Natus Medical's CEO Discusses Q1 2014 Results - Earnings Call Transcript

Apr.23.14 | About: Natus Medical (BABY)

Natus Medical Incorporated (NASDAQ:BABY)

Q1 2014 Earnings Conference Call

April 23, 2014 11:00 AM ET

Executives

James B. Hawkins – President and Chief Executive Officer

Jonathan A. Kennedy – Senior Vice President Finance and Chief Financial Officer

Analysts

Larry S. Solow – CJS Securities, Inc.

Chris W. Lewis – ROTH Capital Partners LLC

Matt Larew – William Blair & Company

Jayson T. Bedford – Raymond James & Associates, Inc.

Ross Taylor – C.L. King & Associates, Inc.

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Natus Medical First Quarter 2014 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, April 23, 2014, and contains time-sensitive information that is accurate only as of today.

Earlier today, Natus Medical released financial results for the first quarter 2014. If you have not received the news release or if you would like to be added to the Company’s distribution list, please email your request to InvestorRelations@Natus.com. This call is being 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 present 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, plans and events and include the Company’s expected results for 2014. Natus reminds you that the future results may differ materially from those looking forward statements due to a number of risk factors. For a description of the relevant risks and uncertainties that may affect the Company’s businesses, 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. Mr. Hawkins?

James B. Hawkins

Thank you, operator. Our first quarter results that we released earlier this morning reported revenue of $85.6 million, compared to $85.8 million last year. We also reported non-GAAP earnings of $0.26 compared to $0.15 in our first quarter last year.

I am very satisfied with these results, especially the 13.7% non-GAAP operating profit in the first quarter. This compares to 8.1% in our first quarter last year. As a result of now achieving vastly improved operating margins for the last three quarters, we 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 increased operating leverage and efficiencies as a result of integrating our acquisition strategy along with excellent execution of our operating plan by all at Natus.

Both Newborn Care and neurodiagnostic products performed well in the quarter. Domestic and international revenues were solid in all geographies and we continue to see growth in the Pacific Rim.

In the first quarter, Natus continue to generate significant cash. Our cash balance increased by $3.5 million, and we reduced our bank debt by $5 million. In the quarter, we paid our annual bonuses as well as $5 million in acquisition-related payments. Cash generally is typically our lowest due to seasonal payouts in the first 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 the 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 revenue growth while attaining our operating objectives with emphasis on earnings and cash generation. We currently are not planning to do a significant acquisition in 2014.

We believe that it’s important to show ourselves, shareholders and the medical community the strong leadership company Natus has become. We look to start showing consistent organic revenue growth in the second quarter of this year. We have implemented a multi-prong growth strategy over the next 18 months to achieve this objective.

First, we have established a new product pipeline that we are very excited about. It will roll out starting in our second quarter and continue over the next 18 months in both Newborn Care and Neurology. This is the combination of new and refresh products.

Second, we have geographic initiatives that will leverage our market position to achieve rapid growth in growing and under penetrated markets.

And third, we launched a new business initiatives Hearing Screening as a Service. We’re very excited about this opportunity. We are now offering newborn hearing screening test to hospitals as an alternative to purchasing equipment and disposables. We look to convert our existing Algo customers to this new service model, as well as attracting new customers to Natus. We are already off to an encouraging start with 14 hospitals under contract in our first three months since entering this business.

As the worldwide leader in hearing screening devices, we believe we are ideally positioned to develop this market. Our opportunity is to increase the approximately $10 a baby we received for our disposable hearing supply to $100 or more for actually performing the hearing screening test. While we do not expect revenue to be meaningful in 2014, as we start to market this service and develop this market. We believe that it will become a more meaningful and significant growth opportunity in 2015 and beyond.

In summary, we are very pleased with our first quarter performance and operating results. We look forward to the remainder of 2014 as we continue our strong earnings momentum in cash generation combined with consistent organic revenue growth. We remain committed to driving towards our long-term goal of 20% non-GAAP operating margins in the years ahead. Jonathan?

Jonathan A. Kennedy

Thank you, Jim. Today I’ll be discussing our financial results on a GAAP as well as a non-GAAP basis. Our non-GAAP results exclude amortization expense, restructurings and certain other charges and the related tax effects. 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.

We reported first quarter 2014 revenue of $85.6 million, compared to revenue of $85.8 million for the first quarter of 2013. Revenue from our Neurology market increased to $56.5 million or 66% of total revenue during the first quarter of 2014, compared to $55.7 million, or 65% of revenue, during the same quarter of last year.

