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Edited Transcript of BABY earnings conference call or presentation 25-Jul-18 3:00pm GMT

Q2 2018 Natus Medical Inc Earnings Call

SAN CARLOS Jul 26, 2018 (Thomson StreetEvents) -- Edited Transcript of Natus Medical Inc earnings conference call or presentation Wednesday, July 25, 2018 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Jonathan A. Kennedy

Natus Medical Incorporated - President, CEO & Director

* Sharon Villaverde

Natus Medical Incorporated - Interim CFO

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Conference Call Participants

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* Andrew Frederick Brackmann

William Blair & Company L.L.C., Research Division - Associate

* David Michael Solomon

Roth Capital Partners, LLC, Research Division - Director & Research 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 morning, everyone, and thank you for joining us today to review our results for the second quarter of 2018. On the call today from Natus is Jonathan Kennedy, Natus' President and Chief Executive Officer; and Sharon Villaverde, Natus' Interim Chief Financial Officer. Jonathan will begin today with a business overview of the second quarter and provide guidance for the third quarter and full year 2018, then Sharon will discuss the second quarter financial performance. 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. Good morning, everyone.

Today, we reported our financial results for the second quarter of 2018. Revenue for the quarter was $130.7 million, near the high end of our guidance. Our non-GAAP earnings per share considerably exceeded guidance at $0.35 per share. Our improved margins and earnings, which Sharon will dive into a bit deeper, reflects strength in our neuro market, measurable progress in the integration of Otometrics into Natus and solid profitability from our Newborn Care business.

Now I'd like to provide a little more color on revenue for the quarter. Overall, revenue grew by 7% versus Q2 last year, driven primarily by the addition of our neurosurgery business in Q4 of last year. Meaningful organic growth in Otometrics and neuro contributed to the increase as did favorable foreign exchange fluctuations. Excluding the effects of foreign exchange, which primarily affects our Otometrics business and the year-over-year comparison for our recently acquired neurosurgery business, our organic revenue declined in the second quarter by about 2% versus the second quarter of 2017. But let's break it down by business unit.

Our Otometrics business grew organically by 4.3% versus Q2 of last year. This growth is driven by strength in our international markets, where pricing and market share have been improving. Revenue from Otometrics U.S. market held back the growth rate and declined primarily from the nonrepeat of a handful of significant corporate orders we fulfilled last year.

Our neuro business grew organically 2.1% versus Q2 of last year. The growth in neuro was driven by global strength in orders, particularly in the U.S. market. Our neuro business continues to be the market leader in neurodiagnostics solutions, and we believe we continue to gain market share.

Revenue from our Newborn Care business declined approximately 15% versus the same quarter last year. This decline was led by intentional end-of-life decisions for certain products that did not have the required scale to remain viable. While we have made most of these product liability decisions, you should expect to see marginal downward effects on Newborn Care revenue over the next several quarters. In the longer term, these decisions will allow us to focus and invest in our most critical and successful products, which we expect will, in turn, increase our long-term profitability.

Next, I'd like to give you my perspective on the significant value-creation opportunities that lie ahead for us. And while today marks only my second week as CEO, I share this perspective with the benefit of having served as CFO over the past 5.5 years. Previously as CFO and even more so now as CEO, I believe that Natus represents a significant value-creation opportunity both in the long run and near term. Over the longer term, Natus' market-leading products are very well positioned to benefit from current health care trends. These trends include hospitals' and physician practices' need to streamline operations, reduce costs and increase patient safety. For example, high-value niche products, like our recently launched Otoscan, will help practitioners increase throughput, reduce injury and dramatically improve the custom hearing aid fitting experience for physicians and patients. Another example in our neuro business is our recently launched next-generation neuromuscular ultrasound device, InVisus. InVisus brings more convenient access to lower cost and superior quality ultrasound technologies to the patient's bedside.

And in Newborn Care, we are well underway in refreshing several very important products on the portfolio. Also in Newborn Care, we are continuing to improve our quality systems. Increasing quality requirements driven by new global regulations such as the EU's Medical Device Regulations or MDR and Canada's Medical Device Single Audit Program or MDSAP not only make our investments in quality systems a necessity, but will form the foundation for increasing competitiveness as smaller and less prepared competitors struggle to keep up with increasing regulatory demand in major markets.

