Natus Medical's (BABY) CEO Jim Hawkins on Q4 2015 Results - Earnings Call Transcript

| About: Natus Medical (BABY)
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Natus Medical, Inc. (NASDAQ:BABY) Q4 2015 Earnings Conference Call January 27, 2016 11:00 AM ET

Executives

Jim Hawkins - President & CEO

Jonathan Kennedy - SVP & CFO

Analysts

Brian Weinstein - William Blair & Company

Chris Lewis - ROTH Capital Partners

Jayson Bedford - Raymond James & Associates

Larry Haimovitch - Haimovitch Medical Technology Consultants

Operator

Welcome to the Natus Medical Fourth Quarter 2015 Financial Results Conference Call. [Operator Instructions]. Earlier today, Natus Medical released financial results for the fourth quarter 2015. 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 2015 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 remind you that 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 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?

Jim Hawkins

Thank you, Andrew. Our fourth quarter results that we released earlier this morning reported revenue of $100 million, compared to $94 million last year. We also reported non-GAAP earnings of $0.51, compared to $0.40 in our fourth quarter last year. We repurchase $2.2 million of stock during the fourth quarter.

I'm very pleased actually, with these results, as we posted record revenues even with a $1.2 million negative currency effect and our gross margin increased to 63.9%. In the quarter, we achieved a non-GAAP operating margin of 20.3%. As previously announced, the guidance we provided in October 2015 included expected revenue of approximately $4 million under the new $232 million Venezuela Ministry of Health contract to supply neonatal and obstetric equipment. We did not ship product on the anticipated schedule because the prepayment under the contract was delayed.

For the full year, our non-GAAP operating margin was 19%. Both of these outstanding operating profit margin results, along with being very satisfying, also confirms our belief that Natus can become a business that can have an operating profit margin at much higher levels in the future.

We had established in 18% operating profit margin goal in 2015 which we exceeded, as well as a 20% operating profit margin goal for 2016. We believe we're now well positioned to achieve a 20% operating margin in 2016. We have come a long way from the 8% operating profit margin we had in 2012.

Our improved gross profit margin has been driven by solid organic revenue growth, achieved through new products and new markets and by leveraging our market-leading products in both newborn care and neurology. Our increased operating leverage and efficiencies are a result of integrating our past acquisitions, our entry into new service initiatives, along with excellent execution of our operating plan by all at Natus.

In our fourth quarter, both our Newborn Care and Neurodiagnostic business segments performed well. Our domestic Newborn Care business and our Neurodiagnostic business segments were exceptionally strong in the United States, as our domestic sales organizations had another outstanding quarter.

As many companies are reporting, business outside the United States continues to be challenging, although I'm pleased to report our Newborn Care business outside the United States had a solid quarter. The fact that we were able to overcome the negative effects of the strong dollar and economic weakness in several countries makes our results very satisfying.

As we have communicated, reestablishing consistent organic revenue was a major goal for Natus last year. I'm extremely pleased to report that we continue to achieve this goal. For the last many years our focus has been to build a leadership position in both Newborn Care and Neurodiagnostic products. We have successfully achieved this through an accretive acquisition strategy. Now, as the market leader, we're positioned to lead our industry segments by developing innovative products and services that will drive organic growth.

We have established a new product pipeline that we're 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.

We also plan to introduce new innovative products over the next 18 months in both Newborn Care and Neurology. Our new service business initiatives, GND, Peloton and NicView, again all reported record revenues in the quarter and all had record years. For new investors that may not be familiar with our service initiatives, I would like to briefly review Peloton, GND, NicView and hearing screening 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 a worldwide leader in hearing screening devices, we believe we're ideally positioned to develop this market. Our opportunity is to increase the approximately $10 a baby we receive for our disposable hearing supply to $90 for actually performing the hearing screening test.

