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Natus Medical Incorporated (NTUS)
Q3Â 2020 Earnings Call
Oct 29, 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 for our review of our results for the third quarter of 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 with a business overview of the third quarter 2020. Then Drew will discuss the third quarter financial result 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 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 would now like to turn the call over to Mr. Jonathan Kennedy, President and Chief Executive Officer of Natus Medical. Mr. Kennedy?
Jonathan A. Kennedy -- President, Chief Executive Officer and Director
Thank you, Cory. Good afternoon, everyone, and thank you for joining us. During our call today, we will discuss our third quarter 2020 financial results as well as our current business environment. Before we get started, I'd like to thank our employees, partners and customers for their commitment and accomplishments during the past quarter. Today, we reported the results for the third quarter of 2020. Revenue for the quarter was $102.8 million, and non-GAAP earnings per share was $0.09. Overall, our revenue declined 17% versus the same quarter in the prior year. Our revenue improved 21% sequentially from the second quarter of 2020, but disruptions from COVID continued to negatively weigh in on our results versus the same quarter in 2019. Our Neuro market led the recovery with Neuro capital sales increasing sequentially. Revenue from Hearing & Balance products also increased sequentially from the second quarter of 2020 as that market begins to recover.
Our Newborn Care business performed within our expected range during the quarter and, once again, have not experienced a significant of a decline due to the pandemic. As we've highlighted in our previous calls, the fundamentals of our business remain intact. Health care providers and patients depend on our products and services every day. And while the demand for our products remains lower than normal right now, we remain the market leader in most of our product categories, and we expect our business to fully recover to normal levels as our customers and patients navigate their healthcare needs during the pandemic and eventually return to a more sustainable activity level post pandemic. We continue to invest across our product portfolio with a number of new and refreshed product launches expected like our new retinal imaging system, neurodiagnostic software solutions and a new handheld infant hearing screener, all expected within the next few months.
In addition, we continue to make progress with our cloud-based initiatives and believe these investments are critical to maintaining leadership positions over the many years ahead. Our balance sheet remains strong as we ended the quarter in a net cash position. Despite the pandemic's negative impact to revenue and margins, we generated $7.5 million in cash flow from operations during the quarter, resulting in a year-to-date positive cash flow of $17.2 million. In a few minutes, Drew will discuss more financial details. But first, I'd like to provide some additional commentary on the quarter and each of our end markets. Our Neuro market includes our industry-leading neurodiagnostic solutions as well as our neurosurgery and neurocritical care products. While Neuro revenue remains below last year's level, it grew sequentially from the second quarter of 2020 by 35%. Revenue from Neuro supplies rebounded even faster than equipment sales during the quarter, but both still lag 2019. We take the accelerated supplies consumption as an indicator that neurology patients are returning to hospitals for necessary care.
Customers continue to be engaged in capital purchase planning, and we believe that we're positioned very well to capture market share as the market recovers. Our Hearing & Balance products include devices and supplies used by audiologists, hospitals and ENTs to diagnose hearing disorders, assist in the fitting and tuning of hearing aids and for the diagnosis of balance disorders. Sequentially, from Q2 2020, revenue from our Hearing & Balance business rebounded by 27.9% during the third quarter, giving us an indication of improved activity in this market. However, Hearing & Balance revenue remains below the same quarter last year as the pandemic continues to affect activity in our customers' hearing centers. Natus' market-leading Newborn Care product family is used by hospitals worldwide. Major products in this family include our newborn hearing screening solutions, neonatal eye imaging and brain injury monitoring, video streaming services and phototherapy solutions. Newborn Care revenue decreased by 4.8% during the quarter versus the same quarter last year driven by lower equipment sales.
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 OfficerDrew Davies as Executive Vice-President and Chie
Thank you, Jonathan. As Jonathan stated, we reported third quarter 2020 revenue of $102.8 million, a 21.3% increase from the second quarter as our business began to recover from the impact of COVID-19. The sequential quarterly revenue increase was attributable to both device and supply sales, which improved by 21% and 26%, respectively. Year-over-year revenue was down 17% from the same period last year. Revenue from our Neuro end market was $58.7 million or 57% of total revenue during the third quarter of 2020 compared to $72.2 million or 58% of total revenue during the same quarter last year. The 18.6% decrease in Neuro revenue resulted from slowing demand attributed to the impact of the COVID-19 pandemic. Revenue from our Newborn Care end market decreased 4.8% to $25.7 million or 25% of total revenue during the third quarter of 2020 compared to $27 million or 22% of total revenue during the same quarter last year.
