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Hill-Rom Holdings Inc  (NYSE:HRC)
Q1 2019 Earnings Conference Call
Jan. 25, 2019, 8:30 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good morning and welcome to Hill-Rom's Fiscal First Quarter 2019 Earnings Conference Call. During the presentation all participants will be in a listen-only mode. At the end of management's prepared remarks we will conduct a question-and-answer session.

(Operator Instructions)

As a reminder, this call is being recorded by Hill-Rom and is copyrighted material. It cannot be recorded, rebroadcast or transmitted without Hill-Rom's written consent. If you have any objections, please disconnect at this time.

I would now like to turn the call over to Ms. Mary Kay Ladone, Senior Vice President, Corporate Development, Strategy and Investor Relations. Ms. Ladone, you may begin.

Mary Kay Ladone -- Senior Vice President, Corporate Development, Strategy and Investor Relations

Thanks and good morning everyone. Thanks for joining us for our fiscal first quarter 2019 earnings conference call. Joining me today are John Groetelaars, President and Chief Executive Officer of Hill-Rom; and Barbara Bodem, Chief Financial Officer.

Before we get started, let me begin our prepared remarks this morning by reminding you that certain statements contained in this presentation are forward-looking statements and are subject to risks, uncertainties, assumptions and other factors that could cause actual results to differ materially from those described. Please refer to today's press release and our SEC filings for more detail concerning risk factors that could cause actual results to differ materially.

In addition, on today's call, non-GAAP financial measures will be used. Reconciliations between GAAP and non-GAAP financial measures are included in our earnings release issued this morning.

Before turning the call over to John. I would like to mention that in addition to the press release issued this morning, we have posted a supplemental presentation, which can be accessed on the Investor Relations page of our website at hill-rom.com under Events and Presentations.

As you know, beginning with our fiscal first quarter, we adopted the new revenue recognition accounting standard ASC 606, on a modified retrospective basis. The focus of our commentary this morning will be on our financial results under the old standard, ASC 605, which will allow for comparability on an apples-to-apples basis, as well as comparisons to our original 2019 financial guidance. After this discussion of our first quarter results, we will review our updated guidance, which now reflects the adoption of ASC 606.

With that introduction, let me now turn the call over to John.

John P. Groetelaars -- President and Chief Executive Officer

Thanks, Mary Kay. Good morning, everyone, and thanks for joining us today. Q1 was another successful quarter for Hill-Rom. We started the year with continued momentum, accelerating core revenue growth and driving solid operational execution, resulting in financial performance that exceeded expectations on both the top-line and the bottom-line.

In addition to these strong results, we continue to make great progress in our strategic priorities, advancing our category leadership with differentiated innovative healthcare solutions, expanding our category presence -- our geographic presence in emerging markets, and transforming the portfolio to enhance outcomes and drive value for patients, caregivers and our shareholders.

For the first quarter, we reported core revenue growth of 6%, reflecting continued progress and benefits from establishing a more durable and diversified business. This represents our third consecutive quarter of mid single-digit growth. Our focus on operational execution led to margin expansion of 110 basis points. And we delivered adjusted earnings of $1.03 per diluted share, an increase of 12% versus the prior year. This represents our 14th consecutive quarter of double-digit earnings growth. Importantly, this strong performance provides flexibility to reinvest in our key growth initiatives, and sets a solid foundation for achievement of both our short-term and long-term financial objectives.

Our teams are doing an excellent job executing on our vision and our four strategic priorities aimed at enhancing our global category leadership to drive durable, sustainable, top -line and bottom-line growth. Their first priority is advancing our category leadership with differentiated solutions and innovation. As I mentioned before, new product revenue is a key metric in measuring the success of our strategy and meeting our objectives of driving core revenue growth 200 basis points to 300 basis points, above our weighted average market growth rate. The contribution of new products was a significant driver of top-line growth in Q1 once again, with revenue of approximately $100 million, on track with our expectation of driving $400 million in new product revenue for 2019.

Supporting this performance were several new innovative products, including Centrella, Connex Vital Signs Spot Monitor, the Monarch Airway Clearance System, Integrated Table Motion and our Vision Care portfolio. In total eight new products represent 90% of new product revenue. Our connected innovations are focused on addressing challenges faced by our customers. These challenges include escalating costs, lower reimbursement and the need for innovation to enhance efficiency, workflow and patient outcomes, while preventing events like falls, sepsis and pressure ulcers that may cause readmissions, unreimbursed complications or reimbursement penalties.

We highlighted a number of recent achievements in our press release this morning, including a global collaboration with Microsoft to bring actionable point-of-care data and solutions to caregivers in real-time. As well as, the commercial launches of the LINQ Mobile smartphone application and EarlySense continuous contact-free heart rate and respiratory rate sensing technology. We believe continued investments in innovation, connectivity and data, will allow us to enter new markets and channels, creating even more opportunities to drive accelerated growth and value for patients and caregivers in the years ahead. Getting information to caregivers and proactively anticipating patient needs not only provides clinical and economic value, it is central to achieving Hill-Rom's mission.

Turning to our second priority. Expanding internationally and penetrating emerging markets. I'm pleased to report, we are beginning to see some progress. We generated international core revenue growth of 3% this quarter, reversing the trend from the second half of last year. While still in the early stages of a turnaround, we were encouraged by strong double-digit growth, collectively across Asia Pacific and Latin America. Emerging markets today account for only 9% of Hill-Rom's total revenue and we are in the process of reinvigorating our commercial operations. We have recently added experienced senior leadership in Asia Pacific and are finalizing our assessment of product categories and go-to-market strategies to support meaningful growth and acceleration in the region.

Our third strategic priority is transforming the portfolio through M&A and portfolio optimization initiatives. We thoughtfully considered our product offerings and have divested or exited a number of low growth and lower-margin product areas that were not strategic to our growth strategy. This has strengthened our portfolio, enabled us to focus our energy and resources to drive more durable and consistent revenue growth in the core. This diversification and our new product introductions has improved our overall revenue mix. This quarter, approximately 50% of our revenue is coming from categories that grow at 4% or greater, demonstrating progress toward our 2020 goal, of achieving 60% of total revenue from these higher growth categories.

In terms of M&A, this has been and continues to be an important part of our growth in diversification strategy. With improved balance sheet flexibility, we're in a strong position to enhance our category leadership and further our growth objectives. We continue to deploy capital with a disciplined approach, adhering to our rigorous strategic and financial criteria to generate attractive returns. Our final strategic priority is driving operational execution and strong financial performance. We've previously discussed, our business optimization program, focused on accelerating growth, reducing complexity and improving our cost structure. We have made significant progress and we are currently executing on a number of initiatives.

We expect to drive $50 million of pre-tax savings over the next few years. These benefits are not included in our long-range plan, but provide us the financial flexibility to reinvest in key priorities, like new products and emerging markets. In conclusion, we are entering 2019 from a position of strength. We are energized by our progress in executing on our four strategic priorities. We remain focused on accelerating durable and profitable growth, while enhancing margins, profitability and generating strong cash flow. We are capitalizing on new products, advancing our pipeline and expanding in emerging markets. We see a clear path to achieving our objectives, to deliver innovative healthcare solutions and improve outcomes for patients and their caregivers by advancing connected care.

Now I'd like to introduce our new CFO, Barbara Bodem, Barb is a seasoned finance executive with over 20 years of experience in healthcare. Barb joins us -- joins Hill-Rom from Mallinckrodt, where she served as the Senior Vice President of Finance. Earlier in her career, she worked at Hospira, as the Vice President, Global Commercial Finance. As well as at Eli Lilly and Company, where she held a variety of finance roles in the US and the UK, including CFO for Lilly Oncology.

With that, I'll now turn it over to Barb.

Barbara W. Bodem -- Senior Vice President, Chief Financial Officer

Thanks, John and good morning everyone. For the fiscal first quarter, we reported GAAP earnings of $0.62 per diluted share. These results include after-tax special items, related to intangible amortization, tax reform legislation, business optimization and other special charges.

These results also reflect the adoption of ASC 606, the new revenue recognition accounting standard. On an adjusted basis, excluding special items, we reported earnings of $1.02 per diluted share. On a comparable basis, under the old accounting standard, adjusted earnings increased 12% to $1.03 per diluted share, exceeding our guidance range of $0.97 to $0.99 per diluted share. These results reflect accelerated core revenue growth, continued margin expansion and strategic investments to drive future growth.

As Mary Kay mentioned, our commentary this morning will focus on our first quarter results, on a comparable basis to the prior year period, before the adoption of ASC 606. Please use the supplemental schedules posted to our website to follow along.

Now, let me briefly walk through the P&L, before turning to our financial outlook. Starting with revenue. For the fiscal first quarter, revenue of $684 million increased 2%, on a reported basis and 3% on a constant currency basis. Core revenue accelerated to 6%, exceeding our guidance of approximately 4% growth. Core revenue growth, adjusts for the impact of foreign currency divestitures and non-strategic assets we may exit, including the Surgical Solutions International OEM business. Domestic revenue on a core basis increased 7% in the first quarter, driven by mid to high single-digit growth across all three businesses.

International core revenue grew 3% in the quarter, driven by improved performance in emerging markets and solid growth in Patient Support Systems and Front Line Care.

Moving on to the business segments. I will address revenue growth on a constant currency basis only. Starting with patient support system, revenue of $342 million increased 3% and core revenue advanced 8%. This represents the strongest growth we've seen in this business in several years and it was well-balanced geographically, with strong growth both in the US and internationally.

For the third consecutive quarter, we generated strong double-digit growth across our key capital product categories in the US, including Med-Surg bed systems, Clinical Workflow solutions and safe patient handling equipment. Outside of the US, core patient support systems, revenue increased 7% driven by solid growth in Europe and double-digit growth in the Middle East, Latin America and Asia Pacific regions.

Now moving on to Front Line Care. Revenue increased 5% to $233 million, new products, including the Connex Spot Monitor, the Monarch Mobile Vest and our Vision Care portfolio, continue to be the key drivers. Domestic revenue increased 5%, while international revenue grew 3%, with solid performance across Europe, Latin America and Asia Pacific.

Lastly, Surgical Solutions revenue of $109 million was flat to the prior year, while core revenue increased 2%. Double-digit growth in placements of the Integrated Table Motion and solid growth in surgical consumables and patient positioning equipment were partially offset by a decline in the Middle East, impacted by the timing of capital orders versus last year.

Now, turning to the rest of the P&L. Adjusted gross margin of 48.3% improved 60 basis points versus last year, reflecting the positive contribution from mix, as well as benefits from manufacturing productivity and procurement efforts. Collectively, these factors more than offset the impact of tariffs and raw material inflation.

R&D spending of $33 million, increased 3% versus the prior year, reflecting our ongoing commitment to innovation and investments in key programs to drive future growth. Adjusted SG&A of $189 million was flat to the prior year, as strategic investments were offset by disciplined cost management.

Our adjusted operating margin in the first quarter was 15.8%, an improvement of 110 basis points compared to the prior year. The adjusted tax rate in the first quarter was 19.7%. Stock-based compensation was a benefit of $0.03 per diluted share, versus a benefit of $0.05 per diluted share last year. Excluding the impact of stock-based compensation, our first quarter tax rate was 21.7%. So bottom-line adjusted earnings for the fiscal first quarter of $1.03 per diluted share increased 12%. Excluding the impact of stock-based compensation from both periods, adjusted earnings per share increased 15%.

Now turning to cash flow. Cash flow from operations was very strong in the first quarter, advancing 25% to $116 million. Higher net income and strong working capital management contributed to this perform. Capital expenditures totaled $15 million, $12 million lower than the prior year period, primarily due to project timing.

As a result, free cash flow of $101 million is 53% higher than last year. In terms of the balance sheet and financial leverage, our debt-to-EBITDA ratio, at the end of December was 3.2% (ph) and we've returned approximately $92 million to shareholders in the form of dividends and share repurchases during the fiscal first quarter.

Now, let me conclude this portion of the call by providing our guidance for fiscal 2019. As noted in the press release, we are reaffirming our full-year revenue growth, margin expansion and adjusted earnings per diluted share growth guidance and are updating the adjusted earnings guidance range to solely reflect the adoption of ASC 606. The updated 2019 financial guidance now compares to the 2018 modified financial results, which are included in our supplemental schedules on the website.

The impact of ASC 606 for fiscal year 2018 is a reduction in reported revenue of $14 million and a reduction in adjusted earnings of $0.10 per diluted share. So for the full-year, we continue to expect reported revenue growth of 1% to 2% in constant currency growth of 2% to 3%. Core revenue growth is expected to increase 4% to 5%, collectively non-core revenue totaled approximately $110 million in 2018 and is expected to decline to approximately $50 million in 2019. This headwind is incorporated in our reported revenue guidance, while core growth guidance is calculated by excluding the non-core components in both the current and prior year period.

By business segment, on a core basis, we continue to expect all three businesses to grow in the 4% to 5% range in 2019. On a reported basis, given the decline in non-core revenue, we expect Patient Support Systems revenue to increase 1% to 2% and Surgical Solutions revenue to be flat to up 1%. From a profitability standpoint, we continue to expect the following; adjusted gross margin to expand approximately 50 basis points, reflecting mix and productivity improvements that more than offset incremental costs, associated with tariffs and raw material inflation.

R&D spending to increase in mid-single digits, representing approximately 5% of sales. Adjusted SG&A of 26% to 26.5% of sales, reflecting both savings related to our business optimization program and the reinvestment in key growth initiatives. Adjusted operating margin expansion of approximately 100 basis points. Other expense, including interest of approximately $90 million and a tax rate of 21% to 22%. And finally, we expect a share count of approximately 67.5 million shares. Again, we are only adjusting our earnings guidance range for the $0.10 impact related to the ASC 606, aligned with the estimated impact we disclosed last November. This adjustment lowers our previously disclosed adjusted earnings guidance of $5.08 to $5.16 per diluted share to $4.98 to $5.06 per diluted share.

Importantly, there is no change in our adjusted earnings growth profile. We continue to expect growth of 7% to 9% and 12% to 14%, growth excluding stock-based compensation. From a cash flow perspective, we now project operating cash flow of approximately $420 million and capital expenditures of approximately $90 million. This change reflects a reclassification, related to ASC 606 between operating cash flow and capital expenditures.

Our 2019 free cash flow guidance remains unchanged at $330 million. For the fiscal second quarter under ASC 606, we expect revenue growth to be flat to the prior year and revenue to increase approximately 2% on a constant currency basis. We expect, core revenue to increase approximately 4% and are providing guidance for adjusted earnings of $1.09 to $1.11 per diluted share. This represents growth of 7% to 9% and 9% to 11% growth excluding stock-based compensation.

You may have noticed that the ASC 606 impact was immaterial to our first quarter performance. As we look forward, the calendarization of the impact of 2019, will vary from the impact in 2018. This is primarily due to changes in quarterly revenue mix, the timing of shipments and software implementations and the timing of the Monarch launch, which occurred mid-year last year. We expect our second quarter adjusted earnings to be impacted by more than half of the expected $0.10 full-year 2019 impact.

Thank you. And now I'll turn the call back over to John.

John P. Groetelaars -- President and Chief Executive Officer

Thanks, Barb. To summarize, we are off to an excellent start this year and look forward to building on that momentum throughout 2019. By executing on our four strategic priorities, we are confident that we can sustain the momentum we have delivered over the past three quarters. We are committed to delivering durable mid-single-digit top-line growth, strengthening our margins and driving double-digit earnings growth. While delivering on our mission and creating enhanced value for our shareholders.

With that, we will open up the call for questions.

Questions and Answers:

Operator

Thank you. We will now begin the question-and-answer session.

(Operator Instructions)

I would like to remind participants that this call is being recorded and a digital replay will be available on the Hill-Rom website for seven days at www.hill-rom.com.

Our first question comes from the line of Larry Keusch from Raymond James. Your line is open.

Larry Keusch -- Raymond James -- Analyst

Thank you. Good morning, everyone. Maybe just two questions. But the -- first one to start is, John, could you talk a little bit about obviously core growth in the first quarter was really very nicely strong at 6%, but the outlook decelerates to 4% in the 2Q. So, and I think the core comps are essentially the same for the 1Q and the 2Q. So could you talk a little bit about thoughts around the deceleration?

John P. Groetelaars -- President and Chief Executive Officer

Yeah, Larry, good question. First, we are very pleased with the first quarter results of 6% core growth, and a nice progression of acceleration from last year, starting the year at 2% in the first half and accelerating in the third and fourth quarter to 4%. So good trajectory. As we look at our guidance for Q2, we are certainly considering all the puts and takes that are occurring in the business. One of the things we see in Q2, is that we've got a tougher comp in Europe and some other international markets, it was a strong quarter last year and we're really just factoring that into the guidance, as we look at Q2.

For the full-year, we're still very confident with the 4% to 5% guide. But for Q2, it looks more like a 4% and we're just calling it out to be representative of what we see across the business.

Mary Kay Ladone -- Senior Vice President, Corporate Development, Strategy and Investor Relations

And Larry, it's Mary Kay with the 6% in Q1 and 4% in Q2 for the first half we're looking at 5%, which is at the top end of our 4% to 5% core growth guidance for the year.

Larry Keusch -- Raymond James -- Analyst

Okay, got it. And then John, obviously very encouraging comments around some of the progress being made overseas. I know, that there have been some geographies that have been challenged for a period of time. I guess, the question is in that 3% growth that you recorded, how durable do you think that is. And if you could weave into your answer, what are the investments that need to be made into the emerging markets to drive that penetration higher, now that you've had a chance to kind of dig in and think a little bit more about the product portfolio and what needs to be done there?

John P. Groetelaars -- President and Chief Executive Officer

Yeah, it's a -- great question, Larry. And we're pleased with the start to the year, 3% core growth in total International, mid-single-digit in emerging markets at about 5% and double-digit growth in the new regions of Latin America and Asia-Pac. So really solid start to the year. As I mentioned earlier, Q2 represents a tough comp for us in some of our bigger international regions. So that's the primary reason for a deceleration in our overall core growth.

But as I look toward international for the full-year, we would expect to see acceleration at the end of the year in emerging market growth rates, and that is driven by some of the early investments we're making in the organization and aligning ourselves around the key product categories for those regions. We're in the final stages now of putting together an investment plan in Asia-Pacific for the emerging markets in Asia-Pacific, with obviously, China being the biggest opportunity for us.

We expect to turn on those investments, as mentioned before in the second half of the year. So the next -- this current quarter that we're in is all about finalizing those plans and preparing ourselves to turn on those investments. We would expect to see those investments really begin to mature about a year later, right at the end of our LRP period, at the end of fiscal '20. So we're excited about the opportunities, they look promising. And similar comments in other emerging markets, in Latin America. And as we previously discussed, we have shown an ability to drive emerging market growth in regions like the Middle East and Africa, where we've had over a three-year period, 18% compounded annual growth rate. So our confidence in being able to deliver more consistent, durable revenue growth in the emerging markets continues to grow and we're pleased with the early success that we saw in Q1.

Larry Keusch -- Raymond James -- Analyst

Okay, terrific. Thank you.

Operator

And Bob Hopkins of Bank of America is on the line with a question. Please state your question. Your line is open.

Robert Hopkins -- Bank of America -- Analyst

Well, thank you and good morning.

John P. Groetelaars -- President and Chief Executive Officer

Good morning, Bob.

Robert Hopkins -- Bank of America -- Analyst

Yeah, good morning. It really -- there's a lot of moving pieces here with some of the accounting changes and such. But I just wanted to ask a question on the earnings guidance for the year. So, just -- I'm curious, what are you assuming in the new guidance on EPS for the impact of stock-based comp on earnings? And the reason I ask that is that it was my impression from the conversations, kind of in the last call that the stock-based compensation, may actually be an offset to the new accounting change. So I guess my question to be very clear, is what are you assuming in terms of the impact on EPS from stock based comp in this new fiscal '19 guidance?

Barbara W. Bodem -- Senior Vice President, Chief Financial Officer

I'll take this one. Hi, Bob, it's Barb. How are you today? Thank you for the question with regards to stock-based comp. If you recall last year, we recognized a pretty large benefit from stock-based comp about $0.24 or -- yes, $0.24 on the full year. When we think about our guidance, we don't typically include this in our earnings guidance and last year's $0.24 was really driven by much of the executive changes that were going on. Something that we don't anticipate seeing a like-for-like. And as you look forward, we don't typically try to project what stock-based comp benefits are going to be. Because they're driven by a couple of different factors. It's driven by individual choices, about when they're going to exercise options, it's also driven by market performance, as you go along. So we have not included stock based comp in our LRP guidance, we have not included it in our 2019 either what we gave last November, nor what we've provided today under 606.

This just not something that we've incorporated because we think it's pretty hard to forecast. And I'm pretty hard to transmit out. What we have done is, we've been very transparent about it. So quarter-by-quarter to the extent that we see a benefit. If you recall, I said earlier that we saw a $0.03 benefit this quarter. We'll be transparent about that to the extent that -- that allows us some reinvestment opportunities in the business, we may consider that, but we will not include it in the guidance as we go forward.

As we think about the impact of ASC 606, the $0.10 impact that we have shown in the revised adjusted earnings guidance on EPS is purely the ASC 606 impact. So it's looking at what we experienced, or what we've seen in the restatement of 2018 and carried that forward into 2019. And then again, I want to reemphasize that as you think about the calendarization of that $0.10. We're anticipating the majority of that to be coming through in Q2.

John P. Groetelaars -- President and Chief Executive Officer

Yeah, and just -- for the full year then, our ex stock-based comp for the full year still 12% to 14% growth rate. Growth rates are not impacted by the ASC 606 changes. And then in Q1, ex-stock-based comp, we had a 15% EPS growth rate. So I hope that answers your question Bob.

Robert Hopkins -- Bank of America -- Analyst

Yeah, you know, that's very clear. I appreciate that. So my interpretation of all those comments is that, it makes sense not to include it, it's hard to predict. But all else equal, that could be an offset. You may choose to invest it, depending on how things play out, but it's still a potential source of offset at least as I read it.

John P. Groetelaars -- President and Chief Executive Officer

Yes, I think that's a good way to read it.

Robert Hopkins -- Bank of America -- Analyst

Okay, perfect. And then the other comment I wanted to ask was just on surgical solutions in particular because that was the one that was maybe a little weaker than we thought and you called out Middle East. Maybe you could just talk a little bit John about how big is that Middle East portion in Surgical Solutions? What was kind of the growth rate this quarter and how long do you think, it'll take to turn that around? Because -- that's obviously been a source of volatility in the past as well.

John P. Groetelaars -- President and Chief Executive Officer

Yeah, I guess, I would start out, Bob, by saying when we put our plan together. This is how we expected that surgical business to kind of phase through the year that we knew it's going to be a lighter Q1. Still confident about our 4% to 5% full-year performance there. We did have double-digit Integrated Table Motion take place internationally, but it was offset by some orders that we expected that have come out of in Q2 or Q3. So it's -- to us, it's what we expected, it's not a surprise. We're on track, and we do have the confidence in the full year guidance of 4% to 5%.

Robert Hopkins -- Bank of America -- Analyst

Perfect (ph), thank you very much.

Operator

And David Lewis is on the line of Morgan Stanley with the question. Please state your question. Your line is open.

David Lewis -- Morgan Stanley -- Analyst

Great. Good morning. Just a quick follow-up for Barb and then maybe two for John really quickly. Barb, just taking ASC 606 aside in the stock-based comp aside, I think you're pretty clear there. If I just sort of think about the beginning of the year, margin is sort of in-line with expectations. You're kind starting the year kind of above expectations, Mary Kay's commentary in the first half kind of suggest. Your operating performance is at the top end of your guidance. So with margins coming in where they expected and revenue kind of toward the top-end of the range, why does that necessitate an earnings revision at this time? And just update us again on tariffs $0.10 to $0.15. Is that still the right number. And then a couple for John.

Barbara W. Bodem -- Senior Vice President, Chief Financial Officer

Yeah, sure. So why don't I start then and we'll talk a little bit about -- I'll kind of go in reverse order and we'll come back to where we are on our guidance for the year. So starting with our margin expansion. I'd like to take you all the way back to what we said in the long-range plan, which is that over the long-range plan, we expected to see an operating margin improvement of about 300 basis points. And we delivered 100 basis points last year and our guidance this year is to provide another 100 basis points.

As you will see, that kind of ebbs and flows from quarter-to-quarter depending on the specific performance in that given quarter. Of that 100 basis points, we would expect about half of that to come from gross margin and the other half of it to come from OpEx leverage in the rest of the P&L. And what we saw in Q1 was very consistent with that. So, in Q1 we showed the 110 basis points, of which 60 was coming through gross margin and the balance of it coming through the rest of the P&L. Of the 60 basis points, when we looked at the 60 basis points and when we looked at the guidance for the full-year on gross margin, we took into consideration tariffs. I think, we estimated last fall that we thought the headwind from tariffs was going to be about $10 million to $15 million. In addition to that, as you probably aware, we're all experiencing a little bit of inflation on our direct materials as well. But what we said is that mix and productivity in gross margin would more than offset that and we would be able to deliver the 50 basis points worth of improvement even after absorbing those.

As we look at Q1, and we look at our experience with the tariffs in Q1. It's very consistent with that $10 million to $15 million for the full year. And as you know, we still have some uncertainty about where tariffs are going to land for the full year as well. So, as we're thinking about gross margin, as we're thinking about our operating margin expansion, we're feeling pretty confident and pretty comfortable with where our Q1 is and how it fits with our overall guidance.

So to your question about you know, if we're seeing growth at the higher end of it and we're seeing a nice margin expansion in Q1. Why is it that we're not adjusting our earnings for the full year. And I think, the answer to that at this point is that it's still very early. While we are very excited about and pleased about our performance in Q1, it is only the first quarter of a four-quarter year. And so, we have a lot of around to cover and at this point in time, we thought it would be to certain to signal any upside to the earnings.

I hope that answers your question.

David Lewis -- Morgan Stanley -- Analyst

Yes. Very, very clear, Barb. And then just John two kind of -- one tactical, one strategic for me. On Centrella, could you just kind of talk about the contribution Centrella to the pipeline this particular quarter? How has that changed over the last couple of quarters? And from here, it is the growth contribution from Centrella improved from here. And then, strategically, just the $50 million you talked about a few weeks ago in and above the LRP. Can you give some sense of sort of as you're thinking right now, where those investments go, whether it's just the Front Line Care business, the communications portfolio or the emerging markets piece? Where is it likely we see that money go? Thanks so much.

John P. Groetelaars -- President and Chief Executive Officer

Yeah, thanks David. So let me kind of broaden it out a little bit beyond Centrella at first, and then I'll get into specifics on Centrella to the extent I can. So for new products first of all, as I first said in my prepared comments about $100 million of contribution in Q1 from new products. What I didn't say is, that's an 80% growth rate over the prior year. So we really like the momentum we're seeing with new product growth. It is contributing significantly to top-line overall core growth, probably to the tune of something above 300 basis points in first quarter.

As we look at that, total new products category, which again consists of eight products that are really driving that overall performance, it continues to look promising to us, this ability to continue to be that fuel that drives above weighted average market growth rate, comfortably of that 200 basis points to 300 basis points.

So that's the overall characterization of that new product bucket, that was specifically with respect to Centrella and probably the best way to address that is our Med-Surg, category because there is some cannibalization of Centrella over other Med-Surg product offerings. We saw double-digit growth rate in Q1. I guess more specifically in the neighborhood of 30% growth. So very strong growth. We're really excited about the new technology we're bringing into that ecosystem, with our new launch of EarlySense and WATCHCARE.

In the case of EarlySense. We think, that's a breakthrough technology. Non-contact, twice per second measurement of heart rate and respiratory rate and getting a really -- a running trend of heart rate respiratory rate to provide actionable insights and early intervention, where required to reduce costly complications and life-threatening complications. So Centrella is that digital hub in that ecosystem. We're pleased with this progress. I'm very pleased with engagements, since the last time we had a call, I visited customers in China, visited customers in the United States, in Europe and in Canada. And all of them are very excited about the offerings that this product provides them. But not just on its own, but at the whole ecosystem of sensing technology, immediate care communication technology and being able to provide a turnkey solution that we can scale and integrate into their system.

I think one of the highlights of the last three months is visiting North America's first digital hospital and seeing how they've incorporated these types of products in that setting with connected vital signs and connected beds, and really a command center that really allows them to show significant workflow improvements of 30%-plus, as well as falls reductions in that same neighborhood. So very excited about the response we're seeing from customers around the world, on the value that these connected products bring, not just as a stand-alone, but as a complete ecosystem.

Getting to your second question David, about the $50 million. We have a lot of investment proposals that are coming forward in the organization. Now neighboring around 30 (ph) or so. We are vetting those as we speak and racking and stacking what those best opportunities look like. It'll be a mix between new products and innovation and emerging markets. And perhaps a couple of select other investments in commercial operations or clinical studies and clinical data generation. So it's a little bit too early to say, what exactly those are. But certainly with $50 million over the coming years that we'll have to invest, we'll be looking to pace new investments, as the savings are realized and put you know, our best investments forward first, as we think about how to deploy that cash. But thank you for the question, David.

David Lewis -- Morgan Stanley -- Analyst

Thanks, John.

Operator

And we have Matt Taylor on the line with UBS. Please state your question. Your line is open.

Matt Taylor -- UBS -- Analyst

Hi, good morning. Thank you for taking the question.

John P. Groetelaars -- President and Chief Executive Officer

Good morning, Matt.

Matt Taylor -- UBS -- Analyst

So I wanted to --. Good morning. I want to ask you about your kind of guidance philosophy, just seeing newer -- with this team. Understand not raising at this early stage in this year, that's certainly prudent I guess. Could you give us a little bit more color on when you might feel comfortable raising? I feel like, it's a little bit of an unfair question but if you had a 6% growth rate in the second quarter, does that give you enough confidence? Or maybe you could just talk about with 6% growth this quarter. Are you getting more confidence that you can actually grow above 4% to 5% or were there just kind of onetime things that helped this quarter?

John P. Groetelaars -- President and Chief Executive Officer

Yeah, great question Matt. Let me reiterate, we're very happy about the momentum from 2% a year ago to now up to 6%. So clearly organic momentum is driving the portfolio and driving our core growth. As we think about providing guidance, we're looking at all the puts and takes across the business. And I think our philosophy would be summarized pretty simply in three words meet or beat, right? We're looking at the guidance as a meet or beat number, we certainly don't want to disappoint anybody including ourselves. So when we look across the portfolio and all the businesses in the regions of all the dynamics that go on in the business as diverse as this.

I can boil it down to those three simple words. That's our view meet or beat.

Barbara W. Bodem -- Senior Vice President, Chief Financial Officer

And Matt, this is Barb. With regards to the timing of when we might revisit, Q2 is the obvious time. So as we get through the second quarter, we'll revisit our position and if we have an update, we will obviously be sending that out. So thanks for the question, Matt.

Matt Taylor -- UBS -- Analyst

Thank you. I just had one follow up, I was wondering if you could expand on some of the cost savings initiatives that you've laid out here. It seems like they're kind of coming into focus. Can you talk about any that you have prioritized, that will be helping margins sooner or anything that's changed sequentially to give us some flavor for the initiative that you'll be executing on here in the back half of the year?

John P. Groetelaars -- President and Chief Executive Officer

Yeah, sure Matt. I'll start with that question and hand it over to Barb for additional comments. We're kicking those off right now. It's going on a multiple fronts. So they're a couple of very -- I'll point it, three big ones. One is continue the consolidation of our manufacturing footprint. More recently, we've begun to consolidate some of our R&D centers. So we can concentrate our R&D in centers of excellence, around the businesses and around specific areas, such as digital and software development. So that is under way as we speak. And the third one is really the whole category of just spending more wisely on everything from meetings to consulting to outside services and travel et cetera.

Things we call indirect spend, that's the third kind of big bucket that we're pursuing as we progress. And because of the decentralized nature of the company, we're able to execute on multiple fronts with respect to -- of manufacturing footprint or reorganizations, like the ones I mentioned.

So those are the first three that I would point out. And as you look, over the three year period, it's relatively, evenly spread between the three year period in terms of when we see the savings. A lot of it gets kicked-off this fiscal year or we begin to realize it at the second half of this year. And then annualize it more into next year as it rolls-out. Any additional comments Barb, you would add?

Barbara W. Bodem -- Senior Vice President, Chief Financial Officer

The only other thing I would add is that what you don't see and so you see relatively, say, well, we've got 3% growth in our R&D spend. We've got flat SG&A. In particular in the flat SG&A, what's not visible is the fact that we are actively repurposing investments within that flat SG&A. So we've taken some actions that have really brought down our G&A, area spend. So that we can turn around and reinvest that in selling and marketing activities or commercial activities and other areas. So some of the changes we're making are really not going to be visible in the P&Ls, the expense lines, as you see it, because it's all happening in the redirection and the realignment of the spend that we have. I hope that's helped in giving a little extra color.

Matt Taylor -- UBS -- Analyst

It does. Thank you so much for all that.

Operator

And we have Rick Wise of Stifel on the line with a question. Please state your question. Your line is open.

Frederick Wise -- Stifel, Nicolaus & Company -- Analyst

Good morning. John, maybe just help us think about the current new product pipeline. Obviously, R&D spending has gone up sort of in the neighborhood of 5%. Clearly, new products are making a difference. Sort of two questions about it. One, today what percentage of the pipeline -- of the new product revenue you're generating is capital. And do you related like Centrella -- but what's next and how is that pipeline changing -- likely to change and evolve over the next few years?

John P. Groetelaars -- President and Chief Executive Officer

Yeah, good question. Rick, I mean if I look at our new product revenue, to specifically answer your question about how much of it is capital. It's probably in the neighborhood of about 15%, maybe 20% the most. But it looks like around 15% of the eyeballs the numbers in front of me here.

That's actually consistent with our frames business. Our bed frames is 20% of our total revenue today. So it's proportionately similar to our current mix or a little bit less capital dependent. If I think, about the future of what we're looking forward to.

We've talked about four key product launches this year with LINQ Mobile as part of our CWS or clinical communications portfolio, WATCHCARE, which is our incontinence detection device with a consumable recurring revenue stream business. EarlySense, which is our heart rate respiratory rate monitoring in the bed. And then RetinaVue, next generation. The first, three are already launched or in the early phases of launch. We're getting great feedback on all of those. They haven't really had the dollared impact in terms of new products yet because they're really in the early phases. But each of those three LINQ, WATCHCARE and EarlySense, we expect those to grow substantially over the coming quarters and couple of years here.

The one is not yet launched is our RetinaVue next generation product, which is really a point-and-click, easy-to-use our retinal scanning device. And that's expected to come in the second half of this fiscal year. So we feel good about what's in that portfolio of the eight products that drive 90% of the new products basket. And then four new products coming into it this year, as well as a pipeline of additional innovation that we have not yet disclosed, looking very promising at driving category leadership in these seven strategic focus categories that we've outlined, most recently in the J.P. Morgan presentation. Those seven focus areas and categories represent about $26 billion of total available market to us.

So we've got a lot of room to grow in -- in these seven strategic categories that we've outlined, many of which have nice growth rates above the overall weighted average market growth rate for the company.

Frederick Wise -- Stifel, Nicolaus & Company -- Analyst

That's very helpful. Second question, just sort of a multipart and it's really for both you and Barbara, just maybe you could just talk through -- I'd like to hear both your perspectives on. Barbara, you're a new CFO, walking in the door. Both of you are building on the great work and foundation that John Greisch and Steve did. Barbara what are your key priorities? You talked about SG&A, sort of repurposing and efficiencies. What do you think are the key opportunities over and above what we may know about the company priorities? John, I'd be hear -- happy to hear your perspective. And maybe the second part of the question is given the significant reduction in leverage and balance sheet improvement and cash flow growth.

John, you've been in place for a while now, how are you thinking about M&A. I heard you promoted a rockstar biz dev strategy kind of person. How are you tasking that excellent individual? What can we expect on the M&A front and portfolio front. Thank you.

John P. Groetelaars -- President and Chief Executive Officer

Yeah. Thanks for the question Rick. And I don't know if I'm a rockstar or not. But well, time will tell and you can review us and judge. But I don't aspire to be a rock star. So when it comes to M&A, and it kind of feeds into my priority at this point. I do feel very good about the operational execution of the organization. I feel very good about the leadership team, both my immediate leadership team, as well as a broader leadership team. And I feel very good about our ability to continue to deliver mid-single-digit top-line growth organically.

So a lot of time and attention is now being directed toward M&A. We are looking for accretive acquisitions, accretive to growth, accretive to our growth profile, improving the profile of the company that drives higher growth rates, higher profitability and gives us the kind of returns on the investments around M&A that we are looking for. And we'll be rigorous and disciplined around. So that's where I'm spending my time. Obviously can't comment on things that are speculative at this point. But I would say, in general, I do like the pipeline that we're developing of opportunities. We're engaging on multiple fronts around M&A. They're are going to be supportive. And you're going to, if we get something done, you'll -- I think see a very clear strategic fit of how these acquisitions would fit into these product categories that we've identified as strategic to us. And I think you'll see that they're going to be accretive to the overall growth of the company. So that's where I'm spending my time. Rick, in addition to everything else that you would expect me to spend time on. Barb?

Barbara W. Bodem -- Senior Vice President, Chief Financial Officer

So, Rick great question and I appreciate you asking it. It has been not quite two months for me. But it's been a very good two months and I've been very impressed with the organization and how focused the organization is on the strategic priorities that John outlined for everybody earlier today. It's embedded in the cadence of how we operate everyday.

When I think about where am I going to be spending my time. Clearly from an M&A perspective, externally doing everything with my team to make sure we're supporting, the M&A process and that we're doing the right deals that are going to drive the future growth of the company. Growth is also where I'll be focusing from an internal standpoint. It's really about making sure our resources are lined-up to the best opportunities that we have. Over the past few weeks have had the opportunity to really get a view of our internal innovation pipeline and it's very impressive. And so making sure that we are funding that appropriately, moving things forward is key. Making sure that as we look at our internal resource allocation that we are as streamlined and efficient in those areas that are not business-facing or not driving growth. So that we can free-up resources for those areas where they will drive growth, is going to be a key agenda and area for us. It's not new from what Steve was doing but it'll be a particular area of focus for me. I hope that helps give you some insight into where my head is.

Frederick Wise -- Stifel, Nicolaus & Company -- Analyst

Thank you so much.

