Natus Medical Incorporated
Q1 2015 Earnings Call Transcript

Published: 22 Apr 2015

[Operator:]

Ladies and gentlemen, thank you for standing by. Welcome to the Natus Medical First Quarter 2015 Financial Results Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. [Operator Instructions]. As a reminder, this conference is being recorded today, April 22, 2015, and contains time-sensitive information that is accurate only as of today. Earlier today, Natus Medical released financial results for the first quarter 2015. 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 [e-mail]. 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 reminds you that future results may differ materially from those 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 the Securities and Exchange Commission. I would now like to turn the call over to Jim Hawkins, President and Chief Executive Officer of Natus Medical. Mr. Hawkins?

[James Hawkins:]

Thank you, operator. Our first quarter results that we released earlier this morning reported revenue of $89.4 million compared to $85.6 million last year. We also reported non-GAAP earnings of $0.30 compared to $0.26 in our first quarter of last year. I’m very pleased with these results as we posted record revenues even with a $2 million negative currency affect and earnings exceeded our guidance and equally important, we out performed on all of our important metrics. In the quarter we achieved a non-GAAP gross profit of 60.7%. This is an increase of 1.2% over the 59.5% we reported in the first quarter of last year. Also, our non-GAAP operating profit of 16.9% in the first quarter is a substantial improvement over the 13.7% we reported last year. We continue to drive to our operating profit margin of 18% in 2015 as well as our 20% operating profit margin goal for 2016. Our 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 newborn care and neurology. Our increased operating leverage and efficiencies are a result of integrating our past acquisitions, along with excellent execution of our operating plan by all at Natus. In our first quarter, both newborn care and neurodiagnostic business segments performed well. Business continued strong in the United States. Our domestic newborn care business was exceptionally strong as our domestic sales force had an outstanding quarter. Has 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 are positioned to lead our industry segments by developing innovative products that would drive organic growth. We have established a new product pipeline that we are very excited about. Yesterday, we announced FDA clearance of Quantum. Quantum is an innovative high channel count amplifier that has applications in epilepsy and seizure monitoring, along with research applications. By providing increased visibility of faster brain frequencies and a wide bandwidth, Quantum facilitates functional brain mapping through cortical stimulation and a dual data stream all in a compact verbal package. We believe Quantum is the first major innovation in many years in the neurodiagnostic market. Prior to Quantum we introduced Vista Ultrasound, the first product in the market that enables the use of ultrasound with an EMG workstation. Vista allows positions on a real time basis using ultrasound to locate nerves that will assist in the placement of needle electrodes to better perform nerve conduction studies. There is a reimbursement available for using ultrasound in this manner and Natus now has the first product that enables with EMG. Feedback from leading neurologists has been positive and we are now booking business in both the United States and our international markets. We plan to continue to introduce new innovative products over the next 18 months in both newborn care and neurology. Our new business initiatives, GND, Peloton and NicView, all reported revenues beyond our expectations. For new investors that may not be familiar with Natus, I would like to briefly review Peloton, GND and NicView. Peloton was started in Q1, 2014 after this newborn hearing screening test the hospitals as an alternative to purchasing equipments and disposables. We look to convert our existing ALGO customers to this new service model as well attracting new customers to Natus. As a worldwide leader in hearing screening devices, we believe we are ideally positioned to develop this market. Our opportunity is to increase the approximately $10 a baby we receive for our disposable hearing supply to a $100 for actually performing the hearing screening test. We expect Peloton revenue to ramp through 2015 as we continue to market this service and develop this market. We are currently approaching 70 hospitals under contract for Peloton. NicView and Global Neuro-Diagnostics, GND are two new business segments that Natus entered in our first quarter. NicView provides streaming video for families with babies in the neonatal intensive care unit or NICU, that enables family members and approve 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. 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 the current Texas base in the near future. Peloton, NicView and GND rapidly growing new offering to the market place, they represent the beginning of an expanding service business and positions Natus for accelerating revenue growth and record earnings in 2015. I’m also pleased to announce that we were recently awarded a five year $32.5 million contract by the state of California to provide hearing screening coordination services. This contract is expected to start July 1st. As Natus is currently under contract for doing this work in one region, this contract will add approximately $24 million over and above our current run rate during the five year contract. We did not have a significant acquisition in 2014, as we believed it was important to integrate our existing acquisitions and show ourselves, shareholders and the medical community, the strong leadership company Natus has become and that we are a consistent organic growth and increasing profitable business. With that said acquisitions are an important part of our business model and we would look to pursue a meaningful acquisition in the latter part of 2015, if the right opportunity were to present itself. In the quarter we generated approximately $14 million after backing out cash used for acquisitions and stock buy backs. We look to continue to generate significant cash in future quarters. In summary, we’re very pleased with our first quarter performance and operating results. We look to continue our strong earnings momentum and cash generation combined with consistent revenue growth throughout 2015. We remain committed to driving towards our long-term goal of 20% non-GAAP operating margin. Jonathan?