The decrease was primarily attributable to the exit from our Peloton business in 2019. Revenue from our Hearing & Balance end market was $18.4 million or 18% of total revenue during the third quarter of 2020 compared to $24.3 million or 20% of total revenue during the same quarter last year. The Hearing & Balance revenue was lower than the previous year, primarily due to the decline in demand from audiologists' offices and retail hearing centers related to COVID-19. In total, revenue from devices and systems contributed 73% of total revenue in the third quarter of 2020 compared to 74% in the 2019 period. Revenue from supplies and services was 27% of total revenue in the third quarter compared to 26% in the 2019 period. Revenue from domestic sales was approximately 62% of total revenue and 38% from international in the third quarter compared to 60% and 40%, respectively, from the same period last year.
On a non-GAAP basis, our gross margin decreased 5.3% in the third quarter of 2020 to 56.2% compared to 61.5% in the third quarter of 2019. 1.5% of the decline in gross margin was attributable to higher freight costs associated with COVID-19. 2% was attributable to a lower mix of Neuro revenue, 1.3%, lower manufacturing overhead absorption and onetime cost of deploying hearing screeners to pediatrics and other fluctuations in cost of goods sold made up the balance of the decline. GAAP gross margin decreased 13.2% to 46.2% in the third quarter of 2020 compared to 59.4% in the same period last year. The decline in GAAP gross margin was also impacted by a noncash writedown of intangibles for a discontinued product of $6.4 million or 6.2% of gross margin. Third quarter non-GAAP operating expenses decreased by $6.1 million compared to the same quarter last year.
The decrease in operating expense was driven primarily by cost reductions in travel, trade shows, employee and certain discretionary expenses, offset by an increase in R&D expenses. Higher R&D included spending on remediation and the medical device regulation for Europe. In September, we completed the final Seattle product remediation. This will free up spending for new products and reduce operating expenses going forward. Our non-GAAP operating margin decreased by 9.1% compared to the same quarter last year on the lower revenues and gross margin, and that was offset by the decreased operating expenses. Our other expense was $200,000 for the third quarter driven by exchange rate fluctuations. Interest expense was $1.1 million during the quarter, and we expect interest expense during the fourth quarter of 2020 to be approximately $700,000, and for the full year, approximately $3.1 million. Our third quarter non-GAAP effective tax rate was 14%. The tax rate was lower due to discrete tax adjustments made during the quarter related to prior periods.
We anticipate our Q4 non-GAAP tax rate to be between 20% and 23%. Net income. On a GAAP basis, our third quarter 2020 net loss was $9.3 million or $0.28 per share compared to net income of $8.2 million the same quarter last year. Non-GAAP net income decreased $8.7 million compared to the same quarter last year. Non-GAAP earnings per share was $0.09. In the third quarter, we recorded $14 million of depreciation and amortization expense, which included $6.7 million for impairment of intangibles. Share-based compensation was $2.3 million during the third quarter. And now let's take a look at some highlights from the balance sheet and the statement of cash flows. Our outstanding debt decreased in the third quarter as we repaid $20 million.
We ended the quarter with $75 million in cash and $66 million in debt. We expect to be free cash flow positive again in the fourth quarter. Cash flow provided by operations was $7.5 million. Our days sales outstanding decreased seven days versus the same period in the prior year to 72 days. Non-GAAP shares outstanding increased to 33.8 million shares compared to 33.7 million shares in the same period last year. Now turning to guidance. As indicated in our earnings press release, we expect our business to continue to recover in the fourth quarter. Demand for both our devices and supplies is increasing, and our customers' activity and hospital procedures related to our business appear to be steadily improving.
With this in mind, we expect our revenues for the fourth quarter of 2020 to be between $104 million and $114 million. GAAP net income is expected to be in the range of $2.3 million to $6.3 million for the fourth quarter or $0.07 to $0.19 per share. Non-GAAP net income is expected to be in the range of $6.6 million to $10.5 million or $0.19 to $0.31 per share. The guidance for the fourth quarter assumes a steady but gradual increase in our business and does not consider the potential of a significant COVID-19 resurgence and its possible impact on any -- if any, on our -- on the economy or our customers.
And with that, I will now open it up for questions.