Revenue from Newborn Care market was slightly down from the prior year's quarter to $29.1 million or 34% of revenue during the first quarter of 2014, compared to $30.1 million or 35% of total revenue during the same quarter of last year.

On a consolidated basis, revenue from devices and systems contributed approximately 60% of total revenue in the first quarter of 2014, compared to 61% in the 2013 period, while revenue from supplies and services was approximately 40% of total revenue in the first quarter of 2014 compared to 39% in the 2013 period.

Revenue from domestic sales was approximately 56% for the first quarter of 2014 and 2013.

Revenue from international sales is approximately 44% for the first quarter of 2014 and 2013. On a non-GAAP basis, our gross margin increased 120 basis points to 59.5% compared to 58.3% in the first quarter of 2013. Non-GAAP operating expenses were $3.8 million lower than the same quarter last year and our non-GAAP operating margin improved to 13.7% compared to 8.1% for the same quarter of last year.

And looking ahead to Q2, we expect non-GAAP operating expenses to approximately the same level as Q1 between $38 million and $39 million. Our first quarter non-GAAP effective tax rate was approximately 31% without the benefit of the R&D tax credit. We expect this rate to approximately 30% throughout the year, excluding the benefit of the R&D tax credit. On a GAAP basis, net income increased to $6.3 million or $0.19 per diluted share, a $2.8 million or $0.08 increase from the same quarter last year.

GAAP net income increased $3.7 million, compared to the same quarter last year to $8.3 million, and GAAP earnings per share increased 73% to $0.26. We recorded approximately $3.9 million of depreciation and amortization expense. Equity compensation was approximately $1.6 million during the first quarter.

Now, let’s look at the balance sheet and cash flow. Net cash increased $3.5 million, during the quarter. And our long-term debt was reduced by $5 million. Cash flow from operations was approximately $5.8 million. As Jim pointed out, our first quarter payments impacted first quarter cash flow. We ended the quarter in net cash position with $59.6 million in cash and $32.9 million in debt.

Our days of sales outstanding improved by 3 to 84 days, compared to the same period last year and which is expect to continue improving DSO throughout the year. And we expect the depreciation, amortization expense for Q2 will be about $3.2 million, including about $2 million of amortization expenses associated with the acquired intangibles.

We expect equity-based compensation expense to be about $1.7 million and we expect about $20 million of interest and other expense for the second quarter. We expect an average diluted share count of approximately 32 million shares for the second quarter.

With that I will turn the call back to Jim.

James B. Hawkins

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

For the second quarter of 2014, we expect revenue of $83 million to $86 million and non-GAAP earnings per share of $0.24 to $0.27. We are increasing our non-GAAP earnings per share guidance to $1.18 to $1.21, an increase from previous guidance of $1.14 to $1.18. Our full year 2014 revenue guidance remains unchanged at $345 million to $350 million.

In summary, we continue to execute on our business model and growing a world class franchise in both Neurology and Newborn Care. We are excited about our revenue growth opportunities and look forward to a rewarding 2014.

With that we will turn the call over to questions. Operator?

Question-and-Answer Session

Operator

All right. So it does look like you have a few questions. Your first question comes from the line of Larry Solow with CJS Securities. Please proceed.

Larry S. Solow – CJS Securities, Inc.

Hi, thanks. Good morning. It looks like your sales were pretty, well, flat across-the-board, domestic and internationally. Anything extraordinary? Any color you can provide there in terms of trends you saw during the quarter and perhaps where you might get growth going forward? If there is any sort of difference between the two that you are seeing.

James B. Hawkins

Yes, Larry, it was a solid quarter really across all fronts. Throughout the quarter, business tracked right to plan, all the way through. So we were very content with that. Going forward, we are very excited about some growth initiatives and growth opportunities we have as I discussed in the call. And I can tell you where I’m at and where the management team is at, at Natus right now is that we are looking to pursue this organic growth the way we’ve pursued our earnings over the last nine months. We’re going to still certainly focus on hitting those earnings numbers, but we are very focused and excited to really show the organic growth opportunities that we have been laying out internally here and to start really show and to really just build a world-class company with both consistent organic growth with great operating margins.

Larry S. Solow – CJS Securities, Inc.

Okay. It looks like for Q2, just doing the math, sort of low to mid-single-digit organic growth, 1% to 5% or so. Is that sort of a good target for the next few quarters? And maybe – not telling you to give us your projections for the next few years, but are you comfortable that that’s a target for the next few years, sort of low to mid single-digit organic growth?

