Natus Medical Management Discusses Q4 2013 Results - Earnings Call Transcript

Jan.29.14 | About: Natus Medical (BABY)

Natus Medical (NASDAQ:BABY)

Q4 2013 Earnings Call

January 29, 2014 11:00 am ET

Executives

James B. Hawkins - Chief Executive Officer, President and Director

Jonathan A. Kennedy - Chief Financial Officer, Principal Accounting Officer and Senior Vice President of Finance

Analysts

Lawrence Solow - CJS Securities, Inc.

Chris Lewis - Roth Capital Partners, LLC, Research Division

Jayson T. Bedford - Raymond James & Associates, Inc., Research Division

Brian Weinstein - William Blair & Company L.L.C., Research Division

Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Natus Medical Fourth Quarter and Full and 2013 Financial Results Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded today, January 29, 2014, and contains time-sensitive information that is accurate only as of today.

Earlier today, Natus Medical released financial results for the fourth quarter and full year of 2013, and if you have not received the news release or you would like to be added to the company's distribution list, please e-mail your request to InvestorRelations@natus.com. The call is being broadcast over -- broadcast live over the Internet on the company's website at natus.com, and a replay of the call will be available on the website for the next 90 days.

The agenda for today's call will be as follows: Jim Hawkins, President and Chief Executive Officer of Natus, will be opening comments; then, Jonathan Kennedy, Senior Vice President and Chief Financial Officer of Natus, will summarize the company's financial results; and then, Jim Hawkins will conclude the prepared remarks with comments about the company's financial guidance for 2014 before opening the call up to 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, and plans and events and include the company's expected results for 2014. Natus reminds you that the 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 its periodic reports on Forms 10-K and 10-Q filed with the Securities and Exchange Commission.

I would now like to turn the call over to Jim Hawkins, President and Chief Executive Officer of Natus Medical.

James B. Hawkins

Thank you, operator. Earlier this morning, we released our fourth quarter 2013 results. We reported revenue of $90.6 million compared to $90.8 million last year, and non-GAAP earnings of $0.37 compared to $0.30 in our fourth quarter last year. For the fiscal year 2013, we reported revenue of $344 million compared to $292 million, and non-GAAP earnings of $1.03 compared to $0.64 last year. Included in the company's 2012 fourth quarter revenues were $2.2 million of onetime shipments of proprietary product to CareFusion. Natus agreed to manufacture this product for CareFusion through a supply agreement that was part of the purchase of Nicolet. I'm extremely satisfied with these financial results especially the 19.1% operating profit in the fourth quarter. As a result of this outstanding achievement, we have established a new long-term annual non-GAAP operating margin goal of 20%, replacing the 13% to 17% annual goal we had communicated in the past. Our improved operating margin has been driven by an increased operating leverage and efficiencies as a result of our acquisition strategy along with excellent execution of our operating plan by all at Natus. Both Newborn Care and Neurodiagnostic products had excellent results in the fourth quarter. Domestic and international revenues were solid in the quarter, and we continue to see growth in the Pacific Rim.

In the fourth quarter, Natus had very strong cash flow. Our cash balance increased by $12 million, and we reduced our bank debt by $10 million or a $22 million increase in liquidity. This is an increase from $17 million in the third quarter. We look to continue to generate significant cash in future quarters and to pay off our bank debt in 2014.

For the last many years, our focus has been top line growth and to build a leadership position in both Newborn Care and Neurodiagnostic products. Clearly, we have successfully achieved both of these objectives. While acquisitions will remain an important part of our business model, our primary focus in 2014 is to achieve organic growth while achieving our operating objectives with emphasis on earnings and cash generation. We do not plan on doing a significant acquisition in 2014. We think it is important to demonstrate to our shareholders the rewards of Natus' leadership in the Neurology and Newborn Care markets.

As the worldwide economy recovers, we believe birthrates will increase and return to historical levels, and hospitals will again make the nursery and NICU, the neonatal intensive care unit, priorities that will translate to higher capital spending in this area, as well as in neurology. We are confident this will occur and there are signs this trend may be starting.

