Natus Medical's (BABY) CEO Jim Hawkins on Q1 2016 Results - Earnings Call Transcript

| About: Natus Medical (BABY)

Natus Medical, Inc. (NASDAQ:BABY)

Q1 2016 Earnings Conference Call

April 20, 2016, 11:00 ET

Executives

Jim Hawkins - President & CEO

Jonathan Kennedy - SVP & CFO

Analysts

Brian Weinstein - William Blair

Chris Lewis - ROTH Capital Partners

Jayson Bedford - Raymond James

Operator

Welcome to the Natus Medical First Quarter 2016 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 call is being recorded today, April 20, 2016 and contains time sensitive information that is accurate only as of today.

Earlier today, Natus Medical released financial results for the first quarter 2016. If you have not received the news release or if you would like to be added to the company's distribution lists, 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 2016 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 2015. Natus reminds you that future results may differ materially from these forward-looking statements due to a number of risk factors. For 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 turn the call over to Jim Hawkins, President and Chief Executive Officer of Natus Medical. Please go ahead.

Jim Hawkins

Thank you, operator. Our first quarter results that we released earlier this morning reported revenue of $87.3 million, compared to $89.4 million last year. We also reported non-GAAP earnings per share of $0.34, compared to $0.31 in our first quarter last year. We repurchase $9.1 million of stock during the first quarter.

I'm very pleased with those of our record non-GAAP earnings per share and our non-GAAP gross profit margin that increased to 63.1% from 60.7% last year. Our improved non-GAAP gross profit margin was driven by favorable mix, continued operating efficiencies, and our ability to maintain pricing even with a strong dollar. It is our belief that our leading products, which hold number one positions in markets, should command premium pricing. By maintaining our pricing, we believe it is best for our brand and company in the long run.

I am also pleased that we generated $18.4 million of cash flow from operations during the quarter. As we previously announced, we reported a revenue shortfall to our guidance in the quarter. This was in both our Newborn and Neurodiagnostic product categories. We experienced a shortfall late in the quarter in both our international and domestic markets. No one business segment or geography stood out as having a significant shortfall, and we did not lose expected business to competition late in the quarter. This business was just pushed out to the future.

In the first quarter, we added two sales people to both, Peloton and NicView. As these businesses are relatively new, each only had one or two dedicated sales people, as we had initially focused on leveraging our Newborn salesforce to introduce the product and services to hospitals. As these businesses have grown rapidly, we believe it is now appropriate to invest in a direct sales force in both, Peloton and NicView. We expect to see the benefit of this investments starting in the second quarter.

In March, we expanded our GND services into seven new states with the acquisition of NeuroQuest, a provider of neurodiagnostic services. Our organic growth, combined with the acquisition, offers an exciting opportunity for Natus and our customers as we expand the service throughout the United States.

Regarding Venezuela, while the government remains in place -- or, I'm sorry -- while the agreement remains in place, they have not made the required prepayments. Given the uncertainty of the current economic situation there, we will no longer include revenue or earnings from the agreement in our guidance until there is more clarity on Venezuela's performance under the agreement.

As the market leader in our industry segments, we are well-positioned to continue to lead by developing innovative products that will drive organic growth. We have established a new product pipeline that we are very excited about. We have also created and entered numerous service business initiatives that are tied to our market-leading products, and have made doing business-as-a-service a key focus for Natus going forward. We believe the opportunity exists to provide our customers additional services rather than only selling them equipment and supplies.

For new investors that may not be familiar with our service initiatives, I would again like to briefly review Peloton, GND, NicView, and Coordination services. Peloton, which started in Q1 2014, offers newborn hearing screening tests 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. As the worldwide market leader in hearing screening devices, we believe we are ideally positioned to develop this market.

Our opportunity is to increase approximately $10 a baby we receive for our disposable hearing supply, to $90 for actually performing the hearing screening test. We expect Peloton revenue ramp to ramp throughout 2016 as we continue to market this service and develop this market.

NicView and Global Neuro-Diagnostics are two new business segments that Natus entered in the first quarter of 2015. NicView provides streaming video for families and babies in the Neonatal Intensive Care Unit, the NICU, that enables family members and approved friends to see the new baby 24/7 from anywhere in the world, from any device. NicView solves a long-standing need in the NICU and hospital nurseries.

