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Edited Transcript of BABY earnings conference call or presentation 25-Apr-19 8:30pm GMT

Q1 2019 Natus Medical Inc Earnings Call

SAN CARLOS Apr 29, 2019 (Thomson StreetEvents) -- Edited Transcript of Natus Medical Inc earnings conference call or presentation Thursday, April 25, 2019 at 8:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Benjamin Drew Davies

Natus Medical Incorporated - Executive VP & CFO

* Jonathan A. Kennedy

Natus Medical Incorporated - President, CEO & Director

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Conference Call Participants

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* Brian David Weinstein

William Blair & Company L.L.C., Research Division - Partner & Healthcare Analyst

* Jayson Tyler Bedford

Raymond James & Associates, Inc., Research Division - Senior Medical Supplies and Devices Analyst

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Presentation

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Operator [1]

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Good afternoon, everyone, and thank you for joining us today to review our results for the first quarter of 2019. On the call today from Natus is Jonathan Kennedy, Natus' President and Chief Executive Officer; and Drew Davies, Natus' Executive Vice President and Chief Financial Officer.

Jonathan will begin today with a business overview of the first quarter 2019. Then Drew will discuss the first quarter financial performance and provide guidance for the second quarter and full year 2019. Finally, we will open the call for your questions. (Operator Instructions)

Today's call will include forward-looking statements within the meaning of the Private Securities Litigation Reform Act. These statements include management's beliefs and expectations about our future results. Our actual results may differ materially from these forward-looking statements. For a description of relevant risks and uncertainties pertaining to our business, please see today's press release and our periodic and annual reports filed with the SEC.

I would now like to turn the call over to Jonathan Kennedy, President and Chief Executive Officer of Natus Medical. Mr. Kennedy?

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Jonathan A. Kennedy, Natus Medical Incorporated - President, CEO & Director [2]

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Thank you, operator, and good afternoon, everyone. Today, we reported our financial results for the first quarter of 2019. Revenue for the first quarter was $114.8 million, achieving the higher end of our guidance expectations. The strength in revenue was due to our achieving the higher end of expectations in completing the Audiology product registration and releasing many of the ship holds that we identified during our last quarterly conference call. Within our Neuro end market, sales of EEG products grew 12.5% year-over-year as we continued to grow our market-leading position and hospital spending remained favorable. Otoscan, our digital ear scanning product, continued to ramp up in the Audiology market and phototherapy product sales grew significantly with the relaunch of our neoBlue blanket, which was just announced last quarter. Drew will discuss revenue in further detail in just a few minutes.

GAAP and non-GAAP gross margins increased year-over-year as both our product mix and manufacturing costs have been more favorable. Cash flow from operations was $7.1 million during the quarter, which included $3.3 million of cash severance payments.

In January, we announced our One Natus initiative. This ongoing effort is better positioning us for growth. It's improving our product quality and making us more a efficient competitor in a rapidly changing medical device market. We made significant progress on many fronts with this initiative during the first quarter, and we have begun to realize financial benefits as well as improved operational efficiencies.

Notable achievements include a completed restructuring of the Natus executive team and a completed realignment of the organization around a single company model. In addition, we've made meaningful progress further integrating our supply chain and preparing for further integration of our operations. This new organization now allows us to optimize our proven go-to-market strategies and leverage a common and more efficient infrastructure. Our team is truly energized by the opportunities that One Natus represents, and we look forward to updating you on our progress and improving financial results.

Just 3 weeks ago, we announced the divestiture of our Medix subsidiary in Argentina. This divestiture, along with those announced in January, will reduce revenue but increase our ongoing margins and earnings and allow us to focus on our best opportunities. Looking ahead, we expect to continue evaluating our product portfolio for profit-enhancing opportunities as well as areas where investments will lead to growth. As we communicated in January for the full year 2019, we expect the benefit of approximately $4 million as a direct result of immediate efficiencies gained through the One Natus initiative. I'm happy to report that we are on track to achieve these savings and continue to expect additional ongoing annual benefits beyond 2019 that will enable us to achieve our immediate target model of 15 -- our intermediate target of model 15% to 17% non-GAAP operating margin.

As you can see from our guidance, we expect continued operating margin improvement during the second quarter and continued operating margin expansion towards the mid-teens as we execute in the second half of the year.

