Natus Medical Incorporated
Q4 2019 Earnings Call Transcript

Published: 7 Feb 2020

[Operator:]

Good afternoon and thank you for joining us today to review our results for the Fourth Quarter of 2019. On the call today from Natus is Jonathan Kennedy, Natus' President and Chief Executive Officer; and Drew Davies, Natus' Executive Vice President and Chief Financial Officer. Jonathan will begin today with a business overview of the fourth quarter 2019. Then, Drew will discuss the fourth quarter financial performance and provide guidance for the first quarter and full-year 2020.Finally, we will open the call for your questions. [Operator instructions] Today's call will include forward-looking statements within the meaning of the Private Securities Litigation Reform Act. These statements include management's beliefs and expectations about our future results. Our actual results may differ materially from these forward-looking statements.For a description of relevant risks and uncertainties pertaining to our business, please see today's press release and our periodic and annual reports filed with the SEC. Managements presentation of the financial results will be on a GAAP and non-GAAP basis. The non-GAAP results exclude amortization, expense, restructurings, and certain other charges and the related tax effects.Management believes that the presentation of the non-GAAP measures along with our GAAP financial statements provide a more thorough analysis of our ongoing financial performance. You can find a reconciliation of our financial results on a GAAP versus non-GAAP basis in today’s earnings release.I would now like to turn the call over to Jonathan Kennedy, President and Chief Executive Officer of Natus Medical. Mr. Kennedy?

[Jonathan Kennedy:]

Thank you, operator. Good afternoon, everybody. Today, we reported the results for our fourth quarter and full year 2019. Revenue for the quarter was $131.8 million and non-GAAP earnings per share was $0.46. Revenue for the full year was $495.5 million and non-GAAP earnings per share was $1.24. Both the quarter and the full year were in line with our previous expectations.Natus is the global leader in neurodiagnostic equipment solutions. Our solutions are used by the majority of hospitals and neurologists worldwide. We have the most comprehensive line of neurodiagnostic equipment offered by any global manufacturer today offering a full line of EEG, EMG, and PSG sleep solutions.During the fourth quarter, we continued to see strong growth across our neuro product family. Overall, our neuro business grew by 15% year-over-year during the fourth quarter and grew 8% for the full year versus 2018, after adjusting for the divestiture of GND. The strength in neuro revenue for the quarter and full year was driven primarily by the domestic sales of EEG equipment where cybersecurity concerns, new features, and Windows 10 upgrade led demand for a robust upgrade environment.We believe that we are in the final phase of this upgrade cycle and expect growth in EEG to level off during 2020. Our PSG, or sleep diagnostics hardware business also had strong growth during the quarter and the full year as we continue to be market leader and high-end diagnostic sleep labs.Neurosurgery and neurocritical care grew modest during the quarter as new investments in our sales efforts are beginning to result in additional revenue. However, the product group was down slightly for the full-year. Sales of EMG hardware were down slightly during the quarter and relatively flat for the year.Natus is also a global leader in hearing and balance diagnostics. Our hearing and balance products are composed of devices and supplies used by audiologist, hospitals, and ENTs to diagnose hearing disorders assistant of fitting and two new hearing aids and for the diagnosis of balance disorders. This product group includes our well-known Otometrics, Madsen, Oracle and Bio-logic brands.After adjusting for discontinued products, revenue from our hearing and balance product family declined 25% from the fourth quarter of last year and 8% for the full-year due mostly to the timing of quality-related ship holds of certain products. We expect to resume these shipments during 2020.Natus’ market-leading Newborn Care product family is used by hospitals worldwide. Major product categories in this family include our newborn hearing screening solutions, neonatal eye imaging and brain injury monitoring, video streaming services, and phototherapy solutions.Newborn Care revenue declined to 8% after adjusting for divestitures and discontinued products during the fourth quarter versus the same quarter last year and declined 6% for the full-year 2019 versus 2018. The timing of certain quality related ship holds also impacted Newborn Care revenue and we expect to resume these shipments as well during 2020.Next, I’d like to update you on the progress of the One Natus restructuring project we announced last January. During the year, we completed all of the organization restructuring that we expected, reducing our headcount by 32% in total and 8% after adjusting for reductions related to divestitures.We also completed a comprehensive strategic plan focusing the company on the central nervous system and sensory systems for patients of all ages. And following our strategic plan and financial goals, we divested or exited multiple non-core and low performing products and businesses.While these divestitures produced revenue, our margins and cash flow have increased significantly. On the operations front, we consolidate our distribution centers from 12 to just 2, reducing our inventory, simplifying operations and increasing customer responsiveness.We consolidated 10 manufacturing centers into seven and are executing further consolidation plans that will bring that count to four by the end of 2020, further enhancing our margins and simplifying our supply chain. The completion of our One Natus project has now enabled us to focus on growing our business.Before I turn the call over to Drew, I want to address how we believe the Wuhan coronavirus outbreak will affect Natus. So far, we’ve seen some negative impact to Natus with lower than normal sales activity and some indications of supply disruption both related to restricted travel within China post the Lunar New Year holidays. While we hope this outbreak runs its course quickly, we are obviously uncertain as to how long it will last. Drew will discuss in more detail about how we factored this into our Q1 guidance.In summary, we’re very pleased with the progress and performance of the business in 2019 and the outlook for 2020. We hold several leading positions in each of our end markets and look to expand that leadership as we grow our business. At the same time, we will continue to focus on our strategic plans for growth, cash flow, and profitability with the goal of expanding our annual non-GAAP operating margins to our target range of 15% to 17%.Now, I’ll turn the call over to Drew Davies, our Executive Vice President and Chief Financial Officer for a deeper dive into our financial results. Drew?

