Natus Medical Incorporated
Q1 2013 Earnings Call Transcript

Published: 20 May 2013

[Operator:]

Ladies and gentlemen, thank you for standing by. Welcome to the Natus Medical 2013 First Quarter Financial Results Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded today, May 20, 2013, and contains time-sensitive information that is accurate only as of today. Earlier today, Natus Medical released financial results for the 2013 first quarter. 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 Investor Relations at 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

[James B. Hawkins:]

Thank you, operator. Our first quarter results that we released earlier this morning reported revenue of $85.8 million compared to $59.4 million reported last year and non-GAAP earnings per share of $0.15 compared to $0.07 in our first quarter last year. I am very pleased with our record revenue and non-GAAP net income in the first quarter. We believe our first quarter results reflect excellent execution by our teams and the improved productivity and operating efficiencies that are being achieved at Natus. Our non-GAAP earnings came in well above our guidance range in the first quarter due to higher revenues, cost savings and operating synergies that are being realized. Our recent acquisitions are helping to drive our leadership position in our markets. We are especially pleased with the increase in our gross profit to 58.3% versus 56.2% in our first quarter last year. We plan to focus on achieving improved gross profits for Natus in 2013. But as previously mentioned, our recent Grass acquisition currently has a lower overall gross profit that will have a small temporary effect on this metric in 2013. As we enter 2013, we successfully integrated the Nicolet sales organization into Natus and, in the first quarter, integrated Grass products as well. Natus now has the largest neurodiagnostic and service organization in the world. After entering this market just 7 years ago, Natus is now the worldwide leader. We are very proud of this accomplishment. We believe it puts Natus in a unique position to further drive technological advancements in this market and allows us to better serve our customers. We look to participate in the recently announced government brain mapping initiative. As often mentioned, the brain remains the last frontier, and we believe Natus is positioned to participate in this exciting opportunity in this rapidly evolving field. As previously discussed, we reorganized Natus into 2 strategic business units

[Jonathan A. Kennedy:]

Thank you, Jim. Before I start with the financial review, I'd like to address the delay in our -- in filing our financial reports. As you know, Natus has grown significantly over the past year and at the same time, we've been replacing our multiple legacy information systems into a single ERP system that will enable us to more efficiently and effectively manage our global businesses. While these efforts have resulted in unacceptable delays in our financial reporting, we are committed to getting back on track with timely and accurate financial reporting to the investment community. Now to the financials. Today, I will be discussing our financial results on a GAAP basis, as well as a non-GAAP basis. Our non-GAAP results exclude amortization expense and certain other charges. We believe that the presentation of these non-GAAP measures, along with our GAAP financial statements, provide a more thorough analysis of our ongoing financial performance. You can find the reconciliation of our earnings on a GAAP versus non-GAAP basis in today's press release. We reported first quarter 2013 revenue at $85.8 million, an increase of 44% or $26.4 million from revenue of $59.4 million for the first quarter of 2012. Revenue from our Neurology end market increased to $55.7 million or 65% of total revenue during the first quarter of 2013 compared to $28.4 million or 48% during the same quarter last year. The increase was driven primarily from the addition of Nicolet and Grass product families, which together accounted for $27 million during the first quarter. Revenue from our Newborn Care end market decreased slightly to $30.1 million or 35% of total revenue during the first quarter of 2013 compared to $31 million or 52% of total revenue during the same quarter last year. The decrease was driven primarily from lower sales of devices and systems, partially offset by an encouraging increase in supplies and services. On a consolidated basis, revenue from devices and systems contributed to 58% of total revenue in the first quarter of 2013 compared to 60% in the 2012 period, while revenue from supplies and services increased to 42% of total revenue in the first quarter of 2013 compared to 40% in the 2012 period. Revenue from domestic sales increased to 56% for the first quarter of 2013 compared with 51% during the same quarter of last year. And revenue from international sales was 44% for the first quarter of 2013 compared to 49% for the first quarter of last year. On a non-GAAP basis, our gross margin increased 210 basis points to 58.3% compared to the first quarter of 2012. Our non-GAAP gross margin increased 60 basis points sequentially from the fourth quarter of 2012 as we continue to realize the benefits of cost reduction programs and a more favorable product mix. Our non-GAAP operating expenses were consistent with our expectations, and our first quarter non-GAAP operating margin improved to 8% compared to 5% for the same quarter last year. On a GAAP basis, our first quarter income tax expense included a benefit of $0.4 million from the retroactive reinstatement of the R&D tax credit. However, we have excluded this benefit in the calculation of our non-GAAP earnings per share as the benefit is not expected to recur in future periods. Our first quarter non-GAAP tax rate was 32.3%. On a GAAP basis, net income was $3.4 million or $0.11 per diluted share, a $3.2 million or $0.10 increase from the same quarter last year. We achieved non-GAAP net income of $4.5 million or $0.15 per diluted share, an increase of 123% from the first quarter of last year. During the quarter, we recorded approximately $3.1 million of depreciation and amortization expense, including $1.6 million of amortization of intangibles associated with our acquisitions. Equity base compensation was approximately $1.4 million during the first quarter. We ended the quarter with approximately $24 million in cash and $53 million in debt. At the midpoint of our 2013 annual non-GAAP guidance, we expect non-GAAP gross profit margin of about 58% and operating expenses of about 46% with these metrics improving throughout the year. We expect our effective tax rate will be 31% to 32% absent discrete and non-GAAP items. We expect that the full year 2013 depreciation and amortization expense will be approximately $12 million, including approximately $7.1 million of the amortization expense associated with acquired intangibles. We expect equity base compensation expense to be approximately $5.6 million, and we expect about $800,000 in interest expense. Our earnings per share guidance is based on an expected diluted share count of approximately 30.6 million shares. With that, I'll turn the call back to Jim.

