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Article by DailyStocks_admin    (08-28-08 08:35 AM)

Filed with the SEC from Aug 14 to Aug 20:

Hill-Rom Holdings (HRC)
Breeden Capital Management, the hedge fund run by Richard Breeden, former chairman of the Securities and Exchange Commission, reported ownership of 3,278,409 shares (5.25%). Breeden Capital has talked with HRC management about its business, financial performance, costs and capital allocation, including share repurchases, operations, strategic plans and potential for divestiture of noncore business units. Breeden intends to continue discussions with management and potentially with members of the board.

BUSINESS OVERVIEW

General
Hillenbrand Industries, Inc. was incorporated on August 7, 1969 in the State of Indiana and is headquartered in Batesville, Indiana. Hillenbrand is a public holding company for its two major operating businesses serving the health care and death care industries in the United States and abroad.
Hill-Rom is a leading worldwide manufacturer and provider of medical technologies and related services for the health care industry, including patient support systems, non-invasive therapeutic products for a variety of acute and chronic medical conditions, medical equipment rentals and health information technology solutions. Hill-Rom’s comprehensive product and service offerings are used by health care providers across the health care continuum in hospitals, extended care facilities and home care settings worldwide, to enhance the safety and quality of patient care and patient customers.
Batesville Casket Company is a leader in the North American death care industry through the manufacture, distribution and sale of funeral service products to licensed funeral establishments. Batesville’s products consist primarily of burial and cremation caskets, but also include containers and urns, selection room display fixturing for funeral establishments, other personalization and memorialization products and services, including creating and hosting websites for funeral establishments.
Unless the context otherwise requires, the terms “Hillenbrand,” the “Company,” “we,” “our” or “us” refer to Hillenbrand Industries, Inc. and one or all of its consolidated subsidiaries, as the context requires, and the terms “Hill-Rom Company” or “Hill-Rom,” “Batesville Casket Company” or “Batesville” and derivations thereof refer to one or more of the subsidiary companies of Hillenbrand that comprise those businesses.

Business Segment Information
Net revenues, segment profitability, identifiable assets and other measures of segment reporting for each reporting segment are set forth in Note 13 to the Consolidated Financial Statements, which statements are included herein under Item 8.
Our operating structure contains the following reporting segments:
• Hill-Rom North America Acute Care

• Hill-Rom North America Post-Acute Care

• Hill-Rom International and Surgical

• Batesville Casket
Separation into Two Independent Companies
As previously announced, Hillenbrand is pursuing a plan to separate into two independent publicly traded companies, each strategically positioned to capitalize on growth opportunities in their respective markets. On November 5, 2007, a Form 10 registration statement was filed with the U. S. Securities and Exchange Commission (“SEC”) related to the separation of Hill-Rom, the Company’s medical technology business, and Batesville Casket, the Company’s funeral service business. Under the previously disclosed plan approved by the Board, Batesville Casket is expected to be spun out of Hillenbrand through a tax free dividend of its shares to Hillenbrand shareholders, and Hill-Rom will become the sole operating unit of Hillenbrand. See the section “Management’s Discussion and Analysis of Financial Condition and Results of Operations” for further discussion regarding the separation.
HILL-ROM — MEDICAL TECHNOLOGIES AND RELATED SERVICES BUSINESS
Hill-Rom is a leading worldwide manufacturer and provider of medical technologies and related services for the health care industry, including patient support systems, non-invasive therapeutic products for a variety of acute and chronic medical conditions, medical equipment rentals and health information technology solutions. Hill-Rom’s comprehensive product and service offerings are used by health care providers across the health care continuum in hospitals, extended care facilities and home care settings worldwide, to enhance the safety and quality of patient care and patient customers.
Products and Services
Hill-Rom has contracts in the United States with numerous group purchasing organizations, or GPOs, which represent large groups of acute care and extended care facilities in order to negotiate rental and purchase terms on behalf of all of their members, as well as with government purchasers in the United States and elsewhere. A significant portion of Hill-Rom’s sales are made pursuant to these contracts.
Patient Support Systems. Hill-Rom’s innovative patient support systems include a variety of electrically adjustable and manual bed systems and integrated and non-integrated therapeutic surfaces for use in high, mid and low acuity settings. Bed systems are one of the most visible and important medical devices in health care and play a significant role in improving patient outcomes and caregiver safety. Improved outcomes are frequently enabled by the interoperability among bed frames, surfaces and clinical information technologies. Specifically, our advanced patient support systems can provide patient data reporting (e.g., weight and therapy statistics), real time caregiver decision support, patient safety alarms and caregiver alerts concerning such things as bed exit, bed height, patient positioning, wound healing and prevention, pulmonary treatment, point of care controls, and patient turn assist and upright positioning. These features and functions, when combined with caregiver training and treatment protocols, have been demonstrated to reduce a number of the top adverse events associated with patient stays, including bedsores (or pressure ulcers), ventilator-associated pneumonia, patient falls, deep vein thrombosis and patient entrapments.

Other Hill-Rom ® patient support systems include bedside cabinets, adjustable-height overbed tables, mattresses, communications products and patient room furniture. Hill-Rom also supplies Temper-Pedic jointly branded, premium, non-powered, comfort mattresses to our acute care customer base. Surgical table accessories include the FlexFrame™ device, which converts a standard operating room table into a surgical table for spine procedures. Architectural products include headwalls and power columns, such as the intensive care architectural arm platform called the Latitude ® system , which enable medical gases, communication accessories and electrical services to be distributed in patient rooms.
Hill-Rom sells these products primarily to acute and extended care health care facilities worldwide through both a direct sales force and distributors. Approximately 60 percent of Hill-Rom’s revenues during fiscal 2007 were derived from sales of patient support systems.

Hill-Rom rents and sells non-invasive therapeutic products and surfaces in the United States, Canada and Europe through a clinical sales force comprised primarily of professionals with a background in nursing or respiratory therapy. Technical support is made available through an extensive network of technicians and service personnel who provide maintenance and technical assistance from more than 250 Hill-Rom service centers located in the United States, Canada and Europe. Certain Hill-Rom Ò therapy systems are also sold to customers. Approximately 24 percent of Hill-Rom’s revenues were derived from these therapeutic products and surfaces in fiscal 2007.

Moveable Medical Equipment Rentals and Asset Management Services. Hill-Rom provides peak-need rentals and full-hospital asset management for a wide variety of moveable medical equipment, also known in the industry as MME, such as ventilators, infusion pumps and monitoring equipment. Hill-Rom’s medical equipment rental and service business also includes equipment service contracts for Hill-Rom’s capital equipment. Hill-Rom provides these products and services primarily to acute and extended health care facilities through a network of over 250 service centers and over 1,600 service professionals throughout the United States, Canada and Europe.
Hill-Rom provides Asset Management services through various business models to hospitals. Customers seek our services in order to optimize use of their capital investment, as well as a means of introducing new technologies to the hospital and improving utilization by controlling the deployment of their assets.
Approximately 10 percent of Hill-Rom’s revenues were derived from these products and services in fiscal 2007.
Health Information Technology Solutions. Hill-Rom develops and markets a variety of communications technologies and software solutions that are designed to enhance operational efficiency, improve asset utilization and capacity optimization of health care facilities. These products include our suite of clinical communication and productivity solutions, our NaviCare ® Patient Flow Management System and WatchChild ® Obstetric Data Management System. These solutions enable patient-to-staff and staff-to-staff communications to improve patient outcomes and caregiver safety and efficiency. By aggregating messages, alarms and data from patient platforms or other integrated communication devices we can provide real-time alerts to caregivers and construct post-event analyses. Included in this suite is a new product that takes important bed data and sends it directly to the caregiver to improve patient safety related to the prevention of patient falls and ventilator acquired pneumonia. Our NaviCare ® Patient Flow Management System enhances facility productivity through a suite of visual display and communication tools that automate patient flow tasking and the bed and room turnover process. Finally, through our WatchChild ® Obstetric Data Management System, Hill-Rom also provides a perinatel safety solutions suite that focuses on maternal and fetal monitoring and data archiving.
Following extension of our health information technology solutions sales team and channels in fiscal 2007, Hill-Rom provides these hardware and software products and services primarily to acute and extended health care facilities through 33 direct sales executives located throughout the United States and Canada. Approximately 6 percent of Hill-Rom’s fiscal 2007 revenues were derived from these products and services to enhance operational efficiency and asset utilization.
Other. Hill-Rom operates hospital bed, therapy bed and patient room equipment manufacturing and development facilities in the United States, France, and with the October 2006 acquisition of Medicraft as well as the start-up of a new low cost manufacturing facility, in Australia and Mexico. Most Hill-Rom Ă’ product sales are delivered by Hill-Rom owned trucks.

