Natus Medical (NTUS) Q3 2019 Earnings Call Transcript

Natus Medical (NTUS)
Q3 2019 Earnings Call
Oct 24, 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 third 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 third-quarter 2019. Then, Drew will discuss the third-quarter financial performance and provide guidance for the fourth 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 Kennedy -- President and Chief Executive Officer

Thank you, operator, and good afternoon, everyone. Today, we reported the results for the third quarter of 2019. Revenue for the quarter was $123.5 million and non-GAAP earnings per share was $0.36. Both were in line with our previous expectations.

Our third-quarter results demonstrate the continued improvement in our business. Our performance in the quarter drove a significant increase in cash flow, achieving $23.9 million in cash flow from operations. After adjusting for divestitures, revenue from our neuro end market grew 8% for the second quarter in a row with all major neuro submarkets making positive contributions to neuro's growth, including neurosurgery. Our newborn care and hearing and balance markets were down year over year but showed growth in phototherapy, vision screening and hearing fitting submarkets.

The negative trend was driven primarily by voluntary ship holds in order to address certain product design changes. We expect these changes to be implemented by early next year. Overall, we achieved organic revenue growth of 2% after adjusting for divestitures and discontinued products. During the quarter, we continued to execute our strategic plan of focusing our efforts in the central nervous system and sensory systems markets and achieved significant improvements in operation efficiency.

In addition to the outstanding cash flow generation during the quarter, we reduced our long-term debt by $10 million. As we've discussed before, our capital-light business has a tremendous ability to generate cash, and we look forward to further improvements in cash flow. Drew will discuss working capital and cash flow in more detail in just a few minutes. Only nine months ago, we announced our One Natus initiative.

The results of this effort have better positioned us for growth, increase our product quality and made us a more efficient company. During the quarter, we added to this progress and our margins and cash flow are evidence of that. In addition to our year-to-date achievements, we continue to make progress further integrating our supply chain and operations. We continue to execute many changes at Natus that we expect to result in sustainable payoffs to our stakeholders in the quarters and years ahead.

I'd now like to briefly describe the recently announced transition of our Peloton hearing screening service business to Pediatrix. Pediatrix Medical Group and MEDNAX are the largest network of neonatologists, pediatric hospitalists and advanced practice providers in the United States, caring for nearly 25% of neonatal patients. We are very excited to have partnered with such an outstanding organization. The combined scale of Natus and Pediatrix will allow us to accelerate much needed innovation in newborn hearing screening.

The transition will allow Natus to focus on delivering technology solutions while Pediatrix will focus on the service and patient care aspects of newborn hearing screening. We expect the transition to be completed during 2020 and we'll provide a more detailed update during our year-end 2019 conference call. We do not expect the transition, however, to have a material effect on the fourth quarter's financial results. We set out at the beginning of this year to redefine Natus so that we could focus our future efforts in areas where we have strength and compelling competencies.

Since January, we've completed the divestitures of our GND, NeuroCom and Medix businesses. With these exits and now the Peloton transition, we have completed the broad strokes of our refocused initiatives. These accomplishments will allow us to build on our strategic core competencies around the central nervous system and sensory systems for patients of all ages. We communicated in January for the full-year 2019 that we expected a benefit of approximately $4 million as a direct result of immediate efficiencies gained through the One Natus initiative.

We have achieved these benefits and continued to expect additional ongoing annual benefits beyond 2019. We remain confident in our ability to deliver on our near to midterm annual non-GAAP operating margin goal of 15% to 17%. And as a reminder, our non-GAAP margins include equity compensation expense. As you can see from our guidance, we expect continued operating margin improvement during the fourth quarter and continued operating margin expansion toward the mid-teens as we finish 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 a goal of expanding margins and continuing to increase 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 basis and a non-GAAP basis. Our non-GAAP results exclude amortization expense, restructurings 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 can find the reconciliation of our financial results on a GAAP versus non-GAAP basis in today's earnings release. As Jonathan stated, we reported third-quarter 2019 revenue of $123.5 million, a 5.4% decrease from the same period last year. The revenue decline was primarily -- was driven primarily by divestitures and other end-of-sale products previously announced, offset by growth in our neuro market for the quarter. Revenue from our neuro end market was $72.2 million or 58% of total revenue during the third quarter of 2019 compared to $69.8 million or 53% of total revenue during the same quarter last year.