In addition to product-specific opportunities, Natus enjoys significant or leading market share in many of the categories in which we participate. Over the long term, we expect to continue leveraging these positions to increase market share, selectively expand our product solutions and increase margins. So that's the long term.

In the short term and the most immediate opportunity is for us to optimize the operations at Natus. This includes completing the integration of Otometrics, better prioritizing our product investments and improving our quality systems to better meet the needs and requirements of our customers. In June, we completed the final round of 6 ERP implementations related to the systems integrations of Otometrics. With this now complete, we can begin to leverage the costs and operational benefits that a modern ERP system provides.

Delivering on these opportunities requires a dedicated, experienced and complete team of leadership and employees with the sheer drive to succeed. Fortunately, our current leadership, management and the global employee teams meet these criteria, and we are well positioned to win. As you may recall from earlier this year, we appointed 2 new members to the Natus leadership team: Leslie McDonnell, who joined us in February to lead our Newborn Care business; and Carsten Buhl, who also joined in February to lead our Otometrics business. But we also have a bench of more tenured team members, including Austin Noll, who has led our neuro business to extraordinary success since 2012; and Dr. Chris Chung, who has led our regulatory and quality programs since 2000. Dr. Chung brings important physician, clinical and patient safety perspectives to our team. Sharon Villaverde, who was just appointed Interim Chief Financial Officer, has worked tirelessly behind the scenes with Natus for the past 5-plus years, leading our financial functions and many of our business integration efforts. Sharon is an outstanding and very capable leader. Over the many quarters ahead, our team and I look forward to sharing with you more about our long- and short-term opportunities, our progress and the financial rewards that we expect from them.

Now let's turn to our updated outlook for the second half of the year. For the third quarter of 2018, we expect revenue of $131 million to $135 million and non-GAAP earnings per share of $0.40 to $0.44. For the full year, we expect revenue of $525 million to $535 million and non-GAAP earnings per share of $1.50 to $1.60. The revenue guidance for Q3 and the full year assumes flat to very slight year-over-year organic growth, while non-GAAP earnings per share guidance reflects overall earnings growth of approximately 5% to 7%. This updated outlook reflects a more cautious view of the second half of the year than our previous guidance. We are encouraged by the promising signs reflected in our second quarter financial results. However, we are taking into account the effects of potentially shifting seasonality and the effects of global trade uncertainty, which affects our visibility into the second half.

Next, I'll turn the call over to Sharon Villaverde, our Interim Chief Financial Officer, who'll provide additional commentary on our financial results, then we'll take your questions. Sharon?

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Sharon Villaverde, Natus Medical Incorporated - Interim CFO [3]

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Thank you, Jonathan. Today, I'll be discussing our financial results on a GAAP basis as well as a non-GAAP basis. Our non-GAAP results exclude amortization expense, restructuring, product remediation costs and certain other charges and their 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. You will find a reconciliation of our financial results on a GAAP versus non-GAAP basis in today's press release. I will also point out that we've included gross margin by business unit and geographical revenue in our press release table to provide more transparency on our financial results.

As Jonathan stated, we reported second quarter 2018 revenue of $130.7 million, an increase from -- of 7% from the same period last year. The revenue growth was driven primarily from the addition of our neurosurgery business and supplemented by organic growth in our neuro and Otometrics business unit, offset by declines in Newborn Care business.

Revenue from our neuro business unit was $70.4 million or 54% of total revenue during the second quarter of 2018 compared to $59.3 million and 49% of total revenue during the same quarter last year. Most of the 18.7% increase in neuro revenue is attributable to the newly acquired neurosurgery business. However, neuro also realized organic growth of 2.1%, and favorable foreign exchange rates contributed another 0.5%.

Revenue from our Newborn Care business unit decreased 14.8% to $29.1 million or 22% of total revenue during the second quarter of 2018 compared to $34.1 million or 28% of total revenue during the same quarter last year. Declines in our Newborn Care business are driven by product line rationalization.

Revenue from our Otometrics business unit was $31.2 million or 24% of total revenue during the second quarter compared to $28.8 million and 24% of total revenue during the same quarter last year. The Otometrics business unit achieved revenue growth of 8.3%, of which 4.3% was organic, and the remainder was due to favorable exchange rates.

In total, revenue from devices and systems contributed approximately 73% of total revenue in the second quarter compared to 67% in the 2017 period, while revenue from supplies and services was approximately 27% of total revenue in the second quarter compared to 33% in the 2017 period.

