Natus Medical Incorporated
Q2 2015 Earnings Call Transcript

Published: 22 Jul 2015

[Operator:]

Ladies and gentlemen, thank you for standing by. Welcome to the Natus Medical Second Quarter 2015 Financial Results Conference Call. At this time, all participants are in listen-only mode. Later, we will conduct a question-and-answer session. [Operator Instructions]. As a reminder, this conference call is being recorded today, July 22, 2015, and contains time-sensitive information that is accurate only as of today. Earlier today, Natus Medical released financial results for the second 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

[James Hawkins:]

Thank you, operator. Our second quarter results that we released earlier this morning reported revenue of $91.9 million compared to $86.3 million last year. We also reported non-GAAP earnings of $0.34 compared to $0.28 in our second quarter last year. I’m very pleased with these results as we posted record revenues even with a $1.5 million negative currency effect and earnings exceeded our guidance and equally impressive, we outperformed on all of our important metrics. In the quarter we achieved a non-GAAP gross profit margin of 63.2%. This outstanding gross profit margin result along with being very satisfying also confirms our belief that Natus can become a 65% gross profit margin business in the future. Also, our non-GAAP operating profit of 18.5% in the second quarter is a substantial improvement over the 13.3% we reported last year. We continue to drive to our operating profit margin goal of 18% in 2015 as well as our 20% operating profit margin goal for 2016. 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 along with excellent execution of our operating plan by all at Natus. In our second quarter, both newborn care and neurodiagnostic business segments performed well. Both our newborn care and neurodiagnostic business segments were exceptionally strong in the United States as our domestic sales organizations had an outstanding quarter. As we have communicated, reestablishing consistent organic revenue has been a major goal for Natus. 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 will drive organic growth. We have established a new product pipeline that we are very excited about. We have also created and entered numerous service businesses 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 opportunity exists to provide our customers additional services rather than only selling them equipment. In the second quarter, we received FDA clearance and began shipping our new Quantum amplifier. Quantum is an innovative high channel 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 in a dual data stream all in a compact wearable package. We believe Quantum is the first major product innovation in many years in the neurodiagnostic market. I'm pleased to report the customer response to Quantum has been very positive. 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 record revenues in the quarter. For new investors that may not be familiar with our service initiatives, I would like to briefly review Peloton, GND, NicView and coordination services. Peloton, which started in Q1 2014, offers newborn hearing screening test for hospital 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 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 $100 for actually performing the hearing screening test. We signed 12 new hospitals during the second quarter and we expect Peloton revenue to ramp throughout 2015 as we continue to develop this market. NicView and Global Neuro-Diagnostics, GND are two new business segments that Natus entered in during the first quarter of 2015. NicView provides streaming video for families with babies in the neonatal intensive care unit or 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 longstanding need in the NICU and hospital nurseries. We hope to make NicView a standard practice for NICUs and nurseries worldwide. I am pleased to report NicView is now in over 50 hospitals in the United States and we expect to complete our first NicView installation outside the United States in the fourth quarter. 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 the current base starting this quarter. Peloton, NicView and GND are rapidly growing new offerings to the marketplace that represents 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 our new contract to provide hearing screening coordination services to the state of California commenced on July 1 as planned. This five-year agreement will add approximately $24 million in total revenue or $4.8 million annually over and above the current California contract. In summary, we’re very pleased with our second 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, 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 second quarter revenue of $91.9 million, a 6.5% increase from the same period last year. The euro and Canadian dollar exchange trends negatively impacted revenue by approximately $1.5 million during the second quarter. This currency impact primarily affected revenue in our neurology business. However Natus has a natural hedge as our euro and Canadian dollar manufacturing and operating expenses benefited by a similar amount, mitigating currency impact to our bottom line. Revenue from our neurology market increased to $58.6 million or 64% of total revenue during the quarter of 2015, compared to $55.8 million and 65% of total revenue during the same quarter of last year. Revenue from our newborn care market increased to $33.3 million or 36% of total revenue during the second quarter of 2015 compared to $30.6 million or 35% of total revenue during the same quarter of last year. On a consolidated basis, revenue from devices and systems contributed approximately 57% of total revenue in the second quarter compared to 61% in the 2014 period while revenue from supplies and services was approximately 43% of total revenue in the second quarter compared to 39% in the 2014 period. Revenue from domestic sales was approximately 66% for the second quarter compared to 61% in the same period in 2014. Revenue from international sales was approximately 34% for the second quarter compared to 39% for the same period in 2014. On a non-GAAP basis, our gross margin increased by 370 basis points in the second quarter to 63.2% compared to only 59.5% in the second quarter of 2014. The year-over-year non-GAAP gross margin improvement was primarily driven by higher relative US revenue where we sell direct and have higher gross margins, combined with a more favorable mix and product sales as well as reductions in overhead spending as we completed the closure of our New York distribution facility. Non-GAAP operating expenses remained constant compared to the same quarter last year. Our non-GAAP operating margin increased to 18.5% compared to only 13.3% for the same quarter last year. Our second-quarter non-GAAP effective tax rate was approximately 32.9%, and our tax rate is expected to remain approximately at this level throughout 2015 as we expect our US based business to drive profitability during the rest of the year. Other income was actually an expense of $0.4 million during the quarter, which was a result of foreign currency losses on intercompany loans. On a GAAP basis, net income increased to $9.9 million or $0.30 per diluted share, a $2.4 million increase from the same quarter last year. Non-GAAP net income increased $2.3 million or 25% compared to the same quarter last year to $11.2 million and non-GAAP earnings-per-share increased 21% to $0.34. In the second quarter, we reported approximately $4.2 million of depreciation and amortization expense. This is about $1 million higher than in prior quarters as we placed finite lives on our trade names during the second quarter and began amortizing them. Equity-based compensation was approximately $1.7 million during the second quarter. Now let’s go to the balance sheet and some cash flow metrics. Net cash increased by $6.2 million in the quarter and we repurchased approximately $4.4 million of company stock. Our days of sales outstanding remained a constant 83 days compared to the prior quarter and our diluted shares outstanding increased to 33.2 million compared to 32.4 million in the second quarter. With that, I’ll turn the call back to Jim.