The 3.5% increase in neuro revenue is attributable to all of our major products within neuro, including EEG, EMG, PSG, our sleep study products and neurosurgery. Revenue from our newborn care end market decreased 21% to $27 million or 22% of total revenue during the third quarter of 2019 compared to $34.2 million or 26% of total revenue during the same quarter last year. The decline in our newborn care business was driven primarily by end-of-sale products and the divestiture of Medix, offset by growth in phototherapy and RetCam. Revenue from our hearing and balance end market was $24.3 million or 20% of total revenue during the third quarter of 2019 compared to $26.7 million or 20% of total revenue during the same quarter last year.

The hearing and balance revenue was lower than the previous year due to end-of-sale products and products on hold pending design modification. In total, revenue from devices and systems contributed approximately 74% of total revenue in the third quarter of 2019 compared to 72% in the 2018 period. Revenue from supplies and services was 26% of total revenue in the third quarter compared to 28% in the 2018 period. Revenue from domestic sales was approximately 60% and 40% from international sales in the third quarter of 2019, which was the same split in the third quarter last year.

On a non-GAAP basis, our gross margin increased 74 basis points in the third quarter of 2019 to 61.3% compared to 60.6% in the third quarter of 2018. This increase was driven by lower operations overhead and strength in our sales of Neuro products. GAAP gross margin increased 59 -- increased to 59.1% in the third quarter of 2019 compared to 59% in the same period last year. Third-quarter non-GAAP operating expense decreased by $2.2 million compared to the same quarter last year.

The decrease in operating expense was driven primarily by cost reduction initiatives, including the impact of removing the operating expenses from divested businesses. Our non-GAAP operating margin decreased to 13.8% compared to 14% for the same quarter last year as a result of lower revenues in the quarter. Non-GAAP other expense was $0.4 million for the third quarter driven by exchange rate fluctuations. Interest expense was $1.2 million during the quarter.

We expect interest expense during the fourth quarter to be approximately $800,000 and full-year 2019 to be approximately $4.9 million. Our third-quarter non-GAAP effective tax rate was 21.6%. We anticipate our overall 2019 non-GAAP tax rate to be between 23% and 25%. On a GAAP basis, third-quarter 2019 net income was $8.5 million or $0.25 per diluted share compared to a net loss of $5.6 million the same quarter last year.

Non-GAAP net income decreased $1.5 million compared to the same quarter last year. Non-GAAP earnings per diluted share was $0.36. In the third quarter, we recorded $7.5 million of depreciation and amortization expense. Share-based compensation was $1.9 million during the third quarter.

Now let's look at some of the highlights from the balance sheet and the statement of cash flow. We repaid $10 million of outstanding debt during the third quarter of 2019, which reduces annualized interest by approximately $460,000. As a result, we ended the quarter with net debt of $6.6 million. Cash flow from operations was $23.9 million.

During the quarter, our days sales outstanding decreased six days versus the same period in the prior year to 78.8 days driven primarily by improved collections. Our total net inventory declined by $1.6 million compared to the previous quarter. Non-GAAP diluted shares outstanding increased to 33.7 million shares compared to 33.4 million shares in the same period last year. Turning to guidance.

We expect our revenues for the fourth quarter of 2019 to be between $128 million and $132 million. This guidance reflects the exit of the GND, NeuroCom and Medix businesses, which contributed $6.4 million to revenues in Q4 last year on a combined basis. We expect to continue to operate the Peloton business for the full fourth quarter. GAAP net income is expected to be in a range of $8.2 million to $10.2 million for the fourth quarter of 2019 or $0.24 to $0.30 per share.

Non-GAAP net income is expected to be in a range of $14.9 million to $16.9 million or $0.44 to $0.50 per share. For the full year of 2019, revenue guidance was revised to a range of $492 million to $496 million with full-year non-GAAP earnings per diluted share narrowing to a range of $1.23 to $1.29. We also expect full-year GAAP loss per diluted share of $0.21 to $0.27. Expected non-GAAP earnings exclude $22 million of amortization of intangibles and $15 million to $18 million of restructuring and other charges.

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

Questions & Answers:

Operator

[Operator instructions] And our first question comes from Jayson Bedford from Raymond James. Your line is open.

Jayson Bedford -- Raymond James -- Analyst

Hi, good afternoon. Thanks for taking the question and congrats on the progress. I guess I wanted to start with Neuro, which seems to be growing quite well. And I appreciate the disclosure around all aspects of that business growing.

Any chance you can give us an idea as to how quickly the EEG portion of the business is growing? It seems like it's been the driver at least in the first half of the year.

Jonathan Kennedy -- President and Chief Executive Officer

Yeah. The EEG, Jayson, is obviously the biggest piece of the business. I want to say it was up double digit -- low double digits for the year quarter over quarter. And that's been a really big win for us over the last couple of years as we've taken, we believe, taken market share in the U.S.

and outside the U.S. and continues to be a really solid product line for us.