In summary, we are very pleased with the performance of the business thus far in 2019 and the opportunities that lie ahead for Natus. We hold several leading positions in each of our end markets and look to expand that leadership as we grow our business. At the same time, we will continue to focus on profitability with the goal of expanding margins and increasing cash flow.

Now I'll turn the call over to Drew Davies, our Executive Vice President and Chief Financial Officer, for a deeper dive into our financial results. Drew?

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Benjamin Drew Davies, Natus Medical Incorporated - Executive VP & CFO [3]

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Thank you, Jonathan. Today, I will be discussing our financial results on a GAAP and non-GAAP basis. Our non-GAAP results exclude amortization expense, restructurings and certain other charges and their related tax effects. We believe that the representation of these non-GAAP measures along with the GAAP financial statements provide a more thorough analysis of our ongoing financial performance. You can find a reconciliation of our financial results on a GAAP versus non-GAAP basis in today's earnings release.

I'll also point out that we have included gross margin by business unit and geographical revenue in our press release tables to continue to provide transparency in our financial results. As Jonathan stated, we reported first quarter 2019 revenue of $114.8 million, an 11% decrease from the same period last year. The revenue decline was driven primarily by the exit of the GND and NeuroCom businesses and other end of sales products as well as lower revenues from our Medix business in Argentina and our Audiology products, which were on hold pending product registrations. I would also like to highlight that we have added a table on Page 12 of our earnings release illustrating the impact of the business -- businesses we have exited on our -- and our revenues for the last 2 years and Q1 of 2019. The table shows the growth for our continuing business.

Revenue from our Neuro end market was $62.4 million or 54% of total revenue during the first quarter of 2019 compared to $65.9 million or 51% of total revenue during the same quarter last year. The 5.3% decrease in Neuro revenue is mainly attributable to the exit of the GND business and a decline in the Neuro Surgery business. The declines were offset by growth in the EEG business of 12.5% compared to the first quarter of 2018. Revenue from our Newborn Care market -- end market decreased 13% to $26.9 million or 23% of total revenue during the first quarter of 2019 compared to $30.9 million or 24% of total revenue during the same quarter last year. The decline in Newborn Care business was driven by the exit of the NeuroCom business, other end-of-sale products, Medix and reduced billings of Peloton.

Revenue from our Audiology end market was $25.5 million or 22% of total revenue during the first quarter of 2019 compared to $31.8 million or 25% of total revenue during the same quarter last year. The Audiology revenue was lower than the previous year's anticipated due to end-of-sale products and products on hold pending international product registrations. The majority of the product registrations were completed near the end of Q1, which was earlier-than-expected and allowed the company to reach the higher end of our revenue guidance.

In total, revenue from devices and systems contributed approximately 71% of total revenue in the first quarter of 2019 compared to 70% in the 2018 period. Revenue from supplies and services was 29% of total revenue in the first quarter of 2019 compared to 30% in the same period of 2018. Revenue from domestic sales was approximately 58% in the first quarter compared to 53% in the same period of 2018. Revenue from international sales was approximately 42% in the first quarter of 2019 compared to 47% in the same period last year.

On a non-GAAP basis, our gross margin increased 70 basis points in the first quarter of 2019 to 59.7% compared to 59% in the first quarter of 2018. This increase was driven by lower manufacturing overhead and higher margins on our services and supplies within the Audiology business.

GAAP gross margin improved to 58.1% in Q1 of '19 compared to 55.7% in the same period last year. Operating income in -- non-GAAP operating income decreased by $2.1 million compared to the same quarter last year. The decrease in the operating expense was driven primarily by lower sales and marketing expense related to lower headcount, travel and outside marketing spend. Our non-GAAP operating margin decreased by 5.6% compared to 9.2% for the same quarter last year as a result of lower revenues for the quarter. Non-GAAP other income was $0.6 million for the first quarter driven by exchange rate fluctuations. Interest expense was $1.5 million during the quarter. We expect interest expense during the second quarter to be approximately $1.4 million, and full year 2019 to be approximately $4.5 million. Our first quarter non-GAAP effective tax rate was 28.5%. We anticipate our overall 2019 non-GAAP tax rate to be between 22% and 24%.

On a GAAP basis, first quarter 2019 net loss was $24.8 million or 74% -- $0.74 per share compared to a net loss of $3.1 million the same quarter last year. GAAP net income includes $24 million of restructuring expenses. $19 million of which are associated with the divestiture of Medix and $4.6 million of severance in other parts of the company.

