Capital sales

Rental revenues

 

Total revenues

 

Cost of goods sold

Rental expenses

 

Total cost of revenues

 

 

 

Research and development expenses

Selling and administrative expenses

 

 

 

 

Interest expense

Investment income and other, net

 

 

 

Income tax expense (Note 9)

 

 

Less: Net income attributable to noncontrolling interest

 

 

 

 

 

 

 

 

 

 

 

 

 

Current Assets

Cash and cash equivalents

Short-term investments (Notes 1 and 6)

Trade accounts receivable, net of allowances (Note 2)

Inventories (Note 2)

Deferred income taxes (Notes 1 and 9)

Other current assets

 

Total current assets

 

Equipment leased to others, net (Note 2)

Property, net (Note 2)

Investments and investment securities (Notes 1 and 6)

Goodwill (Note 3)

Software and other intangibles, net (Note 2)

Notes receivable, net of discounts

Other assets

 

 

 

 

Current Liabilities

Trade accounts payable

Short-term borrowings (Note 4)

Accrued compensation

Accrued product warranties (Note 12)

Accrued litigation (Note 14)

Other current liabilities

 

Total current liabilities

 

Long-term debt (Note 4)

Accrued pension and postretirement benefits (Note 5)

Deferred income taxes (Notes 1 and 9)

Other long-term liabilities

 

 

 

 

Noncontrolling Interest (Note 3)

 

 

Commitments and Contingencies (Note 14)

 

 

Common stock (Note 2)

Additional paid-in-capital

Retained earnings

Accumulated other comprehensive loss (Note 7)

Treasury stock, at cost (Note 2)

 

 

 

 

 

Net income

Adjustments to reconcile net income to net cash flows from operating activities:

Depreciation and amortization

Investment loss

Provision for deferred income taxes

Loss on disposal of property, equipment leased to others, intangible assets and impairments

Stock compensation

Change in working capital excluding cash, current investments, current debt, prepaid pension costs, acquisitions and dispositions:

Trade accounts receivable

Inventories

Other current assets

Trade accounts payable

Accrued expenses and other liabilities

Other, net

 

Net cash provided by operating activities

 

 

Capital expenditures and purchase of intangibles

Proceeds on sales of property and equipment leased to others

Investment in/acquisitions of businesses, net of cash acquired

Proceeds on investment sales/maturities

 

Net cash used in investing activities

 

 

Change in short-term debt

Payment on revolver

Payment of cash dividends

Proceeds on exercise of options

Proceeds from stock issuance

Treasury stock acquired

 

Net cash used in financing activities

 

 

Effect of exchange rate changes on cash

 

 

 

At beginning of period

 

At end of period

 

The unaudited, Condensed Consolidated Financial Statements appearing in this Quarterly Report on Form 10-Q should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Company’s latest Annual Report on Form 10-K for the fiscal year ended September 30, 2009 (“2009 Form 10-K”) as filed with the U.S. Securities and Exchange Commission (“SEC”). Unless the context otherwise requires, the terms “Hill-Rom,” “the Company,” “we,” “our” and “us” refer to Hill-Rom Holdings, Inc. and its majority-owned subsidiaries. The September 30, 2009 Consolidated Balance Sheet data was derived from audited consolidated financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America (“U.S.”). In the opinion of management, the Condensed Consolidated Financial Statements herein, include all adjustments, consisting only of normal recurring adjustments, necessary to state fairly the financial position, results of operations, and cash flows for the interim periods presented. Quarterly results are not necessarily indicative of annual results.

The Condensed Consolidated Financial Statements include the accounts of the Company and its majority-owned subsidiaries. All subsidiaries are wholly-owned with the exception of the 60 percent owned joint venture acquired during the first quarter of fiscal 2010 and discussed in Note 3. Intercompany accounts and transactions have been eliminated in consolidation.

The preparation of financial statements in conformity with accounting principles generally accepted in the U.S. requires management to make estimates and assumptions that affect the reported amounts of certain assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expense during the reporting period. Actual results could differ from those estimates. Examples of such estimates include our accounts receivable reserves (Note 2), accrued warranties (Note 12), investments (Note 6), income taxes (Note 9) and accrued litigation and self insurance reserves (Note 14), among others.