Hill-Rom competes on the basis of clinical expertise and resulting product clinical utility and ability to produce favorable outcomes, as well as value, quality, customer service, innovation and breadth and depth of product offerings.
Regulatory Matters
FDA Regulation
We design, manufacture, install and distribute medical devices that are regulated by the Food and Drug Administration (“FDA”) in the United States and similar agencies in other countries. The regulations adopted and standards imposed by these agencies evolve over time and require us to make changes in our manufacturing processes and quality systems to remain in compliance. These agencies routinely inspect our facilities, as with other medical device manufacturers. If we fail to comply with applicable regulations and standards, determined by inspections or otherwise, we may be subject to compliance measures, including the recall of products and cessation of manufacturing and/or distribution.
As necessary, we engage in voluntary product recalls and other corrective actions, including voluntarily ceasing shipment of devices. Additionally, within our medical equipment rental fleet, we are responsible for extending these types of actions to its customer base when the actions are initiated by the original equipment manufacturer. We also have implemented an extensive program designed to ensure our quality systems continue to comply with the FDA Quality System Regulation requirements and the regulatory equivalents under the Medical Device Directive in the European Union.

Over the past twelve months, the FDA performed inspections at our Charleston, Batesville, Cary and Acton facilities. The FDA issued no reports of observations for the Charleston and Cary inspections and issued reports of observation for the Acton and Batesville inspections. We have responded to the Acton report with a remediation plan and expect no further actions. We have provided a written response to the report of observation for the Batesville facility, and subsequently met with FDA to discuss our response. Thereafter, we reached a decision to perform a voluntary medical device correction of VersaCare ® beds manufactured before January 26, 2006. The medical device correction consists of replacing the siderail latching mechanisms with an updated version of the mechanism. The correction is expected to be fully implemented within the next twelve months. Audits conducted by foreign agencies have resulted in some observations resulting in corrective actions implemented by us. We recently received certification to ISO 13485-2003 for all our facilities supplying products to the European Union. This revised quality system standard is a significant change from past standards and is required for future compliance. While we believe we have responded fully to the findings and have implemented corrective actions when necessary, any determination by the FDA or similar foreign agency that our products or quality systems do not comply with applicable regulations could result in future compliance activities, including product recalls, injunctions preventing shipment of products, or other enforcement actions that could have a material adverse effect on our financial condition, results of operations and cash flow.
Health Care Regulation
Our customers include hospitals and other acute and extended care facilities that receive reimbursement for certain products and services they provide from various third-party payors including Medicare, Medicaid, managed care organizations, such as health maintenance organizations and preferred provider organizations, and traditional indemnity insurers. In our home care business and a small portion of our extended care business, we are reimbursed directly by such third-party payors. Accordingly, our home care business is significantly affected by changes in reimbursement practices of such third-party payors. In addition, our customers are significantly affected by changes that may result in reduced utilization and downward pressure on prices across our health care businesses. Future legislative or regulatory efforts relating to health care reimbursement policies or other factors affecting health care spending may further affect the manner in which our customers acquire and use our products. For example, legislation likely will be considered by Congress that would reprioritize healthcare related expenditures. Any such legislation could negatively impact Medicare and Medicaid reimbursement in a variety of healthcare settings.
The Medicare Modernization Act, or MMA, passed in November of 2003, represents some of the most complex and far-reaching changes to Medicare since its inception. While the MMA has not been fully implemented and all of the implications of this law are not yet clear, there has been and will continue to be an affect on durable medical equipment placed in the home. The latest of these developments is the recent finalization of rules on competitive bidding. Competitive bidding was finalized for ten product categories within ten Competitive Bidding Areas (“CBAs”) in September 2007, with actual pricing under those bids to take effect in July 2008. Following this initial implementation, competitive bidding is planned to be rolled out to seventy additional CBAs in 2009 and nationally thereafter. The products covered will also increase with the roll-out. The overall effect of these actions on our business is not yet known. However, with respect to the competitive bidding initiative, of the initial ten product categories included, only two are applicable to our current product offerings. Hospital beds and related supplies were subject to bid in each of the ten CBAs, while support surfaces were limited to only two of the CBAs. We plan to compete in most of the CBAs where our products are included, and we plan to increase our extended and home care offerings. As the predominant goal of the new rules is to reduce spending, it is appropriate to expect pricing for such products to be lower as a result. Further, as the bidding process could effectively “lock out” vendors from the individual product categories if their bids are too high, the implications could be even more severe.

MANAGEMENT DISCUSSION FROM LATEST 10K

Hillenbrand Overview
Hillenbrand Industries is organized into two operating companies serving the health care and death care industries.
Hill-Rom is a leading worldwide manufacturer and provider of medical technologies and related services for the health care industry, including patient support systems, non-invasive therapeutic products for a variety of acute and chronic medical conditions, medical equipment rentals and health information technology solutions. Hill-Rom’s comprehensive product and service offerings are used by health care providers across the health care continuum in hospitals, extended care facilities and home care settings worldwide, to enhance outcomes for patients and their caregivers.
Batesville Casket Company is a leader in the North American death care industry through the manufacture, distribution and sale of funeral service products to licensed funeral establishments. Batesville’s products consist primarily of burial and cremation caskets but also include containers and urns, selection room display fixturing, other personalization and memorialization products and services, including creating and hosting websites, for funeral homes.
Separation into Two Independent Companies
On May 10, 2007 Hillenbrand announced that its Board of Directors had approved in principle a plan to separate the Company into two independent publicly traded companies, each strategically positioned to capitalize on growth opportunities in its respective markets. Under the plan approved by the Board, Batesville Casket would be spun out of Hillenbrand through a tax free dividend of its shares to shareholders of Hillenbrand, and Hill-Rom would become the sole operating unit of Hillenbrand. In connection with the separation, Hillenbrand plans to change its name to Hill-Rom Holdings, Inc., and Batesville Casket’s publicly traded parent would change its name to Hillenbrand, Inc. Under the plan, the current management team of each company would remain in place. It is anticipated that Hill-Rom would be led by Peter H. Soderberg, and Batesville Casket would be led by Kenneth A. Camp.
In arriving at the decision to separate the two operating companies, the Board of Directors and senior leadership team of the Company carefully weighed a number of alternatives related to the maximization of long-term value for Company shareholders. After a detailed review, the Board concluded that there is a strong business case to support the separation of the two operating companies comprising Hillenbrand. By operating independently, each company would be able to adopt an appropriate capital structure to allow it to better execute its business plans and enhance shareholder returns. Each company would also be able to utilize its own equity as currency for strategic purposes. Further, two focused companies would be better positioned for investors looking for specific industry, valuation, yield, and growth profiles. Accordingly, the plan to separate into two companies is consistent with our strategy to create focused, mission-driven enterprises, and as independent and focused companies, each would be better able to compete for, attract and retain talent.
Immediately after the separation, Hillenbrand shareholders would own shares in both entities. The transaction will be subject to the final approval of the Board of Directors, favorable market conditions, formal tax opinions on select aspects of the transaction from legal counsel, the effectiveness of a registration statement for Batesville Casket’s parent with the U.S. Securities and Exchange Commission (“SEC”) and completion of necessary debt refinancing and other customary conditions.

Upon separation, each company should enjoy sufficient financial strength and flexibility to achieve its objectives. Subject to review by independent rating agencies, it is intended that upon separation, each company’s financial policies, credit metrics and balance sheets would be commensurate with investment grade credit ratings. Until the transaction is completed, Hillenbrand expects to pay its current quarterly dividend of $0.2850 per share. In addition, we intend to pay comparable quarterly cash dividends, at least initially, following completion of our separation of our two operating companies.
To date we are progressing with our plans to execute the separation of our companies within the expected nine-month time frame previously communicated. We are contemplating entering into a judgment sharing agreement intended to predictably apportion responsibility between the separated companies for any potential damages associated with antitrust litigation currently pending against Hillenbrand and its Batesville Casket Company subsidiary. We are consulting with the SEC regarding the accounting treatment for the judgment sharing agreement to confirm whether Statement of Financial Accounting Standards No. 5, “Accounting for Contingencies”, with which the company currently complies, should continue to apply to its accounting for the lawsuits and the judgment sharing agreement after the separation, or if a probability-based analysis should be utilized to determine any reserve needs with respect to the judgment sharing agreement.
Neither Hillenbrand nor Batesville Casket believes it has committed any wrongdoing as alleged in the lawsuits. We believe we have meritorious defenses to class certification and to the plaintiffs’ underlying allegations and damage theories and will continue to assert those defenses vigorously. In accordance with applicable accounting standards, we have not established a loss reserve for the lawsuits. However, Hillenbrand’s management concluded that it would be prudent to establish a judgment sharing agreement between Hillenbrand and Batesville in connection with the lawsuits, prior to a spin-off, to predictably allocate any potential litigation exposure.
Given the extremely high damages numbers the plaintiffs have alleged, even an extremely low probability of an adverse outcome could result in a significant reserve, which plaintiffs might misuse to argue for an admission of liability or as a baseline from which to calculate potential damages. Therefore, if a probability-based analysis were to be required with respect to the accounting for the judgment sharing agreement, the Company intends to evaluate whether to pursue or delay the separation of the businesses or pursue other alternatives to increase shareholder value.
Industry Trends, Strategy and Other Factors Impacting Hillenbrand’s Business
Hillenbrand Industries’ goal is to grow organic revenue and operating income by an average of mid-to-high single digits over the 2008-2009 time frame. Hill-Rom has and plans to continue to invest significantly in research and development, sales channel enhancements and low cost region manufacturing and sourcing initiatives to allow us to protect and grow our core North American acute care businesses, improve gross margins and revitalize our North American rental business. In addition, we believe there are new growth opportunities in post-acute care settings, international markets and our emerging entrepreneurial businesses. At Batesville Casket, we plan to invest selectively to maintain and nurture our current leadership position with independent funeral directors while exploring new opportunities in less penetrated product segments. For Hillenbrand Industries overall, during this period we expect improved sales growth while we fund significant, yet targeted, investments in order to realize our growth potential.