Natus now has the world's largest neurodiagnostic sales and service organizations in the world. We are the largest in newborn care for the markets we serve. We have increased our focus on organic growth and to further achieve operating efficiencies. We look to start to achieve consistent organic revenue growth starting in our second quarter of 2014 as we lap our first anniversary with no new acquisitions. The ability to leverage our product platforms and sales channels in the future will be meaningful, and we are very encouraged for the opportunities that lie ahead.

In January, we entered the newborn hearing screening service business. As the worldwide leader in newborn hearing screening devices, we believe we are ideally positioned to develop this market. The opportunity for Natus is to increase the approximate $10 a baby we receive for our disposable hearing supply to $100 for actually performing the hearing screening test. While we do not expect meaningful revenue in 2014 as we start to make this service and develop this market, we believe it will become a more meaningful and significant growth opportunity in 2015 and beyond. But with that said, I am happy to report that we signed our first hospital for this service yesterday and have already -- and are already generating much interest.

In summary, we are very pleased with our fourth quarter and fiscal year 2013 operating performance. We look forward to 2014 to continue our strong earnings momentum and cash generation, and remain committed to driving towards our new long-term goal of 20% non-GAAP operating margin in the years ahead. Jonathan?

Jonathan A. Kennedy

Thank you, Jim. Today, I'll be discussing our financial results on a GAAP basis as well as a non-GAAP basis. Our non-GAAP results exclude amortization expense, restructurings and certain other charges. We believe that the presentation of these non-GAAP measures along with our GAAP financial statements provide a more thorough analysis of our ongoing financial performance. And you can find the reconciliation of our earnings on a GAAP versus non-GAAP basis on Page 6 of today's press release.

As Jim stated, we reported a fourth quarter 2013 revenue of $90.6 million, a slight decrease from revenue of $90.8 million for the fourth quarter of 2012. However, as Jim mentioned earlier, Q4 2012 included $2.2 million of onetime revenue from sales to CareFusion as part of the Nicolet acquisition.

Revenue from our Neurology market increased to $59.8 million or 66% of total revenue during the fourth quarter of 2013, compared to $59.3 million, or 65%, during the same quarter last year. Revenue from our Newborn Care market was slightly down from the prior year's quarter to $30.8 million or 34% of total revenue during the fourth quarter of 2013 compared to $31.5 million or 35% of total revenue during the same quarter last year.

On a consolidated basis, revenue from devices and systems contributed approximately 61% of total revenue in the fourth quarter of 2013 compared to the same level in the 2012 period, while revenue from supplies and services remained at approximately 39% of total revenue in the fourth quarter of 2013 as well as the 2012 period.

Revenue from domestic sales were approximately 57% for the fourth quarter of 2013, compared to 56% in the same quarter last year. And revenue from international sales was approximately 43% for the fourth quarter of 2013, again, compared to 44% in the same quarter of last year.

On a non-GAAP basis, our gross margin increased 2 percentage points to 59%, compared to 57% in the fourth quarter of 2012. Our non-GAAP gross margin decreased sequentially from the third quarter of 2013 by 170 basis points with about half of the decrease driven by a higher mix of international revenue, which is sold to distribution and has a lower gross margin. And the other half was driven by increased inventory reserves and other accruals made for the year end.

Operating expenses were lower than -- were lower during the quarter on overall lower spending and labor costs, and our fourth quarter non-GAAP operating margin improved to 19.1% compared to only 13.3% for the same quarter last year. GAAP operating income included a onetime tradename impairment charge of $1.5 million. And the impairment resulted from a reduction and the expected life of certain acquired tradename.

Looking ahead, we expect to continue improvements on our operating margin through ongoing, continuous improvement projects and greater integration. Our fourth quarter non-GAAP effective tax rate was 27.5%, and looking ahead to Q1 '14, we expect our tax rate to be about the same, around 28%. On a GAAP basis, net income increased to $9.1 million or $0.29 per diluted share, a $4.1 million or $0.12 increase from the same quarter last year. Non-GAAP net income increased $2.8 million compared to the same quarter last year to $11.7 million and non-GAAP earnings per share increased 23% to $0.37.