At December 31, 2009, investment securities consisted primarily of AAA rated student loan auction rate securities (“ARS”). These securities are generally insured through the U.S. government’s Federal Family Education Loan Program, to the extent the borrowers meet certain prescribed criteria in their underlying lending practices. During the first quarter of 2009, we entered into an enforceable, non-transferable right (the “Put”) with UBS Financial Services (“UBS”), which allows the Company to put all or part of the ARS held with UBS at par value anytime during the period of June 30, 2010 through July 2, 2012. Additionally, UBS may redeem these securities at par value plus interest at any time prior to June 30, 2010 at their discretion.

We recorded the Put as an asset and made the election to report it at estimated fair value and record the income from initial valuation and the related changes in fair value as a component of “Investment income and other” within the Condensed Consolidated Statements of Income. Also, because we intend to sell these securities to UBS at par value, the related ARS are classified as “trading”. As trading securities, the changes in fair value corresponding to the UBS related ARS are also recorded as a component of “Investment income and other” within our Condensed Consolidated Statements of Income. We made these elections so that the effects of changes in the fair value of the UBS related ARS and the Put would substantially offset within our Condensed Consolidated Statements of Income, thereby reducing the volatility we might otherwise experience. At December 31, 2009, the $16.3 million of our ARS not subject to the Put continue to be classified as available-for-sale and changes in their fair value are recorded in Accumulated Other Comprehensive Loss.

We regularly evaluate all investments classified as available-for-sale for possible impairment based on current economic conditions, credit loss experience and other criteria. The evaluation of investments for impairment requires significant judgments to be made including (i) the identification of potentially impaired securities; (ii) the determination of their estimated fair value; and (iii) the assessment of whether any decline in estimated fair value is other-than-temporary. If there is a decline in a security’s net realizable value that is other-than-temporary, the decline is separated into the amount of impairment related to credit loss and the amount of impairment related to all other factors. The decline related to the credit loss is recognized in earnings, while the decline related to all other factors is recognized in other comprehensive income.

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

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

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

There have been no significant changes to recently issued accounting standards included in Note 1 of Notes to Consolidated Financial Statements in our 2009 Form 10-K, except as noted below:

On October 1, 2009, we adopted the Financial Accounting Standard Board’s (“FASB”) authoritative guidance related to business combinations, noncontrolling interests in

consolidated financial statements and assets acquired and liabilities assumed in a business combination that arise from contingencies. Our adoption of this guidance is prospective and applies to business combinations that occur on or after October 1, 2009. See Note 3 for further details.

On October 1, 2009, we adopted the FASB’s authoritative guidance related to the determination of the useful life of intangible assets. Our adoption of this guidance is prospective and did not have a material impact on our consolidated financial statements or the joint venture discussed in Note 3.

On October 1, 2009, we early adopted the FASB’s authoritative guidance for arrangements with multiple deliverables and arrangements that include software elements. Our adoption of this guidance is prospective and did not have a material impact on our consolidated financial statements.

The following information pertains to assets and consolidated shareholders’ equity.

Allowance for possible losses and discounts on trade receivables

 

Inventories:

Finished products

Raw materials and work in process

 

Total inventory

 

Accumulated depreciation of equipment leased to others and property

 

Accumulated amortization of intangible assets

 

Preferred stock, without par value:

Shares authorized

Shares issued

 

Common stock, without par value:

Shares authorized

Shares issued

Shares outstanding

 

Treasury shares

On November 9, 2009, the Company entered into a joint venture with Encompass Group, LLC (“Encompass Group”), a leader in health care textiles and therapeutic and prevention surfaces, to form Encompass TSS, LLC (“Encompass”). This joint venture includes contributed former assets of Encompass Therapeutic Support Systems (“ETSS”), a division of Encompass Group and is 60 percent owned by Hill-Rom and 40 percent owned by Encompass Group. Encompass Group, through its ETSS business unit, has traditionally focused on providing surface replacement systems. For our 60 percent ownership interest

in Encompass, we paid $7.2 million to Encompass Group, contributed cash to ETSS and entered into license and distribution agreements with ETSS.

The following summarizes the fair value of the assets acquired and liabilities assumed at the date of formation.

Goodwill

Trade Name

Customer relationships

Technology

Net liabilities assumed

Noncontrolling interest

Additional paid-in-capital

 

Total purchase price

 

The calculation of fair value of the assets and liabilities is preliminary and subject to adjustment based on finalization of intangible valuations and working capital adjustments.

The joint venture agreements contain both a put option for Encompass Group and a call option for the Company, requiring or allowing Hill-Rom to purchase the remaining 40 percent interest, which are based on predetermined earnings multiples. Changes to the value of the put will be accreted to noncontrolling interest in our Condensed Consolidated Balance Sheet with the expected offset being recorded as a component of equity.

