Natus Medical (NTUS) Q1 2020 Earnings Call Transcript

Natus Medical (NTUS)
Q1 2020 Earnings Call
Apr 30, 2020, 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 2020. 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 of 2020. Then Drew will discuss the first-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. Management's presentation of the financial results will be on a GAAP and non-GAAP basis. The non-GAAP results exclude amortization expense, restructurings, and certain other charges and their related tax effects. Management believes 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'd 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. Good afternoon, everyone, and thank you for joining us today. During today's call, we will provide you with some insight into how the pandemic is affecting our business and how we're responding to its many challenges. After that, we'll look at the results of the first quarter and discuss our visibility into future demand and how the pandemic response factors into each of our end markets and geography.

Unfortunately, we're not providing a financial outlook today, so we'll have to save any detailed discussion about future financial results for another time. Health care providers and patients depend on our products and services every day. Our team members and partners are working tirelessly to maintain our supply chain and deliver our products and services, and I sincerely thank all of them for their steadfast commitment. The health and welfare of our employees, customers, and partners remain our top priority.

As an essential supplier of healthcare products and services, all of Natus' manufacturing, engineering, and customer support functions remain fully operational and will continue to support customers with vital supplies, service, and equipment. We have transitioned to a companywide work-from-home model wherever possible and have utilized collaboration technology to continue our operations, and we believe we'll be able to sustain this model for this foreseeable future without a major disruption to our business. We've made strategic investments in inventory to help mitigate potential supply chain disruptions and we have taken actions to reduce cost, including reducing travel and discretionary expenses. However, we will continue to prioritize spending to allow continued investment in products and services that are key elements of our strategy for profitable growth in the years ahead.

Drew will discuss in more details on how we're operating now and what areas we remain vigilant in identifying unknown risks. Today, we reported the results for the first quarter of 2020. Revenue for the quarter was $109.4 million and non-GAAP earnings per share was $0.04. Overall, our revenue declined 2.8% versus the same quarter in the prior year after adjusting for divestitures.

Despite seeing significant impact from the COVID-19 pandemic during the first quarter, our neuro market continued to perform well, growing at 4.7% versus the same year -- same period last year. Our newborn care and hearing and balance markets declined during the quarter due to a worldwide softening of demand. This brought our total revenues to $109.4 million. While less than we originally expected, we still maintained very strong operating cash flow of $17.4 million.

In addition to the cash flow generated from our business, we also drew an additional $60 million on our credit line as a precaution to ensure that we have the necessary capital to continue to reliably service our customers during an extended period of uncertainty. Now let's look at some of the details around our end markets. Our neuro market, which includes our industry-leading neurodiagnostic solutions as well as our neurosurgery and neurocritical care products performed well during the first quarter with nearly 5% growth versus the same quarter of last year. Growth was driven primarily from double-digit domestic EEG device sales, but offset by declines in all other categories and geographies as the pandemic response began to interrupt our normal business conditions.

The pandemic had the least effect on EEG as the long sales cycles for this equipment provide a momentum going into the quarter. However, we do expect EEG equipment sales will fall off significantly during the next quarter as hospitals reprioritize spending. Revenue from neuro supplies and service was flat versus the prior year. Our hearing and balance products are composed of devices and supplies used by audiologist, hospitals, and ENTs to diagnose hearing disorders, assist in the fitting of -- in tuning of hearing aids and for the diagnosis of balance disorders.

This product group includes our well-known Otometrics, Madsen, Oracle, and Bio-logic brands. Europe is our largest market in this product category and was most impacted by the pandemic responses in Europe, which began early in the first quarter. Revenue from our hearing and balance product family declined 13% from the same quarter last year due to the pandemic response. Shipments of our innovative ear scanner Otoscan resumed during the quarter, and we shipped a quarterly record of 95 systems as we worked to fill the backlog of orders.

We continue to be enthusiastic about Otoscan as it brings the benefit of digital scanning technology and practice workflow improvements to our customers. Natus' newborn care product family is used by hospitals worldwide. Major product categories in this family include our newborn hearing screen solutions, neonatal eye imaging and brain injury monitoring, video streaming services, and phototherapy solutions. Newborn care revenue declined 11% after adjusting for divestitures and discontinued products during the first quarter versus the same quarter last year.

