Natus Medical Incorporated
Q3 2015 Earnings Call Transcript

Published: 21 Oct 2015

[Operator:]

Good day, ladies and gentlemen. Thank you for standing by. Welcome to the Natus Third Quarter 2015 Financial Results Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded today, October 21, 2015, and contains time-sensitive information that is accurate only as of today. Earlier today, Natus Medical released financial results for the third 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 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 these forward-looking statements due to a number of risk factors. For a description of the relevant risks and uncertainties that may affect the company's business, see its periodic reports on Forms 10-K and 10-Q filed with 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, please proceed.

[James Hawkins:]

Thank you, Operator. Our third quarter results that we released earlier this morning reported revenue of $94.6 million compared to $89.9 million last year. We also reported non-GAAP earnings of $0.39 compared to $0.33 in our third quarter last year. In the third quarter cash increased by $15.5 million excluding share buy backs. I’m very pleased with these results as we posted record revenues even with a $1.3 million negative currency effect, revenues and earnings exceeded our guidance and equally important, we outperformed on all of our performance metrics. In the quarter, we achieved a non-GAAP operating margin of 20%. This outstanding operating profit margin result along with being very satisfying also confirms our belief that Natus can become a business that can have an operating profit margin at much higher levels in the future. We have established an 18% operating profit margin goal in 2015, as well as a 20% operating profit margin goal for 2016. We now believe we will exceed our 2015 operating profit goal of 18% and we are well positioned to achieve or exceed a 20% operating profit margin in 2016. We have come a long way from the 8% operating profit margin we had in 2012. Our improved gross profit margin for the year 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. I’m very proud of our Natus team around the world and what they have accomplished. In our third quarter, both our newborn care and neurodiagnostic business segments performed well. Our domestic newborn care business and our neurodiagnostic businesses were exceptionally strong in the United States as our domestic sales organizations had another outstanding quarter. As many companies are reporting, business outside the United States continues to be challenging. The fact that we were able to overcome the negative effects of the strong dollar and economic weakness in several countries makes our results very satisfying. As we have communicated, reestablishing consistent organic revenue growth 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 a market leader we are positioned to lead our industry segments by developing innovative products that will drive organic revenue growth. We have established a new product pipeline that we are very excited about. We have also created and entered numerous service business initiatives that are tied to our market leading products and have made doing business as a service, a key focus for Natus going forward. We believe opportunity exist to provide our customers additional services rather than only selling them equipment. Earlier this year, we received FDA clearance for Quantum. Quantum is an innovative high channel amplifier that has applications in epilepsy and seizer monitoring along with research applications. By providing increased visibility of faster brain frequencies and 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 that customer response to Quantum has not only been very positive but we have exceeded our 2015 Quantum revenue goal already in the third quarter. We also look to add additional exciting new features to Quantum in the first half of 2016. We believe this is and will continue to be a blockbuster product. 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 again all reported strong results 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 hospitals as an alternative to purchasing equipment and disposables. We look to convert our existing ALGO customers to this new service model, as well as attracting new customers to Natus. As a worldwide leader in hearing screening devices, we believe we 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 expect Peloton revenue to ramp throughout 2015 and 2016 as we continue to market this service and develop this market. NicView and Global Neuro-Diagnostics, GND are two new business segments that Natus entered in our first quarter of this year. 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 64 hospitals in the United States and we plan to launch NicView 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 continue to expand GND throughout the United States. 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 report that we launched coverage on our new recently awarded five year $32.5 million contract with the State of California to provide hearing screening coordination services. This new contract added approximately $24 million in revenue open above the existing contract run rate during the five year contract. This contract commenced on July 1st. Last Friday we announced that Medix, our Argentine subsidiary signed a three year agreement with the Ministry of Health of Venezuela for $232.5 million to supply Venezuela with neonatal and obstetric equipment supplies and services. As stated in our filing, we are to receive three payments totaling $69 million by the end of the first quarter of 2016.Pre-payments are to continue throughout the contract period as we fulfill our requirements. We expect to commence on this contract in our fourth quarter but revenue is expected to be minimal in the fourth quarter. In summary, we are very pleased with our third quarter performance and operating results. We look to continue our strong earnings momentum and cash generation combined with consistent revenue growth as we finished 2015 and throughout 2016. With that I'll turn the call over to Jonathan to review our financials.