The goodwill of $7.6 million arising from the joint venture consists largely of the synergies created from combining ETSS’s focus on customer replacement surfaces with our platform brands. The goodwill is deductible for tax purposes and will be allocated entirely to our North America Acute Care segment.

The useful lives assigned to intangibles identified as part of the joint venture are as follows:

Trade name

Customer relationships

Technology

If the Encompass joint venture had been consummated at the beginning of our 2009 fiscal year, the impact to revenues and net income on an unaudited pro forma basis would not have been significant to our financial results in either of the periods presented.

On October 1, 2008, the Company acquired two affiliated companies: Liko Vårdlyft AB (“Liko Sweden”) and Liko North America Corporation (“Liko North America” and, together with Liko Sweden, “Liko”). The purchase price for Liko was $190.4 million, including direct acquisition costs of $3.6 million and the payment of outstanding Liko debt of $9.8 million ($187.2 million net of cash acquired). The purchase price remains subject to adjustment based on finalization of working capital and net debt adjustment provisions contained in the purchase agreements. Any such adjustment is expected to be favorable and not material and would be recorded in our Consolidated Statement of Income as a reduction of the goodwill impairment charge that we recorded during our fiscal 2009.

Total debt consists of the following:

Outstanding finance credit lines

Revolving credit facility

Unsecured 8.50% debentures due on December 1, 2011

Unsecured 7.00% debentures due on February 15, 2024

Unsecured 6.75% debentures due on December 15, 2027

Other

 

Total debt

Less current portion of debt

 

Total long-term debt

 

We have trade finance credit lines and uncommitted letter of credit facilities. These lines are associated with the normal course of business and are not currently, nor have they historically, been of material size to the overall business.

Unsecured debentures outstanding at December 31, 2009 have fixed rates of interest. We have deferred gains included in the amounts above from the termination of previous interest rate swap agreements, and those deferred gains amounted to $2.8 million at December 31, 2009 and $3.1 million at September 30, 2009. The deferred gains on the termination of the swaps are being amortized and recognized as a reduction of interest expense over the remaining term of the related debt through 2011 and 2024, and as a result, the effective interest rates on that debt have been and will continue to be lower than the stated interest rates.

The Company has a $500.0 million five-year senior revolving credit facility with a syndicate of banks led by Citibank, N.A. and Bank of America, N.A. The term of the five-year facility expires on March 28, 2013 (subject to extension upon satisfaction of certain conditions set forth in the credit facility). Borrowings under the credit facility bear interest at variable rates specified therein, and the availability of borrowings is subject to our ability at the time of borrowing to meet certain specified conditions, including compliance with covenants contained in the credit agreement governing the facility. The credit agreement contains covenants that, among other matters, require the Company to maintain a ratio of consolidated indebtedness to consolidated EBITDA (each as defined in the credit agreement) of not more than 3.5:1.0 and a ratio of consolidated EBITDA to interest expense of not less than 3.5:1.0. The proceeds of the five-year facility shall be used, as needed: (i) for working capital, capital expenditures, and other lawful corporate purposes; and (ii) to finance acquisitions.

As of December 31, 2009, we had outstanding borrowings of $45.0 million and undrawn letters of credit of $6.2 million under the five-year facility, leaving $448.8 million of borrowing capacity available under the facility. During the first quarter of fiscal 2010, we made a payment of $45.0 million on our credit facility to reduce a portion of our short-term debt associated with the Liko acquisition.

The fair value of our debt is estimated based on the quoted market prices for the same or similar issues or on the current rates offered to us for debt of the same remaining maturities. The estimated fair values of our long-term debt instruments were $103.0 million and $95.7 million at December 31, 2009 and September 30, 2009, respectively.

The Company sponsors five defined benefit pension plans. Those plans include a master defined benefit retirement plan, a nonqualified supplemental executive defined benefit retirement plan, two defined benefit retirement plans covering employees in Germany and France and a defined benefit retirement plan related to our fiscal 2004 acquisition of Mediq, Inc. Benefits for such plans are based primarily on years of service and the employee’s level of compensation during specific periods of employment. We contribute funds to trusts as necessary to provide for current service and for any unfunded projected future benefit obligation over a reasonable period of time. All of our plans have a September 30 measurement date. The Company also sponsors a domestic postretirement health care plan that provides health care benefits to qualified retirees and dependents. Annual costs related to the domestic postretirement health care plan are not significant.