Revenue from domestic sales was approximately 58% for the current quarter compared to 55% in the same period in 2017. Revenue from international sales was approximately 42% for the current quarter compared to 45% for the same period last year.

On a non-GAAP basis, our gross margin increased by 149 basis points in the second quarter of 2018 -- compared to 62.1% compared to 60.6% in the second quarter of '17. This increase was primarily driven by increased device and system sales, which have a higher gross margin than our supplies and services business.

Non-GAAP operating expenses increased by $4.7 million compared to the same quarter last year. The increase in OpEx was primarily driven by the addition of operating expenses acquired as part of the neurosurgery business as well as additional spending on new product development, including Otoscan and RetCam. Despite the OpEx growth, our non-GAAP operating margin increased to nearly 13% compared to 12% for the same quarter last year. We believe this increase is the result of beginning to realize the benefits of the Otometrics integration.

Other expense was $0.8 million for the second quarter, driven by exchange rate fluctuations. Interest expense was $1.6 million during the quarter. We expect interest expense during the third quarter to be approximately $1.4 million and annual interest to be approximately $6.5 million.

Our second quarter non-GAAP effective tax rate was 19.2%. This rate is lower than we expected due to several nonrecurring discrete items. We anticipate our overall 2018 non-GAAP tax rate to be between 22% and 24%.

On a GAAP basis, our net loss was $2.6 million or $0.08 per share, a $2.4 million decrease from the same quarter last year. Non-GAAP net income increased $0.4 million compared to the same quarter last year, resulting in non-GAAP earnings per diluted share of $0.35.

In the second quarter, we recorded approximately $8.8 million of depreciation and amortization expense. Share-based compensation was approximately $3.2 million during the second quarter.

Now let's look at the balance sheet and cash flow. We repurchased $0.9 million of company stock and repaid $10 million of outstanding debt in the second quarter of 2018. Net debt was essentially unchanged during the quarter at $64.5 million. Cash flow from operations was $5 million during the quarter. Our days of sales outstanding decreased by 4 days versus the first quarter of 2018 to 86 days, driven primarily by a decline in outstanding AR in our Otometrics business unit. This decline was achieved in part due to capabilities provided by the implementation of our global ERP system.

Non-GAAP diluted shares outstanding increased to 33.2 million shares compared to 33 million shares in the same period last year.

With that, I'll now turn the call over to your questions. Operator?

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Questions and Answers

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Operator [1]

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

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Andrew Frederick Brackmann, William Blair & Company L.L.C., Research Division - Associate [2]

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This is actually Andrew Brackmann on for Brian today. Jonathan, first of all, congrats on the new role. And Sharon, you as well. Jonathan, recognizing you've only been in the chair now for a couple of weeks, wanted to kind of first start off with a longer-term question related to your expectations for the business and overall growth. In the last Analyst Day you had, you guys had set forth some goals for the top line on legacy growth and 3% to 4% Otometrics sort of double-digit and some M&A helping with that. Under your leadership, do those still stand? Or how are you thinking about those going forward?

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

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Andrew. Two weeks is a pretty short period of time, given the amount of work that is involved overall. I think I was pretty clear in my prepared remarks about what our long-term and what our short-term opportunities are. And I think for us right now, it's focused on these immediate opportunities of completing our integrations and focusing on the profitability of Natus before we get into any sort of longer-term goals that need to be reviewed or examined. So I realize that's somewhat of a nonanswer for you, but right now, we're focused on the near term.

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Andrew Frederick Brackmann, William Blair & Company L.L.C., Research Division - Associate [4]

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Got it. And then my second question was focused more on the second half guide and some of your assumptions going into your operating expenses. In the past, you had talked about how the Otometrics integration, the SAP integration that you had completed this quarter was going to help you in the second half. Can you talk a little bit more about kind of the puts and takes you have on the operating expense line in the second half of this year?

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

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Sure. It's not going to matter. The Oracle implementation that we've been working on, you'd see a little bit of green shoots we saw in the second quarter, with profitability being a little bit higher than we expected. As we go into the second half, we typically have a little bit better profitability, mostly due to higher revenue that comes with the seasonality, traditional seasonality in the second half. If you recall from last year, we didn't have traditional seasonality in the fourth quarter. It was quite a big downward quarter versus what we'd seen really many, many years before. And so our view in terms of second half guidance is that revenue is flat to very slightly up. That would be -- that's what results in the guidance we provided today. But surely, you can see from the profitability that's implied in the guidance that we do continue to get some of the benefit that the -- that our recent opportunity -- our recent achievements in Oracle have provided.