[Jonathan Kennedy:]

Thank you, Jim. 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, restructurings and certain other charges and the related tax effect. 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 could find a reconciliation of our earnings on a GAAP versus non-GAAP basis in today’s press release. As Jim stated, we reported third quarter 2015 revenue of $94.6 million, a 5.2% increase from the same period last year. Euro and Canadian dollar exchange trends negatively impacted revenue by about $1.3 million during the third quarter compared to the same quarter last year. This currency impact primarily affected revenue in our neurology business. Revenue from our neurology market increased to $59.5 million or 63% of total revenue during the third quarter of 2015 compared to only $58.7 million or 65% of total revenue from the same quarter last year. Revenue from our newborn care market increased to $35.2 million or 37% of total revenue during the third quarter of 2015 compared to 31.2% or 35% of total revenue during the same quarter of last year. On a consolidated basis revenue from devices and systems contributed approximately 58% of total revenue in the third quarter of 2015, compared to 61% in the 2014 period, while revenue from supplies and services was approximately 42% of total revenue in the third quarter compared to 39% in the 2014 period. Revenue from domestic sales was approximately 66% for the third quarter of 2015 compared to 63% in the same period in 2014. Revenue from international sales was approximately 34% for the third quarter of 2015 compared to 37% for the same period in 2014. On a non-GAAP basis, our gross margin decreased by 60 basis points in the third quarter to 62.4% compared to 63% in the third quarter of 2014. Non-GAAP operating expenses increased $0.6 million compared to the same quarter of last year and our non-GAAP operating margin increased to 20% compared to 19% for the same quarter of last year. Our third quarter non-GAAP effective tax rate was approximately 31.3%. We expect to finish 2015 with an annual rate between 31% and 32%. On a GAAP basis, net income increased to $10.9 million or 33% per diluted share a $3.1 million increase from the same quarter last year. Non-GAAP net income increased $2.3 million or 22% compared to the same quarter last year and non-GAAP earnings per share increased 18% to $0.39. In the third quarter, we recorded approximately $4.2 million of depreciation and amortization expense. Equity based compensation was about $1.9 million during the third quarter. Now let's look at the balance sheet and cash flow. We repurchased $6.5 million of company's stock and net cash increased to $15.5 million excluding the stock purchases. Our days of sales outstanding increased 4 days during the quarter to 86.5 days and this increase was due to the timing of revenue during the third quarter, as compared to the second quarter of 2015. Our diluted shares outstanding increased to $33.2 million compared to $32.6 million in the third quarter of last year. With that I will turn the call back to Jim.

[James Hawkins:]

Thanks Jonathan. Before opening up the call to questions, I would like to review our financial guidance for our fourth quarter and full year 2015 all on a non-GAAP basis and make a few closing comments. For the fourth quarter of 2015, we expect revenue of $102 million to $105 million and non-GAAP earnings per share of $0.47 to $0.49. This compares to revenue of $94 million and non-GAAP earnings per share of $0.40 in the fourth quarter last year. We are increasing our 2015 non-GAAP earnings per share guidance to $1.51 to $1.53, an increase from previous guidance of $1.50 to $1.52. We are increasing our full year 2015 revenue guidance to a range of $378 million to $381 million increased from the previous guidance of $376 million to $378 million. We plan to give our 2016 guidance on Monday January 11 of next year. As I reflect on what we have built in neurology, a newborn care at Natus it is more satisfying. With the 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 and now the large order from Venezuela uniquely positions Natus for an exciting future. With that, we will turn the call over to questions. Operator?

[Operator:]

[Operator Instructions] Your first question comes from the line of Chris Lewis representing Roth Capital. Please proceed.

[Chris Lewis:]

Good morning. Thanks for taking the questions. Wanted to start on the Venezuelan contract, hoping you could provide a little bit more color just on how we should think about that contract contributing next year both in terms of revenues and earnings and the cadence of when those prepayments expected by the first quarter will be recognized as revenues throughout 2016.