We expect Peloton revenue to ramp throughout 2016 as we continue to market this service and develop this market. We currently have 90 hospitals under contract for Peloton. NicView and Global Neurodiagnostics, GND, are two new business segments at that Natus entered in our first quarter of 2015. NicView provides streaming video for families with babies in the neonatal intensive care unit, 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'm pleased to report NicView is now in 80 hospitals in the United States and we plan to receive our first NicView order from outside the United States in the first half 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 or 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 GND our 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.

I'm also pleased to report that we launched coverage 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 run 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, we're very pleased with our fourth quarter performance and operating results as well as our full-year 2015. We look to continue our strong earnings momentum and cash generation, combined with consistent revenue growth, throughout 2016. We remain committed to driving towards our 2016 goal of a 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 stated, we reported fourth quarter 2015 revenue of $100 million, a 6.3% increase from the same period last year. Revenue for the full year increased 5.6% to $375.9 million versus the prior year. The euro and Canadian dollar exchange trends negatively impacted revenue by approximately $1.2 million during the fourth quarter compared to the same quarter last year and approximately $5.7 million for the full year 2015 compared to the prior year. This currency impact primarily affected revenue in our Neurology business.

Revenue from our Neurology market increased to $63 million or 63% of total revenue during the fourth quarter of 2015, compared to $61.7 million and 66% of total revenue during the same quarter last year. Revenue from our Newborn Care market increased to $37 million or 37% of total revenue during the fourth quarter of 2015, compared to $32.3 million or 34% of total revenue during the same quarter last year.

On a consolidated basis, revenue from devices and systems contributed approximately 60% of total revenue in the fourth quarter of 2015, compared to 64% in the 2014 period, while revenue from supplies and services was approximately 40% of total revenue in the fourth quarter 2015, compared to 36% in the 2014 period. Revenue from domestic sales was approximately 64% for the fourth quarter of 2015 compared to 62% in the same period of 2014. Revenue from international sales was approximately 36% for the fourth quarter of 2015 compared to 38% for the same period in 2014.

On a non-GAAP basis, our gross margin increased by 150 basis points in the fourth quarter to 63.9%, compared to 62.4% in the fourth quarter of 2014. Non-GAAP operating expenses increased by $1.9 million, compared to the same quarter last year. The increase was driven primarily by increased R&D efforts to improve the engineering quality systems in our Seattle facility. Our non-GAAP operating margin increased to 20.3%, compared to 19% for the same quarter last year.

Our fourth quarter non-GAAP effective tax rate was approximately 17.4%. This lower rate primarily reflects the benefit of the implementation of a more efficient operating structure and a permanent reinstatement of the R&D tax credit. The R&D tax credit contributed approximately $520,000 or just less than 1% of the rate reduction.

Our January 11 guidance for 2016 implies a tax rate of approximately 30%. This rate will likely be on the conservative side, as it did not contemplate all of the benefits of our new operating structure nor the permanent reinstatement of the R&D tax credit. However, as we see continued profitability growth from our U.S. service businesses, it is likely that we will continue to have a consolidated tax rate just under 30% during 2016.

Non-GAAP other income decreased $350,000 in the fourth quarter compared to the same quarter last year. On a GAAP basis, net income decreased to $8.5 million or $0.26 per diluted share, a $1.9 million decrease from the same quarter last year. The decrease in GAAP net income was driven by a $5 million recall accrual and an increase in the rate of intangible amortization. However, non-GAAP net income increased $3.9 million or 30% compared to the same quarter last year and non-GAAP earnings per share increased 29% to $0.51.

In the fourth quarter, we recorded approximately $4.4 million of depreciation and amortization expense. Equity-based compensation was approximately $1.5 million during the quarter. Now let's look at the balance sheet. We repurchased $2.2 million of Company stock and had an acquisition of about $4.7 million. Net cash increased $7.1 million excluding the stock purchases and acquisitions. Our days sales outstanding increased 4.7 days during the quarter to 91.2 days. The increase in DSO was driven by a high shipment rate very late in the quarter. Our diluted shares outstanding increased to 33.1 million shares compared to 32.9 million shares in the fourth quarter of the prior year.