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Operator [6]

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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 [7]

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So just a couple of quarter -- questions related to the quarter and then a couple of big-picture questions. In terms of the strength in neuro that you called out, and I think you mentioned particularly in the U.S., were there any kind of large orders that contributed to the strength? And did you eat into the backlog? I realized that U.S. neuro has been slow for a couple of quarters. Just wondering -- I'm wondering if the strength was a bit of a fulfillment of the backlog.

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Jonathan A. Kennedy, Natus Medical Incorporated - President, CEO & Director [8]

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Yes, great question. We did eat into the backlog a bit in neuro, and that was to my comment about shifting seasonality. If you recall last year, if you looked at the trend for last year, we saw strength in the middle of the year. And for purposes of guidance and looking forward, we have assumed that curve applies to this year. Now if we revert back to our historical seasonality, then maybe there's more to it. But that's the -- that's what happened in neuro. So yes, there was a couple of big orders in neuro, but they're big in the normal sense of big, a few hundred thousand dollar-type orders, but nothing extraordinarily large, but within the normal large orders.

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Jayson Tyler Bedford, Raymond James & Associates, Inc., Research Division - Senior Medical Supplies and Devices Analyst [9]

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Okay. And Jonathan, is your sense that the end market -- again, over the last few quarters, neuro in the U.S. has been a source of fragility, if you will. Do you think that those end markets are firming up here? Or are you seeing better end market trends?

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Jonathan A. Kennedy, Natus Medical Incorporated - President, CEO & Director [10]

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We are especially outside the U.S. We've seen it -- that's firming up of the trend, although some of that's probably helped by a weaker dollar, where it gives our customers more purchasing power. In the U.S., we've seen also better trends in neuro. We talked about on the call last quarter and probably the quarter before that around the involvement of the IT department of the hospital getting involved in the selling process for neuro equipment. And so as we've learned more and understand more the requirements there and get used to sort of the shift in the purchase cycle, I think that, in and of itself, firms up our ability to predict and our ability to meet customers' needs along the way of the selling process to include IT.

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

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Okay. And you mentioned intentionally end of life-ing, if you will, some product lines. Is that complete? Or is there another layer of pruning that's necessary to optimize the business?

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Jonathan A. Kennedy, Natus Medical Incorporated - President, CEO & Director [12]

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A lot of it's complete there. We go to this process regularly. If you recall from back when I started as VP/GM for the new Newborn Care business, one of the things that we did was to pull back on products that, like I said, just weren't meeting the scale requirements to really be a successful medical device. In the med device world, you don't -- it's very difficult to just turn things off. It takes some time to make the decision and then for those products to fall off the revenue chart, and we're starting to see that now. So many of these decisions were made many months ago, and we're starting to see that in revenue today. There are, I'm sure, in the product portfolio, not just in newborn but also across neuro and Otometrics, some of those things to come. But I would say they're more in the normal course, and so I wouldn't expect to see large reductions in revenue from making product rationalization decisions in the future. But I would say in Newborn Care for sure, you'll see that continued pressure, at least until we lap the comps on this time period.

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Jayson Tyler Bedford, Raymond James & Associates, Inc., Research Division - Senior Medical Supplies and Devices Analyst [13]

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Okay. Gross margin, at least relative to our estimate, is a little stronger. Is it just related to the mix of revenue in the quarter? And then how should we think about gross margin for the year?

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Jonathan A. Kennedy, Natus Medical Incorporated - President, CEO & Director [14]

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Well, the gross margin is included into the guidance. So if you do the math, you'll see that gross margin stays at a healthy level. Although in our guidance, we don't have it as strong as what we actually achieved in Q2. We have it maybe a little bit lower than that. And that would typically trend with revenue. So if we have a back half that's stronger than what our guidance implies, then we'd see margin go up on absorption. If the guidance holds true, then we'll see gross margin in that 60%, maybe slightly above 60% range that is implied in the guidance.