Hill-Rom Industry Trends
General Trends. The medical device industry remains diverse and highly competitive. We believe that over the long term, patient and provider demand for health care products and services will continue to rise as a result of a number of factors, including an aging population, longer life expectancies, and an increasing number of sicker patients across all care settings, including hospitals, extended care facilities and in the home. These patients have more complex co-existing diseases, or co-morbidities, such as diabetes, heart failure, obesity, pulmonary and vascular disease, immobility issues and chronic wounds. Patients and their families are becoming increasingly discerning consumers who demand solutions that enhance their quality of life in all settings of care. At the same time, health care providers across the care continuum are under continued pressure to improve efficiency, control costs, improve the quality of care, maintain good relations with physicians and caregivers and comply with a complex and demanding reimbursement and regulatory environment. These challenges faced by providers will continue due to demographic trends, increasing numbers of uninsured patients, reimbursement pressures from third-party payors, continuing nurse and physician shortages, facility capacity constraints and increasing technology and supply costs.
Rising Acuities in All Care Settings. As a result of the growing population of the elderly, particularly in the United States, the health care system is challenged to treat rising incidences of complex diseases and conditions such as obesity, diabetes, congestive heart failure and respiratory disease. Patients are being moved through the hospital faster and we see a progression of sicker patients who are being moved to lower acuity care settings. These trends are putting pressure on caregivers across all care settings and increasing the need for more sophisticated means to care for these patients. Improved medical technologies, communications tools and information technologies will likely be an integral part of helping increasingly challenged providers care for these sicker patients with more complex diseases and conditions.
Patient Safety & Quality. An increasing emphasis is being placed within U.S. hospitals to assure quality of care through increased accountability and public disclosure. Quality indicators surrounding patient safety and clinical outcome measurements are increasingly being publicized, and improvement of institutional performance is a matter of focus by many hospital executives and their boards. The “pay for performance” initiative by the Centers for Medicare and Medicaid Services (“CMS”) aims to better align reimbursement with improved patient outcomes and the reduction of adverse events. Transparency through public reporting of quality data continues to accelerate, as well as the focus to increase accountability through penalties or rewards resulting from whether quality measures are reported. Most recently, CMS has issued its Final Rule for fiscal 2008 inpatient payment, a continuation in the agency’s efforts to align reimbursement more closely with cost of care and severity of illness. Within this measure, hospitals may experience reduced reimbursement for hospital acquired adverse events, marking a stronger connection with these adverse events and revenue levels. A number of the top adverse events and preventable medical errors in United States hospitals can be mitigated in part by our technologies, processes and services, including bedsores (or pressure ulcers), ventilator associated pneumonia, patient falls, deep vein thrombosis and patient entrapment. We are well positioned to benefit from the emphasis being placed on patient safety due to our strong clinical capabilities, products and technologies that are designed to assist providers in materially improving outcomes associated with patients confined to beds across all care settings.
Caregiver Safety. Caregiver shortages, work-related injuries, the aging work force, and other staffing requirements have focused hospital and health care executives on the need to improve caregiver safety. Our products and services seek to address these concerns through novel application of technology, clinical and ergonomic science, and customer feedback. We believe that meaningful competitive differentiation can be achieved.

Patient Consumerism and Satisfaction. Patients and their families are becoming increasingly discerning consumers and are increasingly approaching health care as they do other free-market goods and services, basing decisions on price, quality and services. Open access to and exchange of information empower patients to make more informed decisions concerning their health care. As a result of these trends, health care providers are actively competing for these consumers through enhanced services, quality initiatives, amenities and improved aesthetic design of their facilities. We believe we are well positioned to enhance the experience of the patient through our initiatives in patient comfort and patient room design.
Capital Expenditures and Construction. Hospitals and health systems continue to break ground on new facility projects and renovation at rates that exceed historic levels. This construction activity is generated by the need to modernize aging facilities and to effectively compete for more demanding consumers. In over half of the renovation or new construction cases an increase in inpatient bed capacity occurs. At the same time that capital spending has increased, competition for the share of capital expenditure dollars has also been significant. Much of the health system spending is focused on information technology, imaging, outpatient development and the addition of new service lines.
Growing Desire Among Developed and Developing Countries to Invest in Health Care. While industry growth rates in more mature geographic markets such as western and northern Europe and Japan have moderated, in many other geographic markets, where the relative spending on health care is increasing, we are experiencing increasing demand for medical technologies. New hospital construction and hospital refurbishments have been accelerating in regions such as Latin America, the Middle East and many parts of Asia. We believe that we are moving appropriately to establish the products and resources in these regions that will help to improve the standard of care available to their citizens and caregivers.
Legislative. We are continuing to monitor reimbursement developments and their implications particularly in the U.S. A number of Medicare rules have been finalized this year by CMS dealing with a variety of care settings. Overall, these result in a somewhat mixed bag of consequences with, for example, skilled nursing facilities benefiting from a payment increase, and long term care hospitals receiving cutbacks. Overall, hospitals’ position has remained generally favorable. For example, earlier this fall, Congress partially restored funding that had been cut in conjunction with the hospital inpatient rule. CMS carried out its proposed Medicare Severity DRG system designed to account for differences in the severity of illness among patients within a given DRG. The severity adjusted DRGs threaten to induce payment volatility and burden hospitals with increased administrative and implementation costs. The ruling also focuses on greater transparency and accountability related to the occurrence of hospital-acquired conditions. Circumstances remain likely for Medicare and Medicaid cost containment measures in the foreseeable future. Further, at the state level, while some easing of budgetary pressures has been noted, fiscal challenges largely remain with Medicaid expenditures claiming increasing portions of state budgets. Universal health care has become one of the most widely discussed issues of the upcoming presidential election, and some states have already implemented programs aimed at achieving 100 percent coverage. Lastly, the competitive bidding issue continues to be very active within the home health care sector, and the circumstances surrounding the proposed State Children’s Health Insurance Program legislation illustrate the controversial nature of the prospect of expanded coverage, as well as underscore the significant financial implications of the legislation for government and health care providers.
Hill-Rom Strategies
Our financial goal is to grow our annual revenue organically by an average of mid-to-high single digits and operating income by ten to thirteen percent over the 2008-2009 timeframe. We plan to continue the investments begun in fiscal 2007 in new product development, sales channel development and low cost region manufacturing and sourcing initiatives that are required to execute our strategy.

RESULTS OF OPERATIONS

Fiscal Year Ended September 30, 2007 Compared to Fiscal Year Ended September 30, 2006
In the following section, we provide a high level summary of our consolidated results of operations for fiscal 2007 compared to fiscal 2006. Immediately following this summary section is a more comprehensive discussion of revenues and divisional income by operating segment.
Summary
Net Revenues
Consolidated revenues in 2007 increased $60.8 million, or 3.1 percent to $2,023.7 million, compared to the prior year.
The increase in revenues was related entirely to Health Care sales revenues, which increased $78.1 million, or 9.1 percent, on higher volumes and to a lesser extent favorable exchange rates and price realization when compared to the prior year. The higher volumes were driven by our International and Surgical segment, which experienced continued success with our new AvantGuard™ 800 product line in the mid and low-end acuity bed frame environment within Europe, along with sales from our first quarter acquisition in Australia, Medicraft, which helped provide $14.4 million of incremental revenues. Some volume strength was also realized in our North America Acute Care segment, led by CareAssist ® ES bed frames, our Latitude ® architectural arm platform, service revenue and our recently updated stretcher and maternal lines. Somewhat offsetting the volume strength from these products, we experienced lower volumes in our TotalCare ® ICU and mid-acuity and VersaCare ® bed platforms. Within the North America Post-Acute Care segment, sales revenues were up $6.7 million, driven primarily by positive sales growth of The Vest ® products and higher bed frame volume within the extended care environment. In fiscal 2008, global health care sales are expected to remain strong, with growth projected to be at an upper single digit rate.