[James B. Hawkins:]

Thanks, Jonathan. Before opening up the call to questions, I would like to review our financial guidance for our second quarter and full year 2013, all on a non-GAAP basis, and make a few closing comments. For the full year 2013, we expect to report revenue of $362 million to $367 million and non-GAAP earnings per share of $0.85 to $0.88. For the second quarter of 2013, we expect to report revenue of $86 million to $90 million and non-GAAP earnings per share of $0.17 to $0.20. Our non-GAAP earnings per share guidance excludes charges for amortization expense associated with acquired intangible assets. In addition, our non-GAAP earnings per share guidance excludes the effects of restructuring charges that we expect to incur in 2013 associated with recent acquisitions, the amount and timing of which have not yet been determined. We are not, at this time, providing GAAP earnings per share guidance because of the uncertain nature of the restructuring charges. And, as usual, our non-GAAP guidance excludes the impact any future acquisitions might have on our results of operation. In summary, we continue to execute on our business model and build a world-class franchise in both Newborn Care and Neurology. We continue to be very excited about the opportunities in 2013 and look forward to delivering strong earnings, growing revenues and significant cash generation throughout the year. With that, we will turn the call over to questions. Operator?

[Operator:]

[Operator Instructions] Your first question comes from the line of Matt Dolan with Roth Capital Partners.

[Matthew Dolan:]

Jim, I wanted to start on the revenue side. It seems like you're fairly confident in the visibility you have in both divisions of the business outside of Europe. Can you give us just any more detail on maybe what you've seen this quarter to date in terms of the market? Is stability the name of the game? Are there still some choppy areas to be concerned about?

[James B. Hawkins:]

Yes, overall, Matt, we have certainly seen stability especially compared to going back 2, 3 years ago when things were very choppy. The U.S. domestic business has been solid. As we've mentioned, Europe has been soft -- continued to be soft, certainly an improvement in the decline from last year but overall soft. John, do you have any extra color to add to that?

[John T. Buhler:]

I would echo that, Matt, that we continue to see strong forecasted funnels out of the United States, North America in particular, which gives us a great deal of confidence. And we've obviously had a pretty good mix amongst the products that we offer. And in Europe, we continue to be guarded a bit, as Jim noted. But certainly, it's more predictable than it has been in the past.

[Matthew Dolan:]

Okay, great. And then on the margin side of the equation, it seems like you're well on your way towards your -- towards potentially hitting your goals this year. Are there particular lines where you see the most opportunity for improvement? And maybe in the context of that response, I know you mentioned a 13% to 17% longer term range. So how should we anticipate the Natus business showing that leverage over a longer period of time?

[James B. Hawkins:]

Yes. So as we said, the business has been stable, which has helped. And even we've had organic growth, certainly, the way that we look at it with the acquisitions and year-over-year comparison, accordingly, the gross profit improvement that we have, as Jonathan mentioned, has been a few things. Certainly, product mix has helped. As you noted -- as we noted, the supplies and services is a higher percentage of the business in the quarter, which has a little better margin. We've also been able to -- on our pricing discounting, been able to get some benefit there. And then with the operational efficiencies that we've been working on, we're seeing that benefit as well. As far as long term as -- we said these are goals that we're looking to do, and we're really focused on 1 year at a time. But we just wanted to communicate to our shareholders and investors that this -- we do look to get back to building the kind of nice, profitable, cash-flow-generating business that we had in the past. We see it over a 2- or 3-year kind of platform to get to those kinds of higher-end numbers. But every year, we look to improve our operating profitability by 1% or 2% per year. So I think it will be noticeable, and it's all part of our plan.