[James Hawkins:]

Sure. Just briefly review that. First, we haven't given guidance for next year yet. So take that in consideration but I would say it will probably be fairly even throughout the three years. It is probably a good way to look at it. We expect to receive some payments here by the end of the year to start those three payments totaling to $69 million and then to – have most likely those will extend into the first quarter of next year. Once we get those payments, we will be in a position then to start shipping. As we know the way this contract is, we are going to be prepaid throughout the entire contract, so we will ship after we get prepaid, we will get more prepayments and we will have that kind of cadence.

[Chris Lewis:]

Great. And so sales start coming through, how should we think about that impacting the overall gross margin profile and OpEx profile for the company?

[James Hawkins:]

Yes certainly on the gross profit side, it's going to reduce our gross profit going forward during the life of this contract. On the bottom line, we don’t think it will have much of an effect. We believe it will have - it will carry about the same operating profit margin that our regular business has. What we are looking to do on this so is to separate out this Venezuela revenue quarter-by-quarter along with the gross profit. So then I think it will be good for our shareholders and you Chris and other analysts will be able to see how both sides of the business are tracking.

[Chris Lewis:]

Great, appreciate it. And then if I could just turn to operating margins, congrats on the strong quarter there with 20%. If I look at the updated guidance for the year, gets me on operating margin above 19%, so actually closer to kind of that 20% goal that you have laid out in the out years versus the original goal of 18% this year. Can you just talk a little bit about where that plan has been driven this year versus the original outlook and where the further expansion opportunities are going forward? Thanks.

[James Hawkins:]

Jonathan, you want to take that.

[Jonathan Kennedy:]

Yes, Chris. One of the areas we have done pretty well this year versus last year is in our gross margin. On a non-GAAP basis prior year gross margin was right around 60 and we are triangulating to be above 61, maybe as high as 62 for the year. And so that’s contributed quite a bit to the operating margin. And then on top of that our operating expenses have held fairly flat to the prior year. So just to follow through, our operating margin has helped quite a bit and the source of that gross margin increase has been increased revenue and also reduced product cost and operating cost in the overhead section.

[Chris Lewis:]

Perfect. And just one more for me. Can you give some update on what the share buyback stands today as you continue to build that cash balance what are the plans for repurchasing shares going forward. Thanks.

[Jonathan Kennedy:]

Sure, it's Jonathan again. We have $20 million share repurchase plan open right now. We have executed about $5 million of that, maybe a little less, so we've got about $15 million worth of share repurchases that we would expect to do evenly over the remaining period of the plan, which runs through June of next year about $15 million between now and June.

[Chris Lewis:]

Okay. Thanks for the time.

[Operator:]

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

[Jayson Bedford:]

Good morning, and congrats on the progress. The first couple questions here, what was the contribution from NicView and GND in the quarter?

[Jonathan Kennedy:]

We typically, I don't believe to break that out Jayson. They both certainly had nice growth year-over-year and both were nicely profitable. We have so many level different initiatives now I think if we try to constantly give each segment as we get into more services, it just gets to be too much detail, but all obviously continue to carry a lot of water for us throughout the quarter.

[Jayson Bedford:]

Fair enough. In the fourth quarter guide, is there any contribution from the Venezuela contract?

[Jonathan Kennedy:]

Yes I think we put in a couple of million dollars in there. I think as we go forward on that, we will probably have a tendency to be conservative on those forecast that we give in our guidance. It's sort of practice of ours anyway. We'd rather be on a conservative side and if we do better great, but certainly those numbers are ones we would hope to hit.

[Jayson Bedford:]

Got you. And on this call you seemed to talk more about the pipeline, I think you mentioned the line extension with Quantum. Can you may be give us an idea to may be the number of products you have coming out over the next year to 18 months and maybe what those products may do to your growth profile.

[Jonathan Kennedy:]

Yes. Basically there was a couple of products in each segments of the business, neurology and newborn care. We really don’t give forecast or guidance on new products. But I’d say that these products that we have typically aren't going to be products that are $20 million to $50 million in revenues. They are probably more in the 0 to $20 million revenue opportunities over time.