Questions and Answers:
Operator
[Operator Instructions] You do have a question from Jayson Bedford from Raymond James.
Jayson Bedford -- Raymond James -- Analyst
Can you hear me OK, guys?
Jonathan A. Kennedy -- President, Chief Executive Officer and Director
Yes. Hey, Jayson.
Drew Davies -- Executive Vice-President and Chief Financial OfficerDrew Davies as Executive Vice-President and Chie
Hi, Jayson.
Jayson Bedford -- Raymond James -- Analyst
So I guess a few questions for me. As we look at the quarter, and specifically capital, can you just give us any kind of discernible trends from a customer perspective, meaning is -- are they more receptive in any of the three segments? Are there any geographic trends within capital purchases or even geography? I'm just kind of wondering where the relative strength is in capital and where is the relative weakness.
Jonathan A. Kennedy -- President, Chief Executive Officer and Director
Sure. It's Jonathan. Jayson, so relative strength, the high end, Neuro capital U.S. has been probably the most positive capital side of the 3-product families. Outside the U.S., we -- it's come up but not as quickly. And our level of -- what's the word? Our level of -- just question is as Europe starts to go through increased COVID cases and lockdowns here and there, our concern there is perhaps it stays kind of where it is and doesn't continue to grow. That's all -- it's all encapsulated in our guidance, but it is something that we still have a little question mark on. But the U.S. Neuro has been stronger. Newborn Care been flat more or less across the board, all regions. We had a decent number from last quarter. We shipped a backlog of NICU cameras, and so that kind of came out this -- versus last quarter. And versus last year, we had a pretty good capital quarter, Q3 last year, and that didn't repeat, so we're down a little bit in Newborn Care. We don't see the megatrends there. A little bit down in supplies. That probably tracks birth rates coming down as you probably see elsewhere. And then in Hearing & Balance -- most of the -- that business is a bigger business for us in Europe to begin with. And earlier in the quarter, that started to rebound pretty good, continues to strengthen.
But again, our antenna are up on making sure that, that business rises and probably sort of -- the rise rate flattens a little bit going into the winter months here with the rise in COVID and lockdowns. What we've seen anecdotally with hospitals is that they are operating as normal as they can be. In other words, it doesn't appear to be a repeat of Q2 where they were really focused on COVID response and overflow. They're now able to operate the rest of their business at the same time, and that's a good sign for us, and we see that in our supplies. As I said on my prepared remarks, the supplies business has been rebounding faster in Neuro, but that's actually true in Hearing & Balance as well, though it's just a smaller -- a totally smaller business to begin with. But that increasing supplies business leads us to believe that normalcy is returning, although definitely not returned.
Jayson Bedford -- Raymond James -- Analyst
Okay. And just on Neuro, I'm still a little surprised it's down 19% year-over-year. Maybe that's a tough comp. But any idea -- if you could give us -- if supply is a true gauge of procedures, what were supplies in Neuro, just to give us a little context on the down 19% in the quarter?
Jonathan A. Kennedy -- President, Chief Executive Officer and Director
Yes. I think supplies were down low double digits, I want to say 11% or 12%, versus last year in Neuro supplies alone. That equates to probably $3 million-ish. I'm just trying to think of what those numbers were, but $3 million versus last year in comps. And I would say that normally, we don't have a difficult comp on the supply side. You just don't have that sort of volatility unless there's a pandemic. On the hardware side, we do have a pretty strong comp to compete with. Last year was a really good year for us in Neuro, if you recall. And so it's tough to say, hey, that would have continued. Although, there was still quite a bit of upgrading to do with Windows 10, and we had been optimistic going into 2020. But that is the bigger piece is the hardware. But I will tell you that, as I said in my prepared remarks, customers are still very engaged. We have a number of deals we've closed in the quarter and a number of deals that are continuing to be worked in a diligent fashion that are large deals for us. And a large deal, as you know, for us is $500,000, $600,000 up to $2 million or $3 million for a given deal. And those deals continue to evolve. And hospitals have maintained their activity with us on those.
Jayson Bedford -- Raymond James -- Analyst
Okay. And I guess just looking at the implied growth from the fourth quarter guidance. It seems like the year-over-year growth down 17%-ish is similar in the fourth quarter to third quarter. And it seems like you're building a backlog. So is there some -- in the guidance, are you factoring in some hesitation around COVID flareups? I'm just wondering why you wouldn't see a little bit more progress into the fourth quarter.