[Jonathan Kennedy:]

Thank you, Jim. Today, I will be discussing our financial results on a GAAP basis, as well as non-GAAP basis. Our non-GAAP results exclude amortization expense, restructuring and certain other charges, and the related tax effects. We believe that the presentation of these non-GAAP measures along with our GAAP financial statements provide a more thorough analysis of our ongoing financial performance and you can find a reconciliation of our earnings on a GAAP versus non-GAAP basis in today’s press release. As Jim stated, we reported first fourth quarter 2015 revenue of $89.4 million, a 4% increase from the same period of last year. Euro and Canadian dollar exchange trends negatively impacted revenue by approximately $2 million during the quarter. However, due to our European and Canadian operations Natus has a natural hedge to the bottom line as our Euro and Canadian dollar manufacturing and operating expenses mitigated the effect of these currency impacts. Revenue from our neurology market decreased slightly to $56.3 million or 63% of total revenue during the first quarter of 2015, compared to $56.5 million and 66% of revenue during the same quarter last year. Revenue from our newborn care market increased to $33.1 million or 37% of total revenue during the first quarter of 2015, compared to $29.1 million or 34% of total revenue, during the same quarter last year. On a consolidated basis, revenue from devices and systems contributed approximately 59% of total revenue in the first quarter of 2015, compared to 60% in the 2014 period, while revenue from supplies and services was approximately 41% of total revenue in the first quarter of 2015, compared to 40% in the 2014 period. Revenue from domestic sales was approximately 61% for the first quarter of 2015, compared to 56% in the same period in 2014 and revenue from international sales was approximately 39% for the first quarter of 2015, compared to 44% from the same period in 2013. On a non-GAAP basis, our gross margin increased by 120 points in the first quarter to 60.7%, compared to only 59.6% in the first quarter of 2014. The year-over-year non-GAAP gross margin improvement was primarily driven by higher relative U.S. revenue, where we sell direct and higher gross margins, combined with a more favorable mix in product sales. Non-GAAP operating expenses remain constant compared to the same quarter last year and a non-GAAP operating margin increased to 16.9% compared to only 13.7% in the same quarter last year. Our first quarter non-GAAP effective tax rate was approximately 28.5%. Our tax rate is expected to remain approximately this level throughout ‘15 as I expect our U.S. based business to drive profitability during the year. This estimate does not include any benefit from the R&D tax credit. Other income was an expense of $0.8 million during the quarter, which was primarily the result of foreign currency losses related to the declining value of the Euro. On a GAAP basis, net income increased to $8.6 million or $0.26 cents per diluted share, a $1.8 million increase from the same quarter of last year. Non-GAAP net income increased $2 million or 24% compared to the same quarter last year to $10.3 million and non-GAAP earnings per share increased 19% to $0.31. We reported approximately $3 million of depreciation and amortization expense in the first quarter. Equity based compensation was approximately $1.7 million during the quarter. Now let’s go to the balance sheet. Net cash increased by $0.4 million during the quarter and we spent $12.1 million on acquisitions and we repurchased approximately $1.3 million Natus stock during the quarter. And as Jim mentioned, that’s approximately $14 million of cash flow generation during the quarter. Our days of sales outstanding improved by two days to 83 days compared to the same period last year and our diluted shares outstanding increased to $33.1 million compared to $32.2 million in the first quarter of last as all outstanding options continued to be in the money. With that, I’ll turn the call back to Jim.

