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Natus Medical Inc (NTUS)
Q2Â 2019 Earnings Call
Jul 25, 2019, 4:30 p.m. ET
Contents:
- Prepared Remarks
- Questions and Answers
- Call Participants
Prepared Remarks:
Operator
Good afternoon and thank you for joining us today to review our results for the Second 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 second quarter 2019. Then Drew will discuss the second quarter financial performance and provide guidance for the third 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, Chief Executive Officer and Director
Thank you, Ashley. Good afternoon, everyone. Today we reported our financial results for the second quarter of 2019. Revenue for the quarter was $125.4 [Phonetic] million, achieving the higher end of our guidance expectations. Revenue growth from our neuro market was driven by strong sales of our neuro EEG devices both in the United States and International markets. EMG and other neuro device sales also contributed to the revenue growth. But revenue from our neurosurgery products declined 6% during the quarter offsetting some of the growth from neuro diagnostics. Natus continues to lead the neuro diagnostic device market with Q2 year-to-date revenue growth of approximately 8%.
Otoscan, our digital ear scanning product continued its ramp-up, contributing to growth in our audiology market. However, certain product ship holds offset growth and drove an overall revenue decline in that market. We expect to resolve these ship holds in the second half and we estimate that the ship holds had a negative impact to Q2 revenue of about $2 million.
Sales of our Algo hearing screening devices and Neoblue phototherapy systems grew nicely year-over-year in the newborn care area. However, overall revenue for newborn care products declined approximately 5%, after adjusting for the previously announced product exits. Natus continues to be an important brand with newborn care customers. And while overall birth rates have continued to decline, premature birth rates and NICU utilization have increased. Products like RetCam, retinal imaging system, NICVIEW, family video solution and our Olympic brain monitor are well positioned to benefit from this trend.
Drew, will discuss cash flow, working capital improvements in more detail, but we were very pleased to have generated $17.6 million in cash flow from operations during the quarter, which also included $1 million of cash severance payments. Our capital-light business has a tremendous ability to generate cash and we look forward to continuing improvement in cash flow in the coming quarters due to the streamlining benefits of our One Natus project. Just six months ago, we announced our One Natus initiative. This ongoing effort is better positioning us for growth and improving our product quality and making us a more efficient competitor. We made significant progress on many fronts with this initiative during the first half of the year and we are beginning to see that in our operating margins.
In addition to the leadership and organizational achievements we announced last quarter, we continue to make progress further integrating our supply chain and operations. Our overall staff levels excluding those associated with business exits are down over 10% since the beginning of the year and we continue to responsibly execute many changes at Natus that will offer sustainable pay-offs to our customers and shareholders in the quarters and years ahead.
Completing the divestitures of GND, Neurocom and Medix in the first half of the year has increased our ability to focus on and grow our core businesses. It has driven operational efficiency and increased cash flows. As we communicated in January for the full year of 2019, we expect a benefit of about $4 million as a direct result of immediate efficiencies gained through the One Natus initiative. We remain on track to achieve these savings and continue to expect additional ongoing annual benefits beyond 2019.
Our near to mid-term annual non-GAAP operating margin goal of 15% to 17% remains intact and we look forward to that achievement. With our One Natus initiatives progressing according to plan, we are now able to look forward beyond the reorganization. Natus has a rich portfolio of solutions focused on the diagnosis and treatment of central nervous and sensory system disorders for patients of all ages.
With our customer-focused organization and strategic direction now in place, we are in a solid position to expand and grow within our markets. Also, today we announced a change to our NASDAQ ticker symbol, retiring the BABY ticker and adopting a new one, NTUS. We have diversified our product solutions and core capabilities well beyond the neonatal care market since our IPO back in 2001.
The new NTUS ticker symbol better reflects our identity as a global provider of innovative healthcare solutions focused on the diagnosis and treatment of central nervous and sensory system disorders for patients of all ages. As you -- as you can see from our guidance, we expect continued non-GAAP operating margin expansion toward the mid-teens as we finished the second half of the year. In summary, we're very pleased with the performance of the business with only six months behind us in our One Natus initiative.
We continue to be excited about 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 businesses. At the same time, we will continue to focus on profitability with the goal of expanding margins and increasing cash flow.