The components of net pension expense for our defined benefit pension plans were as follows:

 

Service cost

Interest cost

Expected return on plan assets

Amortization of prior service cost, net

Amortization of net loss

 

Net periodic benefit cost

 

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

Level 1: Financial instruments with unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets and liabilities.

Level 2: Financial instruments with observable inputs other than those included in Level 1 such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

Level 3: Financial instruments with unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Unobservable inputs reflect the Company’s own assumptions that market participants would use in pricing the asset or liability (including assumptions about risk). Unobservable inputs shall be developed based on the best information available in the circumstances, which might include the Company’s own data.

The following table summarizes the Company’s financial assets and liabilities measured at fair value on a recurring basis included in its Condensed Consolidated Balance Sheets, as of December 31, 2009:

Cash equivalents

Trading securities

Foreign exchange contracts

Available-for-sale marketable securities

Put rights

 

 

The investment securities identified in the above table consist primarily of AAA rated student loan ARS. While we continue to earn interest on the ARS at the contractual rate, these investments are not currently being bought and sold in an active market and therefore do not have readily determinable market values. At December 31, 2009, the Company’s investment advisors provided a valuation based on unobservable inputs for the ARS. The investment advisors utilized a discounted cash flow approach (an “Income approach”) to arrive at this valuation, which was corroborated by separate and comparable discounted cash flow analysis prepared by us. The assumptions used in preparing the discounted cash flow model include estimates of interest rates, timing and amount of cash flows, credit spread related yield and illiquidity premiums, and expected holding periods of the ARS. These assumptions are volatile and subject to change as the underlying sources of these assumptions and market conditions change. We valued the associated Put right (see Note 1) as the difference between the par value and the fair value of ARS on a present value basis, as adjusted for any bearer risk associated with UBS’s financial ability to repurchase the ARS beginning June 30, 2010.

The following table presents the activity related to our ARS and the Put during the quarter ended December 31, 2009.

Balance at September 30, 2009

Change in fair value

Sales or redemptions

 

 

The net-of-tax effect of unrealized gains or losses on our available-for-sale securities, foreign currency translation adjustments and pension or other defined benefit postretirement plans’ actuarial gains or losses, prior service costs or credits and transition obligations are required to be included in comprehensive income.

The composition of comprehensive income (loss) is as follows:

 

Net income

 

Unrealized losses on available-for-sale securities:

Unrealized holding (losses) gains arising during period, net-of-tax

Less: Reclassification adjustment for losses (gains) realized in net income, net-of-tax

 

Net unrealized gain (loss)

 

Foreign currency translation adjustment, net-of-tax

 

Items not yet recognized as a component of net periodic pension or postretirement benefit cost, net-of-tax

 

Total comprehensive income (loss)

Comprehensive income attributable to the noncontrolling interest

 

Total comprehensive income (loss) attributable to Hill-Rom

 

During the second quarter of fiscal 2009, we announced a plan to manage our cost structure through consolidation of certain manufacturing and selected back office operations, redeployment of U.S. sales and service resources to increase our customer presence and support; a further reduction in non-sales, non-research and development discretionary spending; a voluntary early retirement program and involuntary job eliminations to reflect lower capital equipment demand and productivity improvements.

The plan impacted approximately 450 salaried, hourly and temporary employees, or 7 percent of our U.S. based workforce. In total, the plan resulted in a charge of $11.9 million related to severance and early retirement packages. Additionally, postretirement health care costs and the waiver of an early retirement pension penalty offered in conjunction with the voluntary early retirement incentive and the associated curtailment charges resulted in additional charges of $4.2 million. Asset impairment, discontinued use of a building under an operating lease and other charges of approximately $4.4 million were also recorded in conjunction with these actions. The charge related to severance and early retirement packages will result in cash expenditures that will primarily be paid over the next year. Cash expenditures for the lease will be paid over the remaining lease period.

Activity related to these actions during the first quarter of fiscal 2010 was as follows:

Fiscal Year 2009

Q2 Action — Restructuring

 

The above table excludes the impact of asset impairments related to assets held for sale and the impact of these actions on our pension and postretirement health care plans.