We recorded approximately $4.8 million of depreciation and amortization expense, including about $3.5 million of amortization intangibles associated with our acquisitions. Equity-based compensation was about $1.4 million during the fourth quarter.

Now, let's look at the balance sheet and cash flow. As Jim mentioned, net cash increased $22 million during the quarter, driven primarily by strong cash flow from operations and continued improvements in working capital. We entered the quarter in net cash position, with $56.1 million in cash and $38 million in debt. Our days of sales outstanding have improved again during the quarter by 7 days, down to 83 days, and we expect to continue these improvements in DSO throughout 2014.

As Jim stated, our first -- fourth quarter results are demonstrating the results of our efforts to improve profitability and drive cash flow. At the midpoint of our first quarter 2014 guidance, we expect non-GAAP gross profit margin of about 59% to 60%, and non-GAAP operating expenses of about 47%. We expect our non-GAAP effective tax rate to be approximately 28% for the first quarter absent any discrete or non-GAAP items. We expect the depreciation and amortization expense for the first quarter of 2014 will be about $13 million, included about $8 million of amortization expense associated with acquired intangibles. We expect equity-based compensation expense to be approximately $6 million for the year, and we expect about $1.6 million of interest and other expenses for the year. We expect the diluted average share count of about $32 million -- 32 million shares for the year.

With that, I'll turn the call back to Jim.

James B. Hawkins

Thanks, Jonathan. Before opening up the call to questions, I would like to review our financial guidance for our first quarter and full year 2014, all on a non-GAAP basis, and make a few closing comments.

For the first quarter of 2014, we expect revenue of $82 million to $86 million and non-GAAP earnings per share of $0.21 to $0.24. For the full year 2014, the company expects to report revenue of $345 million to $350 million and non-GAAP earnings per share of $1.14 to $1.18. This is an increase from previous guidance of $1.12 to $1.16.

In summary, we continue to expect to execute on our business model and build a world-class franchise in both neurology and newborn care. And we look forward to 2014 and to achieve record financial results.

With that, we'll turn the call over to questions. Operator?

Question-and-Answer Session

Operator

[Operator Instructions] The first question comes from Larry Solow from CJS Securities.

Lawrence Solow - CJS Securities, Inc.

Just a couple of quick -- just on -- you guys talked about continued efficiencies and some further cost-cutting. What would -- your 20% operating margin goal, is that something that you believe is achievable in the next couple of years? Is that -- was that a sort of a short to midterm goal? What's sort of the timetable on that? And a follow-up to that would be just, you achieved a 17% margin in the second half of the year, 19% in Q4, and I fully realize that there is some seasonality and some timing of expenses. But what would sort of -- the midpoint of your guidance for the full year is below 16% adjusted operating margin. Is that an area of conservatism? Or is there something else there?

James B. Hawkins

Yes, Larry. Our guidance is our guidance. And we put these goals out there as we've done in the past. I agree, we have had excellent performance, and we hope to continue that. But there is a lot of unknowns out in the world and with the new ObamaCare and Europe and other events in other countries, we just want our guidance to be conservative, and hence, I've guided that way. Regarding the 20%, certainly, Q4 is always our best quarter of the year. And we're not -- our plan is not to have 20% organic growth in 2014 but, certainly, in the future, we could certainly -- it's a goal that we've laid out and we hope to attain. But for '14, our guidance is our guidance, with the caveats that I stated. And that's what we feel good about.

Lawrence Solow - CJS Securities, Inc.

Okay. Just a quick -- you just talked about some signs that the birthrate may be improving or perhaps you're just seeing some hospitals may be looking to spend more money in that area or is that a combination of the 2 or...?

James B. Hawkins

Well, what we've seen, Larry, is some stability over the last couple of quarters now, where it had been trending lower consistently for a number of years. We've seen stability and maybe even an uptick in the 0 to 1% kind of range. And we've seen renewed interest also in the nursery and NICU overall. These orders take time and -- but we do see a changing of attitude when it comes to spending in that area. With that, Larry, maybe we'll go to another question.