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 and make a few closing comments. As we previously guided on January 11, 2016, we expect revenue of $96.5 million to $97.5 million for the first quarter of 2016 and non-GAAP earnings per share of $0.34 to $0.35. The first quarter revenue guidance includes approximately $5 million from the Venezuela contract. This compares to revenue of $89.4 million and non-GAAP earnings per share of $0.31 in the fourth quarter last year.

For the full year, we expect revenue of $445 million to $450 million and non-GAAP earnings per share of $1.84 to $1.88. Full-year revenue guidance includes approximately $60 million from the Venezuela contract. As I reflect on what we have built in Neurology and Newborn Care at Natus, it is most satisfying. Through a combination of acquisitions organic growth and new product development we have created the number-one neurodiagnostic company in the world.

With our world-class sales organization we continue to grow and gain market share in the United States and markets around the world. Now with an exciting new product pipeline along with GND, our opportunities are better than ever to grow our businesses and expand the entire Neurodiagnostic market.

Our Newborn Care business continues to perform well, leveraging our leading Newborn Care products and our salesforce with our rapidly growing Peloton Hearing Screening Service business, combined with the recent addition of the fast-growing NicView and now the large order from Venezuela uniquely positions Natus for an exciting future.

With that, I'll turn the call over to questions. Andrew?

Question-and-Answer Session

Operator

[Operator Instructions]. Our first question comes from the line of Brian Weinstein from William Blair. Your line is open.

Brian Weinstein

You broke out the revenue contribution from Venezuela. Can you break out the expected earnings impact from that and what you expect the gross and operating margin from that business to be? Just so that we're clear on the base versus the incremental here.

Jim Hawkins

Yes, sure, Brian. I think what we've been communicating is for Venezuela we're saying it should be in the operating margins, the same as Natus. So in that 18% going to 20% range is probably a good way to look at that for profitability on a pretax basis.

Brian Weinstein

Any idea on the gross margin there? I'm just trying to calibrate the model for incremental operating expense versus cost of goods sold.

Jim Hawkins

Boy, what we're going to do and maybe I'll let Jonathan explain, is try to break out Venezuela going forward on a gross margin basis. But Jonathan?

Jonathan Kennedy

Yes, we haven't given any guidance on the gross margin piece of it. Quite frankly, until we really start getting up and going on it, it's going to be difficult to how much of it's gross margin and how much of it's going to be just pure operating margin. The operating piece we can pretty much predict. If I had a gun to my head and had to predict, it's probably in the mid-40%s for a gross profit margin and Jim said just under 20% for the operating.

And a tax rate on that is somewhere in the probably 30% range as well. Maybe we can do better than that depending on what type of structure we ultimately get with the taxes. But in terms of reporting that, Brian, when that occurs, we'll break those pieces out down to the operating income level. It's going to be almost impossible to break it down to an earnings-per-share contribution. We'll give an estimate. But it's just not that easy to do with taxes, because taxes are a global all-in tax basis, so they are all intermingled. But we'll definitely break it down to the operating income level.

Jonathan Kennedy

You'll see it as a separate business more or less, at least down to operating income.

Brian Weinstein

As you're looking at the business in 2016, how are you thinking about the business outside of the U.S. in the core? You talked about ongoing weakness in some countries there. What are you assuming for growth rates outside of the United States in 2016? Are there particular countries that we should be focusing on?

Jim Hawkins

Yes, so Brian, and we'll talk our guidance. As you know, we have our internal goals and our guidance. On a guidance basis, we do see growth internationally. Having that headwind last year of that big currency situation with the euro -- I think, boy, it was maybe 15% or 20% differential for the year, when you look at how the euro changed. This year right now on average I think it's like 3% of 4%, so it's not nearly the headwind.

Without giving a long-winded answer, I think we're -- in our guidance we have maybe 1% to 1.5% international growth and we're probably in the 4% domestic growth, something like that, to get us to this roughly 3% organic growth.