Health Care rental revenues were down $9.9 million, or 2.3 percent, compared to the prior year. The lower rental revenues resulted from changes in GPO affiliations and lower volumes, which were expected coming into the year. Although working diligently to restore confidence and repair strained customer relationships, we also continued to experience the carryover effect of many of the unfavorable conditions encountered in fiscal 2006, including customer relationship issues resulting from past billing issues, service and product deficiencies. As discussed earlier, we continue to have significant initiatives underway to reverse those trends and to revitalize our rental operations, including having made increased investments in our therapy rental fleet during 2007, as well as various initiatives intended to increase efficiencies and reenergize customer focus. We have already begun to realize benefits in these areas which have received our initial focus and investments, but certain other initiatives will require more time and focus to take hold. Accordingly, the desired benefits of some of these initiatives are not expected to be fully realized until fiscal 2008. As a result of these and other initiatives and after the slight decline in 2007, we expect rental revenues to grow in fiscal 2008 by mid-to-high single digits.
Funeral Service revenues were down slightly for the year, decreasing $7.4 million or 1.1 percent, driven primarily by declining volumes resulting from the continued decline in burial deaths during the year and competitive market dynamics. Although we have seen some mix improvement as a result of our merchandising focus, overall mix was also unfavorable for the year. One key driver to the unfavorable mix results was the increased sales in our new lines of lower-end metal products. Favorable net price realization compared to the prior year partially helped to offset the lower volumes and unfavorable mix. As we head into 2008, Funeral Service revenues are expected to show modest growth in response to the numerous initiatives underway.
Gross Profit
Consolidated gross profit increased $31.3 million, or 3.7 percent, and was slightly higher as a percentage of revenues, by 20 basis points, when compared to the prior year period.
Health Care sales gross profit increased $32.3 million and held steady as a percentage of revenues. The increase was driven primarily by the increased volume, various cost savings initiatives in our sourcing and manufacturing areas and favorable price realization. This favorability was partially offset by the heavier mix of International revenues, which generally carry lower gross margins, unfavorable product mix, and start-up costs associated with our new manufacturing facility in Mexico of $3.4 million. Product shift in the U.S. from our TotalCare ® ICU and mid-acuity VersaCare ® bed platforms to lower acuity platforms and stretchers also resulted in an unfavorable mix impact on gross profits.
Despite lower revenues, both Health Care rental and Funeral Service gross profit remained essentially flat to the prior year period as we were able to increase gross margins by 120 basis points and 30 basis points, respectively, in those areas. Health Care rental gross margins grew to 50.2 percent of sales, driven by our field service restructuring efforts taken in 2006, along with other improvement initiatives employed in 2007. Funeral Service gross profit for the year grew to 41.8 percent of sales as a result of favorable price realization, cost savings associated with our prior year wood plant consolidation, other manufacturing process and sourcing efficiencies, and relatively lower fuel and utility costs.
In fiscal 2008, consolidated gross margin rates are expected to be flat to up slightly, despite pressure on commodity pricing. We will look to offset these pressures with continued supply chain initiatives, improved price realization, productivity improvements and benefits from our low-cost region sourcing and manufacturing initiatives.
Operating Expenses
Other operating expenses, which consist of selling, marketing, research development and general administrative costs, increased $75.3 million in 2007 compared to the prior year. The overall higher expense levels were due to increased investment spending previously outlined as part of our 2007 strategic plan of $33.6 million for the year, including increased spending in research and development, marketing, merchandising and the development of additional sales channels and focus. We also incurred $12.4 million of costs associated with the proposed separation of Hillenbrand into two independent public companies, along with $8.7 million associated with the expensing of deferred acquisition and other costs related to the previously planned acquisition of Yorktowne and our related supply agreement with Yorktowne. Also contributing to the increase in other operating expenses were costs associated with the acquisition and operations of Medicraft of $5.4 million, general inflation estimated to be approximately $16 million and the impact of foreign exchange rates of $3.5 million. On a year-over-year comparative basis, we will continue to see increased spending in the first half of fiscal 2008 on research and development, marketing, including numerous product launch costs, and sales channel initiatives as we look to continue various initiatives started in fiscal 2007 to position ourselves for future growth.

Like the prior year, litigation credits of $1.2 million reflect the reversal of previously accrued legal costs relating to the original Spartanburg antitrust litigation settlement recorded in fiscal 2005 which were no longer needed. Special charges, which netted to a credit of $0.2 million in 2007, reflect a $1.0 million special termination benefit charge recorded in the second quarter of fiscal 2007 associated with reductions in force at our Hill-Rom Batesville, Indiana manufacturing plant related to the start-up of manufacturing at our new low-cost region facility in Monterrey, Mexico. This charge was more than offset by the net reversal of $1.2 million of excess reserves from prior year actions which were also determined to be no longer necessary. Comparatively, in 2006 we recorded special charges totaling $5.4 million related to the alignment of Hill-Rom’s field service organization and rental product offerings with lower rental revenue levels, along with the continuation of voluntary restructuring actions at Hill-Rom’s French manufacturing facility. See “Special Charges” on page 62 for more detail on these actions.


Interest expense increased $0.9 million compared to 2006 due to the increase in short-term interest rates and their negative impact to our interest rate swaps on long-term debt. Investment income decreased $7.5 million due to lower gains from limited partnership investments in 2007. While performance of our limited partnership investments was favorable in both years, the gains and corresponding cash distributions received during the prior year were larger than those of the current year. The timing and magnitude of gains or losses from our limited partnerships are volatile and not subject to our control, thus they may not recur in fiscal 2008.
Income tax expense of $100.9 million in 2007 represented an effective tax rate of 34.6 percent, which compares to a tax rate of 34.7 percent in 2006. Both years were favorably affected by a number of discrete tax benefits, including the release of valuation allowances resulting from capital gains on investments (as discussed above). Also impacting the 2007 tax rate, we recognized a benefit from the current year retroactive reinstatement of the federal research and development credit, which had expired last year. Comparatively, in addition to the release of valuation allowances following capital gains as described above, the 2006 tax rate was also impacted by the release of valuation allowances on foreign tax credit carryforwards and a deferred tax benefit reflecting favorable state tax law changes. The effective tax rate without discrete tax benefits would have been 36.8 percent and 37.4 percent in 2007 and 2006, respectively, with the lower rate in fiscal 2007 being driven by the estimated benefit of the reinstatement of the research and development tax credit for a full year and the ability to take advantage of the deduction for qualified domestic production activities in fiscal 2007. Partially offsetting these favorable items in fiscal 2007 is the fact that many of the separation costs we are incurring will be non-deductible for income tax purposes.

Ultimately, as expected coming into the year, income from continuing operations decreased $30.9 million to $190.6 million in 2007 reflecting increased investment spending in line with our 2007 strategic plan. This equates to diluted earnings per share of $3.07 compared to $3.60 in 2006.
Fiscal 2006 included discontinued operations, representing Forethought Federal Savings Bank (“FFSB”), which provided a loss of $0.3 million for the first quarter of 2006. The sale of FFSB was completed on January 3, 2006, and, accordingly, the operations of FFSB were presented as discontinued operations within our Statements of Consolidated Income (Loss). See Note 3 to the Consolidated Financial Statements for more information.

Reconciling differences between total divisional income above and income from continuing operations include public entity and other costs, as well as litigation and special charges/credits and other income/expense. See Note 13 in the Consolidated Financial Statements for more details.
North America Acute Care
Total North America Acute Care revenues increased $4.7 million, or 0.5 percent, in 2007 compared to the prior year. Sales revenues reflected an increase of $18.8 million, or 3.0 percent, primarily on improved price realization, while rental revenues were lower by $14.1 million, or 5.9 percent, due to lower volumes. During 2007, volume strength was realized in CareAssist ® ES bed frames, the Latitude ® architectural arm platform, service revenue and our recently updated stretcher and maternal lines.