Jonathan A. Kennedy -- President, Chief Executive Officer and Director
Well, we wanted to give some guidance. We're one month into the quarter. We really wanted to predict the next two months. And so we have a pretty good view to where the guidance is, but we also see what you see in terms of COVID flareups and just uncertainty in the world. But -- so we put out numbers that we felt represented realistically what we see based on our sales calls, based on the roll-up internally with virtually no filter on it. And it's -- even if we achieve the guidance in Q4, it's still substantially lower than we would normally see in a quarter. So I think there's already that baked in. But it's what we see -- fully transparently what we see in the market as we sit here today. We didn't want to continue to go no guidance because the truth of the matter is, is we've actually -- we have a pretty good line of sight for the next 60 days, which includes a holiday period, right? So in the grand scheme of things, you're predicting maybe six or eight weeks in total of business.
Jayson Bedford -- Raymond James -- Analyst
Right. Okay. Okay. Of the new products that you announced over the next -- or you're going to roll out over the next few months, which products will have the biggest impact on the business in your view?
Jonathan A. Kennedy -- President, Chief Executive Officer and Director
Well, I think they're all very important, depending on which customer you ask. I think from a financial perspective, the rollout of our new RetCam, which we've been talking about for a little while now, probably represents the biggest opportunity from a steep growth. The RetCam that's out there today is a market leader, but it's been in the field for quite some time. And I think there's an opportunity to -- for a replacement market, but then also to drive customers who may be using the manual monocular method to upgrade to a digital imaging system. And so that's pretty exciting. Our upgrades to our neuro software is a major upgrade that I think customers will really enjoy. And while that's just a bigger business in total, it probably represents something that grows more slowly than the release of a brand-new RetCam because that's kind of a software upgrade.
And then our hearing screener, this is a handheld one where -- we also are working on a bigger platform for hearing screeners, but this one that we'll launch here in the next couple of months or so represents one of our -- a new handheld hearing screener that we haven't had for a long time. And there's quite a bit of pent-up demand for such a device and will have some new features. So that will be important to our hearing screener customers. All three are important, Jayson. They all tie together to our strategy of data collection and modern operability and products that are feature-rich that improve our customers' workflow.
Jayson Bedford -- Raymond James -- Analyst
Yes. I didn't mean to ask you to pick your favorite child there.
Jonathan A. Kennedy -- President, Chief Executive Officer and Director
Well, it depends on -- yes. I think it matters who the customer is, and I love them all. But RetCam will be the biggest one, and that we'll be happy for.
Jayson Bedford -- Raymond James -- Analyst
Okay. And I guess just maybe last one for me. Just given your market position, the business has historically benefited from some pricing power. And as you think of new products coming out, is price a little harder to take in this environment?
Jonathan A. Kennedy -- President, Chief Executive Officer and Director
Well, I would say pricing is always subject to negotiation for like GPOs. Of course, that's a price-sensitive aspect of the market. We try not to be opportunistic when it comes to pricing. We look at what are we offering for value. And when we offer new products, we try to get the price on that. In some cases, you can get price in certain markets where you just clearly have a better device. So I would say that the pricing environment is probably unchanged versus normal times, even though there's a pandemic and our cost on a volume basis go up because we have lower volume.
Operator
Your next question comes from the line of Michael Vermut from Newland Capital.
Michael Vermut -- Newland Capital -- Analyst
Two quick ones. So as we progress through the fourth quarter here into next year, I know this is hard to say. When would you say we get back to a new normal in your opinion? Is there a point where they have to go to the hospital, they got to get the hearing? In second quarter or so, you think we're going back to normal if you had to take the best guess?
Jonathan A. Kennedy -- President, Chief Executive Officer and Director
Michael, it's Jonathan. It's impossible to know. I mean here's how I would make that analysis. The products that we sell are not optional products, right? You have hearing issues, you need to see your hearing specialist, and that specialist needs to use our devices. So that business, dependent on the hearing specialists, feeling comfortable to buy new capital. And the same thing for Neuro and the same thing for our Newborn Care. When it comes back to normal, I think really equals when patients, especially the older patients, feel really comfortable going back out into the market, physically going out and doing normal life, but I would say that there's a lot of pressure on patients to get things done. So if you've got epilepsy, you can't wait to get your EEG. If you've got hearing issues, you'll need your hearing aids tuned or batteries replaced or new hearing aids, et cetera.