[James Hawkins:]

Thank you, Jonathan. Before opening up the call to questions, I would like to review our financial guidance for our third quarter and the full year 2015 all on a non-GAAP basis and make a few closing comments. For the third quarter of 2015, we expect revenue of $93 million to $94 million and non-GAAP earnings-per-share of $0.37 to $0.38. This compares to revenue of $89.9 million and non-GAAP earnings-per-share of $0.33 in the third quarter last year. We are increasing our 2015 non-GAAP earnings-per-share guidance to $1.50 to $1.52, an increase from the previous range of $1.47 to $1.51. We are maintaining our full year 2015 revenue guidance to a range of $376 million and $378 million. Again, with the continued strengthening of the dollar in July, we feel it prudent not to raise full year revenue guidance. 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 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 fast growing NicView along with our coordination services uniquely positions Natus for an exciting 2015 and 2016. With that, we will turn the call over to questions. Operator?

[Operator:]

[Operator Instructions] Your first question comes from Chris Lewis from Roth Capital Partners.

[Chris Lewis:]

Wanted to start on the gross margin strength in the quarter. Can you perhaps elaborate on the key drivers that led to that upside in the quarter? And then second, you unveiled the expectation that this could become a 65% gross profit business at some point in the future. Maybe walk us through where that additional expansion comes from that would get you to that level and what do you think a realistic timeline is to achieve that goal? Thanks.

[James Hawkins:]

Yeah, maybe I’ll start off with the second part of the question and then I’ll hand it over to Jonathan for some details. But you know, we have kicked around that we think with our innovative new products, with our service opportunities, businesses that we are creating along with just the management of our business and with a strong position in the marketplace, that there is no reason over time Natus cannot be a 65% gross margin business. We’ve been driving that to that over the last few years internally. So we thought we’d really start talking about that so investors can get the idea of where we are going to take this business. Now we are not setting any timeline on this, certainly not next year but we do continue to make strides towards that over the next one, two, and three years. So we think it will be a nice pleasant journey and Jonathan, maybe to just comment on this most recent improvement.

[Jonathan Kennedy:]

Sure. Yes, the recent improvement was an outstanding result for Natus, no doubt. A couple – really several things added up to that. First, the relative US mix of revenue definitely plays a role in that where we sell outside the US primarily it goes through distribution where there is a lower gross margin. So as revenue outside the US declines relatively, then the US market strengthens. But beyond that, we’ve also got a lower cost where we manufacture in Europe as a result of the euro, so that’s helpful. And we’ve migrated some of our production to Europe over the last several months and so that migration is now benefitting from an even lower cost due to currency. But then beyond that, we’ve done a numerous cost reductions both on the direct labor side, also on material costs, we’ve reduced that over the last several months. We have reduced – I made a comment in my prepared remarks – we reduced the size of our footprint in the US. We had a New York distribution facility that was part of an acquisition many years ago, we reduced that. So it’s really a number of things that are pushing the gross margin in the direction that we always had anticipated but the currency move has really juiced it this quarter and we expect this currency to more or less stay this way for some time. I don’t think it’s a temporary issue. So the company was already lined up to take advantage of a European cost structure and now that’s gotten even cheaper.