Now I'd like to 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 on non-GAAP basis. Our non-GAAP results exclude amortization expense, restructurings and certain other charges and the 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 a reconciliation of our financial results on a GAAP versus non-GAAP basis in today's earnings release. I will also point out that we have included gross margin by market and geographic revenue in our press release tables to continue to provide more transparency in our financial results. As Jonathan stated, we reported second quarter 2019 revenue of $125.5 million, a 4% increase from the same period last year -- decrease, excuse me, in the same period last year.
The revenue decline was driven primarily by the previously announced divestitures and other end-of-sale products, offset by growth in our neuro market for the quarter. Revenue from our neuro market was $71.6 million or 57% of total revenue during the second quarter of 2019, compared to $70.4 million or 54% of total revenue during the same quarter last year. The 1.7% increase in neuro revenue is mainly attributable to the strength in EEG with our strong backlog in Q1 shipping during Q2, offset by the exit of the GND business and a decline in the neurosurgery business.
Revenue from the newborn care end market decreased 13% to $26.6 million or 21% of total revenue during the second quarter of 2019, compared to $30.6 million or 23% of total revenue during the same quarter last year. The decline in our newborn care business was driven by end of sale products, the divestiture of Medix and reduced billings for Peloton, offset by the relaunch of Neoblue products and growth in our Neometrics and Algo product lines.
Revenue from our audiology end market was $27.4 million or 22% of total revenue during the second quarter of 2019, compared to $29.7 million or 23% of total revenue during the same quarter last year. The audiology revenue was lower than the previous year as anticipated, due to end-of-sale products and products on hold pending international product registrations. The decline was offset by year-over-year growth in Otoscan and other hearing fitting products.
In total, revenue from devices and systems contributed approximately 74% of total revenue in the second quarter of 2019, compared to 71% in the 2018 period. Revenue from supplies and services was 26% of total revenue in the second quarter of '19 compared to 29% in the 2018 period. Revenue from domestic sales was approximately 59% in the second quarter of 2019, compared to 58% in the same period in 2018 making revenue from international sales approximately 41% in the second quarter compared to 42% in the same period of 2018.
On a non-GAAP basis, our gross margin decreased 279 basis points in the second quarter of 2019 to 59.3% compared to 62.1% in the second quarter of 2018. This decrease was driven by lower margin sales in China and the reversal of a warranty reserve, which benefited second quarter 2018 did not -- that did not recur this quarter.
GAAP gross margin decreased to 57.1% in the second quarter of 2019, compared to 57.4% in the same period last year. Second quarter non-GAAP operating expenses decreased by $6.8 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 increased to 13.4% compared to 12.8% from the same period last year. As a result of the lower operating expenses in the quarter. Non-GAAP other income was $200,000 for the second quarter driven by exchange rate fluctuations. Interest expense was $1.4 million during the quarter. We expect to interest expense during the third quarter to be approximately $1 million and full year of 2019 to be approximately $4.5 million.
Our second quarter non-GAAP effective tax rate is 27.8%. We anticipate our overall 2019 non-GAAP tax rate to be between 23% and 25%. On a GAAP basis, second quarter 2019 net income was $4.2 million or $0.12 per share compared to a net loss of $2.6 million in the same quarter last year. Non-GAAP net income decreased by $300,000 compared to the same quarter last year. Non-GAAP earnings per diluted share was $0.34. In the second quarter, we recorded $7.8 million of depreciation and amortization expense. Stock-based compensation was $1.9 million during the second quarter.
Now let's look at some highlights from the balance sheet and the statement of cash flow. We repaid $20 million of outstanding debt in the second quarter of 2019, which reduces our annualized interest expense by approximately $900,000. As a result, we ended the quarter with net debt of $27.6 million. Cash flow from operations was $17.6 million during the quarter. Our days sales outstanding decreased 11 days versus the same period in the prior year to 76 days, driven primarily by increased collections.
Our total net inventory both current and non-current declined by $2.5 million compared to the previous quarter. Non-GAAP diluted shares outstanding increased to 33.7 million shares compared to 33.2 million shares in the same period last year.