The effective tax rate for the first quarter of fiscal 2010 was 39.2 percent compared to 32.4 percent for the first quarter of 2009. The higher rate in the first quarter of fiscal 2010 is due mainly to the difference in the amount of discrete tax items recognized in the two periods and the expiration of the research and development tax credit in fiscal 2010. The effective tax rate for fiscal 2010 was unfavorably impacted by the recognition of discrete period tax expenses of approximately $0.5 million. This compares to $1.3 million of discrete period tax benefits recorded in the first quarter of fiscal 2009 which related primarily to the “catch-up” for the retroactive reinstatement of the research and development tax credit.

Basic earnings per share are calculated based upon the weighted average number of outstanding common shares for the period, plus the effect of deferred vested shares. Diluted earnings per share are calculated consistent with the basic earnings per share calculation plus the effect of dilutive unissued common shares related to stock-based employee compensation programs. For all periods presented, anti-dilutive stock options were excluded from the calculation of diluted earnings per share. Excluded shares were 4.4 million for the three month period ended December 31, 2009 and 4.7 million for the comparable period of fiscal year 2009. Cumulative treasury stock acquired, less cumulative shares reissued, have been excluded in determining the average number of shares outstanding.

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

 

Net income attributable to common shareholders

 

 

Average shares outstanding — Basic

Add potential effect of exercise of stock options and other unvested equity awards

 

Average shares outstanding — Diluted

 

 

Net income attributable to common shareholders per common share — Basic

 

 

Net income attributable to common shareholders per common share — Diluted

 

The stock based compensation cost that was charged against income, net of tax, for all plans was $2.2 million and $1.6 million for the three-month periods ended December 31, 2009 and 2008, respectively.

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

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

 

Balance at beginning of period

Provision for warranties during the period

Effect of acquisition

Warranty claims during the period

 

Balance at end of period

 

In the normal course of business we enter into various other guarantees and indemnities in our relationships with suppliers, service providers, customers, business partners and others. Examples of these arrangements would include guarantees of product performance, indemnifications to service providers and indemnifications of our actions to business partners. These guarantees and indemnifications would not materially impact our financial condition or results of operations, although indemnifications associated with our actions generally have no dollar limitations.

In conjunction with our acquisition and divestiture activities, we have entered into select guarantees and indemnifications of performance with respect to the fulfillment of our commitments under applicable purchase and sale agreements. The arrangements generally indemnify the buyer or seller for damages associated with breach of contract, inaccuracies in representations and warranties surviving the closing date and satisfaction of liabilities and commitments retained under the applicable contract. For those representations and warranties that survive closing, they generally survive for periods up to five years or the expiration of the applicable statutes of limitations. Potential losses under the indemnifications are generally limited to a portion of the original transaction price, or to other lesser specific dollar amounts for select provisions. With respect to sale transactions, we also routinely enter into non-competition agreements for varying periods of time. Guarantees and indemnifications with respect to acquisition and divestiture activities, if triggered, could have a materially adverse impact on our financial condition and results of operations.

We disclose segment information that is consistent with the way in which management operates and views the Company. Our operating structure contains the following reporting segments:

North America Acute Care

North America Post-Acute Care

International and Surgical

The Company’s performance under each reportable segment is measured on a divisional income basis before special items. Sales between the segments, while not significant, are generally accounted for at current market value or cost plus markup. Divisional income generally represents the division’s standard gross profit less its direct operating costs, excluding functional costs, along with an allocation of fixed manufacturing overhead, research and development, and distribution costs.

Functional costs include costs such as administration, finance, information technology, legal and human resource costs. Eliminations represent the elimination of inter-segment sales. Functional costs and eliminations, while not considered segments, are presented separately to aid in the reconciliation of segment information to consolidated financial information.

Revenues:

North America Acute Care

North America Post-Acute Care

International and Surgical

Total eliminations

 

Total revenues

 

 

Divisional income:

North America Acute Care

North America Post-Acute Care

International and Surgical

Functional costs

 

Total divisional income

Interest expense

Investment income and other, net

 

Income before income taxes

 

In 2005 the Funeral Consumers Alliance, Inc. (“FCA”) and a number of individual consumer casket purchasers filed a purported class action antitrust lawsuit on behalf of certain consumer purchasers of Batesville^® caskets against the Company and its former Batesville Casket Company, Inc. subsidiary (“Batesville”) (now wholly owned by Hillenbrand, Inc., an unaffiliated company), and three national funeral home businesses (the “FCA Action”). The FCA plaintiffs sought certification of a class including all United States consumers who purchased Batesville caskets from any of the funeral home co-defendants at any time during the longest period permitted by the applicable statute of limitations. A similar purported antitrust class action lawsuit was later filed by Pioneer Valley Casket Co. and several so-called “independent casket distributors” on behalf of casket sellers who were unaffiliated with any licensed funeral home (the “Pioneer Valley Action”). On March 26, 2009, the District Judge denied class certification in both cases. On April 9, 2009, the plaintiffs in the FCA case filed a petition with the United States Court of Appeals for the Fifth Circuit for leave to file an appeal of the Court’s order denying class certification. On June 19, a three-judge panel of the Fifth Circuit denied the FCA plaintiffs’ petition. On July 9, 2009, the FCA plaintiffs filed a request for reconsideration of the denial of their petition. On July 29, 2009, a three judge panel of the Fifth Circuit denied the FCA plaintiffs’ motion for reconsideration and their alternative