[James Hawkins:]

Yes. We talked extensively of the model of Peloton, GND when we introduced NicView we talked about that. Those are the larger of our opportunities and the rest are product extension, there are technology updates in the field really more of - a means to continue to keep Natus at the forefront of technology not so much major revenue drivers. They're helpful but they are not big news.

[Jayson Bedford:]

Okay. So some but more line extension versus incremental new opportunity.

[Jonathan Kennedy:]

Well I'd say – it's incremental new opportunities, but let's say where Peloton could get to be a $100 million business. A new product probably is going to be in the $10 million to $20 million opportunity range. It’s just a different kind of ramp.

[Jayson Bedford:]

Fair enough. And may be last one and then I'll let someone else jump in. Is the ERP system now integrated? And then secondly, what's the anticipated impact on margins with that now part of the fall?

[Jonathan Kennedy:]

Yes. The ERP system is completed. We went live in August with the remaining piece, so that’s done. The impact on margins, we haven quantified exactly what that’s going to be as a standalone project. But I can tell you Jayson that over time that system will enable Natus to operate in much efficient manner than it is today. But its going to be over a period of time and you'll see that through our increases in gross margin, increase in operating margin. And on Jim's comments, he said that we had said that we had an opportunity to go all beyond the 20%, the implementation of the ERP system is just one piece of the puzzle to make that happen

[Jayson Bedford:]

All right. Thanks.

[Jonathan Kennedy:]

Thanks, Jayson. Maybe we should let another question come in.

[Operator:]

Your next question comes from the line of Brian Weinstein, representing William Blair. Please proceed.

[Brian Weinstein:]

Hey, guys. How are you? So couple of questions. First, on the Venezuela contract. Can you talk about how that revenue sort of breaks out between new devices and services and stuff that you are bringing in from third parties? And then I would assume that there would be a backend tail. It’s a three year contract, but assuming that they are buying some equipments that’s going to need disposable down the line. Can you help us kind of understand the contribution from the disposable component end?

[James Hawkins:]

Sure. Natus products itself its about $50 million between Natus and Medix that we'll be supplying. Then there is a – the biggest component of that will be for other products that we don’t manufacture and then there also a service installation and training component to it, that totals a 230, $2.5 million. And yes, we think you're right, after this contract expires we do believe there will be a continuing relationship for supplies, other products going forward. So this contract a long time in the making and we're very excited to have it and very pleased about it. I think we had mentioned a few different times, that it was a possibility even when we acquired Medix five years ago, this was certainly something that we had thought as a possibility and here its happened, really bigger than we thought. So very excited.

[Jonathan Kennedy:]

The other comment to make about this, this is in the first contract we'll have with Venezuela that Medix has entered into. So this is a continuation of an ongoing relationship, while its lumpy it comes over the course of several years. The orders are typically very large and stretch out over many years. So when we acquired Medix in 2010 they had just completed a, I want to say about $100 million deal with Venezuela. So there is an ongoing relationship between Medix and other South American country that is valuable.

[Brian Weinstein:]

Great. On the gross margin, I want to make sure I heard this right. You said, you were down 60 basis points, but you did have more growth in the US and you had more service component to the revenue. So can you explain kind of the gross margin, why it was down year-over-year?

[Jonathan Kennedy:]

Yes. I mean, it was down 60 basis points, which is a – that small numbers that we deal in, I would say still in the noise. But yes, the service businesses, especially Peloton, doesn't have the same high gross margin, the operating margin is accretive, but the gross margin is dilutive, so that’s a piece of it, maybe probably the biggest piece. And then secondly, always mixed, depending on what we're selling and to whom and how much is going through distribution, always a factor. So if you look at the spreadsheet with the analysis on it, it's a lot of little number added up to another small number.

[James Hawkins:]

When you look at Peloton Brian, most of our cost are above the line and consider the cost of sale, cost of goods sold. The screeners going in, there are all those people that are doing the service affects the gross profit somewhat. But the bottom line, there is not a lot of cost below that gross profit line. So it is – it doesn’t help our gross profit so much, but it certainly helps our bottom line.