Brian Weinstein

And then last one for me is on operating expense. You guys have done a nice job leveraging that. Is there room for further reductions there? Should we expect that? We saw R&D tick up a little bit. I think you reference some reengineering or something in Seattle. Can you just give some additional commentary on how we should think about operating expense and the opportunity for leverage there in the model in 2016 and beyond? Thanks.

Jonathan Kennedy

Sure, it's Jonathan. From the OpEx side, I would say that we're in pretty good shape in terms of operating expenses. For the next year I would think R&D stays at a little bit of an elevated level, as we work on remediating some of the Warning Letter issues we had in Seattle. That's going to be somewhat of a drag on operating expenses.

Beyond 2016 there probably is an opportunity to bring R&D down to a little bit less level to where it is. But the operating expenses you see today are pretty much where I would expect them to be throughout the year. So, no, I don't think there is an opportunity in 2016 to do much on the OpEx side. On the cost of goods side, we continue to work on material costs, continue to work on efficiencies in various locations. So on that side I think there is opportunity, but on the OpEx side, I think we're where we will stay for the next year.

Operator

Our next question comes from the line of Chris Lewis from ROTH Capital Partners. Your line is open.

Chris Lewis

I wanted to start on Venezuela. Just was hoping you could provide any additional color or commentary around the contract delay, the reasons for that. I guess the biggest question we've been receiving is, what gives you confidence that that contract will begin this quarter? Thanks.

Jim Hawkins

Sure, Chris. Well, there are a lot of factors. I think we put them in the January 11 press release about all the factors going on in both Argentina and Venezuela regarding elections that changed both governments in a material way. Heads of Ministry of Health and in Argentina certainly banking heads, the Head of the Treasury, all these positions changed, I think along with the Christmas holidays and the devaluation that Argentina also did in December, from when we announced guidance in October it changed that outlook.

As we sit now, we're certainly very confident that this business will happen. Trying to predict the exact day or week or even month of when those prepayments will be released with all these changes does make it a little more difficult. But the funding is there. It's really set aside where we believe it is going to happen. So now it's just a waiting game and yes, we're ready to execute when it arrives.

Chris Lewis

Understood. So if my math is correct, based on some of the assumptions you've given around the margins for that Venezuelan business, is it safe to assume guidance implies about $0.20 in earnings from Venezuela this year?

Jim Hawkins

Yes, I think that's the number, Jonathan, that we've put in our guidance. That's right. So if you back that out, you could see what our base business guidance is.

Chris Lewis

And then in the past you've provided some directional goals versus relative to the guidance, I guess. You talked about 20% operating margins. Any more commentary around the goals this year both on the top and bottom line versus the guidance you've provided?

Jim Hawkins

Yes, I think, Chris -- well, maybe one way to look at it -- just to give everybody a sense. We give our guidance in earnings to the numbers that we really expect to hit. I think if you go back over the last two years, I don't think we've missed any earnings, and typically we're at the high end or beat. If you go back to the beginning of last year I think we guided -- we started the year at about $1.38 to $1.51 and here we came in at $1.53, was it? $1.55? $1.55.

Certainly that was -- things really went well during the year. But we plan certainly internally to hit that 20% operating profit. We look to grow, hopefully, faster than we've guided and also earnings. So we set high internal goals for ourselves that we all strive for. But we're going to guide based upon a lot of other conditions that are going on in the world that could be a headwind. As it worked out last year, even with the currency situation we were still able to nicely beat our guidance.

Chris Lewis

Good. And then just one more for me, Peloton, you're in 90 hospitals now. Do you care to provide any type of goal for new hospital additions in 2016? And what type of margins is that business running at today? Thanks.

Jim Hawkins

Yes. With Peloton, we have hired two new salespeople and we're really looking for 2016 to be a big expansion year. In 2015 I think we communicated throughout the year we wanted to get that business solidly profitable which it is, it's contributing very nicely now. For next year, we have hopes of getting 60 or more new hospitals next year for Peloton. What's really nice for Peloton and NicView and GND, all these new service businesses have better gross margins and we believe are certainly going to get to better operating profit margins than our existing businesses. So it's a nice tailwind and we're very motivated to invest and grow in those businesses.

