Mortara”) for consideration of $330.0 million in cash ($314.1311.2 million, net of cash acquired), primarily financed through a private offering of $300.0 million of senior unsecured notes (see Note 5 of our Condensed Consolidated Financial Statements). Mortara provides a portfolio of diagnostic cardiology devices designed to serve the full continuum of clinical care, from acute care to primary care and clinical research organizations.

The results of Mortara are included in the Condensed Consolidated Financial Statements since the date of acquisition. Our reported revenue included $12.9 million for the quarter ended March 31, 2017 related to Mortara™ products. The impact to net income was not significant. The impact to our comparable quarter and year to date fiscal 2017 revenue and net income on an unaudited proforma basis, as if the Mortara acquisition had been consummated at the beginning of our fiscal 20162017 year, would not have been significant.

The following summarizes the preliminary estimate of the fair value of assets acquired and liabilities assumed at the date of the Mortara acquisition. The fair value of assets acquired and liabilities assumedresults are still considered to be preliminary and are subject to further adjustments.final.

Goodwill in connection with the Mortara acquisition was allocated entirely to our Front Line Care segment. The preliminary fair value attributes aA majority of the goodwill is attributable to the acquired U.S. operations which is deductible for tax purposes.

The following summarizes goodwill activity by reportable segment:

Note 5. Financing Agreements

Total debt consists of the following:

In February 2017, the Companywe entered into $300.0 million of senior unsecured notes maturing February 2025 for purposes of financing the Mortara acquisition. These notes bear interest at a fixed rate of 5.00% annually. We also have outstanding senior unsecured notes of $425.0 million maturing in September 2023 that bear interest at a fixed rate of 5.75% annually (collectively, the "Senior Notes"“Senior Notes”). These Senior Notes were issued at par in a private placement offeringofferings and are not registered securities on any public market. All of the notes were outstanding as of March 31, 2017.2018. We are not required to make any mandatory redemption or sinking fund payments with respect to the Senior Notes, other than in certain circumstances such as a change in control or material sale of assets. We may redeem the 5.75% and 5.00% notes prior to maturity, but doing so prior to September 1, 2021 and February 15, 20202023, respectively, would require payment of a premium on any amounts redeemed, the amount of which varies based on the timing of the redemption. The indentures governing the Senior Notes contain certain covenants which impose limitations on the amount of dividends we may pay and the amount of common shares we may repurchase in the open market, but we do not expect these covenants to affect our current dividend policy or open share repurchase program. The terms of these indentures also impose

We were in compliance with all financial covenants under our Senior Credit Agreement and our amended and restated credit agreement as of March 31, 2017.

We are exposed to market risk from fluctuations in interest rates. We sometimes manage our exposure to interest rate fluctuations through the use of interest rate swaps. As of March 31, 2017,2018, we had nineseven interest rate swap agreements, with notional amounts of $750.0 million, in aggregate, to hedge the variability of cash flows associated with a portion of the variable interest rate payments for the period December 2016 tothrough September 2021 on the Senior Secured Credit Facilities. The interest rate swaps have effective start dates ranging between December 31, 20162017 and September 8, 2020 and were designated as cash flow hedges. AtAs of March 31, 2018, these swaps were in a net asset position with an aggregate fair value of $21.7 million, all of which were classified as Other assets. As of September 30, 2017, these swaps were in a net asset position with an aggregate fair value of $11.5 million.$7.3 million, of which $8.5 million were classified as Other assets and $1.2 million were classified as Other current liabilities. We classify fair value measurements on our interest rate swaps as Level 2, as described in Note 1.

The fair value of our debt is estimated based on the quoted market prices for the same or similar issues or on the current rates offered to us for debt of the same remaining maturities. The book values of our short-term debt instruments and Revolving Credit Facility approximate fair value.

The estimated fair values of our long-term debt instruments, including the current portion, are described in the table below:

The estimated fair values of our long-term unsecured debentures were based on observable inputs such as quoted prices in markets that are not active. The estimated fair values of our term loans and the Senior Notes were based on quoted prices for similar liabilities. These fair value measurements are classified as Level 2, as described in Note 1.

We sponsor five defined benefit retirement plans. Those plans include: a master defined benefit retirement plan, a nonqualified supplemental executive defined benefit retirement plan, and three defined benefit retirement plans covering employees in Germany and France. Benefits for such plans are based primarily on years of service and the employee’s level of compensation during specific periods of employment. We contribute funds to trusts as necessary to provide for current service and for any unfunded projected future benefit obligation over a reasonable period of time. All of our plans have a September 30 measurement date. The following table details the components of net pension expense for our defined benefit retirement plans.