Turning to guidance, we expect our revenues for the third quarter of 2019 to be between $122 million and $126 million. This guidance reflects the exit of the GND, Neurocom and Medix businesses, which contributed $6.7 million of revenue in Q3 last year on a combined basis. GAAP net income is expected to be in the range of $6.3 million to $8.6 million for the third quarter of 2019 or $0.19 to $0.26 per share. Non-GAAP net income is expected to be in the range of $11 million to $13.2 million or $0.32 to $0.39 per diluted share. For the full year 2019, revenue guidance was narrowed to a range of $492 million to $500 million with full year non-GAAP earnings per diluted share narrowing to a range of -- to a range of $1.19 to $1.32.
We also expect full year GAAP loss diluted -- per diluted share of $0.26 to $0.13. Expected non-GAAP earnings exclude $23.5 million of amortization of intangibles and $10 million to $14 million of restructuring charges. The exit of GND, Neurocom and Medix businesses are expected to have a $22.4 million impact on our full year revenue guidance compared to 2018. We also expect a year-over-year decline of $6 million on previously determined end of life newborn care products and $13.7 million of other estimated revenue declines this calendar year, offset by $9 million of growth in our existing businesses.
With that I will now open it up for questions.
Questions and Answers:
Operator
Thank you. [Operator Instructions] And our first question comes from the line of Brian Weinstein with William Blair. Your line is now open.
Brian Weinstein -- William Blair -- Analyst
Hey, guys, thanks for taking the questions. Starting out just on neuro, it was a nice step-up sequentially, second quarter neuro, you've seen good results out of EEG. Can you just comment specifically, what's going on with EEG and why that's been, so much of a growth engine for you in the last couple of quarters.
Jonathan A. Kennedy -- President, Chief Executive Officer and Director
Yeah. I mean that's a leadership role that we play in the market. We've got some of the best products out there. We've got a really strong sales force. And so that, like I said in my comments, we are up 8% year-to-date. The second quarter was definitely up from -- we had a little bit of backlog going into Q2. And so there is assistance in that respect. But then I say, the year-to-date, which moves that out was up 8%. We have a Quantum 2 device, which is our flagship amplifier that released late last year, that's doing very well in the market, and it just drives the sales of the rest of the business. And then as I said in my other remarks, the rest of the neuro device business was contributed to growth as well, and not for the neurosurgery would have seen pretty significant growth out of our neuro business.
Brian Weinstein -- William Blair -- Analyst
Anything as far as a backlog as you exit Q2 that we should be thinking about for Q3 here.
Jonathan A. Kennedy -- President, Chief Executive Officer and Director
Yeah. The Q2 backlog was fairly normal. And by that I mean our backlog doesn't usually vary. No, it was up a little bit more in Q1, because of some ship holds and things like that, but in Q2, we ended with a pretty normal backlog.
Brian Weinstein -- William Blair -- Analyst
Great. And then can you provide an update on Otoscan with some more specific statistics on kind of where you are, how that business model is playing out?
Jonathan A. Kennedy -- President, Chief Executive Officer and Director
Yeah. So that's -- it's growing on a year-over-year basis. We didn't have much in Q2 of last year. This year was over $1 million in Q2 of revenue for the device. We continue to sell them into leading hearing aid dispensers. We have agreements with number of the manufacturers for hearing aids. And I'd say that, you know as I've said before, the build out and the growth of that market is going to -- always going to take some time. It's a new device, it's not a predicate out there, but I think the market is still very interested in. We've not seen really a slowdown in the interest of it, and so we're excited about it.
Brian Weinstein -- William Blair -- Analyst
Great. And then as far as the guidance goes, the mid-point of revenue came down just a little bit and the mid-point of EPS I think was down around a $0.05 [Phonetic]. Can you just talk about the narrowing of the range there. Specifically on the high end of the range, things that may not be taking place that you thought, might have taken place at this point.
Jonathan A. Kennedy -- President, Chief Executive Officer and Director
Well, I mean, I think, Q2 was a little better than we had guided pretty much all into the backlog reduction on the piece there, because we knew the backlog was high going into the quarter. So maybe that's not as big of an impact on my thing. But going into the back half of the year, we're still cautious going into Q3. Well, with hospital spending, we know there is still changes in the healthcare market space. And just rolling up from our field, we look at Q3 and see it where it is in terms of guidance. And then for Q4, when we gave Q2 guidance, we also implied Q4 because we get the full year.
