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Natus Medical Incorporated (NASDAQ:BABY)

Q4 2008 Earnings Call Transcript

February 26, 2009 11:00 am ET

Executives

Brienne Fisher – Director, IR

Jim Hawkins – President and CEO

Steve Murphy – VP, Finance and CFO

Analysts

Erik Schneider – UBS Securities

Joshua Zable – Natixis

Ed Shenkan – Needham & Company

Jayson Bedford – Raymond James

Daniel Owczarski – Avondale Partners

Matt Dolan – Roth Capital Partners

James Sidoti – Sidoti & Company

Operator

Ladies and gentlemen, thank you for standing by. Welcome to Natus Medical 2008 fourth quarter financial results conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. (Operator instructions) As a reminder, this conference is being recorded today, February 26, 2009 and contains time sensitive information that is accurate as of only today. I would now like to turn the call over to Brienne Fisher, Director of Investor Relation for Natus Medical. You may proceed.

Brienne Fisher

Good morning. Earlier today, Natus Medical released financial results for the 2008 fourth quarter. If you have not received the news release or you would like to be added to the company’s distribution list, please call Natus Medical in San Carlos, California, at 650-802-0400 or e-mail your request to investorrelations@natus.com. This call is being broadcast live over the internet at www.natus.com and a replay of the call will be available on the company's website for the next 90 days.

In terms of structure for today's call, Jim Hawkins, President and Chief Executive Officer of Natus will present opening comments. And then Steve Murphy, Chief Financial Officer of Natus will summarize the company's financial results. Then Jim Hawkins will conclude the prepared remarks with comments about the company's strategy and financial guidance for 2009. Ken Traverso, our Vice President, Marketing and Sales; and Dr. Chris Chung, Vice President, Medical Affairs and R&D will join in answering any questions.

Some of the information to be furnished in today's session will constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are those focused on future performance results, plans and events, and include the company's expected results for 2009.

Natus reminds you that its future results may differ materially from these forward-looking statements due to a number of risk factors. For a description of the relevant risks and uncertainties that may affect the company's business, see our periodic reports on Form 10-K and Form 10-Q as filed with the Securities and Exchange Commission. I’d now like to turn the call over to Jim Hawkins, President and Chief Executive Officer of Natus Medical.

Jim Hawkins

Thank you, Brienne. I’m pleased to report our fourth quarter 2008 results. In the fourth quarter, our revenue increase by 27%, up 43.4 million, up from $34.2 million reported last year. Our net income was $6.3 million in the fourth quarter, up from $3.8 million on a non-GAAP basis in 2007, representing a 66% increase.

In the fourth quarter, we continue to see growth in sales of our newborn hearing screening supplies. Our ALGO 5 newborn hearing screener also continued to experience growth in the fourth quarter. We believe this growth validates that the improvements in the ALGO 5 represent a significant upgrade opportunity for our customers and we remain confident that our customers will continue to be motivated to upgrade and hold their products to the ALGO 5.

May this continues to be recognized as a worldwide market leader in newborn hearing screening in both technology and product breadth. We believe the market for newborn hearing screening outside the United States will continue to be a growth opportunity for Natus in the years ahead.

In the fourth quarter, we continue to have excellent results from our XLTEK division, as they contributed significantly to our revenue growth for the quarter. As we have previously discussed, the acquisition of XLTEK has allowed us realign our domestic sales force into two distinct sales organizations focused on the newborn care and neurology markets.

We believe this has allowed us to devote the appropriate sales resources to these two distinct market opportunities. As we had expected, we have seen increased productivity from both sales groups with this new market focus.

In the fourth quarter, we completed the restructuring of our operating divisions that was started in February of 2008. We have consolidated product development activities by both product – by product categories at our Olympic, Bio-logic, and XLTEK facilities, as well as consolidating our customer and technical service organizations.

We believe this restructuring have resulted in a more streamline and efficient operation and has reduced redundant activities that had previously been performed at multiple sites. Although the restructuring resulted in approximately $600,000 of incremental cost during the first three quarters of 2008, we started to realize savings in the fourth quarter, making the restructuring approximately cost neutral for the year.

However, this restructuring should result in about a $2 million to $2.5 million annual operating cost reduction in 2009 and beyond. In the second quarter of 2008, we also strengthen our balance sheet by completing two public offerings of common stock, raising approximately $100 million in new equity.

As we exited the fourth quarter, we had approximately $57 million in cash and less than $2 million of debt. Our current strong cash position supports our strategy of identifying acquisitions and integrating businesses that will be accretive to our earnings.