In addition to defined benefit retirement plans, we also offer two domestic postretirement health care plans, one of which was assumed in the acquisition of Welch Allyn, that provide health care benefits to qualified retirees and their dependents. The plans are closed to new participants and include retiree cost sharing provisions. Annual costs related to these plans are not significant.

We have defined contribution savings plans that cover substantially all U.S. employees and certain non-U.S. employees. The general purpose of these plans is to provide additional financial security during retirement by providing employees with an incentive to make regular savings. Our contributions to the plans are based on eligibility and employee contributions. Expense under these plans was $7.1$7.5 million and $7.2$7.1 million in each of the quarterly periods ended March 31, 2018 and 2017, and 2016,$13.9 million and $13.1 million and $13.3 million in the year to date periods ended March 31, 20172018 and 2016.2017.

The following table represents the changes in accumulated other comprehensive loss by component:

The following table represents the items reclassified out of accumulated other comprehensive loss and the related tax effects:

(a) Reclassified from accumulated other comprehensive lossincome (loss) into Investment income and other, net.Interest expense.

(b) Reclassified from accumulated other comprehensive lossincome (loss) into Cost of goods sold and Selling and administrative expenses. These components are included in the computation of net periodic pension expense.

During the first quarter of fiscal 2018, we initiated a global transformation program focused on reducing complexity, increasing efficiency, improving our cost structure and accelerating growth with targeted investments that align with our strategic priorities. For the quarter and year to date periods ended March 31, 2018, this program resulted in charges of $9.6 million and $18.8 million, of which $4.8 million and $10.8 million were severance and benefit costs. We continue to evaluate additional actions related to this program and expect additional special charges to be incurred. However, it is not practicable to estimate the amount of these future expected costs until such time as the evaluations are complete.

During the second quarter of fiscal 2017, we sold our Architectural Products businessCharleston property for $6.1 million in cash proceeds and recorded a gain of $5.2 million.

Since the inception of the Site Consolidation program through March 31, 2018, we have recognized aggregate special charges of $1.1 million, primarily related$42.8 million. We continue to severance.evaluate our facilities footprint and expect to incur additional costs with respect to other actions in the future, however, it is not practicable to estimate the amount of these future expected costs until such time as the evaluations are complete.

We recently acquired Mortara and Tridien and initiated integration activities to optimize the available synergies of our combined company. Additionally, with the acquisition of Welch Allyn in September 2015, we initiated plans to realign our business structure to facilitate the integration, take full advantage of available synergies, and position our existing businesses to capitalize on opportunities for growth. We also incurred costs, including severance and benefit costs, associated with other business realignment and integration activities. During the quarter and year to date periods ended March 31, 2017,2018, we incurred total integration and business realignment charges of approximately $0.1 million and $0.4 million. These amounts compare to charges of $2.1 million and $2.3 million during the quarter and year to date periods ended March 31, 2017, of which $1.4 million were severance and benefit costs for the quarter and year to date periods ended March 31, 2017. These amounts compare to charges of $6.3 million and $10.8 million during the quarter and year to date periods ended March 31, 2016. We continue to evaluate additional actions related to integration and business realignment and expect additional special charges to be incurred. However, it is not practicable to estimate the amount of these future expected costs until such time as the evaluations are complete.

For all accrued severance and other benefit charges described above, we record restructuring reserves within otherOther current liabilities. The reserve activity for severance and other benefits during the year to date period ended March 31, 20172018 was as follows:

The effective tax rate for the quarter and year to date periods ended March 31, 20172018 was (32.6)% and (123.3)% compared to 17.7% and 24.9% compared to 21.4% and 22.1% for the quarter and year to date periods in the prior year. The effective tax rate for the current quarter is lower than the comparable period in fiscal 20162017 due primarily to theperiod tax benefits fromof $11.2 million primarily related to a change in a tax accounting

method approved by the adoption of ASU 2016-09 discussedInternal Revenue Service in Note 1.the current period. The change in accounting method resulted in a reduction in U.S. tax for prior year currency exchange losses. The effective tax rate for the year to date period is higherlower than the comparable period in fiscal 2016 primarily2017 due to athe lower percentage impact ofcorporate tax rate and period tax benefits and a shiftof $75.6 million primarily related to recording the items attributable to the new tax legislation in the geographic mix of income.U.S. as described below and the change in tax accounting method. The six monthcomparable prior year period included period tax benefits of $3.5 million primarily related to the adoption of the ASU 2016-09 partially offset by the expense to revalue the France deferred tax assets due to the law change that reduced the future corporate income tax rate in France.