[James Hawkins:]

Thank Jonathan. Before opening up the call to questions, I would like to review our financial guidance for the full year 2015 and all on a non-GAAP basis and make a few closing comments. For the first quarter, we expect revenue of $89.5 million to $91.5 million and non-GAAP earnings per share of $0.31 to $0.33. This compares to revenues of $86.5 million and non-GAAP earnings per share of $0.28 in the second quarter last year. We are increasing our 2015 non-GAAP earnings per share guidance to $1.47 to $1.51, an increase from the previous guidance of $1.42 to $1.46. We are also increasing our full year 2015 revenue guidance to a range of $376 million and $378 million, an increase from our previous range of $373 million to $375 million. I would also like to note that we recently received a warning letter from the FDA that asked us to start shipments of certain products due to misbranding and/or adulteration which we have complied. Revenue from these devices total in the low single digit millions in the United States and have been excluded in our second quarter and annual guidance that we gave today. We continue to work with the FDA to resolve these violations in a timely manner. As I reflect on what we have built in neurology at Natus it is more 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 business and expand the entire neurodiagnostic market. Our newborn care business continues to perform well. Leveraging our leading newborn care products and our sales force with our rapidly growing Peloton Hearing Screening Service business combined with the recent addition of NicView uniquely positions Natus for an exciting 2015. With that we’ll turn the call over to questions operator.

[Operator:]

[Operator Instructions] Our first question comes from the line of Chris Lewis with Roth Capital Partners. Please proceed.

[Chris Lewis:]

Hi guys, thanks for taking the questions. First on the California HSC [ph] contract award, can you just elaborate on that award, what types of investments are required to build the infrastructure to support those services beginning in the third quarter and then I think you said incremental revenues of $24 million over the five year period. So do you already have some of that business related to that award in California currently? Thanks.

[James Hawkins:]

Yeah we do. I think I mentioned on the call, it’s approximately about $8 million that we currently have, but that contract was going to be expiring I think Chris in the September timeframe. So it’s new business. With the new business assuming we were going to get a renewal on the region that we already had. It’s sort of an incremental $24 million of new business. As far as our initial cost, we’ll have to get a couple of facility or two to house some follow up coordinators to work with the state and it’s a head count. I’m not sure off the top my head, but I think the 10 to 15 people kind of range.

[Chris Lewis:]

Okay great and then on the revised revenue guidance implied 6% growth at the mid-point over 2014, pretty healthy pick up implied in the second half of this year. So can you walk us through the leverage that gives you a confidence in that implied acceleration as we progress in the second half of this year?

[James Hawkins:]

Sure. We’ve had nice growth going forward over the last year standalone and then when you look at the way Peloton is ramping and then the NicView ramp along with the California contract ramping up the second half of the year and then certainly our existing businesses just continue to grow. That is how that’s made up. Now, on the other side, we are having a currency headwind of about $2 million a quarter. So we just really feel good about being able to have this growth when we’re looking at an $8 million approximate year-over-year headwind on currency. So well, if that wasn’t happening we’d really be ripping it up, but still not bad, we’re happy.

[Chris Lewis:]

So now on the acquisition front NicView and GND had about a quarter there of integration. Can you just provide an update on how those products are integrated into the bag and in the sales forces responses and feedback with those products and then what are the plans to scale that GND business beyond Texas going forward? Thanks.

[James Hawkins:]

Yeah, Chris and then maybe we’ll take some other questions too. Well, may be starting off with NicView, I almost hate to say it, but the response is just huge. I think we now have quotes, this is all in a three month period. We have given quotes to something like 80 hospitals that are very interested in acquiring NicView. Yeah, it’s been just a great reception. GND has been one where we’ve come in and having to learn that business, put a plan together. We’re in the planning stages of how we’re going to ramp our expansion there. They’re pretty much in Texas and a couple of surrounding states and we’re looking to put a program together to take it nationwide and I would say that would probably start happening at the back of the year as well.

[Chris Lewis:]

Great, thanks for the time.

[James Hawkins:]

Take another question. Thanks, Chris.

[Operator:]

Your next question comes from the line of Brian Weinstein with William Blair & Company. Please proceed.

[Brian Weinstein:]

Hi guys, thanks for taking the questions. First question, Jonathan, you had given the specifics on the narrow business and indicated that it returns [ph] year-over-year, was that due to - I know that warning issue, is that part of the business that was impacted there or is there any other dynamic that would cause that business to be down year-over-year?

[Jonathan Kennedy:]

Yeah, most of that is caused by the euro decline. Most of newborn care business has sales in dollar. We sell mostly through distributors and very little direct outside the U.S., so most of the sales are denominated in USD. The neurology business in Germany and France and a couple of other parts of Europe is direct and in euro also in Canada, so they’re suffering the most from euro and Canadian dollar declines.

[James Hawkins:]

But also maybe with the specify brand the warning letter was to a newborn care facility.

[Jonathan Kennedy:]

And that stopped shipment didn’t really occur until the second quarter, so no effect on that first quarter whatsoever for the warning letter.