On October 2nd, we completed the acquisition of NeuroCom. We are pleased to report that NeuroCom had excellent results in the fourth quarter. And its results were accretive to earnings per share in the quarter. NeuroCom is a worldwide leader in the development of computerized tools for the assessment and rehabilitation of patients with balance and mobility disorders.

NeuroCom systems are used worldwide in a broad spectrum of medical disciplines, including neurology, orthopedics, sports medicine, geriatrics, and physical rehabilitation. More than 1,000 medical and academic institutions are currently utilizing NeuroCom technology in the United States and abroad.

We are very excited about the growth opportunities in this developing field. And believe NeuroCom is and will continue to be a market leader. We strongly believe that our overall business model is intact. Our success over the past four years has been driven by a combination of internal growth and accretive acquisitions.

However, because the current economic environment is very uncertain, we have taken an even more cautious approach in our evaluation of potential acquisition targets and of the terms under which we would engage in transactions. That being the case, we have held off on finalizing acquisitions that could potentially be consummated in a short term.

However, we continue to engage in discussions with potential acquisition targets. We will move forward on our acquisition when we are confident that the target business conditions are stable, the valuation is appropriate, and the timing is right for Natus. With that said, we should also point out that we have an exciting pipeline of opportunities. Our strong balance sheet leaves us well positioned to be able to take advantage of these acquisition opportunities as they present themselves. With that overview, I would like to turn the call over to Steve Murphy. Steve?

Steve Murphy

Thank you, Jim. Today, I will be discussing our fourth quarter and full year 2008 financial results on a basis consistent with accounting principles generally accepted in the United States or GAAP. We will also reference our non-GAAP results for 2007, as we believe they aid in comparison to our financial results for 2008.

All per-share amounts presented today are on a diluted basis. For the fourth quarter, in the December 31st, 2008, we reported net income of $6.3 million or $0.22 per share, compared with net income of $2.8 million or $0.12 per share for the fourth quarter of 2007.

Our fourth quarter 2008 results reflect increases of 126% and 81%, respectively, in net income and earnings per share over our 2007 results. Our 2008 fourth quarter results are inline with the preliminary financial results we announced on January 20th, 2009. For the 12 months in the December 31st, 2008, we reported net income of $17.5 million or $0.66 per share, compared with net income of $9.8 million or $0.43 per share for the comparable period in 2007.

Our 2008 results reflect increases of 79% and 54%, respectively in net income and earnings per share of the prior year. Our historical results for 2007 included acquisition related charges associated with the acquisition of XLTEK in November 2007. Our non-GAAP net income excluding those charges was $3.8 million or $0.17 per share and $10.8 million or $0.47 per share for the three and twelve months in the December 31st, 2007, respectively.

In our press release issued today, we have included a reconciliation of our 2007 GAAP and non-GAAP results. Our results for 2008 reflect increases in net income and earnings per share of 62% and 40%, respectively over our non-GAAP results for 2007. Average diluted shares outstanding worth 26.6 million shares for the 12 months in the December 31st, 2008, compared to 22.8 million shares in the 2007 period.

As Jim mentioned, we reported record fourth quarter revenue of $43.4 million, an increase of 27% or a $9.2 million from revenue of $34.2 million for the fourth quarter of 2007. For the 12 months ended December 31st, 2008, we reported revenue of $161.8 million, an increase of 37% from $118.4 million reported in the 2007 period.

Revenue from devices in systems contributed to 66% of total revenue in the 2008 and 2007 fourth quarters. And revenue from supplies and services contributed to 33% of total revenue. Other revenue consisting primarily of crate charges was between 1% and 2% in both periods. Revenue from domestic sales was $29.4 million with the fourth quarter of 2008 or 68% of total revenue, compared with $21.8 million or 64% of total revenue reported last year. Revenue from international operations increased 13% to $14 million in the fourth quarter of 2008, compared with revenue of $12.4 million reported last year.

Earlier this year, we communicated in broad terms our expectations for revenue contribution and product mix from our pre-product families as follows – we expected 40% of our revenue to come from our hearing products, including newborn hearing screening and diagnostic hearing; 30% from our diagnostic neurology products; 25% from our newborn care products; and 5% from other sources.

Actual results for the 12 months ended December 31st, 2008, reflect the following percentages – 41% from our hearing products; 34% from our neurology products; 19% from our newborn care products; and 6% from other sources. Results for the three month ended December 31st reflected a slightly higher percentage of revenue from our neurology products, which was driven by our acquisition of NeuroCom on October 2nd, 2008.