These gains were essentially offset by lower volumes in our TotalCare ® ICU and mid-acuity VersaCare ® bed platforms. TotalCare ® bed experienced lower volumes due to saturation of the TotalCare ® bed system in some ICU segments and a perceived stall in buying decisions by customers following recent product introductions into the markets. VersaCare ® bed volumes are lower than the prior year primarily the result of the increasing acceptance of our CareAssist ® ES bed platform. The decline in rental volume resulted from changes in GPO affiliations and lower volumes, which were expected coming into the year. Although working diligently to restore confidence and repair damaged relationships, we also continued to experience the carryover effect of many of the unfavorable conditions encountered in fiscal 2006, including customer relationship issues resulting from past billing issues, service and product deficiencies. Rental volumes were also negatively impacted by continuing declines in the pulmonary product areas resulting from increasing capital purchases by customers of these products. The lower volumes were partially offset by lower customer allowances compared to prior year and related collection reserve adjustments for such allowances, which was favorable to the prior year by $6.5 million.
Divisional income for North America Acute Care increased $12.8 million, or 5.8 percent, in 2007 compared to the prior year due to higher gross profit, which was up $21.8 million. Sales gross profit was up $28.7 million driven by our strategic initiatives towards price realization and various cost reductions realized in our service fulfillment channels and manufacturing operations. For rentals, gross profit was down $6.9 million. Despite the generally fixed cost nature of the field service and sales network, better than half of the $14.1 million revenue shortfall was recovered by lower costs associated with our prior year restructuring actions and other profit improvement activities related to unprofitable products and customers. Operating expenses partially offset the higher gross profit and were up $9.0 million in 2007 due to increased spending in research and development, marketing and the sales channel and rental equipment portfolio additions as we made various investments to better position ourselves for future growth.

MANAGEMENT DISCUSSION FOR LATEST QUARTER

The following discussion and analysis should be read in conjunction with the accompanying interim financial statements and our 2007 Form 10-K.
Hill-Rom is a leading worldwide manufacturer and provider of medical technologies and related services for the health care industry, including patient support systems, non-invasive therapeutic products for a variety of acute and chronic medical conditions, medical equipment rentals and health information technology (“IT”) solutions. Hill-Rom’s comprehensive product and service offerings are used by health care providers across the health care continuum in hospitals, extended care facilities and home care settings worldwide, to enhance the safety and quality of patient care and patient customers.
Spin-off of Funeral Services Business
On March 31, 2008, the Company completed the spin-off of the funeral services business operating under the Batesville Casket name, through a tax-free stock dividend to its shareholders. In connection with the distribution, the Company (formerly known as Hillenbrand Industries, Inc.) changed its name to Hill-Rom Holdings, Inc. and is now trading under the symbol “HRC” on the New York Stock Exchange (“NYSE”).
Immediately prior to the effective time of the spin-off, the Company contributed all of the assets and liabilities of the funeral services business to Hillenbrand, Inc., the recently formed holding company for the funeral services business. The Company then distributed approximately 62 million shares of Hillenbrand, Inc. common stock to the Company’s shareholders. As a result, Hillenbrand, Inc. is now an independent publicly traded company trading under the symbol “HI” on the NYSE.

In accordance with Statement of Financial Accounting Standards No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (“SFAS No. 144”), the results of operations of the funeral services business have been presented as a discontinued operation for all periods presented in this Form 10-Q. See Note 3 of our Notes to Condensed Consolidated Financial Statements for a further discussion of the spin-off of the funeral services business. Unless otherwise noted, this MD&A excludes information related to the funeral services business.
For a detailed discussion of industry trends, strategy and other factors impacting our businesses, see “MD&A — Industry Trends, Strategy and Other Factors Impacting Hill-Rom’s Business” in our 2007 Form 10-K.
Current Progress against Strategic Plan
As referred to above, in our 2007 Form 10-K, we described our key strategic initiatives, designed to support our goal to grow organic revenue by an average of six to eight percent and operating income by an average of 12 to 15 percent over the 2007 to 2010 time frame. Our strategy, as more fully described in our 2007 Form 10-K, is designed to provide patients and those who care for them across all patient care settings around the world with affordable patient support and related therapy and information platforms that promote safer and more effective patient care. We have provided progress updates in our Quarterly Reports on Form 10-Q for the quarters ended December 31, 2007 and March 31, 2008, remain committed to those initiatives and continue to make progress against them. The most significant developments with respect to our strategic imperatives since the filing of our last Form 10-Q include:
North America Acute Care: Differentiate the Core and Revitalize Rental Business : We continued to increase our competitiveness by introducing a number of new products across the price/feature continuum, focusing on the optimal deployment of our sales and marketing resources in both our Acute Care’s Capital and Rental businesses and developing more integration between our patient support and health IT platforms.
• We continue to accelerate our pace of new product research and development efforts and have introduced additional new and enhanced products for acute care customers. Our new TotalCare ® Connect and TotalCare ® Connect Bariatric bed platforms, released in March of this year, helped drive positive revenue growth within intensive care settings during our third fiscal quarter. Coming off the trend of slowed sales of our patient support systems in intensive care settings during the second half of fiscal 2007 and early 2008, we are optimistic that these and other related new products will continue to provide revenue growth within that portion of our business. We also launched several new surface offerings recently. One such new product introduced during the third quarter was our NP200 Wound Surface, a next generation surface with aerospace honeycomb memory foam and nanoAg+™ antimicrobial technology. During the third quarter, we also launched our VersaCare ® Transition Care patient support system, an enhanced model with additional caregiver safety features and functionality. We expect the output from our increased focus on product development initiatives, which began in earnest in 2007, will continue into the foreseeable future, particularly with the October 1 st start of initiatives by the Centers for Medicare and Medicaid Services to halt payment for certain adverse events that occur during a patient’s hospital stay. Our technologies are frequently used to avoid and mitigate such adverse events potentially leading to favorable economic and clinical outcomes for patients and customers.

• Our health IT business continues to experience a steady turnaround in profit margins fueled by a higher mix of service related revenue streams and new product introductions. In February 2008 we released the enhanced NaviCare ® Clinical Operations Platform and we launched an enhanced version of our NaviCare ® WatchChild ® solution during the third quarter. Subsequently, we announced two key agreements that will facilitate increased accessibility to our NaviCare ® WatchChild ® solution via mobile devices and impart an education component to further enhance its value to customers. In addition, we continue to develop new products, some in collaboration with industry partners, that are designed to enable connectivity and integration among patient support systems, health IT products, third party medical devices and clinical information systems. We expect additional new health IT product introductions over the next several quarters.

• Our Therapy Rental business has grown significantly in recent quarters and was up 22 percent during the quarter, as a result of several new products, fleet investments we made in 2007, and the renewed channel focus we have placed on this business as a result of creating a separate dedicated moveable medical equipment (“MME”) channel. Our new E700 Wound Surface, launched late in fiscal 2007, is an intelligent multi-zone wound prevention and treatment surface that has exceeded our expectations. In addition, our decision to reduce the focus of our Account Clinical Directors from MME products has enabled more selling time to be directed toward therapy rental and customer conversions.

• Although we remain disappointed by the performance of our MME business, we are encouraged by our recently completed training and initial deployment of over 30 new sales representatives dedicated to our MME products. Additionally, a new Group Vice President was brought in late in second quarter to oversee this and other related businesses and has embarked on a detailed review of our fundamental MME business processes in effort to drive improved profitability.
Develop North America Post-Acute Care : As Hill-Rom seeks to increase our presence across the North America care continuum, we have made investments in new products, new business models and improved business systems that we believe will enable us to profitably participate in large and growing home care and extended care segments.
• We are progressing towards significantly differentiating our patient support systems portfolio through the launch of a number of new products. Hill-Rom now has a full line of capital and rental patient support frames and surfaces at several price points addressing a variety of patient acuities. As we move forward on product platform development, we expect to be able to more effectively compete in this space.

• Our Home Care business unit has continued its trend with its fifth successive quarter of double-digit growth. The introduction of high quality standard and bariatric frames and surfaces into this otherwise primarily rental focused segment has been well received by customers and patients alike. As well, our wound care “gold standard” product, the Clinitron ® fluidized bead bed offering continues its strong performance. Changes made last year in sales channel, product offering and account development has begun to deliver strong value.

• Despite the progress made with respect to the launch of several key new products, we are still making the transition from a selling organization that has been primarily focused on renting specialty items such as wound surfaces to one that is focused on selling capital products specifically in our Extended Care business unit that has performed below our expectations to date. We are currently evaluating a variety of new selling strategies to enable greater capital sales penetration.

• Our Hill-Rom Respiratory Care business unit continued its strong growth. This growth is a result of continued growth in our base rental home care business and from our prior year launch of a new version of The Vest ® respiratory product designed specifically for acute care applications. Further, we recently announced a new distribution agreement with Tri-anim Health System, Inc., the nation’s largest provider of respiratory specialty sales and distribution solutions for healthcare manufacturers across the healthcare continuum. Tri-anim’s 200 sales and customer service professionals will help expand our sales channel and drive even further profitable revenue growth from these acute care settings.