motion for leave to file a petition for rehearing by all of the judges sitting on the Fifth Circuit Court of Appeals.

The Pioneer Valley plaintiffs did not appeal the District Court’s order denying class certification, and on April 29, 2009, pursuant to a stipulation among the parties, the District Court dismissed the Pioneer Valley Action with prejudice (that is, Pioneer Valley cannot appeal or otherwise reinstate the case). Neither the Company nor Batesville provided any payment of consideration for the plaintiffs to dismiss this case, other than agreeing to bear their own costs, rather than pursuing plaintiffs for costs.

Plaintiffs in the FCA Action have generally sought monetary damages on behalf of a class, trebling of any such damages that may be awarded, recovery of attorneys’ fees and costs, and injunctive relief. Plaintiffs in the FCA Action filed a report indicating that they were seeking damages ranging from approximately $947.0 million to approximately $1.46 billion before trebling on behalf of the purported class of consumers they seek to represent, based on claims of approximately one million casket purchases by the purported class members.

Because Batesville continues to adhere to its long-standing policy of selling Batesville^® caskets only to licensed funeral homes, a policy that it continues to believe is appropriate and lawful, if a class were ultimately certified and the case was to go to trial, Plaintiffs are likely to claim additional alleged damages for the period between their report and the time of trial. At this point, it is not possible to estimate the amount of any additional alleged damage claims that they might make. We and Batesville will vigorously contest both liability and plaintiffs’ damages theories.

Despite the July 29, 2009 ruling denying class certification, the FCA plaintiffs have indicated that they intend to pursue their individual injunctive and damages claims. Their individual damages claims are limited to the alleged overcharges on the plaintiffs’ individual casket purchases (the complaint currently alleges a total of ten casket purchases by the individual plaintiffs), which would be trebled, plus reasonable attorneys fees and costs. On January 27, 2010, the District Court issued an order stating that no summary judgment motions would be entertained and that the trial of the FCA plaintiffs’ remaining individual claims may begin as early as the week of June 7, 2010.

After the district court renders a final judgment as to the individual claims, the FCA plaintiffs may file an appeal, which could include an appeal of the District Court’s order denying class certification. If they succeeded in reversing the district court order denying class certification and a class is certified in the FCA Action filed against Hill-Rom and Batesville and if the plaintiffs prevail at a trial of the class action, the damages awarded to the plaintiffs, which would be trebled as a matter of law, could have a significant material adverse effect on our results of operations, financial condition and/or liquidity. In antitrust actions such as the FCA Action the plaintiffs may elect to enforce any judgment against any or all of the co-defendants, who have no statutory contribution rights against each other. We and Hillenbrand, Inc. have entered into a judgment sharing agreement that apportions the costs and any potential liabilities associated with this litigation between us and Hillenbrand, Inc. See Note 3 in our 2009 Form 10-K for more information regarding the judgment sharing agreement.

We believe that we have committed no wrongdoing as alleged by the plaintiffs and that we have meritorious defenses to class certification and to plaintiffs’ underlying allegations and damage theories. In accordance with applicable authoritative guidance, we have not established a loss reserve in connection with this litigation.

After the FCA Action was filed, in the summer and fall of 2005, we and Batesville were served with Civil Investigative Demands by the Attorney General of Maryland and certain other state attorneys general who had begun an investigation of possible anticompetitive practices in the death care industry relating to a range of funeral services and products,

including caskets. We fully cooperated with the attorneys general. We have been informed by the Maryland and Florida Attorneys General offices, which were leading this investigation, that the investigation has been concluded. No claims were filed against us or Batesville as a result of this investigation. The Maryland Attorney General reserved the right to re-open the investigation and to take any further action in the future as the public interest may require.