As we moved into 2009, we expect that the mix of revenue will be approximately 40% from our hearing products, 37% from our neurology products, 18% from our newborn care products, and 5% from other sources. The expected increase in the contribution from our neurology products is again driven by our acquisition of NeuroCom. Our gross margin was 63.8% in the fourth quarter of 2008, compared to 62% reported in the third quarter of 2008, and 63.1% reported in the fourth quarter of last year.

We have been able to consistently improve the gross profit of XLTEK, increasing it from 50% at the time of the acquisition to 62.4% in the fourth quarter of this year. But now we have a similar situation with the Schwarzer neurology business that we acquired in July 2008, where their gross profit was approximately 52% in the third quarter of 2008 and improved to 56% in the fourth quarter of this year.

Total operating expenses were 44.3% of total revenue with the fourth quarter of 2008, down from 46.1% of total revenue in the fourth quarter last year and 45.4% in the third quarter of this year. Our operating expenses as of percent of revenue are typically higher in the first half of our fiscal year and as we expected, trailed down in the fourth quarter.

We also began to benefit from the restructuring activities we initiated earlier this year. As you may remember in February, we announced a restructuring of our North American operating units. While these restructuring activities resulted in increased expense during the first three quarter of this year, we began to benefit from the realignment of functions in the fourth quarter.

While we believe that the restructuring will result in an annual cost reduction of about $2 million to $2.5 million in 2009, keep in mind that total operating expenses will increase in 2009 due to the impact of our 2008 acquisitions as their costs will be annualized going forward.

Our effected tax rate for 2008 was 36.8%. This rate is lower than we had previously expected and communicated because of the mix of taxable income from domestic and foreign sources and through of our research and development tax credits in the fourth quarter. Our cash tax payment rate in 2008 was approximately 20%. And we expect that we will continue to see a significant differential between our book and cash tax rates in 2009.

During the 12 months in to December 31st, 2008, we recorded approximately $6.9 million of depreciation and amortization expense, including $3.7 million of amortization of intangibles associated with our acquisitions. We recorded $3.3 million of stock-based compensation expense.

We raised approximately $100 million in April and May 2008 and two separate public offerings totaling 5.5 million shares of our common stock. We used approximately $30 million to the proceeds to pay down our revolving and term debt. However, the purpose of the capital raise was not primarily to pay down debt, but to provide us with capital to fund future acquisitions. This capital raise had a significant diluted effect on our earnings per share during the second half of 2008. Based on our calculations, the diluted impact of the additional shares, net of incremental investment income was about $0.06 per share.

At June 30, 2008, we reported cash, cash equivalents and short term investments of $57 million termed at tied to our XLTEK real estate of approximately $1.3 million, stockholder’s equity of approximately $227 million, and working capital of approximately $102 million.

In August 2008, we renegotiated our revolving credit facility with Westborough bank, increasing it from $10 million to $25 million, but we have not borrowed against it. With that, I will turn the call back to Jim.

Jim Hawkins

Thanks, Steve. Before opening up the call to questions, I would like to make a few comments and review our guidance for 2009. We believe Natus has been one of the fastest growing profitable medical device companies in the country. Many of our product offerings enjoy market leading positions and we have accomplished this in part through eight acquisitions over the last four years.

We continue to be the worldwide leader in newborn hearing screening. It is a growing business with a great recurring disposable revenue model. We continue to believe the combination of the Cool-Cap and the Olympic cerebral function monitor will become very successful products for Natus.

We also believe the integration plan we initiated at XLTEK last year, coupled with the restructuring activities among our North American operating divisions we initiated earlier this year have positioned us to approximately maintain the earnings margins we have achieved over last year.

Before we discuss our guidance for 2009, I want to note that we have attempted to develop our guidance on a conservative basis, which we think is prudent given the current potential for a worldwide economic slowdown, along with the impact of a strong US dollar to have on our international business.

For the full year 2009, we expect revenue to range from $166 million to $170 million and earnings per share to range from $0.57 to $0.61. This compares to revenues of $162 million and earnings per share of $0.66 reported for the year 2008.

For the first quarter of 2009, we expect revenue to range from $37 million to $38 million and earnings per share to range from $0.06 to $0.08. This compares to revenues of $36.9 million and earning per share of $0.11 reported for the first quarter of 2007.