And lastly, I'm happy to report that we resolved all of our significant product ship holds by the end of the first quarter in all three product categories. Before I turn the call over to Drew, I want to again thank all of our employees, customers, and partners for their willingness and ability to quickly change how we work in order to meet our obligations and the ultimate needs of our patients. Everyone's health and safety is paramount to our mission and, of course, to the well-being of the families and teams that we work alongside with every day. Our hearts and thoughts are with those who are suffering, their family members and the frontline caregivers that are sacrificing so much in order to eventually restore health and normalcy to all of us.

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 and the changes driven by the pandemic response. Drew?

Drew Davies -- Executive Vice President and Chief Financial Officer

Thank you, Jonathan. As Jonathan stated, we reported first-quarter 2020 revenue of $109.4 million, a 4.7% decrease from the same period last year. The revenue decline was driven primarily by divestitures and other end-of-sale products previously announced and the impacts of COVID-19, partly offset by strength in domestic EEG device sales. Revenue from our neuro end market was $65.3 million or 60% of total revenue during the first quarter, compared to $62.4 million or 54% of total revenue during the same quarter last year.

The 4.7% increase in neuro revenue is attributable to growth in EEG. Revenue from our newborn care end market decreased 9.8% to $24.2 million or 22% of total revenue during the first quarter of 2020, compared to $29.5 million or 26% of total revenue during the same quarter last year. The decline was primarily attributable to the divestiture of Medix and end-of -ale of NeuroCom Balance products. Revenue from our hearing and balance end market was $19.8 million or 18% of total revenue during the first quarter of 2020, compared to $22.8 million or 20% of total revenue during the same quarter last year.

The hearing and balance revenue was lower than the previous year, primarily due to the slowdown in demand related to the COVID-19 pandemic. The virus spread significantly during the latter part of the quarter in Europe, which -- where the majority of hearing and balance sales occur. In total, revenue from devices and systems contributed approximately 73% of total revenue in the first quarter of 2020, compared with 71% in the 2019 period. Revenue from supplies and services was 27% of total revenue in the first quarter, compared to 29% in the 2019 period.

Revenue from domestic sales was approximately 62% of total revenue and 38% from international in the first quarter of 2020, compared to 58% and 42% international in the same period last year. On a non-GAAP basis, our gross margin decreased by 35 basis points in the first quarter of 2020 to 59.2%, compared to 59.5% in the first quarter of 2019. This decrease was driven by revenue deferrals, higher freight costs related to COVID-19, and lower-than-expected manufacturing overhead absorption as a result of the lower revenues. GAAP gross margin decreased 55 basis points to 57.4% in the first quarter, compared to 57.9% in the same quarter last year.

First-quarter non-GAAP operating expenses decreased by $600,000 compared to the same quarter last year. The decrease in the operating expense was driven primarily by cost reduction initiatives including the impact of removing the operating expenses from divested businesses, offset by an increase in R&D expenses. Higher R&D included spending on remediation and MDR, the Medical Device Regulation for Europe. Only three of the 15 Seattle product remediations will remain after this quarter and are expected to be complete in Q3 this year.

Our non-GAAP operating margin decreased to 2.9%, compared to 5.2% in the same quarter last year on lower revenues and gross margin and slightly lower operating expenses. Non-GAAP other expense was $800,000 for the first quarter, driven by exchange rate fluctuations. Interest expense was $700,000 during the quarter. We expect interest expense during the second quarter of 2020 to be approximately $900,000 and for the full year to be approximately $3 million.

Our first-quarter non-GAAP effective tax rate was 24%, and we anticipate our overall 2020 non-GAAP tax rate to be between 22% and 24%. On a GAAP basis, first quarter 2020 net loss was $3.6 million or $0.11 per share, compared to a net loss of $30.4 million in the same quarter last year. Non-GAAP net income decreased $1.4 million compared to the same quarter last year. Non-GAAP earnings were $0.04 per diluted share.

In the first quarter, we recorded $6.9 million of depreciation and amortization expense. Share-based compensation was $2.3 million during the first quarter. Now let's look at some of the highlights from the balance sheet and the statement of cash flow. Our outstanding debt increased by net of $45 million in the first quarter as we repaid $15 million early in the quarter and drew $60 million on our line of credit in the quarter as a precaution to ensure we have the necessary capital to continue to reliably serve our customers during the extended period of uncertainty.

We ended the quarter with $107 million in cash and at this time, expect to remain cash flow positive for the year. Cash flow from operations was $17.4 million during the quarter. Our days sales outstanding decreased three days versus the same period the prior year to 75 days, driven by increased collections. We repurchased 465,000 shares or 1.4% of shares outstanding at an average price of $22.56 during the quarter.