[Brian Weinstein:]

Got it and on that warning letter are there other FDA inspections going on, is there a risk that this moves to other products and can you be a little more specific on the issue?

[Jonathan Kennedy:]

Yeah, in fact we just had two other FDA inspections at two other facilities and those closed out with [indiscernible] or issues.

[Brian Weinstein:]

Got it, Perfect.

[Jonathan Kennedy:]

No nothing going on right now besides that.

[Brian Weinstein:]

Good. As far as the California piece of business, are there other states that you guys are looking at without naming what those are specifically and can you frame what the opportunity is or the time frame to maybe sign some other areas, some other states rather?

[James Hawkins:]

Yeah, so to may be explain our business, that’s through a division that we historically haven’t talked about much called neometrics. And neometrics is a - the platform of that business is a software database management, a software platform that we sell to states where they can manage this themselves and that has been predominantly the model. We are now launching out and trying to promote this service that we have. Unfortunately Brian, these states aren’t going to move quick. They have to get it budgeted. They’ve got to get it approved. So we don’t see this being a big ramp up for this year and we’re hoping next year that perhaps we can get additional traction, but when you do get it it’s more for your contracts and what we’re doing with this service business that we have, we’re just really flattening out or taking up the lumps of just being a capital equipment company and this repeatable service business just happens and so we think we’re de-risking business model adding to the predictability and yeah it’s a great thing.

[Brian Weinstein:]

Great, last question from me on the business model for NicView. Can you describe what that business model looks like in terms of any upfront revenues and then what type of a recurring revenue stream do you get? In other words how do you price this thing? Thanks.

[James Hawkins:]

And that was for NicView you said Brian right?

[Brian Weinstein:]

Correct.

[James Hawkins:]

Yeah. Well, for NicView it’s an initial hardware sale and it’s around $60,000 for the average NICU and that’s what they sell into right now is just really the neonatal intensive care business and then we’ll get the 20% or 30% sort of maintenance fee to keep the software upgraded as we move forward. So it’s a nice repeatable model there. The big opportunity is trying to advance into the newborn care unit and that’s something that we are - again just having been in the business three months getting our arms around and we’re trying to understand exactly the best way to enter that market. There is a huge opportunity in the NICU still, so there’s no panic, urgency to get into newborn nursery, but internally we’re trying to get it all positioned for next year. So, and that’s if you look at the market sizes, I would say it’s like 80-20, the 20% is roughly the NICU and 80% is newborn. So a very big opportunity and then with NicView it’s not only a US product that can be just can be sold everywhere in the world and we are talking to people all the time and getting it budgeted Nicview outside the United States.

[Brian Weinstein:]

Are you also collecting your fee from the parents or from whoever want to view these babies or is that a fee that the hospital that would get. How does that work on kind of a per quick basis?

[James Hawkins:]

Yeah, so right now we’re not, we’re just selling it - it’s all a hospital sale. Going forward there are some very interesting opportunities especially as we get into the world baby nursery, where we’ve picked around the ideas of potentially having it as an app, where you can start getting per click fees and may be you can advertise and all sorts of things on there. It could be very revolutionary for a medical device company to have this kind of technology and application into this social media kind of application. So that’s really going to be we think a 2016 story, but we’re excited about the opportunities in that view to say the least.

[Brian Weinstein:]

Great. Thanks for taking the questions.

[Operator:]

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

[Jayson Bedford:]

Good morning and thanks for taking the questions. I guess first on Peloton, you mentioned that it has exceeded your expectations. Can you give us a level of revenue that you booked in the first quarter from Peloton?

[James Hawkins:]

We don’t talk about that. I don’t believe much, I think what we’ve said is, we have a goal for the year of $6 million to $7 million up from about $2 million last year, I think Jason. I’ll just say, it’s ramping up and tracking to that.

[Jayson Bedford:]

Okay and you also mentioned approaching 70 hospitals under contract, what are your goals for contracted hospitals for the year?

[James Hawkins:]

Yeah, so we’ve started last year and I think we ended the year at around 58 or 59 hospitals. And last year I think we branched out to may be 15 to 18 states something like that and what we said for this year is that our planning goal was not to bring a new state, but try to expand in our existing states because the more states we can get - after we have the infrastructure in a state, the more states we get in there is when it can become very profitable. So that’s what we’re focusing on. With all that said, we said, we were going to sort of slow down the rate of growth since we’re just going to focus in the states that we are in and our goal was to take it from the high 50’s up to about a 100 hospitals this year and I’d say we’re tracking to that.