[Brian Weinstein:]

Okay. That make sense. I guess I didn't appreciate that fully. Okay. And then Jim, you talked about opportunities to add additional – additional opportunities for bringing on services to your customers. Where are you in that sort of process, I mean, obviously large deals are off the table now. But are there NicViews and GNDs that are still out there? And should we expect that something that you guys are going to be willing to pull the trigger on in the next, I don’t know, whatever time frame you want to comment on?

[James Hawkins:]

Yes. There is two sides for that. One is that we can add additional services through our existing network at GND and Peloton and NicViews. There is something’s that we can do we believe that will attach to the services that we have in that channel. Then as you said there is also other opportunities for acquisitions and yes, that’s something that we are continuing to look at, most of these would be smaller in nature I would say at this point. But if the right opportunity came up for a larger service opportunity, we certainly look at it. But its – that’s not our focus is.

[Brian Weinstein:]

When do you think that we would learn about some of these additional services that you can add to GND and NicViews, that’s something let say a 12 month timeframe, was that six months, its intriguing…

[James Hawkins:]

Yes. I'd say, and 2016 probably a third time line.

[Brian Weinstein:]

Okay. And I think that, last question, any other state programs on the hearing screening side that you guys are working on or is that an area that we should expect additional comments on, over the next year as well?

[James Hawkins:]

Yes. So, yes, we are. And we're not going to get into detail there, but we are talking with other states. I will say thought that these don’t happen overnight, states have a way they've been doing it in the past and to go then to our model its typically a one to two year process to get them to convert over. There is a lot of bureaucracy involved, and it just takes time. But yes, we are talking to other states.

[Brian Weinstein:]

Okay. Great. Thanks.

[James Hawkins:]

Sure.

[Operator:]

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

[Larry Haimovitch:]

Hey, Jim. Hi, Jonathan. Just quick question, quick question Jonathan, its kind of technical accounting question. Given that the Venezuelan contract involves prepayments, I was just curious from an accounting standpoint, will you still recognize revenue on shipment or does the prepayment in fact represent a way that you can recognize revenue in advance of actually shipping?

[Jonathan Kennedy:]

No, I mean, the matching principle still applies. We have to perform on a contract before we recognize the revenue. So while the cash will increase, we'll have a deferred revenue that will also increase and then revenue gets recognized as we perform services, as we ship products and complete the contract.

[Larry Haimovitch:]

Okay. And then second question is, is the contract have equal installments for all three years, is it pretty much exact same amount of money each year?

[Jonathan Kennedy:]

Yes. The contract has a little bit heavier payments in the front and as it tails down. So we will always be in a position of being ahead. But the prepayments are pretty equally spread, other…

[Larry Haimovitch:]

And these are all…

[Jonathan Kennedy:]

24 months on a contract.

[Larry Haimovitch:]

And these are all in US dollars, right?

[Jonathan Kennedy:]

Right. We get paid in the US dollar instrument and then we convert those to pesos when we need to purchase and pay for the stuff we buy in Argentina.

[Larry Haimovitch:]

Okay. So is there any foreign exchange implications of that because the cost of peso has been plunging, as you – I am sure well aware?

[Jonathan Kennedy:]

Yes. I mean, there is foreign exchange, no doubt. Any time you deal with the countries in South America there is currency controls and there is exchange risks. The thing that most protective on us here is that we do get the contract is denominated in dollars and our payment is a dollar denominated payment. So over time, we will be recognizing - we're taking prepayments in a constant currency. Once we convert the currency into pesos to pay vendors and employees then will take the currency risk to the extent of that – that peso stays on our balance sheet. But our intend would be to time that, to go equally timed, so that as we're collecting pesos we're paying pesos, and it minimizes the currency risk. But there is some risk, although I call it minimal.

[Larry Haimovitch:]

Okay. Great. Thank you. Congrats.

[Jonathan Kennedy:]

Thanks.

[Operator:]

Ladies and gentlemen, this concludes the question-and-answer session. I would now like to turn the call back to Mr. Jim Hawkins for closing remark.

[James Hawkins:]

Thanks, operator. Well, in closing, I would like to say that we're very pleased with our achievements so far in 2015 and look forward to finishing another great year at Natus. We also want to thank you for participating in today's call and for your continued interest and support. Thanks again.

[Operator:]

Thank you. Ladies and gentlemen thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Good day.