Our current share buyback program has $40 million remaining. We plan to put further buybacks on hold until uncertainty around COVID-19 clears. Non-GAAP diluted shares outstanding have increased to 33.8 million shares, compared to 33.7 million shares in the same period last year. So, looking ahead to Q2, we expect revenue to be down significantly from our previous guidance and relative to the same quarter last year due to the uncertainty of demand in the coming quarter and the full year.

We will not be providing revenue and earnings guidance at this time. However, I want to provide a little more detail on how we view our demand, the impacts we see to -- on our supply chain and what we have done to reduce spending and usage of cash. As we analyze our demand, we look at it in a few different ways. One way is device sales versus service and supplies.

Device sales typically make up roughly 70% of our revenues with service and supplies constituting 30%. In this environment, we expect revenue from service and supplies to be less impacted than the revenues from devices. Another way we look at demand is by the elasticity of when a patient needs to receive care to -- and related to one of our three end markets. Based on what we know to date, we expect demand for our newborn care end market to be the least impacted because care is determined by the birth of babies.

In neuro, we expect demand to be mixed with areas like neurosurgery and neurocritical care as well as portions of acute EEG to be relatively inelastic, while demand for EMG and PSG would be more negatively impacted. The third of our three end markets, hearing and balance, is expected to be the most elastic. And therefore, the most negatively impacted by the COVID-19 environment as the patients, our customers serve, belong to an older demographic and will be less likely to visit an audiologist until after fear of contracting the virus has subsided. Geographically, we expect Europe and the Middle East to show the most weakness with North America down to a lesser degree.

Asia Pacific -- and Asia Pacific beginning to rebound from the low in the first quarter. On the supply side, we have made strategic investments in inventory to help mitigate potential supply chain disruptions. At this time, our supply chain appears to be relatively stable. Our known risks for the second quarter are not significantly more than what we have seen in recent quarters and should not have a meaningful impact on revenue.

We are monitoring our supply chain around the clock to surface any new risks. The issues we are monitoring include supplier capacity issues, freight traffic limitations, suppliers prioritizing COVID-19 supplies over our orders and lead time challenges for raw materials or suppliers use to make their products. In light of the reduction in demand, we've had several actions to reduce our spending in Q2 and beyond. Reductions include minimal travel, canceled trade shows, constraints on overall payroll increases, required time-off, and reductions in outside services and incentives.

The annualized benefits of these actions is roughly $10 million. We expect to resume providing quarterly and annual guidance when revenue visibility returns to normal in the coming quarters. And with that, I will now open the call for questions.

Questions & Answers:

Operator

[Operator instructions] We have a question from the line of Jayson Bedford with Raymond James. Your line is now open.

Jayson Bedford -- Raymond James -- Analyst

Hi. Good afternoon. Can you hear me OK, guys?

Jonathan Kennedy -- President and Chief Executive Officer

Yes, we do. Thanks, Jayson.

Jayson Bedford -- Raymond James -- Analyst

OK. I hope everyone is healthy. So a few questions, and I appreciate the additional disclosure here. I may jump around.

But when you look at your capital business, the device business, is there any way you can kind of break that out by segment? Is one segment more reliant on capital than another?

Jonathan Kennedy -- President and Chief Executive Officer

Yes. Jason, this is Jonathan. Definitely, the EEG device business is capital intensive and our largest product category in the subproduct category. In the newborn care area, we sell the RetCam, vision screen, vision imaging device.

That's capital intensive more so than anything else in newborn care. And then in hearing and balance, it's much more -- it's capital to -- but to a smaller degree but in that area, the environment is more retail like in that there's thousands of small audiology shops to buy our equipment. These are individual owned shops, some corporate-owned shops, but they're much more sensitive to equipment and they cost thousands of dollars more so than, say, a hospital would be in that case. So kind of that's the big pieces by each end market that would look like capital.

Jayson Bedford -- Raymond James -- Analyst

OK. So which segment has the most exposure to capital? Sorry, if I missed it.

Jonathan Kennedy -- President and Chief Executive Officer

Neuro.

Jayson Bedford -- Raymond James -- Analyst

Neuro. OK. And then you guys, obviously, have a pretty diversified portfolio. Can you walk us through the typical ticket size? Just as we think about hospitals reprioritizing spend.

