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Natus Medical Inc (BABY) Q1 2019 Earnings Call Transcript

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Natus Medical Inc  (NASDAQ: BABY)
Q1 2019 Earnings Call
April 25, 2019, 4:30 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

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?

Jonathan A. Kennedy -- President and Chief Executive Officer

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 and completing the Audiology product registrations 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 continue to grow our market leading position and hospital spending remained favorable. Otoscan, our digital ear scanning product continue 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 and 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 a more 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've 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 three 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 a 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 model of 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 toward the mid-teens, as we execute in the second half of the year.

In summary, we're 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?

Drew Davies -- Executive Vice President and Chief Financial Officer

Thank you, Jonathan. Today, I will be discussing our financial results on a GAAP and non-GAAP gap basis. Our non-GAAP results exclude amortization expense, restructurings and certain other charges and the related tax effects. And we believe that the presentation 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. 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 -- on our revenues for the last two 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 our Neuro revenue is mainly attributable to the exit of the GND business and a decline in the neurosurgery business. The declines were offset by growth in the EEG business of 12.5% compared to the first quarter of 2013.

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 -- non-GAAP operating income decreased by $2.1 million compared to the same quarter last year. The decrease in 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 $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 reported $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, with full year non-GAAP earnings per diluted share narrowing to a range of a $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 exclude $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 a 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'll open up the call for questions.

Questions and Answers:

Operator

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

Brian Weinstein -- William Blair & Company -- Analyst

Hey, guys. Thanks for taking the questions. 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 II, is there a benefit from that? And can you talk about the sustainability that you see with that business to show these trends of growth rates going forward?

Jonathan A. Kennedy -- President and Chief Executive Officer

Yeah. Hi. It's Jonathan. Thanks for the question, Brian. Yeah. Our Xltek brand products just do very well in the marketplace. And the Quantum II definitely is the flagship of the Natus line in the Xltek technology. We see hospitals continue to want 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 upgrade due to a number of reasons, one usability, cyber security is a big piece of it. So you're seeing hospitals wanting to buy new computer-based equipment that are attached to the networks. And I think that's driving a lot of work -- a lot of it by -- purchasing in the United States.

Brian Weinstein -- William Blair & Company -- Analyst

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?

Jonathan A. Kennedy -- President and Chief Executive Officer

It's definitely up from the ship hold products, it 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 just sort of a snapback method. In terms of the normal cadence of seasonality, yeah, Q1 is typically very light for all our businesses, 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 piece in there Brian, we tried to put some information on that as you said on Page 12 of the press release. We had a -- I'll call it a generic business for lack of a better word or a lower end product line, called a Oscilla (ph) 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 over the 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 ship holds 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.

Brian Weinstein -- William Blair & Company -- Analyst

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?

Jonathan A. Kennedy -- President and Chief Executive Officer

I can. We're trying to sort of push that back into the product mix. I don't mind disclosing some information, but it wasn't something we specifically called our units for this quarter. We sold less units than we did last quarter. I know that, but still a significant number, and we probably have somewhere in the -- we'll just under 200 units out in the field that are working. And I think you'll see that it contributes -- start to contribute meaningfully -- I'm sorry, we're little over 200 units (inaudible) I cannot had that wrong.

I think revenue wise, we're under a couple of million dollars at this quarter for that, but that was a decent piece of the growth, the inherent growth in the Audiology business that we see.

Brian Weinstein -- William Blair & Company -- Analyst

And then last one from 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 working to accomplish? You kind of talked about it in generic terms what you kind of get 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? Thank you.