[Drew Davies:]

Thank you, Jonathan. As Jonathan stated, we reported fourth quarter 2019 revenue of $131.8 million, a 6.6% decrease from the same period last year. The revenue decline was driven primarily by the divestitures and other end of sale products previously announced, offset by growth in our neuro market.Revenue from our neuro end-market was $80.9 million or 61% of total revenue during the fourth quarter of 2019, compared to $73.7 million or 52% of total revenue during the same quarter last year. The 9.8% increase in neuro revenue is attributable to growth in the EEG and PSG sleep study and neurosurgery product lines.Revenue from our Newborn Care end market decreased 21% to $27.8 million or 21% of total revenue during the fourth quarter of 2019, compared to $35.2 million or 25% of total revenue during the same quarter last year. The decline was primarily attributable to the divestiture of medics and the end of sale of NeuroCom balance products, offset by growth in our neonatal brain monitor products.Revenue from our hearing and balance end market was $23.1 million or 18% of total revenue during the fourth quarter of 2019, compared to $32.2 million or 23% of total revenue during the same quarter last year. Hearing and balance revenue was lower than the previous year as anticipated due to end of sale products and products on hold pending international product registrations.In total, revenue from devices and systems contributed approximately 76% of total revenue in the first quarter of 2019, compared to 74% in the 2018 period. Revenue from supplies and services was 24% of total revenue in the fourth quarter of 2019, compared to 26% in the 2018 period.Revenue from domestic sales was approximately 60% of total revenue and 40% from international through the fourth quarter of 2019, compared to 56% domestic and 44% international for the same period in 2018. On a non-GAAP basis, our gross margin increased by 390 basis points in the fourth quarter of 2019 to 62.1%, compared to 58.2% in the fourth quarter of 2018. This increase was driven by strength in sales of neuro products, lower operations overhead and the exit of lower margin businesses.GAAP gross margin increased 440 basis points to 61.3% in the fourth quarter of 2019, compared to 56.9% in the same period last year. Fourth quarter non-GAAP operating expenses increased by $600,000, compared to the same quarter last year. The increase in operating expense was driven primarily by an increase in R&D expenses related to remediation and preparation for the medical device regulations in Europe.Offset by cost reduction initiatives, including the impact of removing the operating expenses from divested businesses. Our non-GAAP operating margin increased to 15.3%, compared to 14.9% from the same quarter last year on lower revenues as a result of the increase in gross margin.Non-GAAP other income was $100,000 for the fourth quarter driven by exchange rate fluctuations. Interest expense was $900,000 during the quarter. We expect interest expense during the first quarter of 2020 to be approximately $600,000 and full-year 2020 to be approximately $2 million.Our fourth quarter non-GAAP effective tax rate was 20.3%. We anticipate our overall 2020 non-GAAP tax rate to be between 23% and 25%. On a GAAP basis, fourth quarter 2019 net income was $3.2 million or $0.10 per share, compared to a net loss of $11.6 million the same quarter last year.Non-GAAP net income increased $900,000, compared to the same quarter last year. Non-GAAP earnings per diluted share was $0.46. In the fourth quarter, we recorded $7.3 million of depreciation and amortization expense. Share based compensation was $2 million during the fourth quarter.Now, let’s look at some highlights from the balance sheet and statement of cash flow. We repaid $15 million of outstanding debt in the fourth quarter of 2019 and a total of $50 million for the full-year. As a result, we ended the quarter with net cash for the first time since fourth quarter of 2016.Cash flow from operations was $12.7 million during the quarter. Our days sales outstanding decreased two days versus the same period the prior year to 85 days driven primarily by increased collections. Our total inventory declined by $8.5 million, compared to the previous quarter. The non-GAAP diluted share outstanding increased to 33.8 million shares compared to 33.5 million shares in the same period last year.Turning to guidance, we expect our revenues for the first quarter of 2020 to be between $113 million and $117 million. GAAP net income is expected to be in the range of $2 million to $3.9 million for the first quarter of 2020 or $0.06 to $0.12 per share. Non-GAAP net income is expected to be in a range of $16.6 million or $18.6 million or $0.19 to $0.25 per diluted share.Q1 revenue and earnings guidance does not include the possible impact for the coronavirus in China. Our sales in China range from 5% to 7% of total sales and a portion of our supply chain originates in China. We will provide further updates to guidance during the quarter, if and when we believe revenue and earnings are anticipated to be negatively impacted by the health issues.For the full-year of 2020, we expect revenue to be between $480 million and $490 million with full-year non-GAAP earnings per diluted share of a $1.45 to $1.55. We also expect full-year GAAP profit per diluted share of the $0.89 to $0.99. Expected non-GAAP earnings exclude $18 million of amortization and intangibles and $1 million to $2 million of restructuring and other charges.While our full-year revenue guidance adjusted for divestitures is relatively flat, our full-year earnings per share guidance in the mid-point represents a 21% increase in earnings, compared to 2019.And with that, I will now open the call for questions.