We are forecasting net income to be flat in 2009 compared to 2008. Our earnings per share for 2009 will be impacted by the shares issued in the stock offerings we completed in April and May 2008, where we issued an aggregate of 5.5 million shares of common stock for about 25% of our then outstanding shares.

The effect of these offerings will be particularly significant to the comparison of results for the first two quarters of 2009 versus the same period in 2008, as the new shares were outstanding for only a potion of our second quarter of 2008.

Our 2009 guidance is on a GAAP basis, including the impact of dispensing employee equity base compensation, which we expect to be approximately $3.5 million. We expect the depreciation and amortization expense would be approximately $8 million in 2009, including approximately $4.1 million of amortization of intangibles associated with our acquisitions. Combined, this represents over $11 million of non-cash expenses included in our 2009 guidance. Our guidance does not include the impact of any non-recurring acquisition related costs for potential acquisitions. All earnings per share amounts are on a diluted basis.

In conclusion, we want to reflect once again on our accomplishments for 2008. Our pre-tax earnings are up 73% on a year-over-year basis, and our net income is up 79% on a year-over-year basis. There are few medical device companies out there that can attest to results like these. We remain confident in our business model and believe that we’re poised for growth as economic conditions stabilize.

Before we respond to questions, I would like to make a few brief comments related to our acquisition strategy. We will continue to be cautious when considering an acquisition opportunity. We’re going to make sure that the forecast we use to evaluate acquisition, take into account the market uncertainties that exist today and do not reflect undue optimism. We’re going to ensure that the purchase price of any targets reflect recent changes and valuations of all companies, Natus included. And finally, we are treating our cash as a treasured financial resource, and we will only employ it for the right opportunity.

With that said, Steve, Ken, Chris, and I would be happy to take your questions. Operator?

Question-and-Answer Session

Operator

(Operator instructions) Your questions will be taken as time permits. And your first question comes from the line of Erik Schneider with UBS Securities. You may proceed.

Erik Schneider – UBS Securities

HI. Good morning, gentlemen. You just mentioned your – the acquisition criteria, I think, more broadly versus your previous formal targets. When you were describing, historically, a one, one and a half times revenue, that was somewhere half or less of where you’re trading at. Are you still looking to pay that sort of multiple discount relative to your current trading, given that you’re around one times revenue today?

Jim Hawkins

Yes. That’s a very good question, Erik, and something that we are monitoring as we go throughout our process here. Certainly, the arbitrage of paying one to one and a half times when we’re on that one to one and a half times revenue range is something that we have to consider. Certainly, the profitability of the company that we acquire or the potential profitability of the company is a big factor as well because it can certainly still be accretive if we were to pay over one times and certainly get their earnings up compared to ours and certainly the cost of capital we have. But it is something we are going to monitor. And ideally, if things stabilize and the valuation stay here, we would assume that our criteria would ratchet down as well, as far as valuation.

Erik Schneider – UBS Securities

Yes. But you could imagine paying your own multiple if it was a higher margin than you enjoy currently.

Jim Hawkins

Yes. I think that’s right. I wouldn’t want to certainly eliminate that. We weren't planning on doing that, but I wouldn’t want to eliminate it either.

Erik Schneider – UBS Securities

Okay. And relative to customer capital spending for that portion of your business, it sounds like you haven’t had to move your functions relative to what you put out there previously. But can you describe how those cutbacks are being manifested? You see people not making orders, you expect people not making orders, you expected people canceling orders, or people reducing order size? What are you actually seeing in the field?

Jim Hawkins

Erik, so far this quarter, as you rightfully noted, we’re keeping the guidance where we had it. I think it was maybe five weeks ago. And I think that’s an indication that we have not seen any further deterioration of the business since that time. Certainly, the last month of the quarter for the capital equipment is a very key period. And a higher percentage of those orders are placed in March. So we’re going to be monitoring that closely. But we believe that we have incorporated the changes in market dynamics into our guidance.

Erik Schneider – UBS Securities

Again, with respect to the orders that you’re seeing in December, was it – were the orders not coming through at all or orders that were smaller than you would have expected?

Jim Hawkins

I think the – it’s not like hospitals that were ordering, say, five systems, cut it to three systems. We didn’t see that as much as hospitals that just said, “We’re not ordering.” Does that answer that question?

Erik Schneider – UBS Securities

Yes, that’s helpful. Just one other question, what do you think the long term opportunity is for AST improvement for the hearing disposables?