We hope to make NicView a standard practice for NICUs and nurseries worldwide. I am pleased to report that NicView is now in 83 hospitals in the United States, and we plan to receive our first NicView order from outside the United States in the second quarter of 2016. We remain very excited about the growth opportunity for NicView.

GND provides a service that allows patients a more convenient way to complete routine EEG testing in the home, hospital, and physician's office. The service also provides comprehensive reporting and support to the physician. We look to expand GND throughout the United States from their current base throughout 2016. Peloton, NicView, and GD are rapidly growing new offerings to the marketplace that represent the beginning of an expanding service business, and positions Natus for accelerating revenue growth and record earnings in 2016.

Last July, we launched coverage of a new -- of our recently awarded five-year $32.5 million contract with the state of California to provide hearing screening coordination services. This new contract added approximately $24 million in revenue over and above the existing contract rate during the five-year contract. This contract commenced on July 1. We believe additional states and governments may consider an outsourcing model for hearing screening coordination in the future. Natus is well-positioned to benefit if this trend plays out as we anticipate.

In summary, while disappointed with our revenue shortfall, we are very pleased with our operating results. We look to continue our strong earnings momentum and cash generation, combined with revenue growth in 2016. We remain committed to driving towards our 2016 goal of 20% non-GAAP operating margin. Jonathan?

Jonathan 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, 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 a reconciliation of our earnings on a GAAP versus non-GAAP basis in today's press release.

As Jim said, we reported revenue for the first quarter of $87.3 million, a 2.3% decrease from the same period last year. But on a consolidated basis, our North American business grew by 2% compared to last quarter -- the same quarter last year, driven by the growth in our service businesses. Our international business did decline about 10% which was driven by lower device sales across both business segments.

Revenue from our neurology market increased slightly to $56.7 million or 65% of total revenue during the first quarter of 2016 compared to $56.3 million and 63% of total revenue during the same quarter of last year. Revenue from our Newborn care market decreased to $30.6 million or 35% of total revenue during the first quarter of 2016 compared to $33.1 million or 37% of total revenue during the same quarter last year.

On a consolidated basis, revenue from devices and systems contributed approximately 55% of total revenue in the first quarter of 2016 compared to 59% in the 2015 period, while revenue from supplies and services was about 45% of total revenue in the first quarter 2016 compared to 41% in the 2015 period. Revenue from domestic sales was approximately 65% for the first quarter compared to 61% in the same period in 2015. And revenue from international sales was about 35% for the first quarter 2016 compared to 39% for the same period in 2015.

On a non-GAAP basis, our gross margin increased by 240 basis points in the first quarter of 2016 to 63.1% compared to 60.7% in the first quarter of 2015. This outstanding increase in non-GAAP gross margin was due to a combination of more favorable geographical sales mix and lower overall manufacturing costs.

Our non-GAAP operating expenses increased by $1.7 million compared to the same quarter last year. The increase was driven primarily by ongoing increased R&D efforts to improve the engineering quality systems in our Seattle facility and higher G&A costs related to a one-time non-cash equity compensation adjustment. Our non-GAAP operating margin decreased to 16.3% compared to 16.9% for the same period last year.

Our first quarter non-GAAP effective tax rate was about 24.3%. This lower rate primarily reflects the benefit of the implementation of a more efficient operating structure, the permanent reinstatement of the R&D tax credit, and certain discrete benefits taken in the first quarter. But looking ahead, we expect our overall 2016 tax rate to be between 26% and 27%.

Non-GAAP other income increased by $1.3 million in the first quarter compared to the same period last year. And on a GAAP basis, net income was flat at $8.5 million or $0.26 per diluted share, a $0.1 million reduction from the same period last year. However, non-GAAP net income increased by $0.9 million or 8% compared to the same quarter last year, and non-GAAP EPS increased 9.7% to $0.34.

In the first quarter, we recorded approximately $4.2 million of depreciation and amortization. Our share-based compensation was about $2.9 million during the first quarter.

Now let's look at the balance sheet and cash flow statement. As Jim pointed out, we repurchased about $9.1 million of company stock and paid $4.7 million for acquisitions during the quarter, and our net cash decreased about $1.2 million. Our cash flow from operations was $18.4 million during the quarter. And our DSO increased 1.6 days during the quarter to 92.8 days. Our diluted shares outstanding increased very slightly to 33.2 million compared to 33.1 million shares during the first quarter.