[James Hawkins:]

You know, one other thing that we’ve done sort of at the corporate level is made the conscious decision not to really going aggressively lower our prices to be more competitive in Europe. We believe our products are good. We’ve kept our pricing and even though, hey, if we dropped our prices, I am sure it would help revenues. But we wanted to maintain the high margins and we’ve done that, and I think that’s having an effect as well.

[Chris Lewis:]

Great. And then for Peloton, it appears you’ve continued to gain steam there. Perhaps you can just give us a sense of how many hospitals you expect to exit the year and then, second, maybe you could update us on the profitability profile of that business now and what you expect exiting this year? Thanks.

[James Hawkins:]

Okay. I’ll – and thanks Chris for your questions, then we should let some others get an opportunity. I’ll start off. Certainly for the year we had set a target of 100 hospitals, we are about 80 now. And so we are driving towards that and feel that’s certainly a – it’s certainly a realistic goal. As we talked about, we’ve slowed down that expansion to focus in states that we are already established in to really get to profitability and for the profitability part, I will pass it over to Jonathan.

[Jonathan Kennedy:]

So the second quarter marked the first really solid profit quarter for Peloton. We’ve grown faster and spent more than we thought on the infrastructure build. It was somewhere in the mid-20s in terms of operating profit for the quarter. We expect that now to continue as we lever the business and as we get more hospitals online, we can sign contracts, there is a delay in actually providing service and then getting paid, and that is all starting to catch up now. So as we exit the year, we would expect Peloton to be contributing above the corporate average of our operating margins, so that’s been a really positive. And I’ll also point out on gross margin relative mix, think of Peloton, GND, our services are all US businesses. So they have an impact to gross margin, typically favorable but also an unfavorable impact to taxes when we get down to tax line. So some of these US growing businesses are putting pressure on taxes but also helping gross margin.

[Operator:]

Thank you. Our next question comes from the line of Brian Weinstein from William Blair & Company.

[Brian Weinstein:]

Hi good morning. Thanks for taking the questions. Can we talk a little bit about the revenue contributions from Peloton, GND and NicView, so we can sort of back into kind of an organic number? I think in the first quarter, Jim, you had talked about $800,000 from Peloton. How did that track in Q2? What were the contributions from GND and NicView?

[James Hawkins:]

Yes, I don’t have those exact numbers, Brian, and we don’t want to make it – to be tracking every little product line that we have. But just in a general way, I will be able to comment on some of that. Peloton, I believe, revenues almost doubled from Q1 to Q2, right up from maybe that $800,000 mark to $1.6 million. So it was very solid. GND did $2 million or more, performed very well. And the California contract had not started yet, so we didn’t get any additional California business but on the NicView side, where I think when we got into that business in January, they were doing approximately 1 million, 250,000, 300,000 a quarter, I think in Q2 we did north of 700,000 in the quarter and we look for all these businesses to continue to grow rapidly. So we are very excited about these service initiatives.

[Jonathan Kennedy:]

I would say also, when we think of organic growth, the only two items we really would not include NicView and GND, the run rate we acquired in Peloton, by all means is organic. So pulling those throughout our organic growth rate, excluding NicView and GND was well over 3% when you all those in, it brings you to the 6.5% on a current basis of currency – on a constant currency basis, it’s even better.

[Brian Weinstein:]

Okay. That makes sense. Okay. Jim, can you talk a little about the European market and what you are seeing there relative to your kind of capital spending and kind of what you are seeing on maybe not a country by country specific basis but kind of just globally, in Europe? You had talked about some weakness over the last couple of quarters as it compares to the US market. So how do things appear like they are shaping up there for the back half in Europe?

[James Hawkins:]

Yeah, so I would say overall it’s more of the same, Brian. We have certainly with the strong dollar, it’s had some of our customers pull back potentially delay some purchasing that they had hoping I think that the dollar would maybe flip around. We’ve also -- competitively when we have European or outside the US competitors, that certainly has been advantageous for them but with all that said, our business has held up relatively okay. But it certainly is not in a big growth expansion mode, and we sort of have that forecasted to continue as Europe really stabilizes here but certainly not bad but it certainly is not the growth ramp that everyone would like. And just to elaborate, China is sort of in the same position there. Business is solid but it’s not, I would say, in the high-teens growth that we had seen for some time. It’s probably below 10%. I might be out on a limb there but it’s probably in the 5% to 10% range the growth in China. So in Latin America sort of similar, so outside the US it’s little hard to determine, some of it’s strong dollar, some of it’s their I think businesses or economies are slowing down or contracting and – but overall we feel we are gaining market share and doing very well and like I said we are not dropping the price just to get business. We don’t feel we have to do that and we don’t plan on doing that.

[Brian Weinstein:]

Great. Jonathan, any change on the backlog? Is it still running about the same as when you guys last reported the number?