On December 22, 2017, the U.S. government enacted comprehensive tax legislation commonly referred to as the Tax Cuts and Jobs Act (the “Tax Act”). The comparableTax Act makes broad and complex changes to the U.S. tax code which will impact our fiscal year ended September 30, 2018 including, but not limited to (1) reducing the U.S. federal corporate tax rate, (2) requiring a one-time transition tax on certain unrepatriated earnings of foreign subsidiaries that may electively be paid over eight years, and (3) accelerated first year expensing of certain capital expenditures. The Tax Act reduces the federal corporate tax rate from 35 percent to 21 percent effective January 1, 2018. Internal Revenue Code Section 15 provides that our fiscal year ended September 30, 2018 will have a blended corporate tax rate of 24.5 percent, which is based on a proration of the applicable tax rates before and after effective date of the Tax Act. The statutory tax rate of 21 percent will apply for fiscal 2019 and beyond.

Shortly after the Tax Act was enacted, the SEC staff issued Staff Accounting Bulletin No. 118, Income Tax Accounting Implications of the Tax Cuts and Jobs Act (SAB 118) which provides guidance on accounting for the Tax Act’s impact. SAB 118 provides a measurement period, which in no case should extend beyond one year from the Tax Act enactment date, during which a company acting in good faith may complete the accounting for the impacts of the Tax Act under ASC Topic 740. In accordance with SAB 118, the Company must reflect the income tax effects of the Tax Act in the reporting period in which the accounting under ASC Topic 740 is complete.

To the extent that a company’s accounting for certain income tax effects of the Tax Act is incomplete, the Company can determine a reasonable estimate for those effects and record a provisional estimate in the financial statements in the first reporting period in which a reasonable estimate can be determined. If a Company cannot determine a provisional estimate to be included in the financial statements, the Company should continue to apply ASC 740 based on the provisions of the tax laws that were in effect immediately prior year includedto the Tax Act being enacted. If a Company is unable to provide a reasonable estimate of the impacts of the Tax Act in a reporting period, a provisional amount must be recorded in the first reporting period in which a reasonable estimate can be determined.

We have recorded a provisional discrete net tax benefitsbenefit of $2.0$61.4 million primarily related to the retroactive reinstatementTax Act in the year to date period ending March 31, 2018. No additional adjustments were recorded in the current quarter. This net benefit primarily consists of a net benefit of $93.8 million due to the remeasurement of our deferred tax accounts to reflect the corporate rate reduction impact to our net deferred tax balances and a net expense for the transition tax of $32.4 million.

Reduction in U.S. Corporate Rate: The Tax Act reduces the U.S. federal statutory corporate tax rate to 24.5 percent in fiscal year ending September 30, 2018 and 21 percent for fiscal year ending September 30, 2019 and beyond. We have recorded a provisional adjustment to our net deferred tax balances, with a corresponding discrete net tax benefit of $93.8 million in the current year to date period. In our annual effective tax rate we have reflected the tax effect of the research credit.temporary differences that will originate subsequent to the Tax Act and are required to be remeasured at the 21 percent tax rate. While we are able to make a reasonable estimate of the impact of the reduction in corporate rate, we are continuing to analyze the temporary differences that existed on the date of enactment, and the temporary differences originating in the current fiscal year.

Basic earnings per share is calculated based upon the weighted average number of outstanding common shares for the period, plus the effect of deferred vested shares. Diluted earnings per share is calculated consistent with the basic earnings per share calculation plus the effect of dilutive unissued common shares related to stock-based employee compensation programs. For all periods presented, anti-dilutive stock options were excluded from the calculation of diluted earnings per share. Cumulative treasury stock acquired, less cumulative shares reissued, have been excluded in determining the average number of shares outstanding.

Earnings per share are calculated as follows (share information in thousands):

The stock-based compensation cost that was charged against income, net of tax, for all plans was $7.0 million and $4.5 million in both of the quarterly periods ended March 31, 2018 and 2017, and 2016,$11.6 million and $7.7 million in both of the year to date periods ended March 31, 20172018 and 2016.2017.

During the first quarter of fiscal 2017, we purchased 0.6 million shares of our common stock for $30.0 million in the open market, leaving $34.7market.

As of March 31, 2018, a cumulative total of $175.3 million of shares available for purchase under a $190 millionour share repurchase program approved by the Boardhad been used, leaving us with approximately $165.0 million of Directors in September 2013, whichavailability. This program does not have an expiration date.date and there are no plans to terminate this program in the future.

We routinely grant limited warranties on our products with respect to defects in material and workmanship. The terms of these warranties are generally one year, however, certain components and products have substantially longer warranty periods. We recognize a reserve with respect to these obligations at the time of product sale, with subsequent warranty claims recorded directly against the reserve. The amount of the warranty reserve is determined based on historical trend experience for the covered products. For more significant warranty-related matters which might require a broad-based correction, separate reserves are established when such events are identified and the cost of correction can be reasonably estimated.

A reconciliation of changes in the warranty reserve for the periods covered in this report is as follows: