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Hill-Rom Holdings Inc (NYSE:HRC)
Q3 2020 Earnings Call
Jul 31, 2020, 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 Third Quarter 2020 Earnings Conference Call. [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'd 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-Investor Relations

Good morning, and thanks for joining us for our fiscal third quarter 2020 earnings conference call. Joining me today are John Groetelaars, President and Chief Executive Officer of Hill-Rom; and Barbara Bodem, Chief Financial Officer. Before we get started, let me begin by reminding you that this presentation includes forward-looking statements that are subject to risks, uncertainties, assumptions and other factors that could cause actual results to differ materially from those described, including any impact related to the COVID-19 pandemic. Please refer to today's press release and our SEC filings for more information concerning risk factors that could cause actual results to differ materially. In addition, on today's call, non-GAAP financial measures will be used. Reconciliations between GAAP and non-GAAP financial measures are included in our earnings release issued this morning. I would also like to mention that in addition to the press release issued this morning, we have posted a supplemental presentation, which highlights Hill-Rom's performance. These materials can be accessed on the Investor Relations page of our website.

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

John P. Groetelaars -- President, Chief Executive Officer & Director

Thanks, Mary Kay, and good morning, everyone. I hope you're doing well, and thank you for joining the call. I'd like to start the call today by recognizing the dedicated, committed, passionate and mission-driven team that we have here at Hill-Rom. It's truly extraordinary, and I do mean extraordinary. We were called to fulfill our mission to enhance outcomes for the patients and caregivers. And as a team, we unequivocally executed to a T, ramping up and shipping two times the normal volume of smart beds, ramping up and delivering seven times the normal volume of noninvasive ventilators, securing our global supply chain, ensuring our workers' safety, involving five of our largest manufacturing sites in ramping up manufacturing to meet customer needs, continuing to engage our over 1,200 field service employees and rental employees and those involved in logistics and shipping, you name it. Our overall operational team delivered excellence. And this group of people, which is approximately 7,000 employees out of our 10,000 employees, really deserve special recognition. Next, we pivoted and accelerated our R&D pipeline during the pandemic, launching five new products and pivoting our programs toward innovations to help patients dealing with COVID. It doesn't stop there.

We closed the two acquisitions and supported our vision of Advancing Connected Care in both patient monitoring and OR data integration. And if all that wasn't enough for you, we actually did this while all of our office workers moved to remote work-from-home, and we launched a new website for the company. As I said, extraordinary. Incredible execution by the Hill-Rom team. The combination of our exceptional execution, financial strength and diverse portfolio underscores our commitment to enhancing value for customers, caregivers and our shareholders today and over the long term. Moving to financial highlights for the third quarter. We are pleased to report record results that exceeded our expectations on both the top and bottom line. Core revenue growth was 12%, reflecting the durability and strong value propositions of our Critical Care products and our category leadership in the markets we serve. Core revenue includes a contribution of approximately 400 basis points from the Breathe acquisition and benefit of more than $100 million related to other COVID-related purchases. We continue to be pleased with our ability to significantly expand margins, achieving a record adjusted gross margin of 53.8%. With disciplined cost management and expense leverage, we posted an operating margin of 23.7%.

This resulted in adjusted EPS of $1.95 per diluted share, an increase of 59%. Before turning to performance by business, I'd like to highlight that growth from new products accelerated again this quarter, resulting in more than $440 million in new product revenue year-to-date, an increase of 40% versus the prior year. Importantly, this sets a solid foundation for achievement of $550 million in new product revenue, a key objective we set at the beginning of the fiscal year.

I am very proud of how we pivoted our R&D efforts and recently introduced five new products in the areas of remote monitoring, respiratory care and surgical workflow. These were highlighted in the press release issued this morning. So given our limited time together, I won't walk through them individually, other than to note that they are all representative of how we are advancing our category leadership and plan to accelerate future growth through innovation. Geographically, international performance was strong, with core revenue growth of nearly 40% due to a surge in demand for COVID-related products like ICU and med-surg beds, thermometry and vital signs monitoring equipment. As expected, with the exception of Asia Pacific, all regions generated positive growth, including significant double-digit growth from EMEA, Canada and Latin America.

In the U.S., growth of 2% reflects the puts and takes across our diverse portfolio. Patient Support Systems led the way with core growth of 12%, which was offset by lower revenues in Front Line Care and Surgical Solutions. Now let me touch on our third quarter performance by business at constant currency rates. First, Patient Support Systems revenue increased 21%. Core revenue growth of 23% was driven by a global surge in demand for our ICU and med-surg bed systems as hospitals expanded capacity in the early phase of the COVID outbreak. The vast majority of the company's COVID benefit that I referenced earlier was from med-surg and ICU beds, which comprised approximately 30% of total company revenue in Q3. That's a full 10 percentage points higher than typical.

During the quarter, we worked through the significant backlog in orders that accumulated during the months of March and April, particularly in the U.S., Canada and EMEA. This resulted in revenue that was nearly two times the level of prior year. In the U.S., we estimate that approximately 50% of the peak demand for beds was due to market expansion, while the other 50% was pull-forward from our fourth quarter funnel. Global demand for beds is now beginning to normalize. Due to the pull-forward effect and surge in demand previously mentioned, we anticipate near-term transitory headwinds for our bed portfolio. That being said, we remain optimistic about recent customer commentary and prioritization around ICU beds as a top capex investment priority as they balance capacity needs to treat both COVID and non-COVID patients. We remain encouraged by the long-term growth prospects of ICU market expansion, which may help overcome some otherwise difficult growth comparisons in coming quarters.

While bed revenue was strong, it was partially offset by anticipated headwinds in other parts of the business, including Care Communications, which was impacted by hospital access restrictions to complete installations. The good news is that access restrictions are starting to ease, installations and quoting activity is accelerating toward pre-COVID levels, and we are currently building a robust funnel that we expect to benefit from in fiscal 2021. Turning to Front Line Care. Third quarter revenue increased 4%, reflecting strength in international and onetime noninvasive ventilator orders of approximately $25 million to support U.S. stockpiles. While we experienced strong demand for vital signs monitoring equipment and thermometry, it was not enough to offset the impact of lower physician office visits in the U.S. on the other patient exam and diagnostic tools, including cardiology and vision screening. Generally, physician offices are now resuming and recovery toward pre-COVID levels is occurring across multiple areas of our Front Line Care portfolio. Lastly, Surgical Solutions revenue declined 37%, reflecting the surgical consumables divestiture last year. Core revenue declined 21% as a result of project timing and capital delays due to COVID-19. We expect recovery in the surgical business to be more gradual as OR capital projects, as you can imagine, are currently being deferred by our customers.

With that as a backdrop, I'd like to provide some additional perspectives on our results and visibility to the trends we are now seeing across the portfolio. As you may recall, we have portions of our business that have been favorably impacted and those that have been negatively impacted by the evolving market trends. The net impact to Hill-Rom in various regions and product categories were largely dependent on the scope, intensity and duration of the pandemic as well as the shape of the recovery in the demand for healthcare and access into acute care facilities. Given all these variables, the last quarter, we elected to suspend our previously issued guidance. And while we are not reinstating guidance today, as the situation remains very fluid, we are now through three quarters of our fiscal year, and we have some visibility into our final fourth quarter. Given the strength of our financial results to date, including core revenue growth of 8% and adjusted EPS growth of 28% and the evaluation of various scenarios for Q4, we are confident in projecting adjusted earnings of at least $5.40 per diluted share for fiscal 2020.

Our confidence is based on various outcomes of the puts and takes across our portfolio. This includes the assumption of normalized demand for med-surg and ICU beds following the Q3 surge, continued growth across multiple product categories in Q4 and reflects no benefit from a second wave. In addition, we anticipate recovery across other areas of our portfolio that were negatively impacted by project delays, customer access and reduced physician office visits. We are pleased with the speed of this recovery and expect double-digit sequential growth with these products as we exit our fiscal year. So in summary, amid a challenging environment, our performance to date demonstrates the advantage of our company's transformation into a diverse and more resilient portfolio of connected care solutions. And that is more important than ever. Looking ahead, we will continue to focus on our strategic priorities, advancing our mission and category leadership strategy, executing on our growth-oriented M&A strategy and driving operational execution and strong financial performance in the years to come.

Thanks, and I'll turn the call over to Barb now.

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

Thanks, John, and good morning, everyone. Let me briefly walk through the P&L before commenting on trends we are seeing as we close out fiscal 2020. For the third quarter, global revenue of $768 million increased 6% over prior year revenue of $727 million. On a constant currency basis, revenue increased 7%. Core revenue advanced 12%, reflecting a benefit from COVID-related purchases of more than $100 million, new product contributions as well as approximately 400 basis points from the Breathe Technologies acquisition, which we'll anniversary in August. Adjusted gross margin expanded 350 basis points versus the prior year and peaked at 53.8%, a new record level. This reflects favorable product mix, particularly from higher-margin onetime COVID purchases as well as the impact of new products and portfolio optimization initiatives and the benefit of lower manufacturing and service costs. R&D spending of $34 million was comparable to the prior year.

Adjusted SG&A of $197 million decreased 3%, primarily of lower discretionary spending, like travel, meetings and certain marketing expenses, more than offset strategic investments to drive future growth. Given strong adjusted gross margin expansion and expense leverage, adjusted operating margin of 23.7% improved 590 basis points compared to the prior year, setting a high watermark for the fiscal year. Interest and other nonoperating expenses for the quarter totaled $17 million, and the adjusted tax rate was 21%. This translates into adjusted earnings for the fiscal third quarter of $1.95 per diluted share, which is an increase of 59% from $1.23 per diluted share in the prior year. Excluding the dilutive impact of the surgical consumable divestiture, which contributed $0.07 per diluted share last year, adjusted earnings per share increased 68%.

Now turning to cash flow. Cash flow from operations for the first nine months of 2020 was $315 million, a 5% increase to prior year. Capital expenditures on a year-to-date basis totaled $72 million, $21 million higher than the prior year, driven by IT transformation costs and capitalized software costs related to R&D investments. As a result, year-to-date free cash flow totaled $243 million. Our balance sheet and overall financial position remains very strong. To date, we returned $114 million to shareholders through dividends and share repurchases during fiscal 2020. We ended the quarter with $332 million in cash. And our debt-to-EBITDA ratio at the end of June was 2.9 times, the first time it's been below three times since the Welch Allyn acquisition. We continue to operate well within our debt covenants, and we have no material debt maturities until 2024.

Lastly, given our refinancing efforts last year, we have access to a revolving credit facility of up to $1.2 billion to address any capital needs as necessary. Now before turning the call back over to John, let me expand on the current business trends as we continue to actively monitor the evolving landscape and track potential implications geographically and within each of our three businesses. As John mentioned, Q3 reflected peak demand overall for 60% of the portfolio, which translated into actual growth of more than 40% for this category of products. As demand for certain products like ICU and med-surg beds begins to normalize, we do expect double-digit growth for the other products in this category, like thermometry, vital signs monitoring and respiratory products as we exit the year.

Collectively, for the 60% revenue category, we expect Q4 revenue to be comparable to the strong fourth quarter last year, resulting in growth of nearly 20% for the second half of 2020. This reflects the current backlog and visibility to orders and no benefit from a second wave. The other 40% of our revenue is now showing signs of recovery and is expected to show sequential double-digit revenue growth as we exit our fiscal year as customer access and physician office visits improve. We continue to expect second half revenue for this portion of the portfolio to decline by about 25%. This is in line with the expectations we shared with you last quarter. Given the ongoing uncertainty, scope and evolving nature of the pandemic, we are not reinstating formal guidance. We would also not recommend extrapolating our recent results into projections for the remainder of the fiscal year. However, given our results to date and disciplined management of the business, full year adjusted earnings of at least $5.40 per diluted share, for additional updates in the future.

Thank you. And with that, I'll turn the call back over to John.

John P. Groetelaars -- President, Chief Executive Officer & Director

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

With that, let's open up the call for Q&A.

Questions and Answers:

Operator

[Operator Instructions] And first question comes from Rick Wise with Stifel. Please go ahead.

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

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

John P. Groetelaars -- President, Chief Executive Officer & Director

Yes. Thanks, Rick. When it comes to our PSS business and, in particular, the bed portion, both med-surg and ICU beds, I think what we saw in Q3, and as we outlined in our prepared comments, was, in fact, market expansion. We took a lot of time to detail out that incremental $100 million of COVID-related business and saw that roughly, as we said, about half of it was due to market expansion. So and a big portion of that in Q3 was not just the U.S., it was international. And I can give you examples. I'll give you one example that we talked about last time. In Canada, we sold well over $25 million of ICU and med-surg beds, primarily ICU. And they weren't replacing other beds in that instance, and saying was that whole category that we said was market expansion, they were adding new incremental capacity. In that instance, it was done in a hurry. It was done pretty much across the country, and we were well positioned to support those customer needs in a real hurry. So the fact that we could adapt and respond so quickly to that urgent need in a moment of panic, quite frankly, led to immediate market expansion in Q3. And that's why I think in other prepared comments, and I'm sure we'll talk about this, but let me try and address it now. We've always said, and I've always said, that we're going to see a nonlinear recovery when it comes to this part of our business.

We're seeing a nonlinear expansion ahead as it relates to this part of our business right now. There was an incredibly urgent and significant healthcare need. And Hill-Rom was able to deliver for that need to provide immediate market expansion. Now at the same time, it pulled forward a lot of sales that we had in for Q4. But I think to your question about the long-term outlook, we feel really good about the long-term outlook for market expansion for ICU beds and med-surg beds that have the ability to flex up and become an ICU bed for a transitional temporary period. Both of those are in our portfolio. In fact, you'll see on our website, a new product offering that we're just out promoting now, that's a Centrella bed offering, that can be flexed up to become an ICU bed offering to provide for this transitory capacity that may be required. So we think we're really well positioned, Rick, to go to benefit from this trend. It's a global issue. Many countries require more ICU capacity than they have. There's a clear recognition after the wave that we've just been through that this seems to happen. And you're seeing a much more measured kind of thoughtful approach around how various healthcare systems do this. However, I would say we've got a lot of a tremendous amount of feedback. We kind of did a lot of research on this topic, and our confidence is very high that we're going to see market expansion over the coming years for the ICU bed market.

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

Great. John, you talked about the Care Comm business. And I'm not surprised that obviously that during this period, you didn't have the access you wanted to install. And but I'm excited to hear that you're building a backlog, and you were very positive about the impact on fiscal 2021. Can you talk about what kind of I mean I don't know if you can give us any numbers about where the backlog is, but maybe can you help us think about what kind of incremental benefit could we see from this turnaround in Care Comm as we contemplate fiscal 2021?

John P. Groetelaars -- President, Chief Executive Officer & Director

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

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

And just last for me. With debt now 2.9 times, maybe just talk to us about your thinking about M&A. Do you feel like, just because of all the craziness in the world that are more businesses available? Or more of the kind of acquisitions that you're interested in are available now? And maybe talk through, with the help of your outstanding business development strategic team, where are your priorities as we think about that portfolio?

John P. Groetelaars -- President, Chief Executive Officer & Director

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

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

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

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

Thanks.

Operator

And Larry Keusch is on the line with from Raymond James with a question. Please state your question.

Lawrence Soren Keusch -- Raymond James & Associates -- Analyst

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

John P. Groetelaars -- President, Chief Executive Officer & Director

Yes. Let me probably address that two ways, Larry, one with capex and one with our down businesses, the 40% of our portfolio that was negative. And I'll start with the latter. In that group of 40% of revenue that was negatively impacted by COVID, it breaks down into three categories. One, Care Comm, which we talked briefly about earlier. The second one is all of our physician office businesses in Front Line Care, everything from vision care to vital signs and thermometry. Well, not thermometry, thermometry is in the other part of the portfolio, but all of our physical assessment tools. And then our surgical business as well as some of the safe patient handling equipment in our PSS portfolio. Those are the three big elements. And they're all on different recovery curves, I would say. Care Comm, as I mentioned earlier, is one of quicker ones to come back. And we're seeing we saw a nice uptick in the trend as we exited the quarter. And our outlook for Q4 is kind of getting back to we're we hope to show some growth in that category in Q4. If not, we'll come pretty close. In our Front Line Care portfolio, you can imagine, primary care physician office visits were not as high a priority as elective surgeries and the return to healthcare demand. So that was slow to show recovery in Q3, but did definitely show signs in the month of June, and we're seeing that trend continue in the month of July. So we're again that's on its way back to pre-COVID type of levels, we believe, in the coming quarter. And then the surgical business as well as safe patient handling, which does involve many times installing infrastructure in the ceilings of the hospital or in the OR, given the importance of OR activity and resumption of surgical backlogs in elective surgery, that's one of the reasons you're not we're not seeing we don't anticipate seeing a significant increase in those businesses from Q3 to Q4. But we do expect and have schedules to see those product lines coming back in our new fiscal year starting in October. So they're going to come back. We feel very confident they're going to come back. It's just a slower recovery curve in that area. The other area I would comment on is capex, and in particular, U.S. capex. Our international capex is really not impacted in the markets we're in and the products we're in. If anything, it's favorable because of the need for more bed capacity, more ICU bed capacity and in other parts of our portfolio that are experiencing a tailwind in this environment. And the U.S. is where more of the uncertainty is. And I'm sure everyone's heard this commentary on that from providers as well as other companies in the industry. We're actually very favorably positioned. We know that the top one of it a couple of the top priorities for our customers is workflow and clinical communications with both caregivers to caregiver and caregiver to patient. That positions our Care Com business pretty well as a priority. And then ICU capacity and ICU needs for critical care equipment, whether that's vital signs equipment or ICU beds. So those are going to have relative high priority even in a constrained capital environment in the U.S. So it will be certainly a challenging environment for the next couple of quarters until hospitals see the full benefit of government stimulus and support. So far, about $125 billion out of $175 billion has flowed to them, and maybe there will be more in future stimulus packages. That combined with a return of normal elective surgery volumes and normal consumption of healthcare in the acute care environment certainly helps shore up their financial certainty, the combination of those two events. And we anticipate that over the coming couple of quarters that the financial certainty around capex will significantly improve in the United States. But in the near term, our portfolio is well positioned for their most pressing, urgent requirements.

Lawrence Soren Keusch -- Raymond James & Associates -- Analyst

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

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

Larry, thanks for the questions. I hope you're doing well. Let me start with gross margin. So gross margin for Q3 was at record levels, 53.8%. And we're really pleased with that. As we highlighted in our presentation that's online, about 180 basis points of that really is related to the onetime COVID sale that we saw in Q3. On a year-to-date basis, if you look at our performance, we are year-to-date, for the first nine months, at 51.7% and

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

Lawrence Soren Keusch -- Raymond James & Associates -- Analyst

Yes. No, that was terrific.

John P. Groetelaars -- President, Chief Executive Officer & Director

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

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

Maybe just a clarification, this is deliberate choices about volumes, not about any risk of obsolescence.

Lawrence Soren Keusch -- Raymond James & Associates -- Analyst

Okay, got it.

Operator

Bob Hopkins from Bank of America is on the line with a question. Please go ahead.

Robert Adam Hopkins -- BofA Merrill Lynch -- Analyst

So I have some yes, I know it's confusing times. Things are kind of all over the place. So I've got a just some clarifications on the guidance, and then a longer-term question. First, just to be clear on the on what you're saying about the fourth quarter. What are you saying about the fourth quarter in terms of absolute dollar revenues?

John P. Groetelaars -- President, Chief Executive Officer & Director

Well, I'll start with that, and then I'll turn it over to Barb. We haven't specified, Bob, explicitly. I think the best we can articulate is on Page 20 of the slide presentation we provided, where we're saying like 60% of the we're providing overall second half outlook of what we believe the revenue of the 60% resilient and the 40% impacted, how they look for the second half. And you can certainly do the math and back into what the fourth quarter looks like. But when you do that, you'll see we're projecting a decline in fourth quarter revenue overall, which is heavily driven, in fact, primarily driven from the surge in bed volume that we saw and we're able to deliver in Q3. And as you know, Bob, the customers were desperate to get this product and delivered immediately. Thankfully, we were able to meet those requirements. But as a result of that, we have a nonlinear transition between Q3 and Q4 of our resilient products because we delivered over $100 million of benefit effectively financially around beds, and then another $25 million of noninvasive ventilators that are that will be a onetime stockpiling order in Q3. So those things don't repeat, hence our attempt to smooth that out over the second half of the year, and say, look, this is what the second half would look like if you take two quarters and average them out.

Robert Adam Hopkins -- BofA Merrill Lynch -- Analyst

Right. No, I understand. I mean I think everyone gets that there's a lot of moving pieces right now. We're just I'm just trying to understand for the purpose of clarity for people because we're just getting a lot of questions on I realize they gave us some things to work with in terms of math, but it seems like it would be sort of maybe in the low $700 million range for the fourth quarter. When you do all that math, is that kind of roughly...

John P. Groetelaars -- President, Chief Executive Officer & Director

I think what we tried yes, what we tried to do, Bob, and I'll let Barb chime in here, but what we tried to do is underpin it with the $5.40, right, on the EPS side because there are a lot of puts and takes on the revenue line. And quite frankly, it's quite difficult for us to that's why we're not providing guidance. We don't have the ability to provide accurate enough outlook on the top line. However, there's enough other levers in the P&L that we feel we have an up-certainty where we are in our fiscal year to save $5.40 EPS for the full year is something we feel confident is the floor. And that would give us if you exclude the surgical consumables divestiture last year, that's 11% growth year-over-year. So again, our ability to deliver in highly uncertain times, deliver double-digit EPS for our fiscal year, is something we're quite proud of.

Robert Adam Hopkins -- BofA Merrill Lynch -- Analyst

Yes. No, and that makes total sense. It's just that you are providing information in this slide deck and I'm just trying to understand what that information implies about the fourth quarter. And it looks like to me, it's kind of very low $700 million. And I just wanted to see if we were kind of doing the math right.

John P. Groetelaars -- President, Chief Executive Officer & Director

Well, Barb, do you want to take that?

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

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

Robert Adam Hopkins -- BofA Merrill Lynch -- Analyst

Okay. And that's fair. Let me just follow-up on the...

John P. Groetelaars -- President, Chief Executive Officer & Director

Bob, look, I wouldn't maybe just a comment, Bob, I'm not going to object or comment either way to your number of $700 million in the quarter. But let me just say, for the last two quarters, we said, please don't extrapolate off of these quarterly results, right? This quarter and the prior quarter. And whatever our results ended being in Q4, we would probably say the same thing again. So yes, so even though you might end up on the number for Q4, you can't extrapolate off of it.

Robert Adam Hopkins -- BofA Merrill Lynch -- Analyst

No, no, I get that. So let me just let me take it back up for a second. Just with one additional question. On the $5.40, I guess, two quick things. One is where is there conservatism built into that number? Just maybe some thoughts around the kind of what assumptions are underlie that in that $5.40 and where there might be some conservatism?

And then I know there's it's such an uncertain time. But John, maybe you could just comment on once we get through all this, like what is your view kind of on based on what you know right now, just in terms of how you think about the growth outlook for the business as you see it right now, thinking a little bit longer term, and what from maybe a revenue and earnings perspective, just some rough thoughts on how you're thinking about this business long term based on all the new learnings over the course of the last couple of quarters? I'll leave it at that.

John P. Groetelaars -- President, Chief Executive Officer & Director

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

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

Happy to take it. So I think we talked a little while ago about gross margin and the expectations for Q4. So you should not be expecting a repeat of 53.8% in Q4. But our overall trend toward gross margin expansion have not been significantly out of alignment with where we stated our goals for the beginning at the beginning of the year. And I think that we continued to kind of lean into our expectations around gross margin expansion. With regards to operating expense leverage, we saw very good operating expense leverage in Q3 as we saw expenses decline year-over-year because of the impact on the business as we all moved to remote working. Now in Q4, as you think about operating expenses, there are a couple of things that will be a little bit different as you think about Q4. One is, as John has talked about, activity has picked up. And so our spend level is expected to pick up as well just because we're out in the marketplace and we're reconnecting with customers. So it's a different level of normal activity in Q4. Plus, the investments that we turned on in Q3, we will continue to fund as we go into Q4. But our overall commitment to both the gross and operating margin expansion remains strong, and we believe we're on a good path to be able to deliver on those for the year. The uncertainty around or Q4 and where relative to that $5.40 is going to come down to the net impact of the puts and takes on the portfolio and the timing of those, that's really the question, and why we're not giving specific guidance? Because there are so many moving pieces, as you highlighted earlier.

John P. Groetelaars -- President, Chief Executive Officer & Director

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

Robert Adam Hopkins -- BofA Merrill Lynch -- Analyst

Thank you.

Operator

David Lewis with Morgan Stanley is on the line with a question. Please go ahead.

David Ryan Lewis -- Morgan Stanley -- Analyst

Just a couple of follow-ups here. I just I hate to go back to Bob's question, but I'm going to. So guys, for the fourth quarter, there is guidance out there in your deck, and it does it says kind of assess that kind of a $6.95 to $7.10 range for the fourth quarter is sort of the range implied by your deck. And if you look at your earnings guidance, it implies 17% margins-ish on sort of that number. So are you saying $6.95 to $7.10 sort of isn't the range implied by those slides? Where you're sort of saying we don't have as much confidence in the revenue, we have a lot more confidence in the earnings. I'm sorry, I'm still confused, and just I want to make sure expectations are very closely set here before we exit the call.

John P. Groetelaars -- President, Chief Executive Officer & Director

Yes. Like I said, we're because we're not explicitly giving guidance, David, we provided we did our best to provide as much color as we could. And I think you're seeing that and backing into numbers that I can say, look, yes, you're in the right ZIP code. But we're not going to explicitly affirm it, but you're certainly in the right ZIP code and so is Bob. And we don't mean to evade the question. In fact, we tried to do the opposite. We tried to provide you as much color as possible on current results and second half year results so you can get to that kind of a range that you just outlined. But we have a lot more confidence in our ability, with moving levers and everything down the P&L, to provide a hard number on the floor for EPS.

David Ryan Lewis -- Morgan Stanley -- Analyst

Okay. That gives us an arrangement to work with. And so kind of related to that for Barb or John. The I think investors sort of fear this business trough dynamic. And I think you've been asked this question a lot. And sort of 4Q sort of paints that picture as these tailwinds and headwinds cross in sort of any given quarter. But for the back half of the year, core growth is around 2%. Is that a decent way of thinking about the business floor or a decent proxy for the first half of next year? Or are there reasons to believe that thinking about the peak and the trough, third and fourth as an average, is just a that's just not a very good number at 2%?

John P. Groetelaars -- President, Chief Executive Officer & Director

Yes.

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

Do you want me to address that, John?

John P. Groetelaars -- President, Chief Executive Officer & Director

Go ahead and start, Barb. Sure. Go ahead and start.

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

So I think that it's difficult. And as we've talked about it, we would not extrapolate purely off of Q3. And as John commented earlier, we wouldn't extrapolate off of Q4. Even taking the average of those 2, David, could present some challenges. You really have to think about the shape and the speed of the recovery that we're seeing in the underlying portfolio, much as John talked about it earlier. We're seeing different speeds based on whether you're in Care Comms versus in physical diagnostics versus safe patient handling and surgical. And then we're going to have in the near term, some of the lumpiness around the U.S. capital market and the impact on the bed sales as a result of the really phenomenal volumes that we had in Q3. So there's a lot of moving lines that are moving at different speeds. And therefore, I think even taking just a second half is a troublesome sort of extrapolation. I wouldn't advise doing that. I think that you're going to have to bear with us a little longer as the pandemic rolls out and we have clear trajectories on where 2021 will be. And the next time we're together, we'll have more information and will be able to talk more about that then.

David Ryan Lewis -- Morgan Stanley -- Analyst

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

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

So we've given you on the second half of the year. We've talked about the 60% and where we see that growing in the 20% range. I think we've also talked about that in that 60%, we continue to see double-digit growth on subcategories around thermometry, around patient monitoring. Those areas continue to grow as we think about Q4.

David Ryan Lewis -- Morgan Stanley -- Analyst

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

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

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

John P. Groetelaars -- President, Chief Executive Officer & Director

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

David Ryan Lewis -- Morgan Stanley -- Analyst

Yes. Totally understand. And just lastly, John, on the LRP, just more specifically. I mean you've expressed some confidence recently in the LRP. And the first half of the LRP, if we assume that guidance range for fourth quarter is correct, it's kind of did 3.5% core growth here in 2020, did closer to 7% in 2019. So you kind of did 5% growth in the first half of the LRP. To deliver your LRP, you have to do 5% growth in the back half of the LRP. So if you think about 2021 and '22, are you now feeling that you can do 5% in the back half of the LRP? Or it's now just looking like it's more likely you can do that 5% for the next two years if 2021 comes in lower?

John P. Groetelaars -- President, Chief Executive Officer & Director

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

Mary Kay Ladone -- Senior Vice President-Investor Relations

We have time for just two more questions. I know we'll go a little bit longer today, but two more questions, please.

Operator

And we have a question from Matt Taylor with UBS. Please go ahead.

Matt Taylor -- UBS -- Analyst

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

John P. Groetelaars -- President, Chief Executive Officer & Director

Yes. It's a good question. And the simple answer is tough comps from the prior year. We normally have a really robust Q4. In the current environment, we don't expect the same kind of seasonality in our business or quarterly phasing in our business because of the situation that we're in. That's why we do see sequential improvement of around 10%. We expect around 10% sequential improvement between Q3 and Q4 on whole. And then it was the comment. And then the other part of that is that the safe patient handling and the surgical business, which is about 15% of total revenue. So 15% of that 40% is really going to be a little bit slower on the recovery because of getting access to installed infrastructure.

Matt Taylor -- UBS -- Analyst

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

John P. Groetelaars -- President, Chief Executive Officer & Director

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

Operator

Matthew Mishan with KeyBanc is on the line with the question. Please go ahead.

Matthew Ian Mishan -- KeyBanc Capital Markets -- Analyst

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

John P. Groetelaars -- President, Chief Executive Officer & Director

Yes. It's a good question. And the simple answer is tough comps from the prior year. We normally have a really robust Q4. In the current environment, we don't expect the same kind of seasonality in our business or quarterly phasing in our business because of the situation that we're in. That's why we do see sequential improvement of around 10%. We expect around 10% sequential improvement between Q3 and Q4 on whole. And then it was the comment. And then the other part of that is that the safe patient handling and the surgical business, which is about 15% of total revenue. So 15% of that 40% is really going to be a little bit slower on the recovery because of getting access to installed infrastructure.

Matt Taylor -- UBS -- Analyst

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

John P. Groetelaars -- President, Chief Executive Officer & Director

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

Operator

Matthew Mishan with KeyBanc is on the line with the question. Please go ahead.

Matthew Ian Mishan -- KeyBanc Capital Markets -- Analyst

Just on the $200 million incremental opportunity that you're talking about. There's a big difference in ICU bed per capita and that TAM, if you are talking about developed European countries versus also including emerging markets, like India and China. How do you think about the differences? And are those included in that TAM as well?

John P. Groetelaars -- President, Chief Executive Officer & Director

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

Matthew Ian Mishan -- KeyBanc Capital Markets -- Analyst

Okay. And then just sort of...

John P. Groetelaars -- President, Chief Executive Officer & Director

Local market dynamics.

Matthew Ian Mishan -- KeyBanc Capital Markets -- Analyst

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

John P. Groetelaars -- President, Chief Executive Officer & Director

It's still fairly low. It's around the 15% market. Well, in the last quarter, we've probably given an uptick of a percent or 2%. But it's still below 20% usually below 20% of our on our Hill-Rom base of business in the United States. So we have a long way to go in terms of penetrating that base and then building our connectivity story of smart bed to smartphone and digital product offerings around that as we go into the future. Great. Thank you. Well, with that, I'll turn it back over to Mary Kay and say thank you for the call. We went over a little bit, but I think given the climate, hopefully, everyone hung on to the call. And really want to, yes, thank you for your questions today, and I'll turn it back over to Mary Kay.

Mary Kay Ladone -- Senior Vice President-Investor Relations

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

Operator

[Operator Closing Remarks]

Duration: 65 minutes

Call participants:

Mary Kay Ladone -- Senior Vice President-Investor Relations

John P. Groetelaars -- President, Chief Executive Officer & Director

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

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

Lawrence Soren Keusch -- Raymond James & Associates -- Analyst

Robert Adam Hopkins -- BofA Merrill Lynch -- Analyst

David Ryan Lewis -- Morgan Stanley -- Analyst

Matt Taylor -- UBS -- Analyst

Matthew Ian Mishan -- KeyBanc Capital Markets -- Analyst

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