Operator

Our next question comes from the line of Jayson Bedford from Raymond James. Your line is open.

Jayson Bedford

Just a few quick ones here, the gross margin in the fourth quarter was pretty strong. Can you just give us a little flavor as to where the strength came from? Then from a gross margin standpoint, what is your expectation for 2016?

Jonathan Kennedy

Sure. Gross margin in the fourth quarter was good. We had a pretty favorable mix. We also have some of the service businesses that are actually kicking in quite a bit, with the GND and the hearing screening coordination services. That's got a really nice high margin on it, so that will help drive it up quite a bit. Gross margins going into 2016, I would expect them to be in that 62% to 63% range for the year.

Jayson Bedford

Okay. The strategy with GND, can you just talk about -- is the business still largely confined to Texas right now? Then what's the plan in terms of rolling out the platform to new states?

Jim Hawkins

Yes, Jayson, well if we go to last year -- and these are approximate numbers -- I think we did roughly, let's say $8.5 million in GND and probably I would guess $6.5 million to $7 million was in Texas of that revenue. If we go out to next year, we have already now in Q4 expanded into many other states and we look for big growth in GND next year. We've actually now planted the flag in 14 states and we'll be expanding into probably as we go through the year another five to eight states that will get us into approximately half the states by the end of the year. We're very excited about that opportunity. We're looking for rapid growth.

We think that in all of these service businesses we have the opportunity -- it's not in our guidance, but if things really come together, all these service businesses could make a run at doubling next year. So there's a lot of momentum there.

Jayson Bedford

Okay. My last question is just on the balance sheet. I guess first, what is your free cash flow expectation for 2016? Then I guess a little bit more broadly, Jim or Jonathan, capital allocation, how do you balance buybacks versus tuck-in type deals in 2016?

Jonathan Kennedy

Okay, sure. On cash flow, based on guidance we gave for 2016 we would expect cash flow to be in the $85 million range. In terms of capital allocation for Natus, it's acquisitions, we've got a share buyback program going. We're doing $20 million a year is the clip we're at right now, so I would expect that to be similar to what we do next year. What was the last follow-on, Jayson?

Jayson Bedford

You know, that was it. But I think I could probably do the math, but what's left on the current buyback?

Jonathan Kennedy

Well, our buybacks go from June to July for the year and we're pretty much straightforward pace. So right now we have done about $5 million, so there's about $15 million left on the current buyback.

Jayson Bedford

Do you expect that to be exhausted by July?

Jim Hawkins

Yes.

Jonathan Kennedy

You know, Jayson, we probably have done more than $5 million, we've probably done closer to $10 million on that second buyback.

Operator

Our next question comes from the line of Larry Haimovitch from Haimovitch Medical Technology Consultants. Your line is open.

Larry Haimovitch

Jim, one quick question or maybe for Jonathan, the Medical Device Tax has been repealed and I thought -- and maybe you made a comment on the call about the impact, but I didn't hear it. If you didn't make it, could you give us some color on how much that will be and any plans on how you will be utilizing the benefit?

Jonathan Kennedy

Sure. Yes, it's Jonathan. It's about $2 million a year that we'll save. Unfortunately, they didn't make that permanent, so it's a difficult thing to commit to spending on a business, so really our plan would have that go to the bottom line.

Larry Haimovitch

Presumably that $2 million dollars is already in your guidance, I'm assuming.

Jonathan Kennedy

That's correct.

Operator

[Operator Instructions]. I don't see any other questioners in the queue at this time. So I would like to turn the call back over to management for closing remarks.

Jim Hawkins

Thanks Andrew. Well, in closing I would like to say that 2015 was an outstanding year for Natus and we're looking forward to a promising 2016. Also like to thank you for participating in today's call and for your continued interest and support. Thanks again.

Operator

Ladies and gentlemen, thank you again for your participation in today's conference. This now concludes the program and you may all disconnect your telephone lines at this time. Everyone have a great day.

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