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

Jim 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 2016, all on a non-GAAP basis. For the second quarter of 2016, we expect revenue of $92 million to $93 million and non-GAAP earnings per share of $0.35 to $0.36. This compares to revenue of $91.9 million and non-GAAP earnings per share of $0.34 in the second quarter last year.

For the full year 2016 non-GAAP, we expect revenue of $378 million to $382 million, and non-GAAP earnings per share guidance of $1.61 to $1.65. The guidance -- this guidance excludes revenue from the Venezuela contract of approximately $60 million for the full year 2016.

We will now turn the call over to questions. Operator?

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] Our first question comes from the line of Brian Weinstein from William Blair.

Brian Weinstein

Hey, guys, thanks for taking the question. So I just wanted to dig into the shortfall in the quarter there. It looks like OUS and Newborn care were particularly impacted. Can you just give some commentary around the dynamics in those -- in that geography, and then also in that segment, that might help us understand kind of what's going on there?

Jim Hawkins

Yes, Brian. It -- you know, it was actually, as we said, a little bit everywhere -- international, you know, in both sides of the business, where is we saw the shortfall, and domestically as well. We had our service businesses such as Peloton, continued to do well. And it was just a little short everywhere -- certainly international, we -- across all international markets, I would say we saw softness; orders that didn't come in that we had expected to. And the first quarter is always a little tough, the combination of -- you know, you can -- you never know how many orders get pulled into Q4 which is always our strongest. And then with the beginning of the new year and our worldwide sales meetings, the sales force really doesn't get out there until -- like January 20th, 22nd, to really go out and start selling. And so we always get a little bit of a slow start in the quarter and it's our -- it's always the hardest to predict. It usually ramps up, as we've seen over the last few years, nicely, and it was going well, and then at the end of the quarter, it just softens. Didn't pull in the orders we had expected.

Brian Weinstein

And you said that you're confident that there were order delays that kind of took place. So if you're confident in sort of that coming back then I'm curious about taking down the guidance by $7 million to $8 million for the full year. Just trying to reconcile those two kind of statements.

Jim Hawkins

Yes, I know. Good question and point, Brian. And we did a lot of -- had a lot of internal discussions about that as well. I think when you've missed the way we did, I think we are in a position that we'd rather be on the conservative side. We are certainly hopeful that we are going to get this business back and really move forward and hit numbers as we go through the year. But we also have to look in the mirror and say, hey, it didn't happen in Q1, let's not lead out there with what we think, we need to be conservative and so that's our approach.

Brian Weinstein

Great. And then my last question is, can you comment on the backlog right now and where it stands? And how you guys actually use your backlog kind of throughout the quarter, as you think about smoothing out the revenue cycle? That's it for me. Thanks.

Jim Hawkins

Jonathan, do you want to take that, Jonathan?

Jonathan Kennedy

Yes, sure. So, hey, Brian. Backlog was actually up slightly for the -- during the quarter. So we used a little bit of backlog in our Newborn care business. Now, a couple of hundred thousand but our Neuro backlog was actually up over that. And so I mean Q1 was -- on our net basis was not a net use of backlog.

Jim Hawkins

Operator, are there any additional questions?

Operator

Yes. Our next question comes from the line of Chris Lewis from ROTH Capital Partners.

Chris Lewis

Hey guys, good morning. Thanks for taking the questions. Jim, I also kind of wanted to do start out on the revenue shortfall in the quarter. You kind of talked about this dynamic of some of those orders late into the quarter last couple of weeks getting pushed out. I know it's only been three weeks but I'm wondering if you could provide any commentary around if you've seen any of those orders start to come through so far this quarter or what else gives you confidence that those orders are pushed out rather than lost?

Jim Hawkins

Sure. Well, maybe on the first part of your question, and that answer is yes. We have seen some of those orders already come in this quarter. So we're happy about that. Certainly is why we think they are not lost -- well, one, we know they are not lost to competition because that's very factual there. And it always -- then it gets tricky. How much are they delayed? And we haven't had any situation where hospitals have said they are not going to buy. It's -- many factors come into that from -- at the end of the quarter, not to get too much in the rubbish, but we had situations -- with Easter being at the end, people were taking holidays; people weren't there to get PO's signed from that side of things.

And then also doctors at the last minute saying, well, maybe we want a different product mix. And -- because these doctors really don't care whether they get the product in March or April or even May, for that matter. Because a lot of this is replacement business, and they just want to make sure they are getting the exact product mix that they want. So, all that considered, it's always hard to tell the exact timing of when they're going to come back, but we are confident we're going to get the business.