Barbara W. Bodem -- Senior Vice President, Chief Financial Officer

Lisa we have time for just one more question this morning.

Operator

Our final question will come from Kristen Stewart of Barclays. Please state your question. Your line is open.

Kristen Stewart -- Barclays -- Analyst

Hey everybody. Thanks for taking the question Bard, welcome to the first-call (ph). Just to go back, I guess more of a couple of clarifying questions. So when you are talking about flat year-over-year growth for the second quarter, is that going to be also on a ASC 606 revised basis? Is that fair? Or is that flat versus ASC 605?

Barbara W. Bodem -- Senior Vice President, Chief Financial Officer

Kristen it's Barb. Thanks for the welcome. Excited to be here. All of our guidance going forward is under 606. So the only time we were going to do anything under 605 is helping you understand Q1 2019 performance. Go forward is only 606. So, when we talked about guidance for Q2, we said it would be flat on a reported basis, 2% on a constant currency. And then looking at 4% from a core growth for the quarter. All under 606. And remember that I also flagged that we do think we'll see a disproportionate impact from an EPS perspective of the 606 change in Q2.

Mary Kay Ladone -- Senior Vice President, Corporate Development, Strategy and Investor Relations

And Kristen, this is Mary Kay. Just to clarify you do need to update your models for the 2018 modified results. That's the base for 2Q under 606.

Kristen Stewart -- Barclays -- Analyst

Okay. That's what I thought. So it's flat-off of that call it $706 million revenue, the kind of restated ASC 606 number.

Mary Kay Ladone -- Senior Vice President, Corporate Development, Strategy and Investor Relations

Yes, that is correct.

Kristen Stewart -- Barclays -- Analyst

Okay. And then the EPS was lowered by $0.03 under ASC 606 a year ago, but you're basically saying the benefit is going to be greater and that's one of the things driving the little bit lower EPS relative to expectations. It also looks like margins are going to be, little bit lower than at least the full year run rate. Is there any kind of thing causing that or they're just timing of investments? Or effects? Of anything you can speak to into why margins might be a little bit lower in 2Q as well. Or maybe that's all it.

Barbara W. Bodem -- Senior Vice President, Chief Financial Officer

I think when we're looking at Q2 and we're looking at margins for the quarter, margins are going to be driven by multifactorial sort of thing. The mix of the products that we're projecting for the second quarter and that mix does fluctuate a little bit from quarter-to-quarter, as well as timing of initiatives, as well as headwinds. So there's a lot of different moving pieces in there. I don't know that you can draw any straight conclusions between 606 and the margin for the second quarter.

Kristen Stewart -- Barclays -- Analyst

Okay. And then just to kind of go back, I guess, to beginning conversation, not to beat a dead horse, but the stock-based comp was $0.03 in the quarter. You're kind of keeping the guidance, if I'm hearing kind of how you responded back to everyone else's comments. Should we just think about, you guys just really targeting kind of that range for the full year and to the extent there's additional stock-based comp, more of a willingness to kind of reinvest those opportunities? And along the same lines with the $50 million in savings that you've talked about. Should we just think about that as something that just automatically will get reinvested and not necessarily be additive to the LRP?

Barbara W. Bodem -- Senior Vice President, Chief Financial Officer

Kristen thanks. Thanks for the question and thanks for the opportunity to clarify back on the SBC side. First of all, from an LRP perspective and from a fiscal year perspective, again we don't forecast the SBC which you know, also on the business optimization that is not -- it is incremental to what we have in the LRP with the goal of reinvesting all of that. So when we think, about the guidance these two things are not things that we would have factored into achieving the EPS guidance that we've laid out either in the long range plan or for 2019.

When you think about how are we looking at SBC for the remainder of the year. Again, I believe that it's a good position to not try to forecast that out and put it in the guidance. To the extent that we are seeing benefits and we're seeing those benefits early enough in the year where we can do something with those benefits, we will look for reinvestment opportunities, to the extent that the timing of when we see the SBC benefits come through. And when we have investment opportunities within the quarter and within the fiscal year don't align, then that will end up being potentially incremental to our guidance for the full-year. Did that help?

Kristen Stewart -- Barclays -- Analyst

Yes, it does. Thanks so much.

John P. Groetelaars -- President and Chief Executive Officer

Thanks Kristen.

Operator

I'll now turn the call back over to John Groetelaars for closing remarks.

John P. Groetelaars -- President and Chief Executive Officer

Well, thanks. And thanks for all the great questions and engagement this morning. I guess, summary comments was -- would be look, things have never been better. We've gone from a 2% growth in core growth in first half of '18, 4% Q3; 4% Q4 last year, coming into this year with 6%. The organic growth engine is alive and working well. We feel very confident about our ability to deliver mid-single-digit top-line growth, that's consistent, durable. In addition to that, I think, we've shown over 14 quarters. Our ability to deliver double-digit adjusted EPS. So we're confident in our guidance for Q2 and are confident in our guidance for the full year. And I want to thank you for all your time and attention this morning.

Operator

Ladies and gentlemen, this concludes today's conference call with Hill-Rom Holdings Incorporated. Thank you for joining.

Duration: 63 minutes

Call participants:

Mary Kay Ladone -- Senior Vice President, Corporate Development, Strategy and Investor Relations

John P. Groetelaars -- President and Chief Executive Officer

Barbara W. Bodem -- Senior Vice President, Chief Financial Officer

Larry Keusch -- Raymond James -- Analyst

Robert Hopkins -- Bank of America -- Analyst

David Lewis -- Morgan Stanley -- Analyst

Matt Taylor -- UBS -- Analyst

Frederick Wise -- Stifel, Nicolaus & Company -- Analyst

Kristen Stewart -- Barclays -- Analyst

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