On February 8, 2008, we were served with an Administrative Investigative Demand subpoena by the United States Attorney’s Office for the Eastern District of Tennessee pursuant to a Health and Human Services’ Office of Inspector General investigation. The investigation was described as focusing on “claims for payment for certain durable medical equipment, including specialized support beds.” On September 18, 2008, we were informed by the United States Attorney’s Office that the investigation was precipitated by the filing in 2005 of a qui tam “whistleblower” complaint. A qui tam action is a civil lawsuit brought by an individual on behalf of the government under the False Claims Act. Once the complaint is filed with the court under seal, the Department of Justice investigates the allegations and has the right to intervene and in effect take over the prosecution of the lawsuit if it believes the allegations warrant. This particular complaint was filed in the United States District Court for the Eastern District of Tennessee. Although the complaint has been only partially unsealed at this point, we know that the plaintiffs seek recovery of unspecified damages and civil penalties relating to the alleged submission of false and fraudulent claims to Medicare and/or Medicaid for the provision of durable medical equipment. At this point, the government has not yet reached an intervention decision and is continuing its investigation. We have not yet been formally served in this case, nor has the entire complaint been unsealed. In the event that this matter were to proceed to litigation, if it were found that we had failed to comply with applicable laws and regulations, we could be subject to substantial fines or penalties and possible exclusion from participation in federal health care programs. We are continuing to cooperate with the government’s investigation.

On October 19, 2009, Freedom Medical, Inc. filed a complaint against the Company, another manufacturer and two group purchasing organizations (“GPOs”) under the caption Freedom Medical, Inc. v. Hill-Rom Company, Inc. et al (Civil Action No. 5:09cv152, United States District Court, Eastern District of Texas). Since the filing of the complaint, Freedom Medical has dismissed one of the GPOs as a defendant. The plaintiff alleges that the Company and the other defendants conspired to exclude it from the biomedical equipment rental market and to maintain the Company’s market share by engaging in a variety of conduct in violation of state and federal antitrust laws. The plaintiff also has asserted claims for business disparagement, common law conspiracy and tortuous interference with business relationships. The plaintiff seeks injunctive relief and money damages in an unspecified amount. We intend to defend this matter vigorously. Because the litigation is in a preliminary stage, we cannot assess the likelihood of an adverse outcome or determine an estimate, or a range of estimates, of potential damages. We cannot give any assurances that this matter will not have a material adverse impact on the Company’s financial condition, results of operations or cash flows.

In fiscal 2005, we entered into a definitive, court approved agreement with Spartanburg Regional Healthcare Systems and its attorneys to settle a purported antitrust class action lawsuit. The settlement resolved all of the claims of class members that did not opt out of the settlement, including the claims of all United States and Canadian purchasers or renters of Hill-Rom^® products from 1990 through February 2, 2006 related to or arising out of the subject matter of the lawsuit, and the claims that may have resulted from the current or future effects of conduct or events occurring through February 2, 2006. The original settlement amount of $337.5 million was reduced by almost $21.2 million, to $316.3 million, reflecting the portion attributable to customers who opted out of the

settlement. Opt-outs from the settlement account for roughly six percent of the total United States and Canadian revenue during the class period, and over 99 percent of that figure is attributable to the United States government’s decision to opt out of the settlement. We believe we have meritorious defenses against any claims the United States government may choose to make, due to, among other reasons, pricing practices of government purchases that are different than the pricing practices primarily at issue in the lawsuit.

In connection with our assessment that it was probable that a settlement would be reached and finally approved by the Court during fiscal 2006, we recorded a litigation charge and established a litigation accrual in the amount of $358.6 million in the fourth quarter of fiscal 2005, which included certain legal and other costs associated with the proposed settlement. The Court entered the Order and Final Judgment in the third quarter of fiscal 2006, and we paid a total $316.3 million of the settlement amounts into escrow during that year. As of December 31, 2009 we have retained a $21.2 million litigation accrual associated with the opt-outs.

We are subject to various other claims and contingencies arising out of the normal course of business, including those relating to governmental investigations and proceedings, commercial transactions, product liability, employee related matters, antitrust, safety, health, taxes, environmental and other matters. Litigation is subject to many uncertainties and the outcome of individual litigated matters is not predictable with assurance. It is possible that some litigation matters for which reserves have not been established could be decided unfavorably to us, and that any such unfavorable decisions could have a material adverse effect on our financial condition, results of operations and cash flows.