We want to have numbers out there that we feel confident with Q4 is typically a better quarter for us, it although was the strongest quarter, and it's always up several points versus the previous quarters. So we've -- again we put the numbers out there that we believe are realistic and in terms of lower in the guidance. We had a really wide range of guidance going out, starting of the year and as we've passed through six months now of the year, almost seven, we have a better sense of where it's going to be. And so we've got it the way we have, but we're fairly comfortable with the numbers we had out there. And then on the earning side, again, same thing, we ended up a little stronger in Q2.
We've got a number of initiatives that are -- that kicked in Q1 and Q2 that are now starting to find their way and a benefit way into the P&L. Again we want to put numbers out that we feel fairly confident with, but there's still some unknowns internally on the spending side. I think we've mentioned in the past, we have a pretty big project going on with design history file remediation for a number of products and we need to keep that up until they are completed which probably runs us through this time next year. And so we're just conservative on the spending side for Q3 and Q4, and that really what, pretty much what pushes the guidance where it is.
Brian Weinstein -- William Blair -- Analyst
Okay, great. Last one from me, you guys have made some comments in conferences. And I just wanted to make sure that I heard them correct that, you are considering some M&A potentially at this point. You think you're better positioned for that. And maybe where you were previously so, can you just talk about your willingness to do deals. What you guys are sort of building up as a pipeline and when we might see something on that front. Thanks.
Jonathan A. Kennedy -- President, Chief Executive Officer and Director
While certainly part of the One Natus initiative was to get our house in order to be able to do -- to do that sort of transformative growth or strategic growth. We are in much better shape today than we were several months ago in terms of an organization to be able to do that. I don't have any specific names or areas to comment on, but I would say that remains a part of our longer-term growth strategy, even though we've sort of pulled back here recently. One of things you'll notice in our press release, we're talking to -- we started to talk about Natus about what our strategic focus is with the central nervous system and peripheral sensory devices and that will be the area that we look at.
So I think from an M&A perspective. You'll see us playing in that space. We've gone through a pretty big strategic review to look at where, what space is defined for Natus. Where we can win, and where we have, already have a pretty big a space worked out for us. So in terms of M&A, in terms of strategic direction. You can read some of that implied in the way we talked about Natus today and get a sense of where we might go for M&A should that occur in the future.
Brian Weinstein -- William Blair -- Analyst
Thank you.
Jonathan A. Kennedy -- President, Chief Executive Officer and Director
Thanks, Brian.
Operator
Thank you. [Operator Instructions] And our next question comes from the line of Jayson Bedford with Raymond James. Your line is now open.
Jayson Bedford -- Raymond James -- Analyst
Hi, good afternoon and thanks for taking the questions. Just a handful here. So getting back to the neurology piece which was always quite strong, what was the level of growth in the EEG in the quarter?
Jonathan A. Kennedy -- President, Chief Executive Officer and Director
I think EEG was up about 7% quarter-to-quarter.
Jayson Bedford -- Raymond James -- Analyst
Okay. Okay. And just on the Otometrics business, and I apologize, at least on my line and broke out for a while. I think entering the year, you had $6 million of international ship holds you recognized, I think $3 million of that in the first quarter, did you recognize some of that in 2Q. I think you alluded to some ship holds impacting that business in 2Q and I was little unclear on that.
Drew Davies -- Executive Vice President and Chief Financial Officer
Yeah. We did, we still had $3 million plus that was on hold. And we believe that Q2 was impacted by about $2 million. So we shipped a $1 million or a little bit more in Q2 and we still have some to recover in the back half.
Jayson Bedford -- Raymond James -- Analyst
Okay.
Jonathan A. Kennedy -- President, Chief Executive Officer and Director
Is there anything else [Indecipherable].
Drew Davies -- Executive Vice President and Chief Financial Officer
Yeah. That's all I --
Jonathan A. Kennedy -- President, Chief Executive Officer and Director
I'll let you finish your thought. I was going to correct myself on the EEG growth, it's actually closer to 17%, I said 7%, should have said 17%.