[Operator:]

Your next question comes from the line of Larry Solow with CJS Securities.

[Lawrence Solow:]

Just on the organic growth, is it fair to say that on an organic basis, sales were about flat if we back out Nicolet?

[James B. Hawkins:]

Yes, it's a little ...

[Lawrence Solow:]

It's a little bit of hard to think, to calculate, but...

[James B. Hawkins:]

The way that -- without getting into too much detail, we internally look at it at about a 2% organic growth. To briefly walk you through that Larry, if you take what Nicolet had done a year ago in the quarter, but then you back out the change in the sales channel in Europe. They used to go direct in Europe, and now we go through a distributor. Because of that, we take about a 35% haircut on revenues, but we eliminate a lot of expense. That used to be a money-losing operation for Nicolet. So we're making money because we've eliminated a lot of overhead there. So on a profitability basis and also then, as I said on an organic growth basis, the way we look at it, which we think is the correct way, apples-to-apples, we had about 2% roughly organic growth.

[Lawrence Solow:]

Okay. And then, I guess, the Newborn piece is probably a little easier to figure out, and it sounds like you had growth in that side just from the...

[James B. Hawkins:]

Yes, that was sort of flattish, I think, actually. Yes, that was more flat. Again, strong everywhere but in Europe, where we did see a decrease there.

[Lawrence Solow:]

Okay. So sort of a -- I guess it's anecdotal on the birthrate, but it seems -- if it is the case, it seems to be helping more in the U.S., whereas I guess the general malaise in Europe is impacting both...

[James B. Hawkins:]

Yes. I would say from the birthrate, we did see improvements everywhere. So the supply side of our business was up, I think, uniformly. It was just on the capital equipment side in Europe is where we saw the continued weakness.

[Lawrence Solow:]

Okay, okay, okay. And then just any updates on your -- sort of your cost-cutting initiatives and all where you stand. It sounds like maybe you're a little bit ahead of schedule. Are you just seeing better leverage early on in the year? Any thoughts on that?

[James B. Hawkins:]

Well, I think we have put a plan together. And Larry, you're a little new to Natus, but when we bought Nicolet, we instituted a plan very quickly on an integration and cost-reduction plan there. And we've been executing along those lines. And we have a plan laid out through the rest of this year. And as we grow, we'll be seeing more of those efficiencies.

[Lawrence Solow:]

Okay, just a last question. Where is the medical device tax showing up in your P&L?

[James B. Hawkins:]

Jonathan?

[Jonathan A. Kennedy:]

Yes, it's in SG&A.

[Operator:]

Your next question comes from the line of Jayson Bedford with Raymond James.

[Jayson T. Bedford:]

Just a couple here. The annual gross margin guidance, I think, you gave, Jonathan, of 58%, you did 58.3% in the quarter. Obviously, you're expecting revenues to ramp here from the first quarter levels. Does the gross margin, the annual guidance, just solely reflect the impact of Grass?

[Jonathan A. Kennedy:]

That's part of it, but I mean, just predicting for the entire year can be a little bit treacherous when you try to get for an entire annual run rate. So 58% is where we think it will be on average for the year.

[Jayson T. Bedford:]

Was there anything one-time-ish in the first quarter that boosted that gross margin?

[Jonathan A. Kennedy:]

No, not on a non-GAAP basis.

[Jayson T. Bedford:]

And Jim, you mentioned the price increase. I'm guessing you didn't feel the full impact of that in the first quarter. Can you just comment any push-back? How was the price increase sticking, if at all?

[James B. Hawkins:]

Yes. As we mentioned in the past, we have tried to do a combination of price increase along with some discounting, more control in that process. Certainly, we saw some lift in Q1. But in the first quarter, you don't see -- it typically ramps through the year because of contracts, quotes and different issues. John, do you have any more color?

[John T. Buhler:]

Jayson, we have a number of longer-term arrangements with GPOs and others. So for the price effect to take place, it normally takes us some time to get that to impact us across the entire installed customer clientele basis you might assume. So that, as well as our distribution partners, we usually have a 90- to 120-day delay before those price increases can take effect. So we did see a nominal increase in the first quarter. We would expect that to continue throughout the year.

[Jayson T. Bedford:]

Okay. That's helpful. Can you break out Grass -- revenue from the Grass deal in the quarter?