Just so we can put it in context around the typical order from a dollar standpoint, just so we understand kind of what's small orders and big orders, etc.

Jonathan Kennedy -- President and Chief Executive Officer

Sure. So let's talk about ticket size in the capital category. In neuro, it's $25,000 to -- into the millions, depending on just how many beds a hospital might be doing but it's computer-type equipment in the, call it, tens of thousands of dollars per room or per station. In the newborn care, like I said, we have RetCam, and that's $100,000-ish device.

That's the only device in that area that's expensive. We do sell our NicView cameras, which I would say, would be highly discretionary and highly capital-light in a hospital, and those are $10,000, $15,000, $20,000 in installation, maybe more if you're doing more cameras. And then in the audiology area and hearing and balance, we have devices that are in the several thousand dollar range for an ASP up to in the low $10,000 and $20,000 range.

Jayson Bedford -- Raymond James -- Analyst

OK.

Jonathan Kennedy -- President and Chief Executive Officer

So definitely on a size-wise, neuro, millions of dollars, potentially hundreds of thousand dollars average. Newborn care, tens of thousands and then audiology thousands and maybe tens of thousands for an ASP.

Jayson Bedford -- Raymond James -- Analyst

OK. That's helpful. And I thought first quarter actually came in a bit stronger than I think we were kind of expecting given the COVID dynamic. Have you seen that -- but it sounds like 2Q is when you're going to feel it, much like other companies in the group? Have you seen orders being canceled or are these more pushed out?

Jonathan Kennedy -- President and Chief Executive Officer

We haven't seen cancellations. We've seen some hospitals slow down orders. We've seen them actively push some orders out, although I would say it's broad but we have seen that here and there. Our expectation is that that is still more to come very likely as hospitals figure out the spending situation and reprioritize their spending.

We think that -- but what we hear from hospitals is the response to pandemic is going to be ongoing. Even when open-up orders start to come in, hospitals will still need to be vigilant for reoccurrences of the pandemic. And of course, they've just switched over to a COVID ICU model and most hospitals switching back and having their staffs and their professionals be able to jump back into the normal life will take some time. And so we expect that to continue into the second quarter.

Our hope is the second quarter becomes the bottom of the curve, but we won't know for sure until we get there, obviously.

Jayson Bedford -- Raymond James -- Analyst

OK. And then just geographically, you kind of gave us some direction there. Can you break up the percent of sales you, Middle East versus North America versus Asia-PAC? And then also on that, can you just talk about the -- what you're seeing in China today versus what you saw in the first quarter?

Jonathan Kennedy -- President and Chief Executive Officer

Yes. I don't have the details exactly for the geographies that you laid out. We'll get -- we can get you that -- that does show up in our Q. In terms of what we're seeing, so China, obviously, was the first market for us to see the impacts of COVID.

We saw lockdowns and shelter-in-place orders. That really slowed commercial activity in China very early in the first quarter. And so that's where we felt it most in the first quarter. Later, but not much later, in the beginning of the quarter, we felt it in Europe.

And as Europe jumped onboard and started the shelter-in-place and have lockdowns. And then it was very late in the fourth quarter that we saw it in the United States. And as I commented in my prepared remarks, that momentum around the capital sale in EEG was there. So lots of those deals, we had big deals going on in the quarter that closed and shipped as normal, albeit probably as those windows started closing toward the end of the quarter.

Drew Davies -- Executive Vice President and Chief Financial Officer

Hi, Jason. It's Drew. I can give you a little more detail on the breakout. So I'll kind of use Q1 of '19 actuals as a proxy.

I think for the most part, it stayed similar, although during this time, as we said, North America has been a little bit stronger. But last year, North America was roughly 67% of revenue in the quarter, maybe a little bit more or roughly that amount, 25% in EMEA, and 17% in APAC and then LatAm making up the balance.

Jayson Bedford -- Raymond James -- Analyst

OK. That's helpful.

Jonathan Kennedy -- President and Chief Executive Officer

North America continues to be the strongest and most profitable area of the world, for that's United States and Canada.

Jayson Bedford -- Raymond James -- Analyst

Right. OK. Otoscan, how much is left? You mentioned shipping 95 systems in 1Q? How much is left on that backlog?

Drew Davies -- Executive Vice President and Chief Financial Officer

There's a few units left. We weren't able to quite ship all of it, but it's in the -- I think we've got roughly less than 50 to go on that backlog that had built up.