We are also involved in other possible claims and are generally self-insured up to certain limits for product/general liability, workers’ compensation, auto liability and professional liability insurance programs. These policies have deductibles and self-insured retentions ranging from $150 thousand to $1.5 million per occurrence, depending upon the type of coverage and policy period. We are also generally self-insured up to certain stop-loss limits for certain employee health benefits, including medical, drug and dental. Our policy is to estimate reserves based upon a number of factors including known claims, estimated incurred but not reported claims and outside actuarial analysis, which are based on historical information along with certain assumptions about future events.

We have performed an evaluation of subsequent events through February 4, 2010, the date this Quarterly Report on Form 10-Q was filed with the SEC. As of this date, we concluded there were no subsequent events that required recognition or disclosure in these consolidated financial statements other than the tax matter discussed in the next paragraph.

Following the completion of our first quarter of fiscal 2010, we reached agreement with the Internal Revenue Service with respect to an outstanding protest we had filed related to the characterization of payments we received upon the termination of interest rate swap contracts. The effect of this matter will result in the recognition of a favorable discrete income tax benefit in the second quarter of approximately $6.5 million.

Revenues:

Capital sales

Rental revenues

 

Total Revenues

 

Capital sales decreased $4.4 million, or 1.9 percent, including the favorable impact of foreign exchange rates of $7.8 million. On a constant currency basis, capital revenues decreased 5.2 percent. The main drivers of this decrease were the divestiture of certain non-strategic information technology product lines, which totaled $4.1 million of revenue in the first fiscal quarter of 2009, and unfavorable volumes in our North America Acute Care segment as a result of tightening capital spending by U.S. hospitals. In particular, we realized year over year volume declines in our patient support surfaces. These declines were partially offset by growth in select International markets, including Latin America and Asia, as well as growth of our respiratory care and surgical products. Revenues also benefitted from modest price increases.

Rental revenues increased $8.1 million, or 7.0 percent, including the favorable impact of foreign exchange rates of $1.8 million. On a constant currency basis, rental revenues increased 5.4 percent. The increase in rental revenues was mainly due to North America Acute Care growth in therapy rental revenue due to continued growth of our bariatric frames and Envision^® wound surface as well as our VersaCare^® P500 wound surface, along with improvements in our moveable medical equipment fleet rentals associated with a stronger flu season in fiscal 2010. We also realized increased rental revenues in our respiratory care business.

Gross Profit

Capital sales

 

Rental revenues

 

 

Total Gross Profit

 

Capital sales gross profit increased $11.6 million, or 13.0 percent. Gross margin (as a percentage of revenues) for capital sales increased during the quarter 580 basis points due to favorable material costs, cost improvements attained from the January 2009 restructuring, several other productivity initiatives in fiscal 2009 and an improved mix towards higher margin products. The margin improvement was also due to charges taken in the prior year quarter of $1.9 million related to the acquisition accounting step-up of acquired Liko inventories and $0.9 million related to a ratification bonus paid under our union contract.

Rental revenue gross profit increased $6.7 million, or 10.6 percent, led by strong therapy rental revenues within our North America Acute Care segment. Gross margin for rental revenues increased 180 basis points to 56.3 percent related primarily to higher margins on recent product introductions and improved leverage and profitability improvements within our field service network.

Research and development expenses

 

Selling and administrative expenses

 

Interest expense

Investment income

Other income/ (expense)

 

GAAP Earnings

Adjustments:

Effect of Liko inventory valuation

Liko acquisition integration charges

 

 

Adjusted Earnings

 

Revenues:

North America Acute Care

North America Post-Acute Care

International and Surgical

Total eliminations

 

Total revenues

 

 

Divisional income:

North America Acute Care

North America Post-Acute Care

International and Surgical

Functional costs

 

Total divisional income

 

Cash Flows Provided By (Used In):

Operating activities

Investing activities

Financing activities

Effect of exchange rate changes on cash

 

Decrease in Cash and Cash Equivalents

 

October 1, 2009 – October 31, 2009

November 1, 2009 – November 30, 2009

December 1, 2009 – December 31, 2009

Total

 

Letter Agreement effective October 1, 2009 between Hill-Rom Holdings, Inc. and Earl DeCarli (Incorporated herein by reference to Exhibit 10.40 filed with Form 10-K for the year ended September 30, 2009)

 

Letter Agreement effective October 1, 2009 between Hill-Rom Holdings, Inc. and Jeffrey Kao (Incorporated herein by reference to Exhibit 10.41 filed with Form 10-K for the year ended September 30, 2009)

 

Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

 

Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

 

Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002