Jim Hawkins

Yes. As we alluded to in our press release, certainly, we think that for a captive disposable that certainly Natus has put a lot of energy and money in developing, that we should deserve the proper margin on that compared to other companies and products that have those types of captive disposables. With that said, we think that for, certainly, future period, future years, we will have the ability to get our prices to where they should be.

Erik Schneider – UBS Securities

And your margins on that segment of your business today?

Jim Hawkins

We really don’t disclose that, but they are certainly at our corporate margin and slightly above that.

Erik Schneider – UBS Securities

Okay. Thank you.

Operator

And your next question comes from the line of Joshua Zable with Natixis. You may proceed.

Joshua Zable – Natixis

Hey, guys. Thanks for taking my question here. Just a quick follow up to Erik, I know he kind of alluded to this regarding the spending. It seemed, basically, things fall off here in December. Obviously, things haven’t deteriorated from what you expected, but I know you guys put out some pretty bleak expectations. Have things started to improve at all relative to December at least?

Jim Hawkins

I wouldn’t go there, Josh. Let me take that back. December was a pretty dramatic sell off for us or at least against our expectations as far as the orders that came in. I think we’ve commented, the last three weeks of the quarter orders did dry up versus our plans. We’re not seeing that dry out – that slow down versus our plans this quarter. But as you mentioned, our plans are reduced from where they – certainly, they would have been and where they were when we put our regional 2009 budget together back in November.

Joshua Zable – Natixis

Okay. Then, just on the cost cutting front, I know you guys had implemented a cost cutting program in ’08, which you should start to see bear fruit. I saw in the fourth quarter ’09. And I got lost to the noise, the good noise that was going on with acquisitions, and things like that. Are you guys looking at more potential cost cutting programs just given with what’s going on out there?

Steve Murphy

At this time, we’re not, Josh. I think we’re fairly well known to be a pretty lean company when it comes to costs. And in fact, we were out really in front of the train a little bit by having – doing this consolidation and the cost reductions last year before even the market slowed down. With that said, we do have a hiring freeze on and we do have a wage freeze on from 2008 to 2009. But as far as any plans of headcount reduction at this time, we do not have that.

Joshua Zable – Natixis

Okay. Great. And then just, Jim, you made some comments about acquisitions that at the end – I got the sense that it might have been partially for us and partially for maybe some of your targets out there? Can you talk about maybe the mentality of those targets out there? I know over the last half of ’08, you seem to be kind of sovereign, for lack of a better word, or sticking to their valuation even as sales deteriorated, and obviously, valuations across the board have deteriorated. Have they remained picky with those in terms of your targets or at least are they more willing to work with you at this point?

Jim Hawkins

Yes. I don’t want to comment too much, Joshua, on that. And I can understand and I think that’s why you’re not seeing a lot of M&A activity in general. When you have a sharp reduction in valuations, nobody really want to quite believe it, or certainly, do not want to sell at this reduced price that 30%, 40% of where the hell the markets have dropped. I think people do want to wait out and see where things stabilize. But I firmly believe over time, as the markets stabilize, if they do happen to stabilize at these levels, this is going to be the new reality, and so we’re going to step up transactions at current market valuations.

Joshua Zable – Natixis

Okay. Great, guys. Keep up the hard work. Thanks.

Jim Hawkins

Sure, Josh.

Operator

And your next question comes from the line of Ed Shenkan with Needham & Company. You may proceed.

Ed Shenkan – Needham & Company

Yes. Jim, I just wanted to ask about Europe. A percentage of your revenues are European based. And have you seen evidence of a slowdown for cost per capital spending in the rest of the world, similar to what you are seeing in the United States?

Jim Hawkins

It’s a little difficult to answer that. I think in a broad way, I would say, certainly in Q4, I believe, the rest of the world held up better than the United States. And we are anticipating for that to be the case in 2009. As there are government health care programs and especially tied to our strong neonatal business, we don’t expect that to be as affected as much. But with that said, it is government controlled healthcare and they can pull the plug any time. So far, it’s been stable.

Ed Shenkan – Needham & Company

And as you’ve been in the business for many years, does Europe usually hold up much better than the United States? What’s been your experience through these types of events in the past?

Jim Hawkins

Yes. This is certainly a very unique type of event. Certainly, during Hillary’s care, I would say Europe certainly held up better than the United States because that was really a domestic issue going back to the 80s. I would say, overall, the rest of the world has held up in thinking it through. When we had – before Hillary – even when prices were being cut on reimbursement, typically a United States event. With all that said though, international overall seem to be more lumpy on a quarter to quarter basis.