Non-GAAP net income decreased $4.9 million compared to the same quarter last year. Non-GAAP earnings per diluted share was $0.09.

In the first quarter, we recorded $1.5 million of depreciation and $6.2 million of amortization expense. Share-based compensation was $2.5 million during the first quarter.

Now let's look at some of the highlights from the balance sheet and the statement of cash flow. We repaid $5 million of outstanding debt in the first quarter of 2019. And as a result, we ended the quarter with net debt of $45.5 million. Cash flow from operations was $7.1 million during the quarter. Our days sales outstanding decreased 10 days versus the fourth quarter of 2018 to 79 days, driven primarily by collections of the higher sales in the fourth quarter of 2018. Non-GAAP diluted shares outstanding increased to 33.7 million shares compared to 33.1 million shares in the same period last year.

Turning to guidance. We expect our revenues for the second quarter of 2019 to be between $121 million and $125 million. This guidance reflects the exit of the GND, NeuroCom and Medix businesses, which contributed $6 million to revenues in Q2 last year on a combined basis. GAAP earnings per share is expected to be in the range of $0.10 to $0.17 for the second quarter of 2019. And non-GAAP earnings per share is expected to be in the range of $0.25 to $0.32 per diluted share.

For the full year of 2019, revenue guidance was revised to a range of $489 million to $505 million for the -- with full year non-GAAP earnings per diluted share narrowing to a range of $1.17 to $1.44 per share. We also expect full year GAAP earnings per diluted share of $0.05 to $0.32. Expected non-GAAP earnings excludes $17.3 million of amortization of intangibles and $20.4 million of restructuring charges. The exit of the GND, NeuroCom and Medix businesses have a $24.1 million impact on our full year revenue guidance compared to 2018. Again, we added to table to Page 12 of the earnings release showing the impact of the businesses and the products we have exited to indicate -- to give an indication of the health of our continuing businesses.

With that, I will open up the call for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question is from Brian Weinstein with William Blair.

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Brian David Weinstein, William Blair & Company L.L.C., Research Division - Partner & Healthcare Analyst [2]

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Just to start specifically on the quarter and then we'll branch out a little bit. But specifically on the quarter, that EEG number of 12.5%, that continues to be strong. Is that the Quantum 2? Is there a benefit from that? And can you talk about the sustainability that you see with that business to show these kinds of growth rates going forward?

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Jonathan A. Kennedy, Natus Medical Incorporated - President, CEO & Director [3]

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Yes. It's Jonathan. Thanks for the question, Brian. Yes. Our Excel-Tech brand products just do very well in the marketplace. And the Quantum 2 definitely is a flagship of the Natus line and the Excel-Tech technology. We see hospitals continuing to want to upgrade EEG. And by the way, EEG is the largest piece of our Neuro business and our largest market share piece. But we see hospitals wanting to upgrade due to a number of reasons. One, usability. Cybersecurity is a big piece of it so you're seeing hospitals wanting to buy new computer-based equipment that attach to their networks. And I think that's driving a lot of the work -- a lot of the purchasing in the United States.

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Brian David Weinstein, William Blair & Company L.L.C., Research Division - Partner & Healthcare Analyst [4]

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Okay. Then on the Audiology business, the $25 million in the quarter. Obviously, you talked about some registrations there. So how should we think about that business kind of on a sequential basis from here? Is that up meaningfully in Q2?

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Jonathan A. Kennedy, Natus Medical Incorporated - President, CEO & Director [5]

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It's definitely up from the ship hold products. Sort of in an unnatural way, it'll be up where we've got about $3.5 million or $4 million worth of products that we exited the quarter that went into backlog that I would say should pop back into Q2 in a -- in just sort of a snapback method. In terms of the normal cadence of seasonality, yes, Q1 is typically very light for all our business, including Audiology. And we would see that grow in the second quarter kind of in line with historical seasonality. But yes, I would expect it to be up in Q2. The other season there, Brian, too, we try to put some information on the, as Drew said, on Page 12 of the press release. We had a, call it, a generic business, for a lack of a better word, or a lower-end product line called Oscilla that we acquired with Otometrics. And the plan all along was to exit that business from the get-go. And we did do that at the end of last year. So you're seeing the decline there of the Oscilla business, which I want to say was around $10 million a year that we stopped selling. That was a facility and everything involved with it that we -- just wasn't profitable. So we exited that as planned, and that's included as well in the decline year-over-year. But from this point forward, there's nothing in the -- other than the ship hold, which we expect to clear up here in the next month or so, the Audiology piece of the business should be off to a normal growth rate for that piece.