Jonathan A. Kennedy -- President and Chief Executive Officer

Yeah, sure. So there's -- obviously, we've been busy reviewing the portfolio. So a big part of One Natus is this is a portfolio review and trying to 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 communicate that to the team. Everybody is working on a project to reduce those down to a couple of central locations geographically. So that's a project that's under way. We've completely reorganized the entire executive team and three or four levels down below in the Company. So we've seen enough a number of shifts and how we make decisions of the Company, it's flatten the organization quite a bit. And we have definitely seen a reduction in cost, that -- it doesn't show up in Q1, because we executed most of this 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 put in there, this is a multi-step process that I think will take as very much to the end of the year before we're at a point we'd say, OK, the One Natus project is essentially complete, you never finish these sorts of things, but you 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've completed a pretty good review of our supply chain internally. We've created a newly centrally managed supply chain team to really wring out some of the cost and even more importantly inefficiencies in the way we buy products. It'll have significant positive impacts on inventory management, on product obsolescence, and deliveries to customers and overall cost. So those are number of things we were working on to highlight a few.

Brian Weinstein -- William Blair & Company -- Analyst

Great. Thank you very much.

Jonathan A. Kennedy -- President and Chief Executive Officer

You're welcome. Thank you, Brian.

Operator

Thank you. (Operator Instructions) And our next question is from Jayson Bedford with Raymond James. Your line is open.

Jayson Bedford -- Raymond James -- Analyst

Hi, good afternoon, and thanks for the -- all the data here in the press release. I'm just going to ask a few questions here. More 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?

Drew Davies -- Executive Vice President and Chief Financial Officer

So they are 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 that we got the majority of the ship holds done. And then some from the 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.

Jonathan A. Kennedy -- President and Chief Executive Officer

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

Drew Davies -- Executive Vice President and Chief Financial Officer

Yeah. That's $3 million (multiple speakers)

Jonathan A. Kennedy -- President and Chief Executive Officer

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.

Jayson Bedford -- Raymond James -- Analyst

Okay.

Jonathan A. Kennedy -- President and Chief Executive Officer

And we continue -- 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 road.

Jayson Bedford -- Raymond James -- Analyst

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?

Jonathan A. Kennedy -- President and Chief Executive Officer

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

Jayson Bedford -- Raymond James -- Analyst

Okay. And then I guess a couple of other questions within the neurosurgery 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?

Drew Davies -- Executive Vice President and Chief Financial Officer

Yeah. The TSAs run to the end of August I believe or end of September and then we're done with that. So that'll have a positive impact to our cost of goods sold mainly of a few hundred K per quarter.

Jayson Bedford -- Raymond James -- Analyst

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

Drew Davies -- Executive Vice President and Chief Financial Officer

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

Jayson Bedford -- Raymond James -- Analyst

Okay. It ends. Okay.

Drew Davies -- Executive Vice President and Chief Financial Officer

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

Jonathan A. Kennedy -- President and Chief Executive Officer

It probably would show up in the P&L in the first quarter, because those -- all those extra costs end up in inventory and as the inventory turns, you then start to see the benefit. It just probably take -- and we probably got 90 days inventory in those products as we're doing this transition and it'll take probably until Q1 before you start to realize the lower cost per product.

Jayson Bedford -- Raymond James -- Analyst

Right. Okay.

Jonathan A. Kennedy -- President and Chief Executive Officer

And we would really believe, we were able to (ph) manufacture, quite a bit less than what we're paying Integra to do the same work.

Jayson Bedford -- Raymond James -- Analyst

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

Jonathan A. Kennedy -- President and Chief Executive Officer

While the hearing screener, we've talked about in terms of being a new -- in new developments. So don't have a date to report on launch of that, but the RetCam product, we expect to have completed toward the end of this year, maybe early next year. It depends on whether -- how well we execute. But that's the time frame for that.

Jayson Bedford -- Raymond James -- Analyst

Okay. Thank you.

Jonathan A. Kennedy -- President and Chief Executive Officer

Thanks, Jayson.

Operator

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.

Jonathan A. Kennedy -- President and Chief Executive Officer

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

Operator

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

Duration: 27 minutes

Call participants:

Jonathan A. Kennedy -- President and Chief Executive Officer

Drew Davies -- Executive Vice President and Chief Financial Officer

Brian Weinstein -- William Blair & Company -- Analyst

Jayson Bedford -- Raymond James -- Analyst

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