Jayson Bedford -- Raymond James -- Analyst

And Jonathan, can you just remind me how big is that business, either as a percent of total or maybe just Neuro?

Jonathan Kennedy -- President and Chief Executive Officer

Yeah. For just EEG, it's about a $30 million a quarter business for us.

Jayson Bedford -- Raymond James -- Analyst

OK. OK. And then, I guess, I had a question on the ship holds. I think you had about $2.8 million of products under ship hold in 2Q that you were carrying.

Did you recognize that at all in the third quarter?

Jonathan Kennedy -- President and Chief Executive Officer

No. On a net basis, we're still -- our ship hold backlog, if you will, continues to grow, although I wouldn't call it a backlog as much I would opportunities. And we don't book them if we're not shipping and so it continues to grow. And it's an area of improvement for us to be had here coming up over the next couple of quarters, as I said in my prepared remarks.

But it's definitely something that's a headwind to revenue for the last quarter. And also, going up into Q4, it's a bit of headwind for us as well.

Jayson Bedford -- Raymond James -- Analyst

And Jonathan, is this something that's new? For some reason, I thought we entered the year about $6 million, and I thought that would have been exhausted by now. Are there new ship holds? And just maybe a little detail of what's going on there.

Jonathan Kennedy -- President and Chief Executive Officer

Yeah. There are new ship holds. As I said in my prepared remarks, the last couple of quarters, we really tried to step up our quality game at Natus and sometimes, that traps things that otherwise wouldn't have been trapped. And so we just been a lot more disciplined about what goes out the door.

And so here, beginning in the last -- in the very beginnings of the third quarter, we found some products, mostly in the hearing screen -- hearing -- not hearing screening, in the Newborn and hearing and balance business that we're meeting our quality expectation and so we put them on ship hold. It was a material amount for the quarter in terms of marginal revenue, but it was something we felt like we needed to do.

Jayson Bedford -- Raymond James -- Analyst

OK. Maybe you can -- sorry, go ahead.

Jonathan Kennedy -- President and Chief Executive Officer

No, no. I was done.

Jayson Bedford -- Raymond James -- Analyst

Can you give us an update on the timing of new products? I know there's a few in the works. Can you just kind of maybe outline the next 12 to 18 months in terms of new product flow?

Jonathan Kennedy -- President and Chief Executive Officer

Yeah. So we've -- we expect to release our new NicView 2 camera here toward late in the year. That's a $7 million a year product for us. We have a number of those cameras on backlog.

By numbers, I mean, hundreds on backlog. And then we have a -- our RetCam ROP screening device that comes out probably this time next year in terms of release. And then we've got a new software system, a new software revision for our EEG product that comes out about this time next year as well. And then on top of that, there are a number of other product line extensions and things that extend the life of some of the products we have and add new features.

Jayson Bedford -- Raymond James -- Analyst

OK. And just lastly for me, then I'll jump back in queue. I didn't hear you mentioned Otoscan. Any update there in terms of business model development, partnerships, etc.?

Jonathan Kennedy -- President and Chief Executive Officer

No update other than what we've already announced. The product continues to get good reviews. It unfortunately as well was on ship hold this quarter with an issue with the lens that is on the tip of the camera that it -- keeping that lens in place. So we've put it on ship hold for a product -- for a quality issue.

We expect to get that off as well toward the end of the year here, but probably won't resume material shipments until Q1. But the demand for it is still pretty high. And as we've announced, we've established some partnerships with some of the major hearing aid manufacturers and it continues to chug along.

Jayson Bedford -- Raymond James -- Analyst

All right. Thank you.

Operator

[Operator instructions] And our next question comes from Brian Weinstein from William Blair. Your line is open.

Brian Weinstein -- William Blair and Company -- Analyst

Hey, guys. Just a couple for me. Just to piggyback on the last one. Just on the revenue guidance for the full year, the reduction of, I think, $4 million at the high end, that's related to these new ship holds in newborn care and hearing and balance, is that right? Or is there -- was there something else there?

Jonathan Kennedy -- President and Chief Executive Officer

Yeah, that's it. That's evidently a headwind for us. But also, just as we progressed to the year, Brian, just narrowing the range of where we think we're going to be, we're still well within the range that we started with at the beginning of the year. We just continue to tighten that as we have more visibility and clarity into the quarter.

Brian Weinstein -- William Blair and Company -- Analyst

OK. And then just a couple that are longer term in nature. But you talked about the $4 million benefit from efficiencies with the One Natus having been achieved now. You said you expect additional benefits beyond 2019.