So I think that there's a natural desire for our customers and their patients to get back to normal, maybe more than just a desire but a need. When does that happen? It's really hard to tell. And I hate to give you a none answer here, but we just don't know. I believe that it's probably in the foreseeable coming quarters, but I don't know enough about this resurgence. Will there be a resurgence and somehow that causes hospitals to go back into sort of a conservation mode? Or can they just deal with it now that they learn how to do it, and it really doesn't impact the vast majority of hospitals? I think that's the other alternative that would probably support a faster recovery.
Michael Vermut -- Newland Capital -- Analyst
Right. Got you.
Jonathan A. Kennedy -- President, Chief Executive Officer and Director
Is that helpful?
Michael Vermut -- Newland Capital -- Analyst
And then -- yes. Yes, that is. Look, hopefully, it will be within the next few quarters. So something more normal.
Jonathan A. Kennedy -- President, Chief Executive Officer and Director
Yes.
Drew Davies -- Executive Vice-President and Chief Financial OfficerDrew Davies as Executive Vice-President and Chie
Yes.
Michael Vermut -- Newland Capital -- Analyst
The balance sheet, you've done a great job through this with the balance sheet, net cash now. Our stock is down pretty much 50% from where it was trading over the past five years. When do we look at the point where this is an opportunity here we probably won't have for long to start buying some stock here? I'm not so sure what else you do with the cash versus looking at we've been cutting half and now we're on the mend, and next quarter is looking a lot better and probably 2021 is looking a lot better. We'll probably never have another shot at these levels is this where you say, OK, let's think about going in there and buying stock at 50% off?
Jonathan A. Kennedy -- President, Chief Executive Officer and Director
Yes. I can't predict that for you, but I can tell you that it's front and center to our discussions internally. And I agree with you that the valuations we look at today, they certainly do look good over -- versus the most recent past. And as liquidity comes back up, you saw this quarter, we generated cash flow. And we do believe next quarter, with the reduction in some working capital, we'll generate more. I think that looks more favorably on buyback or reinvestment through acquisition or both. But I think the topic is definitely well covered internally. We do have an open share buyback program today that's got $40 million left on it and probably 1.5 years left of life on approval, at least at the Board level. And I think it's a matter of -- kind of ties into your first question, when do we feel like this is normal, maybe not necessarily recovered, but a point where the volatility has removed from our business, I think that's when you look at it stronger and say, hey, if we're still in a position where we think buying back shares makes a lot of sense, then we probably would. I think the last tranche, we did about 10 million. We got in about $21. We still feel really good about that. But you're right at $18. It looks better than $21 from a buyback perspective.
Michael Vermut -- Newland Capital -- Analyst
Right. And getting back on right on to the alternatives, right, is that it's hard to see that there are other acquisitions out there that are better than buying your own stock. And also, it's a good thing if we are going to get back to normal in the next two, three quarters, why wait for that to happen versus here? We're not in a precarious balance sheet issue. We have the cash. We have the balance sheet. You might as well do it when you can.
Jonathan A. Kennedy -- President, Chief Executive Officer and Director
You're right. Right.
Michael Vermut -- Newland Capital -- Analyst
Just a thought.
Jonathan A. Kennedy -- President, Chief Executive Officer and Director
Yes. I mean I think -- I probably don't have any more to add to the topic other than you make some points that we generally have been very aware of, and I'll leave it at that.
Operator
There are no further questions at this time. I'll turn it back to the speakers for any closing remarks.
Jonathan A. Kennedy -- President, Chief Executive Officer and Director
Okay. Thank you, Cory. I want to again thank all of our employees, customers and partners for their commitment and their results during the quarter. Our long-term focus remains on innovation and support of our products and solutions for our customers and patients. We have achieved significant progress in executing on our CNS and sensory systems strategic plan despite the pandemic. We've continued to strengthen our balance sheet and improve our cash flow. These achievements have us well positioned for future recovery and growth. Thank you for joining us on today's call, and have a good day. [Operator Closing Remarks]
Duration: 31 minutes
Call participants:
Jonathan A. Kennedy -- President, Chief Executive Officer and Director
Drew Davies -- Executive Vice-President and Chief Financial OfficerDrew Davies as Executive Vice-President and Chie
Jayson Bedford -- Raymond James -- Analyst
Michael Vermut -- Newland Capital -- Analyst