James B. Hawkins

Yes, I’d say that’s right. I mean, we’re sort of talking ideally in the 2% to 4% range, all things being equal, the way the economy and worldwide economy is. We have opportunities to upsize that. We could. But it is – the overall environment out there is relatively flat. So even 2% to 4% organic growth with our earnings model, we think we can really leverage and create some great value and build our franchises.

Larry S. Solow – CJS Securities, Inc.

Okay, great. Thank you.

Operator

All right. So it looks like you have another question coming from the line of Chris Lewis with Roth Capital Partners. Please proceed.

Chris W. Lewis – ROTH Capital Partners LLC

Hey, guys. Thanks for taking the question.

James B. Hawkins

Sure.

Chris W. Lewis – ROTH Capital Partners LLC

First, I guess I just wanted to talk a bit on the revenue growth strategies you had touched on. First, you talked about the increasing focus on some of the underpenetrated and growing markets. Can you perhaps elaborate on what types of opportunities you see there and what specific markets you’ll be targeting?

James B. Hawkins

Chris, we don’t want to get into too much detail for competitive reasons. But one we have talked about, that we think we are ideally positioned in China. To leverage our strong position there we have very good market share. It continuous to be a rapidly growing market and we think we can continue to grow very fast there with more additional focus than we’ve had in the past.

Chris W. Lewis – ROTH Capital Partners LLC

Good. And then on the screening services side of the business for Newborn, maybe you can talk about the interest levels on a high level of what you are seeing in that market. I think you mentioned 14 hospitals are under contract now. So maybe how does that breakout from existing ALGO customers to potentially new customers? And how is that pipeline developing at this point versus your expectations?

James B. Hawkins

Yes, sure. Well, it’s probably more than 3000 Algo hospitals customers in the United States alone. We have 14 now that we have under contract to perform the Hearing Screening service. I would say our pipeline right now is dozens of hospitals that have expressed interest and this is all in a relatively short period. So we’re quite excited the ways that this is developing.

Chris W. Lewis – ROTH Capital Partners LLC

Okay. And then turning to the guidance for the year, you ticked that up for the full-year EPS guidance. You have talked about in the past your goals versus the guidance. So I was hoping maybe you could elaborate on how you feel you are tracking towards meeting those goals at this point so far this year. And kind of what areas does the Company need to execute on to reach those goals, to provide upside versus that guidance?

James B. Hawkins

I think from the business point of view overall we’re feel comfortable with how we’re progressing towards those goals and maybe I will let Jonathan elaborate on that a little bit.

Jonathan A. Kennedy

As we’ve talked about over the last several quarters, the company continues to integrate and streamline operation that’s a long slow process for medical device company as regulatory issues always come into play. But the opportunities for us continue to increase, operating margin continue to increase gross margin are still out there and of course, that will probably take us another year to 18 months to get to the finish line on that.

Chris W. Lewis – ROTH Capital Partners LLC

Okay. Then if I could sneak one more in. Maybe, Jim, you could just talk about what you are seeing in the macro environment, I guess hospital and capital spending environments. I think you have talked about stabilizing to maybe improving in some markets. So maybe just walk us through what you have seen so far this year that gives you confidence that you can hit that that revenue number this year. Thanks

James B. Hawkins

Sure, Chris. Yes. I think as I mentioned, it was a very stable and solid quarter for us. Certainly, April, although early is doing very well and following that same trend. And so, what we see and then also what you hear overall is that the economy and hospital spending in the United Sates is solid and we look to be able to grab market share and then participate in the growth opportunities around the world. So, yes, we feel very good about how we’re positioned.

Chris W. Lewis – ROTH Capital Partners LLC

Okay, congrats on the progress. Thanks.

James B. Hawkins

Great. Thanks, Chris.

Operator

All right, so it looks like your next question comes from the line of Brian Weinstein with William Blair. Please proceed.

Matt Larew – William Blair & Company

Hi, guys. Thanks for taking the question. This is Matt in for Brian today. I just wanted to follow up on Chris’s question quickly on the Screening as a Service business. Just wondering if there is anything you can do to sort of accelerate the pipeline, given the strong interest you have seen, whether that is an acquisition or anything else in that space. Just sort of additional color on progressing through that pipeline.

James B. Hawkins

Yes, sure Matt. We are looking for the right opportunities to get us into different geographical areas, if there was the right acquisition. So that is something that we would look at in Hearing Screening. As far as trying to ramp up the growth faster, it is a process because once you get hospital under contract, we’ve got to hire the screeners, we’ve got to get the whole process and procedures down integrated and with the hospital get the state reporting systems. So it is a little bit of a slow process, so that’s where being now guarded and cautious in its revenue ramp. In that we just want to get in front of expectations and let’s just keep it what a nice pace math. But we are very happy with the way things are going.