Operator

The next question comes from Chris Lewis from Roth Capital Partners.

Chris Lewis - Roth Capital Partners, LLC, Research Division

First, just on the revenue side of things, you maintained your guidance there for 2014, and you talked about returning to organic growth starting in 2Q. So, I was hoping you can talk about the strategies that you've implemented, I think, with the sales force and overall sales strategy in order to return to that positive organic growth starting in the second quarter of this year?

James B. Hawkins

Sure. Well, without getting into too much detail, I think as most of you know, we've been very acquisitive over the last number of years. And when you do this, there's a lot of things that happen within the organization. Number one is, many of these companies that we buy or products have gross profits below 50%. The companies have averaged about 47%, 48% of the companies we've acquired. But what that tells you is that some of the products might have gross product profits of 30%, 35%. So we are continually calling out these lower gross profit products. Because it's not really the model that we want at Natus. So we've had this challenge of continually having a headwind in revenue as we eliminate some of these products. As we lap our last acquisition that we made in February of last year, we will have this behind us for all intents and purposes. And we then believe we're going to be able to show true organic growth at Natus on a consistent basis, combined with this new initiative of hearing screening in the hospital as a service, we think will also add revenue very nicely in the years to come.

Chris Lewis - Roth Capital Partners, LLC, Research Division

Okay. And then, in terms of the long-term operating margin goal of 20% you introduced today, I was hoping you could go into a bit more detail on what the company needs to do in order to achieve that here over the next couple of years, both on the top line with gross assumptions there. And then, what specific areas in terms of operations do you see for additional operating leverage going forward?

James B. Hawkins

Jonathan, do you want to discuss that?

Jonathan A. Kennedy

Sure. Yes, Chris, so the first part of your question, on the operating margin goal of 20%, what do we need to do to get there? It's the longer-term goal. I don't think it's something that we would necessarily say we'd accomplish for the full year of '14 but -- so, what do we need? We need a little bit of revenue growth, we need margin stability, gross margin, to keep in the 60% range. And then in terms of operational efficiencies, we still have some major projects going on with the company that will lead us to more efficient operations. And I think the combination of those 3 things will allow us to get there. And you've seen the performance in the second half of 2013 is indicative of the trajectory and the trends that we're trying to maintain. So I think that the results of fourth quarter prove that it's something we can do, it's just a matter of can you do that for multiple quarters in a row. And for that to happen, it's just execution.

Operator

The next question comes from Jayson Bedford from Raymond James.

Jayson T. Bedford - Raymond James & Associates, Inc., Research Division

Jonathan, I think you gave a good explanation of gross margin in the fourth quarter. You kind of gave us the first quarter guide. What are your expectations for gross margin in all of '14?

Jonathan A. Kennedy

I think on '14 -- Yes. Well, I think for '14, we were going to -- our expectations are to -- that it stays in the 60% range, plus or minus a point, to the extent that Europe comes back, that puts pressure on gross margin, like I said, in the prepared remarks, anything to distribution comes down -- comes at a substantially lower gross margin than the corporate average. So that could be something that would keep it from going up much above 60%. And I think that if we look out in the international markets, Europe does appear to at least have stabilized, and the declines we've seen over the last few years in Europe have stopped. So I would expect over the next 24 months or so, as we work towards this 20% operating margin goal that we'll see some pressure from increased revenue outside the U.S. and that will put pressure on gross margin.

Jayson T. Bedford - Raymond James & Associates, Inc., Research Division

Okay, that's helpful. Just kind of following up on that, Jim, you mentioned strength in the Pacific Rim. Is that just better execution? Have you entered new countries? Why the strength? And then just generally, can you maybe talk about emerging markets and how you’re positioned and the strategy going forward?