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Brian David Weinstein, William Blair & Company L.L.C., Research Division - Partner & Healthcare Analyst [6]

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Okay. And can you give us some update on the Otoscan stats, either in terms of units or revenue or just give us an idea of how that is rolling out?

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Jonathan A. Kennedy, Natus Medical Incorporated - President, CEO & Director [7]

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I can. We're trying to start to push that back into the product mix. I don't mind disclosing some information but it wasn't something we've specifically called out units for this quarter. We sold less units than we did last quarter. I know that. But still a significant number. We probably have somewhere in the -- or just under 200 units out in the field that are working. And I think you'll see that it contributes -- start to contribute -- I'm sorry, a little over 200 units. Just wanted to make sure I had that wrong. I think revenue-wise, we are under a couple of million dollars this quarter for that. But that was a decent piece of the -- that growth, the inherent growth in the Audiology business that we see.

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Brian David Weinstein, William Blair & Company L.L.C., Research Division - Partner & Healthcare Analyst [8]

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And then the last one for me. Just as you think about the restructuring initiatives throughout the year, can you be a little bit more specific in kind of what you guys are looking to accomplish? You've kind of talked about in generic terms what you kind of did in Q1. But can you just be a little bit more detailed or provide some information about some of the things that you want to try and accomplish by the end of the year there?

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Jonathan A. Kennedy, Natus Medical Incorporated - President, CEO & Director [9]

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Yes, sure. So there's -- obviously, we've been busy reviewing the portfolio. So a big part of One Natus is a portfolio review and trying identify businesses that are not profitable and take up our time for no reward. And so you've seen us do that with the Medix business. Now you've seen us do that with GND. We continue to look at the portfolio for other business that meets that criteria. We've begun to consolidate our dozen-or-so distribution centers around the world. We've communicated that to the team. Everybody's working on a project to reduce those down to a couple of central locations geographically. So that's a project that's underway.

We've completely reorganized the entire executive team and 3 or 4 levels down below in the company. So we've seen a number of shifts in how we make decisions in the company. It's flattened the organization quite a bit. And we have definitely seen a reduction in cost that doesn't show up in Q1 because we executed most of those very late in the quarter. And you'll see the benefits of that as we roll into the second quarter and into the back half of the year. And the other piece I'd put in there, this is a multistep process that I think will take us very much to the end of the year before we're at a point we say, "Okay, the One Natus project is essentially complete." Although you never finish these sorts of things, but essentially complete such that you would then begin to see the biggest benefit of these initiatives going into 2020, because if you complete everything late in the fourth quarter then you'll get the full year benefit after that.

The other thing I'd say we completed a pretty good review of our supply chain internally. We've created a newly centrally managed supply chain team to really ring out some of the cost and even more importantly, inefficiencies in the away we buy products. It'll have significant positive impacts on inventory management, on product obsolescence, on deliveries to customers and overall cost. So those are a number of things we've been working on to highlight a few.

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Operator [10]

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(Operator Instructions) And our next question is from Jayson Bedford with Raymond James.

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Jayson Tyler Bedford, Raymond James & Associates, Inc., Research Division - Senior Medical Supplies and Devices Analyst [11]

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Thanks for all the data here in the press release. I'm just going to ask a few questions here, more a clarification than anything else. I guess just on the Audiology ship holds, I think coming into the quarter here I was expecting a $6 million negative impact on a year-over-year basis. What was the impact of it, the ship hold?

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Benjamin Drew Davies, Natus Medical Incorporated - Executive VP & CFO [12]

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So by getting some of those product registrations done sooner than expected, we were able to recover about $3 million of the $6 million. So that's why that kind of helped us get to the higher end of the range there. We still -- we said in the press release or the comments there that we got the majority of the ship holds done. And then from a revenue standpoint, that's the case. But we still have a few that will be completed in May and June. And so we really see the revenue come back for those products more in the third quarter. But we should recover most of what we expected to lose in Q1 by Q2.