Ed Shenkan – Needham & Company

And you had some price increases in 2008. Do you expect to continue to give or put through increases in ’09?

Jim Hawkins

Yes. On certain product lines, certainly. And we have pretty much established for our newborn hearing screening disposables a price increase in 2009.

Ed Shenkan – Needham & Company

Okay. Good. Thank you.

Operator

And your next question comes from the line of Jayson Bedford from Raymond James. You may proceed.

Jayson Bedford – Raymond James

Good morning, guys, just a couple of quick questions. First, on the fourth quarter gross margin, it was up just shy of 200 basis points from the third quarter, only $1.5 million increase in revenue. And I’m just wondering, where did that come from? It looked like devices and systems was actually a greater portion of revenue. So I’m just wondering what accounted for the jump there? And then, perhaps, if you could just touch on the FX impact on the gross margin line.

Jim Hawkins

Sure. On the FX side, I’m not aware off the top of my head if that had an impact or not. Potentially, it could have, but we didn’t really do that analysis of the gross profit line. I would say the biggest percentage was the NeuroCom had very good gross profits in Q4, about 70% plus. So it’s a very good product line that is a unique and a market leader, and they have been able to get very good margin.

Jayson Bedford – Raymond James

And Jim, NeuroCom goes in the devices and systems bucket, is that right?

Jim Hawkins

That’s correct.

Jayson Bedford – Raymond James

Okay. Is this a level from gross margin’s standpoint that we work off of for 2009?

Jim Hawkins

That’s probably a little high. Q4 does have a tendency to be the highest revenue quarter and it will be the same way in ’09 as well. And typically, our gross profit ramps up as we go through the year, but it does always fall back in Q1 as revenues drop back. It’s a seasonal business and Q1 usually being our weakest quarter. Typically, what happens is sales people drain the pipeline in Q4, and Q1 always starts off a little lighter. But it’s forecast that way, and historically, the numbers show that as well.

Jayson Bedford – Raymond James

Okay. Just a couple of other line items here in the P&L, the R&D dropped off quite a bit in the fourth quarter, is that just reflective of the timing of certain projects or is this kind of a level we’re operating at in 2009?

Jim Hawkins

Yes. It’s a level we’ll be operating at in 2009 overall, Jayson. It’s part of that whole reorganization we did by consolidating engineering groups, and part of that the $2 million to $2.5 million savings that we will see. Rather than having three different curing engineering groups for example, now they’re all consolidated into one facility, actually headcount.

Jayson Bedford – Raymond James

Okay. Just lastly, hearing – infant hearing screening you mentioned was strong. Can you give us a sense of the growth rate and then where that’s coming from. My guess is that it’s mostly international? But are you still growing in the US business?

Jim Hawkins

Certainly, on the disposable side, we’ve had higher ASPs and so that has been – the growth on the domestic side overall. Internationally, we have had good growth year-over-year. But we are forecasting more of a flatter year in international, maybe on a cautious basis. But we have a feeling that in this economic downturn, it’s going to be difficult for new countries to start screening programs, which typically is always a nice pop for us because that‘s the buy equipment one time and then a nice supply inventory. So we’re not forecasting any major country starting a new program up in ’09.

Jayson Bedford – Raymond James

Okay. That’s helpful. I’ll get back on the queue. Thanks.

Jim Hawkins

Okay. Thanks.

Operator

And your next question comes from the line of Daniel Owczarski with Avondale Partners. You may proceed.

Daniel Owczarski – Avondale Partners

Yes. Thanks. Good morning.

Jim Hawkins

Hi, Dan.

Daniel Owczarski – Avondale Partners

As far as inventory levels, we’re seeing a lot with customers and distributors wanting to keep less on hand. Is that impacting you guys at all? And if so, is there any way to quantify it?

Steve Murphy

Yes. We don’t think so at all. Most of our inventories and the disposable supplies, and most hospitals keep 30 to 60 days on hand. And we haven’t seen or don’t expect to see any change there.

Daniel Owczarski – Avondale Partners

Okay. And you talked a little bit about the hearing market, the newborn hearing market. What about the professional side, any trends in traffic or volumes? Is that business neutral economy wise or is that maybe a little bit weakness from a pure traffic or volume perspective?

Steve Murphy

Yes. In 2008, I believe it was up for the entire year. Going forward, we’d probably haven’t certainly forecasted growth in that area and maybe conservatively, forecasted a slight reduction, but not a lot.