[James B. Hawkins:]

We really -- we'll go ahead and do at this time, but this will probably be the last time since it's our first quarter and it was only a 2-month quarter. But I think it was around $2.3 million. Jonathan?

[Jonathan A. Kennedy:]

That's correct.

[Jayson T. Bedford:]

Okay, okay. And then just last couple here. I typically don't ask about G&A, but that was a little higher than I would have expected. Was there anything kind of -- I'm guessing you're going to -- do you expect to see that level come down over the...

[James B. Hawkins:]

Yes, certainly, Jayson. We have -- the way that it's structured in Natus with our year-end and first quarter, certainly, our year-end audit is a fairly sizable expense at Natus. And the majority of that hits us in the first quarter and then really slides down for the rest of the year. And then we have the normal payroll taxes that everyone has for the first 3 or 4 or 5 months of the year as people are getting up to that level, where the company has the matching and that pays off. So we expect, certainly, that percentage of G&A to go down against revenues throughout the year in a, I'd say, a meaningful way.

[Jayson T. Bedford:]

Can we assume it was a little inflated in the first quarter kind of given the delay in the 10-K filing?

[James B. Hawkins:]

There is probably a little bit of that in there.

[Operator:]

Your next question comes from the line of Brian Weinstein with William Blair.

[Brian Weinstein:]

A question for -- you talked about kind of the 2% organic growth rate in the quarter. I'm just hoping that you can break that out a little bit between that pricing and the volume and kind of bigger than the quarter, what your expectations are and kind of embedded in your guidance for organic growth for the full year in the mix between pricing and volume and then longer term, as you look out to that business over the next few years, with your cost synergies coming in, what kind of organic growth you think the business can deliver.

[James B. Hawkins:]

Sure, Brian. Well, of the 2%, we really don't want to break that down. That's getting a little too myopic, I think. But certainly, going forward and in our plan as we entered the year, we had about 2% growth in our forecast. And so we see that continuing. We're hopeful, as this world economy gets better and especially in the Newborn space we even get potentially more lift, we'd like to be able to exceed that. But certainly, a 2% organic growth, I think, is fine for this year. If you look long term, we see there is no reason as things stabilize, where we can't be a 3% to 5% grower. And obviously, we don't give guidance to out-years at all, but we certainly think, with our market positions, product platforms, sales and distribution channels, we should, over time -- reasonable amount of time, get to that 3% to 5% organic growth.

[Brian Weinstein:]

Okay. And then you talked about driving advancement in neurodiagnostics. There hasn't been a whole lot kind of, I would say, game-changing R&D that's come out internally. So is this really just an opportunity on the brain mapping that you were talking about -- a little bit about and initiatives there. Can you just comment on or expand on your comments about the driving technological advancements in neurodiagnostics and what you guys expect there?

[James B. Hawkins:]

Sure, Brian. I think most people are at least vaguely aware of this brain mapping initiative that the Obama administration has put forth and is going to fund. It's a large chunk of money that's out there, and they're putting out the challenge to companies and research to try to really go out and map the brain. The brain, as everyone knows, is sort of the last frontier, from Alzheimer's, depression, all sorts of different issues that are plaguing society. And our basic products play a role in that. But certainly, to go to the next level, there are some interesting opportunities and technologies that we would look to potentially enter or partner with companies to participate in that. It's early stages, of course, but we wanted to put it out there on everyone's radar. So in the potential months and years ahead, we hope to be able to discuss more on those topics.

[Brian Weinstein:]

Okay. And my last question is on the move to the incubators into the U.S., you talked about -- of that in the past. Can you just talk about where that is and how that's going at this point?

[James B. Hawkins:]

Sure, I'll pass that over to John on that. John?

[John T. Buhler:]

So Brian, we completed, as you know, last year, the 510(k) registration and then we entered into a training process with our sales force. So we entered the year -- also started to build our funnels. We were very fortunate we've got a pretty robust funnel of opportunities. It's a little longer cycle time than many of our products. Most people don't buy one incubator. They tend to buy multiple incubators. But we see very good traction. We've had some very nice early placements of anywhere from 5 to 10 to even 12 incubators at a number of institutions. So we see also good uniformity in holding price relative to our offering in the marketplace. So overall, I think we remain bullish that, that has a very significant upside for us in 2013.

[Operator:]

We've no further question in queue. I will turn the call back over to Natus for closing remarks. Please proceed.

[James B. Hawkins:]

Well, I'd like to thank, everyone, for participating in the call. We are very pleased with our results, and we're very much looking forward to continuing these excellent results for 2013. Thank you very much.

[Operator:]

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect, and have a great day.