• In late 2007 we began selling products directly to consumers and have made modest investments to investigate this opportunity further. We are encouraged by our progress to date and will continue to evolve our direct to consumer strategy over the next fiscal year.

International and Surgical: Expand Across Continuum : Hill-Rom’s International and Surgical division continues to experience very strong growth across most major segments. In addition to the generally favorable impact of currency exchange rates compared to the prior year, we are benefiting from a strong line up of new products, a strong European direct channel, and investments we made in several new segments, including European medicalized long term care, and geographies, such as Asia and the Middle East.
• We continue to experience strong top-line growth from our product launches over the past two and a half years and we expect that trend to continue. Supporting our confidence, in the third quarter we launched another version of our highly successful AvantGuard™ patient support system, the AvantGuard™ 1600, for use in mid- to high-acuity acute care settings throughout Europe.

• Additionally, we continue to make substantial progress in our initiatives to grow our presence within medicalized long-term care in Europe. Recently introduced patient support and furniture products have continued to drive significant revenue growth. Specifically, derivatives of our AvantGuard™ patient support system (our AvantGuard™ 801 and AvantGuard™ 802) have been particularly well-received by medicalized long-term care customers. And similar to what we described last quarter, we have continued to successfully leverage our existing sales channel capacity to increase volume without adding significant overhead or cost.

• Our early fiscal 2007 acquisition of Medicraft, a frame manufacturer based in Australia, has enabled Hill-Rom to obtain a leadership position in Australia. We completed the integration of Medicraft in late fiscal 2007 and are now focused on realizing a number of new growth opportunities available to Hill-Rom in Australia.
Improve Gross Margins : We continue to face higher than expected inflationary pressures in key commodity markets, primarily from fuel and commodities, including steel and plastics. For example, since 2007 oil is up 142 percent, steel up 66 percent and plastics up 47 percent. While we have been able to date to mitigate some of these cost pressures through contracts with our suppliers, because supply for these materials and commodities remains constrained, it is expected these pressures will be even more influential in the near term. During the third quarter, the impact of higher fuel and commodity costs on our gross margins, compared to the prior year quarter, was 70 basis points.
We continue to execute strategies to mitigate inflationary cost pressure and global competition to drive profitability and to be in a position to achieve the necessary cost structure to offer more affordable products to price sensitive customers, particularly in post-acute care and emerging geographic regions. These actions include; Increasing prices on certain products and to customers, where possible continuous improvement initiatives in our Batesville, Indiana and Pluvigner, France manufacturing facilities; the continued centralization of our global supply chain; and increased utilization of low cost region manufacturing and sourcing. Specifically, we are in the process of executing the following initiatives:
• As discussed above, we remain focused on developing and bringing to market more innovative products and features that provide an unmatched value proposition to caregivers while providing the opportunity to further expand our gross margin.

• We continue to expand production of our CareAssist ® patient support system and stretcher lines in our Monterrey, Mexico facility. Transition of our stretcher line, while slightly behind our targeted timeline, is nearly complete, and we are beginning to eliminate redundant production in our Batesville facility, which will position us to more fully realize cost savings as we enter fiscal 2009.

• Expansion of our low-cost region sourcing, which we have increased to nearly 25 percent of our total direct material spend, has helped to partially offset inflationary pressures on plastics, steel and other commodities.

• We continue to accelerate the pace of platforming efforts to provide even further efficiencies and reduce product costs for fiscal 2009 and 2010. With the development and recent launch of new patient support platforms, we have continued to implement our initial platforming efforts designed to increase the use of common subassemblies and modules across multiple platforms which will enable us to meet customer needs faster, provide consistent styling in our products and improve our overall gross margin rates.
In addition to the initiative outlined above to improve gross margins, actions are also underway to streamline our organization, which if approved by the Board, would result in a fourth quarter special charge.
For additional details regarding the current year financial impact of these strategic initiatives, see “Consolidated Results of Operations” which follows in this Form 10-Q.
Consolidated Results of Operations
In this section, we provide a high-level overview of our consolidated results of operations. Immediately following this section is a discussion of our results of operations by reportable segment.

CONF CALL

Andy Rieth

Thanks a lot, Jim and good morning everyone. I'd like to personally welcome all of you to our conference call and web cast for the third quarter of FY 2008. We've got lots to discuss today so let's jump right in. First I'd like to provide a few quick ground rules to make the call a little bit more efficient. We've scheduled an hour for this call and plan to have plenty of time left over for Q&A. During Q&A, please limit your inquiries to one question plus a follow-up per person. Then if you have additional questions you may rejoin the queue. Along with our remarks, we are also displaying slides, real-time, that amplify our disclosure. I'd encourage you to follow along with us. The slides are posted right now on the Investor Relations' portion of our website and the slides will also be a part of the archive of this call. The telephonic audio replay of this call will be available for approximately another week until August 15th. The web cast and the accompanying slides will be archived on the website for approximately one year. Also, I'd like to note that our 10-Q for Q3 fiscal year '08 will be filed later today and will serve as a good complement to today's material.

Finally, I'd like to invite all of you to save the day for an important Investor and Analyst Day meeting that we will host on October 7th in New York. It will be the first comprehensive Investor and Analyst Day since our spin and we are in planning for an informative half day session that will allow plenty of exposure to management including several business segment leaders. We'll be sending out more formal communications in the future but for now I wanted to allow you to place this on your calendar right away.

With that I'll turn the call over to Peter.

Peter Soderberg

Thank you, Andy and good morning to everyone. I'm very pleased to welcome you to this call as we report on our first quarter of operations, following our successful separation of the Batesville Casket unit. Four months ago we emerged as a pure play pure play Medtech entity. Yet for six quarters now we've been executing the strategy that we first set out in the fall of 2006. We have since reaffirmed several times that we believe we have put in place an exciting and value creating strategy for Hill-Rom shareholders and our third quarter results indicate to us that we are on the right track. We hope you agree.

Now let's take a quick look at our agenda for today's call. I'll provide an overview of Hill-Rom's third quarter performance, focusing on our business segments and a few highlights. I want to also address a couple of the key questions that we've been hearing from investors about our macroeconomic environment. Then I'll turn the call over to Greg for a more thorough financial review and discussion. After some brief concluding comments, we'll take your questions.

Let me start with revenue. We are seeing good balanced growth coming for both capital sales and rental revenue. Capital sales were up 10.9% to $250 million. While rental revenues were up 13.4% to $117 million. Even when adjusting for the impact of foreign exchange, consolidated revenue grew 9.3% to $367 million, with constant currency growth of 8.3% for capital sales and 11.4% for rental revenues.

On a year-to-date basis, our consolidated revenue reached nearly $1.1 billion, which represents total organic growth of 10.0%. Constant currency growth was 7.5%. This performance supports the conclusion that our goal of 6% to 8% organic growth is achievable and this quarter represents the fifth out of the past six quarters, where revenue growth fell in our targeted range.

I'd like to now discuss our three reporting segments, starting with North America AcuteCare which showed revenue growth of 5.6%, to $220 million. This segment was paced by growth of over 20% in the rental of our proprietary therapy surfaces and frame surfaces led by the Total Care Bariatric Plus ICU bed and the envision E-700 Wound Surface. Because these products are so highly differentiated and respond to heretofore unmet needs, we believe they are actually growing the entire therapy category.

This quarter's growth also reflects virtually no tail wind from seasonal influenza which you'll recall contributed to similar levels of growth in our second quarter. We reported growth of 3.5% in capital sales. Within that number, capital sales of our hospital beds and proprietary therapy surfaces increased by high single digits. This performance was led by our Total Care connect advanced ICU system launched in late March and the initial traction on the VersaCare line extension launched during this quarter.

As we said in our last call, we believe our strong therapy rental and approved patient support systems performance can be traced to both our sales additions and the introduction of compelling new products stemming from our increased investment and R&D. Our architectural products and healthcare IT lines showed softness during the quarter. Both had major new product launches coming over the next several quarters designed to turn these trends around.

Finally we appear to be stabilizing the rate of decline of our movable medical equipment rentals, but MME still represents a drag on our growth and profit improvement targets. Earl DeCarli an experienced Medtech Executive whom I've worked with in the past joined us early in the quarter as senior VP Care Continuum Services. The assessment of our strategies and the impact of our investments in MME is one of Earl's key priorities.

Turning now to our North American Post Acute Care segment, revenues grew to over $50 million, an increase of 10.7%. Like last quarter, both capital sales and rental revenues grew at double-digit rates. While we are still in early innings here, we feel we will continue to be rewarded by our decision to pursue growth outside of our core hospital segment.

Rental revenue strength again was driven by a respiratory care franchise, the best high velocity chest wall oscillation therapy, and by our home care therapy rental and capital products. Going forward, we expect our respiratory care revenues to further benefit from a channel relationship we recently announced with triumph, the nation's largest provider of respiratory specialty sales and distribution solutions.