Jayson Bedford -- Raymond James -- Analyst

OK. OK. And then maybe last one for me, just on the gross margin line. It came in a little lower than we expected, which weighed on overall op margins.

Is there a way to parse out or how should we think about the gross margin line, given the volatility in the top line? Is there a fixed versus variable portion of that, that you can help us with or any insight or help on that line item would be great.

Drew Davies -- Executive Vice President and Chief Financial Officer

Yes, there was -- we were caught a little bit at the end of the quarter was having that. Going into the quarter, we felt pretty good about it. We didn't really see the drop off until kind of the second or third week of March, and then it started to come down. So we didn't really have time to react to kind of reducing some of the variable expense that we could and some of our overhead and getting that under control, some staffing and things like that.

So we were impacted by that. We also had some revenue deferrals in the quarter, where we had some systems that shipped and we deferred part of the revenue for that because we didn't have the complete items for the system. The system was functional, but there were some additional things that helped make the margin better. We've also seen, during this time that there's been a cutback in the amount of transit capability just around the world that -- so freight costs have actually gone up.

We've had to do a lot more by air. There's been less marine traffic, less -- fewer options in total, and so the cost has gone up there but we're working to remedy all those. It's still -- we do have some manufacturing facilities in the company that represent fixed costs. And so we will -- with lower revenue levels here for a while, we'll be impacted on the gross margin line, but we're working to cut some of the things that are variable that we can and improve those.

Jonathan Kennedy -- President and Chief Executive Officer

Yes. I think it's helpful too to realize that we make a big part of our quarter normally in the last, probably, by three or four weeks of the quarter. So when -- so that's when we absorb a lot of the overhead. If that doesn't happen, as was the case in Q4, we lose out on that absorption and the productivity gains that you typically have in the last three or four weeks of the quarter.

Jayson Bedford -- Raymond James -- Analyst

OK. That's helpful. And maybe just one last one. I just want to make sure I heard it correctly.

You've reduced -- you've taken about $10 million of annual cost savings out of the business. Is that correct?

Drew Davies -- Executive Vice President and Chief Financial Officer

Yes, that's what they would be annualized. So let's say if things started to come back in Q3 or Q4, we would start traveling again. There would be -- we're servicing customers or we're still traveling to service customers, but the sales team is doing a lot more of their interaction with customers remotely based on the relationships they have. But if we get into -- if revenue starts to improve again in Q3 and Q4, we'll start traveling again, maybe some of the trade shows come off, and we can go back to kind of the spending that we had.

So what we've done, if you annualized it, would be $10 million for the year, but with -- that's not necessarily the savings we'll get for this year because if it comes back, we'll start spending again.

Jonathan Kennedy -- President and Chief Executive Officer

And if it goes down, we [Inaudible]

Drew Davies -- Executive Vice President and Chief Financial Officer

Yes, if it goes down, we would certainly do more.

Jonathan Kennedy -- President and Chief Executive Officer

And I would point it out too, Jason, for your out-year models into '21, which I imagine start to -- got to be the year that folks are looking at, at this point or soon here. The $10 million Drew mentioned is a temporary. We haven't made those permanently. So when you say take it out of the business, this is temporary.

These are the exercises that we do. It's some levers that we have to deal with, a dip in demand and that sort of thing. But from an ongoing perspective, we would need to do more if we felt that this was permanent, and we needed to restructure our cost setup at the company.

Jayson Bedford -- Raymond James -- Analyst

All right. That's helpful, and I apologize for any background noise here and there.

Jonathan Kennedy -- President and Chief Executive Officer

We didn't hear it.

Drew Davies -- Executive Vice President and Chief Financial Officer

Didn't hear it.

Jonathan Kennedy -- President and Chief Executive Officer

No, it's good.

Operator

And that concludes today's question-and-answer session. I'd like to turn the call back to Natus for closing works.

Jonathan Kennedy -- President and Chief Executive Officer

OK. Thank you, operator, and thank you, everybody, for joining today. We're doing our best to keep the people that make Natus work safe and productive. We have a dynamic and dedicated global organization driven by the needs of our patients and our business is fully operational.

And most importantly, we have a commitment and the financial strength to support our customers and succeed during this historic environment. Thank you for joining us on today's call, and please have a good day.

Operator

[Operator signoff]

Duration: 31 minutes

Call participants:

Jonathan Kennedy -- President and Chief Executive Officer

Drew Davies -- Executive Vice President and Chief Financial Officer

Jayson Bedford -- Raymond James -- Analyst

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