Can you comment about any additional detail that you're willing to give us as to what that could potentially look like and when we'll hear about some of those additional benefits?

Jonathan Kennedy -- President and Chief Executive Officer

Well, I think, the -- that $4 million was a cumulative amount that we had anticipated for the year. Obviously, that is a run rate that we achieved sometime in the middle of the year. And so just from the annualization of that that probably goes from $4 million to $8 million and beyond going into next year. And that's versus the starting point at the beginning of the year.

We haven't really prepared to give guidance beyond the end of this year. So I'm hesitant to get too far out there. We'll do that in January. But suffice it to say, we felt really good about achieving the 15% to 17% long-term goal -- or midterm goal that we've put out.

Sorry, midterm. And we will achieve that run rate in Q4 according to guidance. And we felt pretty good about being able to layer that in and have that be somewhat of a goal for 2020.

Brian Weinstein -- William Blair and Company -- Analyst

So just to make sure I heard you. So the incremental $4 million benefit potentially 2020 off of where you guys are in Q3 from an expense standpoint. Is that what you were trying to say?

Jonathan Kennedy -- President and Chief Executive Officer

No, I meant for the full year. So we -- the $4 million for One Natus benefits we tabulated would be a cumulative for 2019, and I would expect that to be $8 million to $10 million for cumulative for 2020. But having said that, I'll caution you, we haven't really put together the full guidance plan for 2020. So if it's more than that or less than that that would come out in 2020 or in the same quarter, we'll come out with the guidance.

Brian Weinstein -- William Blair and Company -- Analyst

OK. Got it. And then, where are you getting now? I was thinking of kind of like long-term growth for kind of your end markets at this point. I mean where do you see all these end markets over the next several years as far as what they're able to do in terms of growth? And I assume that you think that you are a share gainer in most of these markets.

Is that correct?

Jonathan Kennedy -- President and Chief Executive Officer

I would agree with that. I think if you look at the markets themselves, the growth rates are in that low single-digit range like we did 2% this quarter, which historically -- based on historics, it's actually pretty good for Natus. I would think that's the end market. But I think in a longer-term model, Brian, there's a demand for new products, upgraded products, products that are connected and products that have better cybersecurity.

In fact, I would say one of the things driving EEG right now is cybersecurity, and hospitals needed to be on later versions of software and more cybersecure devices. And I think over time, the end markets will demand more of this technology. And to the extent that Natus provides that, I think we will be a share taker in terms of solutions for what our products do.

Brian Weinstein -- William Blair and Company -- Analyst

OK. And then last one for me. You guys have paid down the debt. You guys are showing some decent cash flow.

So you clearly have -- and you even had capabilities before this. But M&A had -- seems like it was back on the table. You have financial capability to do it. You're in a better position from a structural or an organizational standpoint.

Can you just talk about where you guys are as far as kind of processing through different ideas and opportunities and the appetite for doing something there? Thanks.

Jonathan Kennedy -- President and Chief Executive Officer

Yeah, sure. Thanks, Brian, for the questions. So what we tried really hard to do this year was really define Natus and put together a strategic plan that defined the markets we're going to operate in and why. Like I said in my prepared remarks, where do we have a compelling value to add? And the output of that is the central nervous system and sensory system disorders for all patients.

And so that'll be the area that we focus our efforts in. And so within that, you got Neuro that they're squarely in the central nervous system. You got some aspects of balance that are in the nervous system but there are also some aspects that are in periphery or sensory systems, same with hearing, sensory systems and newborn care. The -- in a NICU, newborn care is really about the brain and preserving and protecting the newborn's brain.

And so that also fits squarely in that central nervous system. But I would expect us to be interested in those markets, expect us to be interested in markets that -- or businesses that enable us to connect our devices and enable us to clean data from those devices in patients and sort of move up the chain in terms of analysis and research and availability of central nervous system data, brain data, hearing data, that sort of thing.

Brian Weinstein -- William Blair and Company -- Analyst

All right. Great. Thanks guys.

Jonathan Kennedy -- President and Chief Executive Officer

Sure. Thank you, Brian.

Operator

And I am showing no further questions from our phone lines. I'd now like to turn the conference back over to Jonathan Kennedy for any closing remarks.

Jonathan Kennedy -- President and Chief Executive Officer

OK. Thank you, operator. That concludes the program for today's call. Thank you for joining us, and have a nice day.

Operator

[Operator signoff]

Duration: 16 minutes

Call participants:

Jonathan Kennedy -- President and Chief Executive Officer

Drew Davies -- Executive Vice President and Chief Financial Officer

Jayson Bedford -- Raymond James -- Analyst

Brian Weinstein -- William Blair and Company -- Analyst

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