Tri-anim will make the Vest one of its few focused products. Our home care team continues to make real progress in building our franchise, to improve channel management and launches of new products. Extended care suffered from a slower capital and rental revenues. However, we have made a leadership change here and have several new products coming in 2009, which should help us turn this situation around.

Turning to our international and surgical business, we have recorded yet again another strong and balanced performance. Total revenues of $98 million were up 27.9% or 19% on a constant currency basis. Most of our sales growth came from Europe, the Middle East, and Asia and from our surgical business.

In Europe, our expanded focus on medicalized long-term care, which showed almost doubling of sales year-over-year and the strength of our AvantGuard 800 product line, our value point med search offering have been driving much of the growth in capital sales. This growth, however has come at lower margins. Our surgical unit Allen Medical continues to record consistent mid-teens growth, good uptick of its new products and expansion of its OEM relationships.

Let me now comment on our bottom line performance. Consolidated net income from continuing operations was $0.34 per fully diluted share, compared to $0.18 per share in the prior year. Our results include the effects of some discrete tax items that favorably impacted the quarter by $0.12 due to the timing of their resolution.

Even so this is an improvement, this improvement is consistent with our prior guidance that fiscal year 2008 would represent an inflection point, or during the second half we will begin to seed the benefits of the investments made during 2007, and the first half of this fiscal year.

Finally, before turning the call over to Greg, I'd like to address the two questions that we have been receiving most often recently when we speak with investors about our Hill-Rom investment proposition. They relate to the North American hospital purchasing environment and commodity cost inflation.

Regarding the former, we continue to see a good climate in our core North American AcuteCare business, both capital and rental spending. While we do have a handful of examples of customers putting capital expenditures on hold, our quotation and order rates at the moment appear to be stable or growing across most categories.

More over independent services we subscribe to have recently forecasted that new hospital corruption starts will actually increase slightly in 2009 versus 2008. Finally, many of the macro trends we have previously discussed such as patient demographics, CMS no pay reimbursement for hospital acquired conditions beginning October 1st, rising acuities across the care continue, and the need for hospitals to address caregiver shortages have driven strong customer interest in our offerings.

Having said this, if a slowdown in capital products or expenditures does materialize in the future, we believe we have enough levers to pull to stay on track with our bottom line commitments. I'll speak about some of these levers in a moment.

The second question we frequently get is related to today's inflationary environment from materials and fuels. Like most manufacturers, we have seen unexpectedly strong commodity price inflation during the past several months. In response we have intensified our efforts to reduce product in operational cost in a variety of ways, six of which I will share with you at this time.

First, acceleration of cost reduction and continuous improvement activities throughout our business, including the deployment of more engineering resources to cost out projects. Second, the potential adjustments of rental service levels based on analysis of product and customer profitability in light of higher transportation costs. Fuel increases during the quarter adversely impacted our rental gross margins by 40 basis points. Third, consideration of alternative capital product distribution strategies.

During the quarter, we saw inflationary fuel cost reduce capital margins by 80 basis points, versus approximately a 50 basis point impact we saw on capital margins from material inflation.

Fourth, acceleration of in sourcing of external purchases into our Monterey, Mexico facility to fully leverage its increasing cost advantage versus other low cost regions. Fifth, utilization of contractual provisions bodied many of our capital contracts to take inflationary price increases on contract anniversaries, and finally the streamlining of the organization in response to our post spin mandate to be a faster leaner organization, driving profit expansion.

If approved by the Board, such an action would impact about 3% of our salary worldwide workforce or about 150 people and would result in a fourth quarter charge. In closing, our current view, is these external issues should not cause us to alter our strategy or materially change our sales and profit growth targets.

We now have three quarters of the year in the bank and anticipate a very strong quarter, with 10% to 16% top line growth and nearly a 50% to 75% operating income growth as adjusted. Accordingly, we are comfortable with updating financial guidance from our May call to reflect increased sales and gross profit expectations. We expect operating income as adjusted to remain consistent with prior guidance, in spite of the negative impact of inflation and currency movements.

Furthermore, we have adjusted earnings per share guidance upward, primarily to reflect the benefits from discrete tax items realized in the quarter. We believe more than ever that the foundation that we are laying is the right one to build shareholder value.

Now I'd like to turn the call over to Greg Miller.

Greg Miller

Thank you, Peter. To begin with, as we separated in the middle of the fiscal year on April 1st, it is important to note that all amounts presented in the slide that I will be discussing, are presented on the basis of our continuing operations and, therefore, exclude all impact associated with the former funeral services business and most costs associated with the separation. There are no separation-related costs included in our continuing operations in the current quarter. As a reminder, there are $10.6 million of separation-related costs in continuing operations on a year-to-date basis. All other separation-related costs are included within discontinued operations, and are discussed in more detail in our SEC 10-Q.

Now let's get started with the financial review. We had another strong quarter in terms of revenue growth. Revenues continued to increase with an accelerating rate on a constant currency basis, with strength in both capital and rental revenues and across all reporting segments. This growth results from our investments in new products and our sales channels and a receptive business market.

As noted on the slide, we have seen double-digit total revenue growth year-over-year for the past two quarters, with constant currency growth greater than 9% both quarters. Our currently 12-month growth rate is now 8.5% or 6.2% on a constant currency basis.

Looking at capital sales, third quarter revenues increased 10.9% year-over-year, with international surgical leading the way. Our trailing 12-month growth rate for capital sales was 9.7% or 7.1% on a constant currency basis. Rental revenues continued to accelerate, even in the non-influenza period, with 13.4% growth over the prior year, or 11.4% on a constant currency basis.

As Peter has mentioned in North America Acute, this has been driven by investments into our innovative bariatric frame and wound care surface rental fleet, as well as the refocus of our account clinical directors after adding the MME sales channels and the conversion of recently won GPO therapy rental contract. Our other two business segments have also seen double-digit growth in rental revenues.

Our trailing 12 months growth was 5.8%, or 4.2% on a constant currency basis. That said, it should be noted that rental revenues have increased at a double-digit rate in the past two quarters. As Peter has already discussed other parts of our revenues for our reporting segments, I'll move straight into discussion of gross profit and margins.

During the third quarter, Hill-Rom's gross profit increased on a year-over-year basis 10.4% as both capital and rental gross profit showed growth. This is the highest growth rate in consolidated gross profit in six quarters. Gross margin, measured as the percent of revenues, declined 50 basis points, compared to the prior year, with the decline related entirely to capital sales, as rental margins continue to be strong. In fact, despite inflationary pressures that I will discuss next, we experienced gross margin improvements in our North America Acute and our Post-Acute segment. Unfortunately, we continue to see gross margin declines in our international segment.

We continue to face higher than expected inflationary pressures in key commodity markets, primarily from fuel and commodities, including steel and plastics. Overall gross profit and margins were negatively impacted on a year-over-year basis by higher inflation by $2.6 million or 100 basis points in the third quarter. While we have been able to mitigate some of these cost pressures through contracts with our suppliers, cost improvement activities and trade contract and route optimization programs, we were not able to keep pace. As supply for these materials and commodities remained constrained, we expect commodity inflation pressures to continue in the fourth quarter and into fiscal 2009.

In addition to the incremental activities that Peter has covered in offsetting these inflationary pressures, we will continue to execute our strategic initiatives towards improving gross margins which includes low cost region manufacturing sourcing, continuous improvement initiatives in our long-standing manufacturing facilities, continued centralization of our global supply chain, introductions of innovative, higher new margin products and platform product design which is the increased use of common sub-assemblies and modules across multiple surfaces and frame product platforms.

Moving to capital margins, Hill-Rom capital gross profit increased 6.8% with all three segments reporting higher gross profits, led by our International Surgical and North America Acute segments. Despite margin improvements in North America Acute and Post-Acute, overall third quarter capital margins as a percent of sales declined a 150 basis points year-over-year from 41.3% to 39.8%, primarily due to the following. First, continued segment sales mix towards international. As we have discussed in the past, our overall gross margin percentage on products sold internationally generally provide relatively lower margins than those in North America.

Second, overall international margins declined on a year-over-year basis by 220 basis points. While we had hoped that the lower international margins we experienced in the second quarter would show improvement in the last half of the year, we are disappointed that we've not been able to change this unfavorable trend. In addition to the inflationary pressures I've already discussed our international gross margins continue to be pressured in part by an unfavorable product mix with significant increase in sales of long-term care bed platforms in Europe. The negative foreign currency impact of the strengthening euro on products sourced from France and sold in countries with a different functional currency.

Cost increases and lower than expected margins on a number of recently introduced products and to a lesser degree, the continued inventory adjustment associated with excess and obsolete inventory. We have a number of actions underway to improve international margin levels and expect a rebound in fiscal 2009, including the actions Peter and I have already mentioned, plus cost improvements on new products and exiting of older, lower margin products.