[Jonathan Kennedy:]

Yes, it’s a little bit lower than it was the last quarter and the quarter a year ago. Now I won’t say materially but definitely down a little bit, down [5 million or $1.5 million] versus last year same time.

[Operator:]

And our next question comes from the line of Jayson Bedford from Raymond James.

[Jayson Bedford:]

Good morning and thanks for taking the questions. Just a couple. Can you -- you mentioned the over 50 accounts for NicView as the installed base. Can you just give us a sense of how many -- what was the installed base when you acquired the business? And then just as a related follow-up, can you remind us of the economics around NicView?

[James Hawkins:]

Sure, Jayson. I think it was around 30, 32 hospitals when we acquired them at the end of January or middle of January. We are now up 50 or above and boy, the quotes outstanding, I think we have 80 or 100 hospital quotes out there. And so we really are encouraged that this thing is going to continue to ramp for us. The economics of it in general, it’s for the standard size NICU, it’s about $60,000 but some hospitals might be $100,000 to 150,000 the actual purchase price. And then we typically get around a 20% sort of like service annuity software companies do just to sort of maintain the system. So that would go on forever. So it’s a very strong model and we see expansion now starting in Q4 outside the United States where we are getting a lot of interest as well. So NicView is going to be a big win for Natus and that’s even just being in the NICU. We still have plans and we are putting together plans to how to get into the well baby nursery and – but that’s really a 2016 event. But that’s the big part of the market and the big opportunity but the NICU is very nice opportunity as well.

[Jayson Bedford:]

Understood. You've kind of shifted your commentary around large acquisitions, but just given the cash balance, can you talk about your appetite for tuck-in deals and are there enough deals out there, say under $20 million in revenue that would make a difference over the next year?

[James Hawkins:]

Yes, so I think what I previously communicated, Jonathan and I was that we were not going to do a major acquisition this year. I don’t think we said anything about next year. Next year is next year. Going to your question on the tuck-ins, yes, there are some opportunities out there. With the growth that we are having, we don’t feel like we have to but most likely there will be some tuck-ins. And as we typically do at Natus, we try to buy them right and have them be immediately accretive and we would hope that trend to continue.

[Jayson Bedford:]

And just lastly as a follow up, what do you think the FX implied in your guidance, the FX impact [indiscernible] on revenue?

[James Hawkins:]

I think it’s around $8 million, isn’t it, $7 million to $8 million?

[Jonathan Kennedy:]

Probably closer to $7 million, $8 million. We did about 3.5 million year to date and then the second half typically has higher revenue, so it should scale about that. That’s at today’s rates. Where the dollar strengthens, it gets worse; dollar weakens, it gets better. But I would reiterate from us from a bottom line perspective, Jayson, we are somewhat immune to that. Top line for sure, tracking revenue growth rate, that sort of thing, absolutely but on the cost side, we do have a pretty decent hedge.

[Operator:]

Thank you. Your next question comes from the line of Larry Haimovitch from HMTC.

[Larry Haimovitch:]

Congratulations on all the [indiscernible] With the tremendous growth you've had with the cash generation you've had, have you given any thought at all to initiating a small dividend? I realize you've been buying back stock and that's obviously a good use of funds. But at some point with the stock up so much, I wonder whether you would continue to do that. Obviously, cash could be used for acquisitions, but has the board ever thought about initiating a small dividend?

[James Hawkins:]

Sure, Larry. It’s been talked about and – but at this time we feel that the stock buyback is certainly the best avenue and one of the reasons is that we have a lot of options, from the past 10 years that are out there. And we really want to try to limit the growth in share count, outstanding shares. Perhaps once these options get behind us and then it really drops down, because now we are typically doing RSUs, so much fewer shares that are for management incentive. Perhaps that will be looked at again but now right now the board’s, I think and rightfully so, concluded that the share buyback is the best thing for our shareholders.

[Larry Haimovitch:]

And Jonathan, it was the buyback $4.5 million in Q2?

[Jonathan Kennedy:]

Yes.

[Larry Haimovitch:]

And how much remains on the buyback that was authorized by the board?

[Jonathan Kennedy:]

Well, the 4.4 really closed out in the first 10, now we got about 20 left. So we just did a new –

[Larry Haimovitch:]

You have 20 left?

[Jonathan Kennedy:]

The 20 is pretty much available [indiscernible]. End of Q&A

[Operator:]

Okay, thank you. And with no more questions, I would now like to turn the call back over to Jim Hawkins for closing remarks.

[James Hawkins:]

Well, in closing, I would like to say that we are very pleased with the success we’ve had so far in 2015 and look forward to continued execution during the second half of the year. We also want to thank you for participating in today’s call and for your continued interest and support. Thanks again.

[Operator:]

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect. And good day.