James B. Hawkins

Sure, Jason. I think the most meaningful growth area for us is China. We have really established now with our last acquisitions a very strong position in China. And our nearest -- our biggest competitor has been Nihon Kohden, and the Japanese company in there are just not as successful in China as the new Natus in neurology. And we have seen over the last, really, 2 quarters an accelerated growth in China, and we really look forward to that to continue. We really built a very strong franchise, we have a very broad product line, and we have a variety of products from these different acquisitions that can hit both the high-end Chinese market and sort of the middle market. We don't play in the very, very low end but we have a nice variety in the middle to high end and are very well positioned there.

Jayson T. Bedford - Raymond James & Associates, Inc., Research Division

And Jim, are you adding resources to China?

James B. Hawkins

Yes, we are, and to the Pacific Rim in general. Without going into too much detail for competitive reasons, we will be expanding there on a sales and service basis.

Operator

The next question comes from Brian Weinstein from William Blair.

Brian Weinstein - William Blair & Company L.L.C., Research Division

First question is on, a little bit on the business units, you talked about seeing some -- are having some positive discussions on the newborn side, can you talk a little bit about what you're seeing on the neurology side both the U.S. and OUS? And kind of how you see those end markets at this point?

James B. Hawkins

Yes. Both have been solid. I would say, the U.S. has been very solid for us. We've been, certainly, we think, over time, been getting market share there. Europe is stabilized, although, still, I believe slightly down, but not nearly what we had seen over the last year where it was 5% to 10% down. It might be flat to down 1%, but we're very happy with that. And as I mentioned in the Pacific Rim, it's been good for both. We had a good quarter for both Newborn Care and Neurology. So we're very happy with where things are and really excited to start showing some organic growth after Q1.

Brian Weinstein - William Blair & Company L.L.C., Research Division

Okay. And then on the newborn side, can you talk a little bit about specific products where you're seeing interest? I know that there's a backlog sort of the screeners that are out there but probably a year or so ago, there was a lot of talk about you guys moving into the incubator market here and what that could mean for you guys. So can you talk a little bit about screeners, incubators and kind of if there's a difference in what you're seeing between the 2 or how we should think about that?

James B. Hawkins

Yes. The hearing screening business, Brian, has continued to be just real solid. We've continued to maintain our market share and do very well. We had the big Saudi win where Saudi is now doing a newborn hearing screening and it'll add a nice, disposable revenue stream to us. On the incubator side, we continue to do well in our markets outside of the United States. But the United States is -- it's a tough go, we do have our FDA approval for our products now. We are getting orders and -- but certainly, for hospitals to change over to a new incubator platform, isn't going to happen overnight and it's something that is taking some work. It's tough competition and we're slugging it out there. But it's not easy.

Brian Weinstein - William Blair & Company L.L.C., Research Division

Good. And then my last question on gross margins, you had talked about 60% on the last call being kind of the floor. Obviously, you're right under that right now. When you mentioned OUS mix is being one of the drivers there, is there a possibility of acquiring any distribution over there and going direct in some of those countries where you use distribution now? And should we still think about 60% as being kind of the floor?

James B. Hawkins

Yes. We have no plans, Brian, to expand or to convert distributors to direct at this time. You need to really have a real solid level of consistent revenues to support that. And our model, we're direct now in France and Germany, and we plan on just remaining in those countries for the foreseeable future.

Jonathan A. Kennedy

Yes, and I would point out, too, one of the ways that we've achieved the operating margins we have is making the selections between the direct model and distribution model where to support a company-owned sales force and distribution system. It's just much more expensive. So you have to pick and choose where you get direct and where you get the distribution.

Operator

There are no more questions at this time. [Operator Instructions]

James B. Hawkins

Well, if there's no further questions, I'll go ahead and close. To do that, I would like to say that we remain very excited about 2014, and really, the whole entire future of Natus. We've built this Neurology franchise, really, from the ground up over the last 8 years to the worldwide leadership position. We're in a position now, we're to continue to grow it in the emerging markets and then the U.S. as health care does come back and stabilize and grows again. We're very excited about that. With that, I'd like to thank everyone for participating in today's call and for your continued interest and support. Thank you very much.

Operator

Thank you. And today -- thank you for participating in today's conference. This concludes your presentation. You may now disconnect and enjoy the rest of your day.

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