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Jonathan A. Kennedy, Natus Medical Incorporated - President, CEO & Director [13]

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Yes. Said another way, Jayson, so if we were able to do 3, then the $6 million only had a negative impact to Q1 of $3 million.

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Benjamin Drew Davies, Natus Medical Incorporated - Executive VP & CFO [14]

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We've got $3 million now.

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Jonathan A. Kennedy, Natus Medical Incorporated - President, CEO & Director [15]

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Yes. That -- the $3 million that Drew just described, that's the normal flow. The abnormal piece is the $3 million that we're unable to ship that, as we said, we expect to come out -- to be able to ship in the second and third quarter. And we continue to -- I'll tell you, one of the benefits of One Natus, by being able to muster a team of engineers from across the company and push to the team that works on the Audiology registrations, we were able to accomplish something that I think in the past would not have been possible and we beat the time schedule that we had estimated early on and got those registrations completed. So it's exciting to see what you can do when the entire company is pulling on the same rope.

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Jayson Tyler Bedford, Raymond James & Associates, Inc., Research Division - Senior Medical Supplies and Devices Analyst [16]

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Okay. The EEG growth, the 12.5%, just out of curiosity. How big is EEG as a percent of the pie? And then what's dragging on Neuro growth if EEG is lifting it?

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Jonathan A. Kennedy, Natus Medical Incorporated - President, CEO & Director [17]

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Yes. The drag side of it is definitely the Neuro Surgery business. And then in terms of the total for EEG, that's a $20 million to $25 million a quarter business for us.

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Jayson Tyler Bedford, Raymond James & Associates, Inc., Research Division - Senior Medical Supplies and Devices Analyst [18]

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Okay. And then, I guess, a couple other questions within the Neuro Surgery business. What is the impact to Natus on the Integra-related TSAs as you wind those down? Is there a net benefit to Natus this year versus last?

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Benjamin Drew Davies, Natus Medical Incorporated - Executive VP & CFO [19]

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Yes. The TSAs run to the end of August, I believe, or into September, and then we're done with that. So that will have a positive impact to our cost of goods sold mainly of a few hundred thousand dollars per quarter.

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Jayson Tyler Bedford, Raymond James & Associates, Inc., Research Division - Senior Medical Supplies and Devices Analyst [20]

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Okay. And Drew, that starts, sorry, in the third quarter, I guess?

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Benjamin Drew Davies, Natus Medical Incorporated - Executive VP & CFO [21]

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It ends, yes, it ends in the third quarter.

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Jayson Tyler Bedford, Raymond James & Associates, Inc., Research Division - Senior Medical Supplies and Devices Analyst [22]

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Okay. It ends. Okay.

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Benjamin Drew Davies, Natus Medical Incorporated - Executive VP & CFO [23]

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The TSA is over in the third quarter and then, we would start to see the benefits, fourth quarter and on, going forward.

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Jonathan A. Kennedy, Natus Medical Incorporated - President, CEO & Director [24]

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It probably would show up in the P&L in the first quarter because all those extra costs end up in inventory and as the inventor turns, you then start to see the benefit. That should probably take -- so we probably got 90 days inventory in those products as we're doing this transition and it will probably take until Q1 before you start to realize the lower cost per product. So we believe we were able to manufacture quite a bit less than what we're paying Integra to do the same work.

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Jayson Tyler Bedford, Raymond James & Associates, Inc., Research Division - Senior Medical Supplies and Devices Analyst [25]

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Right. Okay. And then just timing on the launch of the new hearing screener and the RetCam device?

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Jonathan A. Kennedy, Natus Medical Incorporated - President, CEO & Director [26]

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Well, the hearing screener we've talked about in terms of being a new development so I don't have a date to report on launch of that. But the RetCam product, we expect to have completed towards the end of this year, maybe early next year depending on where that -- how well we execute, but that's the time frame for that.

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Operator [27]

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Thank you. And I'm not showing any further questions in the queue. I would like to turn the call back to Jonathan Kennedy for his final remarks.

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Jonathan A. Kennedy, Natus Medical Incorporated - President, CEO & Director [28]

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Hey, thank you, operator. So that concludes the program for today's call. Thank you, everyone, for joining us today, and have a good afternoon.

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Operator [29]

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Ladies and gentlemen, thank you for joining us today. This concludes the program. Have a wonderful day.