Daniel Owczarski – Avondale Partners

Okay. And then, just last, you talked about pricing and the disposables. What about the equipment side? Are people looking for bigger discounts to get them to make that final purchase decision or anything different than in the past that you’re seeing today?

Jim Hawkins

No. I would say that there are two different sides of the business. Certainly, on the newborn hearing screening side, with our ALGO 5, it has a higher ASP. It’s about 15% or 20% list price, and that certainly is holding. On the capital equipment side for the neurology business, we have not had any impact there. We’re not reducing prices, offering any additional discounts, other than the normal course of business. We have had, certainly on the foreign currency side of the business, when we ship overseas, certainly our customer there have had a price increase that we don’t benefit from that increased margin or any increase pricing, unfortunately. But it is a price increase for our customers.

Daniel Owczarski – Avondale Partners

Okay. Thanks, Jim.

Operator

And we have a new question from the line of Matt Dolan with Roth Capital Partners. You may proceed.

Matt Dolan – Roth Capital Partners

Hi, guys, good morning. Sorry if this is repetitive. I’m bouncing around a little bit. But two topics, Jim, on the guidance for the year, it looks like low single digit decline in organic revenue, obviously excluding the acquisitions from 2008. Can you talk about what you’re baking in, in terms of expectations for overall hospital spending, what you’re hearing out of the industry in trends in terms of capital spending in general? And what areas will exceed or outperform hospital spending declines? And what could be subject to or be not as insulated, so to speak?

Jim Hawkins

Okay, Matt, sure. Maybe I’ll editorialize here a little bit and this is just one person’s opinion as to where things sort of stand. You can probably ask ten people and get ten different opinions, but Matt asked, so I’ll say. I think we’ve all seen the studies and surveys that have been commissioned for hospital purchasing managers, and typically, I’ve seen reductions anywhere as low as 20% year-over-year to 50%, a pretty harsh capital expenditures reduction there.

My personal opinion is you have to dig in to that and do an analysis of that and there’s really a couple of categories, maybe three. Products that sell capital equipment from $20,000 to $100,000 and maybe $100,000 to $300,000 or $400,000, and then everything about that. My personal opinion is capital equipment in that higher bracket, which makes up, I believe, at least half of the capital expenditures, the big MRs, CTs, PET scans, all these different type high dollar offerings are the ones that are dramatically going to be reduced. Our products are in that lower level, typically in that $20,000 to $70,000 range. And our belief and our assumptions are that rather than being down anywhere from 20% to 30% or 30% to 50%, we think in that area, it’s probably reduction of 10% to 20%. And that’s the analysis that we have.

On the newborn hearing screening side, where it’s more of a replacement business in the United States where hospitals have to have it, we don’t see any reduction in spending in that line of business at all. And in fact, with our price increase, we expect to growth in that area.

Matt Dolan – Roth Capital Partners

Okay. Good, very helpful. On the acquisition side of things, it sounds like timing is probably anyone’s guess at this stage. But can you talk about some of the deals that you have been looking at? Have you walked away from those completely or are you still in touch with the sellers there? And obviously, you’ve had some pretty significant goals or still have significant goals in terms of revenue targets. So maybe discuss a little bit on the magnitude of those deals, where that may have gotten you. Thanks.

Jim Hawkins

Sure. Certainly, in Q4, and really for the last four years, we laid out this goal of exiting ’08 at a $250 million run rate. And obviously, we were not able to achieve that and very disappointed as we did have acquisitions pretty lined up to get to that level that we’ve pretty pulled the weight from with this economic slowdown. So we were disappointed but certainly, we’re convinced that was the right thing to do. We did not want to acquire a company with sales that may be going down, its earnings could be hit in the short term, and at the same time pay the price that was over market, something that maybe we have negotiated up before December. So with those situations, we just thought it prudent not to move forward.

Going ahead, we really are excited about the potential opportunities that we have. Certainly, the companies that we’re talking to are still available. There hasn’t really been much M&A out there. And we think there’s a big opportunity for other divisions – really divisions of larger companies, as bigger companies look to evaluate their business model and the focus on their core competencies, we think that they may want to divest some divisions that could be right in our daily rack. So a combination of waiting for the market to settle down, understanding where valuations are, what the business environment is for revenue, but also to – we don’t want to miss an opportunistic opportunity by spending our money on a situation that could be good, but by missing a potential homerun out there.