Chris Lewis

And on Peloton, I was wondering if you could provide the number of hospitals you added during the quarter? And how many are you targeting to be in by the end of this year?

Jim Hawkins

Yes. So, the addition of new Peloton hospitals was lower than we had anticipated. I think it was one or two, is all we received. And that's after, I think, getting 17 or 19 in the December quarter. So, I think looking there, some of those got pulled in to Q4 for whatever reason. And then also, just another little effect, all those hospitals that we signed in Q4, we had expected to start in January, well, a lot of them didn't start until March. And that made certainly for a little bit of a revenue -- contributed to our shortfall a little bit. And that's just beyond our control in those situations. But now they are all up and running.

We have a very strong pipeline for Peloton. We've hired two new salespeople, as I said, in Peloton. And we've never had a stronger pipeline than we have right now, and certainly look to get double-digit sign-ups in Q2.

Jonathan Kennedy

Yes, the sign-up in that business is lumpy. I remember last year, like Jim said, we did 17 in Q4; I think we did 3 in Q3, but we did like 15 in Q2. So it's sort of an up-and-down on an annual basis. Next year we look to add, what, 50, 60 hospitals to the pipeline. So I would look for Q2 and Q3, Q4 to be the stronger quarters. It is lumpy.

Chris Lewis

Understand. And then another pretty strong quarter here in terms of the product gross margin. Just perhaps you can elaborate on where the strength came from during the quarter? And how we should expect gross margins to trend going forward? Thanks.

Jim Hawkins

Yes, Chris. You know, on the gross margin side, as you know, it's something that we've been focusing on for a few years now, and for this constant improvement. So, we -- it's a combination, I would say, of -- we are looking to take cost out of the products, out of the business. Product mix is -- with having less international as a percentage that certainly helps. And then also on pricing, we are just very strong. We haven't lowered our list prices. Many companies will do that internationally with the strong dollar. And we just have not done that. In fact, we've raised prices over the last couple of years.

So that contributes to a stronger gross margin. And we think that's very important, not only for the business, but our shareholders and the value of the company. And we look to continue to improve our gross margin for years to come. And Jonathan, anything to add?

Jonathan Kennedy

Yes, I mean for the things that we can control, which is our own internal stuff, we've done quite a decent job over the last two or three years of lowering our manufacturing costs, setting up a business such that the weaker areas have lower gross margins. So that's been a benefit to us. There's still -- the other thing I'd point out, there's still more to go. I mean, the company continues to work its materials costs down. We continue to get more efficient. If you recall, last year, late in the year in August, we finally completed our Oracle implementation and that has been a big benefit to the company. And I expect over the next year or so, we will get more leverage over a single ERP system.

So, again, the stuff that we can control, we are hard at work. For the things that -- you know, customers that we can't control, we had a little bit of a pothole here for Q1, but overall, we are pretty positive about our ability to hit the operating margins and the gross margins that we've laid out late last year.

Chris Lewis

All right, thank you.

Operator

[Operator Instructions] Our next question comes from the line of Jayson Bedford, Raymond James.

Jayson Bedford

Good morning and thanks for taking the questions, guys. Just to follow on the last question, Jonathan, what's your expectation for gross margin for all of 2016?

Jonathan Kennedy

I think we should be a couple points -- maybe 1 to 2 points higher than we were last year, that put us in the $62 million, $63 million range for non-GAAP gross margin for the year.

Jayson Bedford

Okay. And you highlighted that the service revenue streams -- I'm wondering if you would give us the amount of revenue generated by those streams? Meaning if you want, you can give it more detail, but just Peloton, NicView, GND, just wondering service as a percent of total revenue here in the first quarter?

Jim Hawkins

You know, Jayson, we don't break it down quarter-by-quarter by each segment. Maybe just in general, though, as a total -- I'm just doing it mentally here -- let's see, probably around -- was it about $7 million or $8 million, I guess, in the quarter, something like that, I think? Yes, it's probably -- yes, it's probably around $8 million, something like that. I guess if you count the hearing coordination services in there, maybe you are getting up to about $10 million, which we probably should. I mean, that is a service business. So it was probably in that $10 million range. So, what is that? Over 10% of our revenues.

Jayson Bedford

Yes. Okay. That's helpful, Jim. And are you starting -- on GND, are you starting to see traction in states outside of Texas? From my recollection, a lot of the revenue was generated in that state. Just wondering if you've been able to expand from a revenue generation standpoint outside of Texas?

