Infant health specialist Natus Medical (NASDAQ:BABY) got -- pardon the pun -- spanked soundly after missing analyst consensus earnings estimates last quarter. In the months since, neither the market nor Natus shareholders have ceased their wailing. The stock fell 40% from its May 1 high to today's disheartening price of $12 and change. Tomorrow morning, shareholders will be looking for just that -- change -- when Natus reports its Q2 earnings.

What analysts say:

  • Buy, sell, or waffle? Three analysts follow Natus, and all three now call it a buy.
  • Revenues. With a diaper-full of additional revenues from Bio-Logic helping it out, analysts expect Natus to report a 91% jump in revenue to $19.5 million tomorrow.
  • Earnings. But profits should stink. Wall Street predicts $0.06 per share, a 14% drop.

What management says:
One suspects that Natus' management was a bit taken aback at the market's reaction to last quarter's news. In fact, CEO Jim Hawkins described himself as "exceptionally pleased" with Natus' Q1 performance, pointing out that the firm "exceeded our forecast in both revenues and income before taxes," improved its gross margin 230 basis points year over year, and made good progress in integrating Bio-Logic, finally concluding that Q1 "was truly a great quarter."

What management does:
That said, I have to agree with the market that Natus' numbers looked like that proverbially rare "ugly baby." Gross margins up? Indubitably, and the rolling operating margin continued to climb as well. But just look at what happened to Natus' net margin! The precipitous drop from 14.3% to 1.1% in one quarter's time looks all the uglier when you consider that these are trailing-12-month numbers. It takes a lot of damage in one quarter to drag a year's worth of GAAP results down that far.

Margins %

12/04

3/05

6/05

9/05

12/05

3/06

Gross

58.9

59.8

61.2

63.2

62.6

63.0

Op.

2.1

5.5

11.5

11.9

12.6

13.3

Net

(6.6)

(2.8)

9.7

12.7

14.3

1.1
All data courtesy of Capital IQ, a division of Standard & Poor's. Data reflects trailing-12-month performance for the quarters ended in the named months.

One Fool says:
Essentially, here's what happened to make Natus' results look so bad. First, the company took a huge tax hit ($0.9 million). Second, its acquisition of Bio-Logic entailed a write-off of Bio-Logic's in-process research and development, which cost the firm $5.9 million before taxes. Those charges combined to push Natus' net earnings deeply into the red last quarter.

Even worse, the picture wasn't any prettier when viewed from a cash accounting perspective. There, we saw Natus reverse last year's Q1 free cash flow of $1.7 million, burning through $1 million in cash instead. Ugh. Management had to be awfully confident in its success to try to turn this paint-by-numbers project into a pretty painting. Tomorrow, we'll be looking hard for evidence that they knew what they were doing.

Competitors:
Natus has few, if any, direct competitors in its niche. The most likely threats to its business probably come from medical device makers like:

  • Viasys (NYSE:VAS)
  • GE (NYSE:GE)
  • Siemens (NYSE:SI)
  • Philips (NYSE:PHG)
  • Tyco (NYSE:TYC)

Read more about BABY's first steps in:

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Fool contributor Rich Smith owns shares of Natus Medical. The Fool has an ironclad disclosure policy.