As I mentioned, despite these negative pressures, capital sales gross margins in our North America Acute segment increased 50 basis points due primarily to higher prices and favorable sales mix driven primarily by the launch of our new TotalCare Connect ICU platform in March. In addition, gross margins within our Post-Acute segment were up 220 basis points, principally due to higher margins on new product introductions, improving sales within our respiratory and home care businesses, and the benefits of profit improvement initiatives for specific customers and product lines. I will discuss the impacts of inflation on our guidance for capital margins near the end of my remarks.

Hill-Rom rental gross profit increased 16.8%. Despite fuel inflation, third quarter gross margin improved 160 basis points year-over-year to 52.4%. This improvement results from the increased rental volumes, combined with continued positive leverage of our field service organization, various profitability improvement activities, and the higher product margins we are experiencing on new product introductions.

Looking forward, we continue to be positive with respect to our rental operations and see additional opportunities that lever and improve field service organization cost, despite the margin pressure associated with higher fuel costs necessary to operate our field service network.

Now I'd like to move on to operating expenses. For the quarter, we saw an overall increase of approximately 10% to $137.3 million. As we have predicted in previous calls, we are beginning to see the improvement in operating expenses as a percent of revenues from 37.9% to 37.4% on a year-over-year basis.

Looking at the various components of our operating expenses, selling expense increased 11.9%, generally in line with the increase in revenues. Variable compensation drove 25% of this increase while the headcount additions to the sales channels at the beginning of fiscal 2008 generally contributed the rest of the increase over the prior year. Marketing expenses also increased year-over-year, up 24%, primarily related to the significant rollout of new product launches.

G&A expenses increased just under 5%. As mentioned previously, we are in the process of revisiting and analyzing our investments and our G&A structure with the intent to shift some of these investments, if necessary, streamline the organization and to leverage operating expenses moving forward.

R&D spending have remained consistent during the current fiscal year which results in strong increases year-over-year in accordance with our plan. We currently are spending in a range of 4% of revenues and over the long-term hope to increase this percentage to an excess of 5%. R&D spending for the quarter was up nearly $2 million over the prior year comparable period or 16%.

Although our investments in new and enhanced products have been a key component of our revenue growth, during the quarter we did appoint a new leader of our R&D efforts who is focused on improving the yield of these investments which includes the start up of our Singapore innovation center.

On an as adjusted basis, excluding the effects of prior year separation costs, operating profit increased to $23.3 million, up 11.5% from the prior year. We are beginning to see the benefits of the past year's strategic investments with our first year-over-year improvement in operating profit since the adoption of our current strategy. We are excited about reaching this inflection point in our journey and look forward to continuing improvement in operating results as we move forward.

Moving to tax rate, the effective income tax rate for the company's continued operations for the third quarter was 2.3% compared to 35.4% in the prior comparable period. The lower rate in the current year is due primarily to favorable discrete period tax benefits of $7.8 million, recognized in the quarter. These tax benefits related primarily to the net release of valuation allowances on our foreign tax credit carry-forwards and the recognition of certain previously unrecognized tax benefits associated with the completion of the federal audit of the company's fiscal years ended 2004 to2006. This compares to an immaterial amount of favorable discrete period tax benefits recorded last year.

Looking forward, we believe that our full year effective tax rate should be approximately 29.9% on a continuing operations basis, reflecting discrete items recognized to date, but excluding the impact of future discrete items. With the schedule conclusion of several tax audits and the expiration of various state statutes in the fourth quarter, we generally expected any additional discrete items to be favorable to our tax rate.

Adjusted earnings per share were $0.34 per fully diluted share in the third quarter of fiscal 2008, compared to $0.18 per share in the prior period. The increased earnings per share results related to improved operating results discussed above, as well as to the very favorable tax rate for the quarter. A reconciliation of these amounts to GAAP earnings per share is provided in the appendix of the earnings release slide deck and the earnings release itself.

Now I'd like to take a quick look at free cash flow, which we define as cash flow from operations less capital expenditures. As noted on the slide we continue to show improved quarterly year-over-year free cash flow. As we outlined in our last call, we expected third quarter cash flow to come under pressure as we had significant payables outstanding at the end of the second quarter related to our international business and for non-recurring separation costs. The decline in international payables totaled $11.5 million for the quarter and payments of separation costs totaled $17.3 million for the quarter. Despite that, increased net income continued improvement in accounts receivable and inventory returns over year-over-year, and slightly lower capital expenditures in the current year resulted in slightly improved free cash flow. On a year-to-date basis, free cash flows have improved to $97.4 million, an increase of $92 million from the prior year.

Now a few comments on liquidity and capital resources, overall, we continue to have solid liquidity, and to maintain strong balance sheet from which we can carry out our strategic plan. In light of the continuing liquidity issues associated with auction rate securities, we reclassified such securities in the current quarter from short-term investment to long-term. As of June 30th we continue to hold $46.2 million of AAA rated student loan auction rate securities. These securities are stated net of a $1.5 million unrealized loss, related to an assessment of the fair value of such securities, consistent with the prior quarter.

We continue to be optimistic regarding our ability to fully recover our investments in these securities and we have the ability and intent to hold them until market conditions improve. During this past quarter, we collected approximately $2.4 million of these securities and additional $1.3 million in July.

Now let's move to an update of our 2008 guidance. Based on the strengths of revenues in the third quarter and year-to-date and our expectations for the remainder of the year, we are updating our guidance for revenues as follows: We are raising the guidance for healthcare sales with an updated guidance of 1.040 billion to 1.052 billion which represents a year-over-year growth of 10.5% to 11.7%.

After increasing guidance last quarter end, we will reaffirm our previous guidance for healthcare rental revenues of $455 million to $464 million. As such, total revenues will increase to 1,495 billion to 1,515 billion a growth rate of 10.2% to 11.7% over the prior year.

As previously covered due to the year-to-date results, segment mix pressures, international near term margins and our expectations of continued inflationary pressures, on commodities and fuel cost, we are adjusting our healthcare sales gross margins downward to 40.5% to 41.5% from the previous 41.9% to 43.2%.

Although we continue to expect inflationary pressure in fuel service fuel costs, due to year-to-date results and our expectations to execute on additional opportunity to leverage and improve our field service organization costs, we are raising our previous guidance for rental gross margins to 52% to 53%, from the previous guidance of 50.8% to 52.5%.

Also, our effective tax rate excluding the benefits of discrete tax items, will improve to 35.3% for the year. If the favorable impact of discrete tax items recognized on a year-to-date basis were considered, the effective rate excluding in future discrete items would approximate 30%. This rate does not include any benefit which will occur if the Congress reenacts R&D tax credit which right now appears unlikely for our fiscal year which ends on 930.

Overall our guidance for adjusted earnings per share increases to 133 to 143 from the previous 118 to 132. Additional details of our updated guidance is provided in our slides and our press release. As we have discussed with many of you, 2008 is an inflection year and the exact timing of the benefits of our strategic investments may vary. That said, despite expected inflationary pressures and lower international margin during the third quarter we have turned the corner with our accelerated sales growth translating to higher year-over-year profitability. As our guidance implies we expect to continue to see increased returns from our strategic investments during the fourth quarter and we look forward to sharing those results with you.

With that I'll turn the call back over to Peter. Peter?

Peter Soderberg

Thank you, Greg. Let me wrap up the prepared portion of our remarks with a few observations. As some of you know, I'm quite a baseball fan. If you'll indulge me I'll use a baseball metaphor to characterize where I think we are in our journey to create and sustain the new Hill-Rom as an engine to deliver shareholder value. We are now beginning the middle innings of our ballgame. We've been successfully executing the strategy we first laid out in the fall of 2006 and began to implement in our events during fiscal year 2007. We are following our game plan and tweaking it as required. We're hitting singles and doubles and on occasional home run, such as with successful separation of our two operating companies.

The game plan is a straightforward Medtech strategy, identify solid growth markets that leverage our brand and capabilities, invest in innovation and product and service differentiation, build and maintain world class sales and distribution channels with the like customers and drive operating efficiencies across the P&L. We are steadily improving our stewardship of the balance sheet and we'll use it strategically to generate value for shareholders. After assembling a new lineup early on, drafting some great additions along the way and developing talent already on our bench, we like our team. We now have a solid management group reflecting extensive Medtech experience. The next phase is to infect the entire organization with a passion to perform and continue to increase team speed. Just as great baseball teams usually find ways to win the tough games, we at Hill-Rom have a variety of levers we can pull in order to ensure that we meet our sales and profit growth goals, and we are not hesitant to pull them. Thanks for your interest and we'll now take, have time to take plenty of your questions.

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