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Jayson Tyler Bedford, Raymond James & Associates, Inc., Research Division - Senior Medical Supplies and Devices Analyst [15]

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Okay. And last question, just more of a bigger-picture question. Jonathan, you've obviously been with the organization for many years, but you've only been in the CEO seat for a couple of weeks. So I'm not trying to push you on this, but what's the time line that we should expect for you to really put your imprint on this business?

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Jonathan A. Kennedy, Natus Medical Incorporated - President, CEO & Director [16]

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Well, I think my imprint is on the business, it's been so for several years. I see it as a gradual increase in my involvement in more strategic decisions and more operational things than what I did in the past. I don't know that there's going to be a magic date in the future for where I'd stake a flag in the ground and call it done. I think you'll have to stay tuned and watch while we focus on our near-term opportunities of optimizing the business and increasing profitability. I think at this point and maybe for many months, it will be sometime before that message becomes super clear.

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Operator [17]

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Our next question is from David Solomon with Roth Capital Partners.

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David Michael Solomon, Roth Capital Partners, LLC, Research Division - Director & Research Analyst [18]

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Just want to start off with Newborn here. Just trying to clear out the numbers. You said the systems -- or devices and systems, it was higher than we expected at 73% for the company. Was the pruning on the Newborn side more so on the supply than services? I'm just trying to get a sense of kind of how each of these lines work within the segment.

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Jonathan A. Kennedy, Natus Medical Incorporated - President, CEO & Director [19]

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Yes. I think -- so a couple of things in there, David. We hire devices sales in neuro, which we [indiscernible] in neuro. And then that dilution of the supplies was more -- probably more driven from Otometrics and less so on Newborn Care. But more specifically, Newborn Care, the products that are falling off would have been reported previously as devices.

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David Michael Solomon, Roth Capital Partners, LLC, Research Division - Director & Research Analyst [20]

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Excellent. Okay. And then just moving on to Otometrics. I noticed here that gross margins are, on a non-GAAP basis, look like they went down. And just wondering kind of as revenue goes up, how should we be thinking about Otometrics gross margins over the next couple of years?

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Jonathan A. Kennedy, Natus Medical Incorporated - President, CEO & Director [21]

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Well, over the next couple of years, we would expect to have an upward trending trend there as we complete the integration and optimize that business. So I would say it goes up. In terms of near term, you see from last year to this year where margins -- gross margins came down a little bit, we did have a pretty good improvement on the operating margin. But on the gross margin side, not so much. And I think that's owing mostly to mix, and then we had little a little stronger U.S. business last year on the device side. I guess that we had some pretty favorable unique corporate orders that we shipped last year at this time in Otometrics in the U.S. that's going to repeat, so that would reflect some margin as well.

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David Michael Solomon, Roth Capital Partners, LLC, Research Division - Director & Research Analyst [22]

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Excellent. And just kind of want to circle back to neuro. You mentioned the lead times, and with respect to integration with the IT departments and the health care systems and how everything is evolving and that could impact lead times. I was wondering if you can just get a little bit more color on how things are working. It looks like a couple of larger purchases came in and just want to understand how should we be thinking about that and how the company is responding to that.

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Jonathan A. Kennedy, Natus Medical Incorporated - President, CEO & Director [23]

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Well, in terms of -- on the ground, we have added to the sales process individuals who are more experts in IT, hospital IT and how our systems, how our neurodiagnostic tools interact with the hospitals network. So those folks are more involved earlier on in the process than having them come in at the back end. If you look many years ago up until recent times, IT was not so involved in the purchase. Today, with cybersecurity, and this is really what's driving, it was cybersecurity threats for hospitals, the IT departments were under more of a microscope and more pressure to make sure that devices aren't added as networks that are going to create a security threat, and so they're involved. Most of our devices in neurodiagnostics do connect to hospital's network, and so IT gets involved to understand what those interactions are or what systems we're using and what security [threats] just might be in there. So we've added to the team of expertise for the sales teams to be able to answer and address those questions as well as we've added things to products in terms of security patches and security features to help us be more competitive and better meet customer needs in that area of requirements.

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Operator [24]

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And I'm showing no further questions. I would now like to turn the call back to Natus for any further remarks.

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Jonathan A. Kennedy, Natus Medical Incorporated - President, CEO & Director [25]

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Okay. Well, that completes the call program today. Thank you, everyone, and have a great day.

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Operator [26]

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Ladies and gentlemen, thank you for participating in today's conference. You may now disconnect. Everyone, have a great day.