Matt Dolan – Roth Capital Partners

Okay. Very good. And then, one more on the expense side of things, sales and marketing pumped up Q4, everything else showed some really good cost control. But I’m just trying to get a feel for the impact of NeuroCom. And then maybe for Steve, is this a good base to think about for 2009 or should some of that restructuring bring that absolute number down?

Jim Hawkins

Yes, just in general, and then I’ll pass it on to Steve. Certainly, it was acquisition related, the big increase in sales and marketing and that’s NeuroCom. And also, I will add, in real dollar terms, that is at the end of the year, our sales are the highest, sales, bonuses are achieved, quotas are beat. And so it does have a tendency to certainly be the higher dollar amount. As far as moving forward, Steve?

Steve Murphy

Yes. So I think in absolute dollars, we’ll see the sales pull back in the, let’s say, the first half of the year, and then wrapping up again because of those incentives.

Matt Dolan – Roth Capital Partners

Okay. Thanks a lot, guys.

Jim Hawkins

Thanks, Matt.

Operator

And your next question comes from the line James Sidoti with Sidoti & Company. You may proceed.

James Sidoti – Sidoti & Company

Good morning, Jim. Good morning, Steve.

Steve Murphy

Hey, Jim.

Jim Hawkins

Jim.

James Sidoti – Sidoti & Company

Can you break out for the quarter what you think the contribution from the acquired products was?

Jim Hawkins

The profit contribution or sales contribution?

James Sidoti – Sidoti & Company

Sales contribution. Revenue.

Jim Hawkins

I don’t think we break down sales by – we don’t have a history of doing that, giving–

Steve Murphy

We’ll probably have a little bit of that in the K. Generally, we’re just reporting along the larger product groups.

James Sidoti – Sidoti & Company

Would you think the organic growth was flattish or was down slightly?

Steve Murphy

It was up slightly.

James Sidoti – Sidoti & Company

Up slightly? Okay. Great. And then on currency, so we can watch the exchange rate and we can see the effect of currency on revenue. But can you give us a sense on how much of that goes through to the bottom line?

Jim Hawkins

It’s get a little complex. I’ll try to walk everyone through it. As I mentioned, certainly, our customers are getting a price increase. That really doesn’t affect the fall through of our income statement. Two areas affect our income statement. One is that when our European division, all of their sales, for the most part, are outside of the United States, so they’re in Euros. When we convert those Euros back to dollars right now at current FX rate, we’re taking it 15% to maybe even a 20% hit bringing the Euros back in the dollars. So that’s certainly is a negative for us and is incorporated in our guidance. One of the reasons our guidance is where it is.

On the income side, we do get a benefit or we have been getting a benefit with the Excel-Tech acquisition. It’s the unique situation we’re in. They’re located in Canada. And all their sales for the most part, 99.5% of the revenues come from the United States. So they’re selling in dollars, but their costs are in Canadian dollars, as we bring those costs across to the United States, both costs have gone down by, really year-over-year, I think we’re around a dollar or one to one to the Canadian dollar when we acquired Excel-Tech. Now, it’s around $0.80.

James Sidoti – Sidoti & Company

So that will be a pick up. How about in Europe, do you have any operating costs in Europe?

Jim Hawkins

It offset a little bit by the revenue reduction so all the margins that you can imagine stay the same percentage wise. It’s just that the revenues do go down. Our costs go down but – so the bottom line really is unaffected.

James Sidoti – Sidoti & Company

Okay. Your hedged nationally against the Euro is what you’re saying.

Jim Hawkins

Yes, I would say that’s right.

James Sidoti – Sidoti & Company

Okay. Last question, can you give us what you think the tax rate would be for 2009?

Jim Hawkins

Steve, if you (inaudible) –

Steve Murphy

It’ll be $37, maybe a little loss, I don’t know what.

James Sidoti – Sidoti & Company

Thank you.

Operator

This concludes the question-and-answer portion of your conference. I would now like to turn the call over to Mr. Jim Hawkins for closing remarks. You may proceed, sir.

Jim Hawkins

Well, thank you, operator, and thanks for everyone for participating. We look forward to a – really do look forward to an exciting 2009. And we’re looking forward to the opportunity to really grow our business, especially on the acquisition front. And look back to achieving our run rate goal that we’ve established in 2008. Thanks for everyone’s participation and backing of the company.

Operator

Thanks for your participation in today’s conference. This concludes your presentation. You may now disconnect and have a great day.

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Source: Natus Medical Incorporated Q4 2008 Earnings Call Transcript

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