Matt Larew – William Blair & Company

Okay, thanks for that, Jim. And then this one is probably for Jonathan. It looks like you have sort of the most cash you've had on the balance sheet here in almost five years. And as Jim mentioned, there are no plans to do any substantial acquisitions. Just wonder if there are other plans for that cash, whether it is maybe more aggressively paying down debt, or anything else like that.

Jonathan A. Kennedy

True. I mean right now we said we’re intending to paydown debt. And that puts a little bit of earnings to bottom line not much interest rates fairly low on that. The other alternatives are companies past acquisitions, share buybacks and dividends. But other than that there is not much else to do with it. At this point, we think paying down the debt makes the most sense and there is other alternatives are something we continue to discuss but haven’t made any decisions on.

Matt Larew – William Blair & Company

Okay. Thanks, Jonathan. Then, Jim, just back to your comments, just the last couple quarters about organic growth returning here in the second quarter. We have seen some of the trajectory in Neurology, but just wondering what you are seeing on the Newborn side, whether it’s just the comps becoming easier or the new product pipeline you have talked about, that give you confidence that the Newborn business will sort of return to positive organic growth here in the near future. Thanks.

Jonathan A. Kennedy

Yes, sure Matt, I think we’ve seen stability in the birth rates and we are not forecasting any rapid growth there. But we do believe that from our new product pipeline, we will be starting to kick in. We have one and maybe even two products that will be introduced here by the end of the second quarter. That we think will add some real growth for us. And then coupled with that the newborn Hearing Screening opportunity that we looked at as part of Newborn Care certainly will be a growth driver.

Matt Larew – William Blair & Company

Okay, thanks a lot guys.

James B. Hawkins

Welcome.

Operator

All right, so it looks like your next question comes from the line of Jayson Bedford with Raymond James. Please proceed.

Jayson T. Bedford – Raymond James & Associates, Inc.

Good morning and thanks for taking the questions. I guess just to follow on the last one, the Screening as a Service, was the revenue contribution in the quarter meaningful at all?

James B. Hawkins

No it was minimal. I would say Jayson, I am not sure if we’ll give this metric going forward, we may. We haven’t talked about it yet, but just to give you an idea I think it was less than $200,000 in the first quarter. We started these programs, we got hospitals under contract, and then you start screening. So it was minimal, as I said, but certainly it should ramp up in Q2 and beyond.

Jayson T. Bedford – Raymond James & Associates, Inc.

Right, and I don't know if you're going to give this metric going forward, but you mentioned the number of hospitals under contract. What do you think that looks like, exiting the year?

James B. Hawkins

Well, we hate to set too much in expectations on that. I think what we have talked about this maybe revenues for the year, might total a couple of million dollars, something like that. And then certainly growing at a pretty good rate after that to be leading – certainly the year at a run rate, certainly above $2 million that is for sure. And but we are not really giving exact forecast at this time.

Jayson T. Bedford – Raymond James & Associates, Inc.

That is fair. Wanted to ask a little bit about your initiatives to drive more for faster disposable growth in Neuro. It did look like both Neuro and disposables were a little bit better relative growers for the business and I’m just wondering is that initiative – is it having an impact yet?

James B. Hawkins

Yes, I would say it’s starting to, Jayson, and just for everyone. This is an initiative where we’re really trying to focus on our supply business, our disposables in Neurology. It’s something that the sales force is focusing on. We’ve created a compensation plan to make it – to give them additional incentive to focus on disposables. The metric that we’re trying to improve upon is that we, let’s call it EEG and EMG, we might have 55%, 60% of the market share, but in our disposable business we might be at the 40% kind of level. So we have opportunity there to focus on getting our disposables up to the same market share we have in our hardware and that can be some meaningful number. So that certainly is an area of growth, but we hope to see improvement on throughout the year as well.

Jayson T. Bedford – Raymond James & Associates, Inc.

And you mentioned the three or you called out the three factors that will help drive growth. Which one do you think will have the biggest impact over the next year to 18 months?

James B. Hawkins

Well, that’s a tough one. Jayson, we really think all of them can bring some real growth opportunities. So over that 18-month period, once – hearing screening is off to a good start. The new products were just coming out. And so, it’s a little tough to call. I haven’t really thought of it in an 18-month period, but certainly over time we see them all contributing nicely.