[Operator:]

Thank you. [Operator Instructions] We do have a question from Jayson Bedford with Raymond James.

[Jayson Bedford:]

Good afternoon. I have a few questions, if you don’t mind. Just for clarity, Drew the first quarter guidance does not include any impact from coronavirus. Did I hear that correctly?

[Drew Davies:]

Yes, that’s right. We’ll monitor it. It's – China is about 7% of sales approximately and we will kind of watch it during the quarter. We’ve already had sales in the quarter, so it certainly isn’t going to be impacted by the full amount, but we will keep watching it here and obviously the supply chain as with most companies with electronic components there is a supply chain impact with China, but we’ve got a lot of inventory on hand, probably in most cases we’ve already got the inventory for Q1. So, we are just monitoring right now and if it looks like there will be a significant impact. During the quarter, we will come out and give everyone an update on that.

[Jayson Bedford:]

Okay. Few questions on 2020, EEG was a big driver for the business in 2019, I think you mentioned on the call that EEG will level off to some extent in 2020, can you just talk about what gets better and to the extent that you can give us some direction on segment growth rate expectations in 2020 that will be helpful?

[Jonathan Kennedy:]

Hi Jayson, it is Jonathan. Clearly, we had a really strong year. Last couple of years have been fairly good on EEG, like I said in my call, really driven by cyber security, Windows 10 that sort of thing on these devices connect to the hospital networks. So, that really was a positive for us this year. On the negative side, as I pointed on my prepared remarks, both Newborn Care and balance and hearing and balance were negative growth and most of the negativity on the growth was driven by our quality-related ship holds.We’ve talked a bit for the last year about the ship holds we’ve had and how we expect those to come off. So, I would expect growth rates in the neuro space to be in the flattish range, because we're coming off of such a good year in 2019. I’d expect hearing imbalance and Newborn Care to be in the more modest range because we will have products coming back from the market that have year-to-date been off for the last several months that should drive growth for that reason.So, in terms of rates, I think what our guidance has the overall company rates around 1%. You can do the math of if neuro is flat, then we need to see the other two kind of coming off.

[Jayson Bedford:]

Got you. Okay. In terms of visibility of taking these products off ship hold, what's the timing that we’re look at for 2020?

[Jonathan Kennedy:]

Yes. So, it kind of – it obviously varies by product but we’ve got in Newborn Care we’ve had neoBLUE and we’ve got a new NicView product that we thought would be on the market that will – it will take over the sales of the existing NicView product, and those are expected to be out in Q1 and so we should have them for the majority of the year. On the hearing and balance side, we’ve had our Otoscan product has been out of the market and that’s expected to be back on the market this quarter as well, more towards the end of the quarter and we should see that going back and ramping for the rest of the year.We had another fitting product called ChartrEP that was out and that is expected. It is partially back in the market, but it will be fully back in the market in Europe at the end of Q1 and Q2. So, we are getting several of these back on the market, kind of in late, at late Q2 we should have the benefit for them for most of the year.

[Jayson Bedford:]

Okay. That’s helpful. Maybe just shifting over to the rest of the P&L here, gross margin expectation in 2020?