Jayson Bedford -- Raymond James -- Analyst
Okay, so just getting back to the Otometrics, you got about $2 million in 3Q from the ship hold that is factored into the guidance.
Drew Davies -- Executive Vice President and Chief Financial Officer
Yeah. Well, yeah, Q2 was impacted by $2 million and we've got, we expect to get that in the back half of the year.
Jayson Bedford -- Raymond James -- Analyst
Okay. Gross margin was a bit better than at least what we were looking for. Is this the level you expect going forward? Or are there additional benefits from other One Natus or other initiatives that you have that could lift gross margin from the 59% plus level?
Drew Davies -- Executive Vice President and Chief Financial Officer
Yeah. I think depending on mix, but we expect that we get this gross margin up in the 60%, 60% plus range as we go through the year. We still do have some One Natus initiatives we're working on. We've done a lot on our supply chain side. We've consolidated our team there. We are consolidating our distribution centers, that is all in process. We're working on it. And we've got opportunity there, we're looking at our supply base as well and trying to consolidate our actual outsource manufacturing among our suppliers that will drive some improvement there and we're going -- we're continuing to look for ways to work on that gross margin.
Jayson Bedford -- Raymond James -- Analyst
Okay. And just -- maybe just jumping back to the EEG growth, because you had two straight quarters of double-digit growth. What is driving that? Is there been kind of a flush of capital? Or is there been some disruption from a competitive standpoint? I'm guessing that's not the natural run rate of that end market? What is really driving that?
Jonathan A. Kennedy -- President, Chief Executive Officer and Director
Yeah. I think, primarily, we're taking share. I mean we see that -- we're just successful in almost every deal that we're working on. We've got that new Quantum 2 device, which is a follow-on to Quantum 1 which we launched a couple of years ago. And Quantum 1 of course is now registered and selling globally and Quantum 2 is registered and selling in the US and the big markets. And we're taking share, I think is the case. The end market, obviously doesn't grow that fast. And then I think if you're looking for an end-market catalyst, there is a big push on cyber security issues. And recall that our EEG machines and most of our devices are basically computers hooked to hospital networks. And hospitals are increasingly changing out these devices to take advantage of the newer operating systems and the cyber security features that the new products have. So I'd look at that as maybe a catalyst to the market. But the bigger piece for us is, we believe we're taking share.
Jayson Bedford -- Raymond James -- Analyst
All right. And then maybe lastly in terms of portfolio management, is this the portfolio that you want going forward, meaning, is this where you want to be, or should we expect any more pruning going forward?
Jonathan A. Kennedy -- President, Chief Executive Officer and Director
Well you never done evaluating your opportunities. I think we've done a lot of the work already. There's a couple of small pieces that we continue to evaluate and, see what might not fit. As time goes on here we can share more about our strategic direction and how we see the products going together. There is a pretty nice connection across the pieces that we want to see going forward. And, but I think in terms of broad strokes, Jayson, we're pretty much done. And it's now a matter of executing the new products that we have in the pipeline and getting through remediations and getting through some of these legacy products that will fall off over time and be replaced by new products.
Jayson Bedford -- Raymond James -- Analyst
Okay, great. Thank you.
Jonathan A. Kennedy -- President, Chief Executive Officer and Director
Thanks, Jayson.
Operator
Thank you. And ladies and gentlemen, this concludes today's Q&A session, I would now like to turn the call back over to Natus for any closing remarks.
Jonathan A. Kennedy -- President, Chief Executive Officer and Director
Thank you, operator. That concludes our program for today's call. I'd like to thank all of our Natus employees and partners who have really worked tirelessly over the past several months, both operating our business and serving customers. And at the same time driving the significant changes in just about every area of our operations. We have an excellent team and dedicated global workforce that is committed to serving our customers, our patients, and of course the Company. So, thank you so much for your efforts and our achievements to date. Again, thank you everyone for joining us today. Have a good day.
Operator
[Operator Closing Remarks]
Duration: 29 minutes
Call participants:
Jonathan A. Kennedy -- President, Chief Executive Officer and Director
Drew Davies -- Executive Vice President and Chief Financial Officer
Brian Weinstein -- William Blair -- Analyst
Jayson Bedford -- Raymond James -- Analyst