Jonathan A. Kennedy

Yes, it is hard to tell because the hearing screening business is more of an annuity type of business. Once you get it, it kind of goes; but it will grow slower where the new products tend to be capital equipment, and so it’s a little more lumpy and it’s not as visible at the beginning as it is, say, for something like the hearing screening. But I think, as Jim said, we’ve got confidence in all three of these opportunities. But 18 months from now it’s hard to tell who would be at the back.

Jayson T. Bedford – Raymond James & Associates, Inc.

And just when we look at the revenue growth implied in your second quarter guidance, I imagine you’ll have a little bit of that Screening as a Service revenue, but the other two won’t really have a big impact in 2Q. Is that a fair assumption?

Jonathan A. Kennedy

I’d say that’s how we’ve guided, Jayson. That’s probably correct. We don’t want to get ahead of ourselves and our guidance and new products can be a little tricky when you introduce some, are you going to be able to get orders and ship in the same quarter. So, we’ve guided what we hope to be a conservative way.

Jayson T. Bedford – Raymond James & Associates, Inc.

Fair enough. I’ll jump back in queue. Thanks.

Operator

All right. So it looks like your next question comes from line of Larry Solow with CJS Securities. Please proceed.

Larry S. Solow – CJS Securities, Inc.

Great, thanks. Just a quick follow-up. On the new products, Jim, do you expect sort of a steady rollout of a couple, one, two products a quarter? Not an exact science there. Or are these products more a refresh or upgrades? I imagine various reasons why – but just from customer feedback, is it in new submarkets or are they sort of just replacing mostly existing stuff with just more bells and whistles?

James B. Hawkins

Yes, it’s a combination, Larry, of both. Some are new products that are in areas that we are not in now. And we don’t want to get into that for competitive reasons. But we have a Newborn Care products that is in Q2. We have a Neurology product. We’re very excited about in Q4. And then, we have some refresh products over the next 18 months as well. So it’s really a combination of both I would say.

Larry S. Solow – CJS Securities, Inc.

Okay. So it sounds like a nice mixture, and you have them planned out over the next several quarters

James B. Hawkins

That’s right.

Larry S. Solow – CJS Securities, Inc.

And just on a housekeeping question, maybe, Jonathan, just the bit of a step up in depreciation and the amortization from last several quarters' run rate to this quarter; is there anything noteworthy in that?

Jonathan A. Kennedy

No, we had a little bit of amortization on the acquired intangibles. Just we have changed some lives to accelerate some lives. We also acquired a couple of small businesses in the quarter that added to that.

Larry S. Solow – CJS Securities, Inc.

Got you. Okay, great. Thanks.

Operator

All right. So it looks like your next question comes from the lien of Ross Taylor with C.L. King & Associates. Please proceed.

Ross Taylor – C.L. King & Associates, Inc.

Hi, just had some fundamental questions related to the Hearing Screening business. Just wondered, how do hospitals typically perform the Hearing Screening now? Do they use their own employees or do they contract out to third parties? I guess where I am trying to go is, what would be some of the advantages for hospitals using your service? Is it because you can offer a better price, because you control both the service itself as well as the equipment and disposables? Or what advantages would you be able to offer?

James B. Hawkins

Yes, Ross. Right now the vast majority are using their own employees to do this test. There have been outside screening services that have been sort of doing this on a little regional basis, but the vast majority 85% or more, we think, are doing it themselves. The motivation is, the hospitals for the most part really don’t get reimbursed for this, and it’s an expense for them.

It’s a management issue. It’s not something that nurses really go to nursing school to do. And the test is one that, we can train a person can be trained to do this in a relatively short period of time. And it’s just something that we’re able to take off their hands and hospitals I think in general are looking to outsource more and more. And so, it just makes real sense.

Ross Taylor – C.L. King & Associates, Inc.

Okay. That’s very helpful. Thank you.

Operator

All right. It looks like there are no further questions at this time. (Operator Instructions)

James B. Hawkins

Okay. Well, if there are no further questions, I would like to say to conclude that we are very excited about 2014 and really beyond that for the future of Natus. I’d like to thank everyone for participating on today’s call. And your continued interest and support. Thank you very much.

Operator

All right, ladies and gentlemen that does concludes today’s conference. Thank you all for your participation. You may now disconnect and everyone have a great day.

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Natus Medical (BABY): Q1 EPS of $0.26 beats by $0.03. Revenue of $85.6M (-0.3% Y/Y) beats by $0.9M.