[Jonathan Kennedy:]

Yes, we had a nice increase here in the gross margin the last couple of quarter and really we are seeing the full benefit from the One Natus and the consolidations that we’ve had and also the full benefit of some of the divestitures that we’ve taken and you know we expect that, you know to still have that benefit throughout the year, and see our gross margins in that range, be north of 60 for 2020. And we finished this year in north of 60 on a non-GAAP basis for the full year, but should be between 61 and 63 for 2020.

[Jayson Bedford:]

Oh, well. Okay. R&D looked like it was – it certainly stepped up in the fourth quarter, is that what we should expect into 2020 and I haven’t done all of the math, but what is the implied operating margin in 2020?

[Drew Davies:]

So, we are trying to get to that target of being 15% for 2020, be 15% to 17%. I think as we’ve been talking most recently, we’ve said that we’re probably going to be closer to the lower end of that range and really that’s driven by really putting our foot on the gas to get these remediation’s complete, we’ve made a lot of progress, we got over half of the Seattle remediation’s done in 2019.We have a few more and we want to get those done by approximately mid-year or in the third quarter and then we’ve got some spending on the medical device regulations in Europe and that’s been – that’s driven some additional R&D spending.And then as we get over, we get those finished, we should see some R&D improvements as we move on through the year, but – you know the other thing we’ve said is that the reason we’re staying at the lower end of the operating target range is we have been focusing on investing in some of the existing products that we had and putting R&D in bringing out refresh products in our existing lines and so that’s keeping us more closer to the lower end of the range.

[Jayson Bedford:]

Okay. Last one for me, Jonathan maybe just bigger picture, you’ve done a lot, you’ve accomplished a lot here in the –certainly on the cost side streamlining the portfolio with One Natus outside of the manufacturing the further manufacturing consolidation that you all accomplished this year, what’s left and kind of where do your priorities focus now?

[Jonathan Kennedy:]

Yes. The One Natus initiatives are largely done or said in motion such that you know their operational objectives. I've oversimplified it; I'm sure, but that, from a big picture that’s true. So, where we are focused today is growing the business as I mentioned in my prepared remarks. We created this strategic plan that ties the products together.We will be working on the connectedness of all of our products to the Cloud and managing the data flow for products I think that’s the only natural place for a portfolio like ours to go from a technologies perspective and we’ve – for the last couple of years we focused on really remediation and cleaning up a product port folio from a technical perspective.We’re very close to having that completed. We will be mostly through that this year and we’ve turned our attention to this strategic plan of really trying to figure out what to do to modernize the portfolio, to drive growth. One thing of the – when we released new products in our respective niches, the revenue goes up and that’s because the products are quite old in many cases or there is new technology that they just haven’t jumped onto.So, we see a huge opportunity in modernizing the product portfolio in connecting it to the Cloud and being able to do things like remote management or do things like data management or move data, patient information within health record systems and the like and so as we go over the next two to three years, you will see more and more of that. We already do that today with our Otoscan.We already do it with NicView and our Neometrics data management system is already all connected and sharing data and streaming to the cloud. So, we aim to put the rest of the portfolio on to a similar system so that you know health care providers will have a more modern set of devices.We will have less R&D as the portfolio turns more into a software product and less of hardware and so that’s where we focus internally. And then externally, it’s adding to that portfolio with some of the unique technology that we see out there whether through acquisitions of through hiring the teams of people that can help us go there, but that’s what the strategy is telling us to do and that’s what we tend to pursue.

[Jayson Bedford:]

Perfect. Thanks Jonathan and Drew.

[Jonathan Kennedy:]

Thanks Jayson.

[Drew Davies:]

Thank you.

[Operator:]

Thank you. I’m showing no further questions in the queue at this time. I will now turn the call back over to management for any further remarks.

[Jonathan Kennedy:]

Thank you, operator. We communicated in January last year that we would restructure Natus with a focus on cash flow, profitability, and a focus on our core capabilities. I’m happy to report that we had achieved those objectives for 2019 and as our guidance implies we expect to achieve further expansion of margins throughout 2020. At the mid-point of our guidance, we expect to increase our annual non-GAAP earnings per share by over 20%.And finally, I would like to thank all of our employees for their outstanding efforts and achievements throughout 2019. The Natus team successfully executed a significant restructuring and continued to serve our customers everyday throughout the year. We truly have one of the best teams in the industry. Thank you, operator. That concludes our program for today’s call and thank you for joining us and have a nice day.

[Operator:]

Ladies and gentlemen, this concludes today’s conference call. Thank you for your participation. You may now disconnect.