Jim Hawkins

Yes, for -- this is for GND?

Jayson Bedford

Yes.

Jonathan Kennedy

Yes. We definitely -- if you remember, we -- last -- about a month ago, we bought another business that was operated in Wisconsin area, the Midwest area. GND has expanded beyond Texas. We are in some of the southeastern states. And so, absolutely, Jayson, we've built out some other markets.

From a revenue-wise, the Texas area probably remains the bulk of the business. But with the acquisition of NeuroQuest, that will put about $2.5 million or so annually in that bucket, so that's going to be 20% outside of Texas. But I think --

Jim Hawkins

Yes. I think overall now, I mean, if you look at -- again at GND, I think we are looking at around $15 million in revenue, and maybe half that is Texas. Something like that. If you look going forward now. So we are certainly expanding outside of our base.

Jayson Bedford

Okay, that's hopeful. Jonathan, the interest and other income was a little higher in the quarter than I expected. Was there something kind of one time-ish there?

Jonathan Kennedy

Well, it was higher over last year. Last year, we had a correction of a prior-period error in other income was immaterial, and so we had a big credit last year. This year, other income -- this quarter, other income would have been a combination of bank fees and FX -- yes. So the FX does play a little role there. That moves around and we get a little FX in there.

It's hard to predict with the FX piece of it. We don't have any outstanding debt, and so the only thing we pay the bank really is bank fees -- and bank fees.

Jayson Bedford

Okay. And then just last one for me. On capital deployment, you've been a little bit more active on the M&A front. Is this what we should expect for 2016? These smaller tuck-in deals, more service oriented? Or would you start to look at something a little bit bigger?

Jim Hawkins

Yes, Jayson. I think our plan for this year is to really do more of the bolt-on/tuck-in type acquisitions. And that's what we are looking to do. I would say acquisitions of less than $15 million or $20 million in revenue, we'll certainly -- we'll be willing and are looking at some of those.

And, as you know, if we do an acquisition, it's always immediately accretive. And, historically, we've always hit our mantra of paying about half the revenue of what we are trading at, so we don't get out over our skis and overpay on acquisitions. So, with that, it is a big part of Natus as we -- as it has been in the past, and it will continue to be as we move forward. But it will be accretive and I would say on the smaller side, unless something really falls in our lap.

Jayson Bedford

Okay. Thanks, guys.

Operator

Thank you and we have a follow-up from Chris Lewis, from ROTH Capital Partners.

Chris Lewis

Hey guys, just one follow-up, in terms of cash flow, pretty nice quarter of cash from ops. Just based on the revised guidance, care to provide any commentary around what your expectations are for cash generation from operations and free cash flow for the year? Thanks.

Jonathan Kennedy

Yes, I mean, I think we had a really good quarter for cash flow. We pulled down our receivables as revenue came down. We still have a lot of work to do on receivables and expect to make progress throughout the year there. It's been kind of an ongoing challenge and story for us to do that. We've done -- we've made some changes to help with that. I think that will help bring in cash flow. But on an annual basis, if we did $18 million -- $15 million to $18 million per quarter that would put us somewhere in the $70 million range for the year for cash flow from operations.

And our free cash flow basis, we had a pretty heavy quarter for CapEx. That's kind of unusual for us to spend almost $2 million in CapEx. We bought some equipment in Ireland that was about half that. So, I would think for the rest of the year, we'd probably remain at about another $2 million or so of CapEx. So, from a free cash flow basis, we'd be about $70 million from ops and maybe $4 million or $5 million from that. So, you'd be about $65 million for free cash flow for the year.

Chris Lewis

All right. Great, thanks.

Operator

Thank you. And that concludes our question-and-answer session for today. I would like to turn the conference back over to Natus for any additional comments.

Jim Hawkins

Yes. Well, thanks, everyone, for participating. I'm certainly very pleased with how the Company is positioned, how you look at our -- the way we are operating, from a gross margin percentage down to our operating margin percentage, to how we are continuing to drive to our goal of 20% operating profit margin.

We feel very good about attaining these goals. We get the revenue back on track, which we are really hopeful of, I think it's going to be a very good year for Natus, as we go through 2016, in both earnings and cash generation. So very excited about that.

Again, thank everyone for participating on the call, and look forward to our next call in three months.

Operator

Thank you. Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program and you may now disconnect. Everyone, have a good day.

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