[Jayson Bedford:]

On the warning letter, were there adverse events associated with these products or is this more of a labeling issue?

[James Hawkins:]

Yeah, I would say it’s a labeling issue overall that - I don’t want to get into too much of the details, but it’s tied to our neoBLUE product line, which is phototherapy . And as I said it’s approximately - well, it’s about $3 million of revenue in the United States a year, so it’s not certainly a major product line for us, it’s in our guidance, so it is what it is and we’re working to cure that.

[Jayson Bedford:]

And is there a path Jim, to reintroduce this product or do you kind of show it for now and highlight some other product?

[James Hawkins:]

Yeah, so this has all happened in the last week or two I would say and certainly the objective is - it’s a nice business for us, is to get this cured and back up marketing the product as soon as possible.

[Jayson Bedford:]

And then just lastly and I’ll let someone else to jump on here, but neuro side I realize it was impacted by foreign exchange, but a little weaker than we saw it. You introduced the ultrasound product in the fourth quarter, you’re just launching Quantum, is it fair to assume you’re expecting a bit of a pick up here in neurology over the next few quarters, just given the new product launches?

[James Hawkins:]

I would say Jason, another point to bring up in neuro. I’m trying to remember the exact number, maybe Jonathan you might know, but I want to say our backlog grew by $2 million or $3 million in neuro.

[Unidentified Speaker:]

It grew total by $2 million or $3 million over the prior quarter.

[James Hawkins:]

Yeah, that’s right.

[Jayson Bedford:]

That’s in neuro or for the entire business?

[Unidentified Speaker:]

For the total business, the newborn care backlog was about flat and most of the change was in neuro.

[Jayson Bedford:]

Okay, thank you.

[Operator:]

Your next question comes from the line of Larry Haimovitch with Haimovitch Medical Technology Consultants. Please proceed.

[Larry Haimovitch:]

Good morning, Jim. Congrats on all the progress.

[James Hawkins:]

Thanks, Larry.

[Larry Haimovitch:]

A little more of color from you on acquisitions, I know you’ve been very quiet on the acquisition front over the last many months. You did mention it in your prepared remarks, any more color you can provide on it in terms of potentially the type of company you would buy, would you maybe add a third leg to Natus for example? Would you be able to step up the valuation considering that your stock has moved up so much and you’re not working with an undervalued stock anymore?

[James Hawkins:]

Yeah, Larry let’s see. Where do I start? Certainly we have the same - we like to drive the same financial metrics, which is not to pay over half of what we’re treating at on a revenue basis. So for a three times revenues, we wouldn’t want to pay over one and a half time revenue, it’s just sort of a long tried, tested and through and really worked out for us. By doing that you never overpay and so that’s what we try to do. As far as the acquisitions itself, we certainly would like to do an acquisition, it’s meaningful that would be very accretive and give us good growth opportunities in the future. With that said, I would say though that we see such big opportunities with our core businesses that we have now. We’re sort of taking our foot off the gas a little bit on the urgency and the commitment to do an acquisition at the end of the year. I don’t know if you picked up the nuance in my prepared remarks, but it’s really, if the right opportunity were to present itself we would do the acquisition. And so we are going out and keeping an eye open and actually turning over some rocks, but I would say, we’re also feeling very good about our existing businesses and so to necessarily jump out and put on a third leg right now, just to do an acquisition, we think that the growth is there organically that there’s plenty of opportunities what we have. So hopefully that’s not too confusing, but we’re happy to drive the business as it exists, but we also, for the right acquisition opportunity - that’s where our balance sheet is cleaned up and we’re generating cash, that’s certainly a good option as well.

[Larry Haimovitch:]

No, I don’t think it’s confusing. If I heard you correct, I think what you’re saying is, you’ve got several wonderful internal initiatives that perhaps take the urgency of an acquisition off the table and gives you plenty to focus on within the company itself.

[James Hawkins:]

I think that’s well said Larry. Thanks.

[Larry Haimovitch:]

Okay, great. Okay, thanks Jim.

[Operator:]

There are no further questions in queue.

[Operator:]

Thank you. That concludes today’s question and answer session. Powell Brown, I’d like to turn the conference back over to you for any additional or closing remarks.

[James Hawkins:]

I would like to thank everyone for participating in our first quarter conference call. We’re very excited about where Natus is going in the remainder of 2015 and look forward to our next call as we present our results.

[Operator:]

Ladies and gentlemen that concludes today’s conference. Thank you for your participation. You may now disconnect. Have a great day.