Natus Medical Incorporated

Good morning, everyone, and thank you for joining us today to review our results for the third quarter of 2021. On the call today from NADIS is Jonathan Kennedy, NADIS President and Chief Executive Officer, and Drew Davis, NADIS Executive Vice President and Chief Financial Officer. Jonathan will begin today with a business overview of the third quarter 2021. Then Drew will discuss the third quarter financial performance. Finally, Drew will return the call to Jonathan for closing remarks. 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 research meetings were materially from these forward-looking statements. For a description of relevant risks and uncertainties pertaining to our business, please see yesterday's press release and our periodic and annual reports, followed by the SEC. Management's presentation of the financial results will be on a gap and non-gap basis. The non-gap results exclude amortization expense, restructurings, and certain added charges and the related tax effects. Management believes that the presentation of these non-gap measures, along with our gap 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 NANGAP basis in yesterday's earnings release. I would like to turn the call over to Jonathan Kennedy, President and Chief Executive Officer of Natus Medical. Mr. Kennedy.

Thank you, operator, and good morning to everyone. During our call today, we will discuss our third quarter 2021 financial results, as well as our current business trends. Yesterday evening, we reported the results for the third quarter of 2021, and revenue for the quarter achieved the mid-range of our guidance at $113.9 million, and non-GAAP earnings per share was 28 cents. We are encouraged by the 11% increase in revenue in the third quarter of 2021, compared to the same quarter in 2020, despite the recent supply chain constraints. Demand for our products and service continue to improve throughout the quarter. We saw the benefits of our investments in innovation this quarter, with the release of the new RETCAM Envision newborn eye imaging system in the United States. We also saw the first successfully performed clinical case using Natus' newly launched Exactrode family of subdural electrodes, and another quarter of growing sales for our UltraPro EMG device, which was released in the fourth quarter of last year. 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. As you know, Natus is a global leader in neurodiagnostics. Our products and services are used by a majority of hospitals and neurologists worldwide. We have the most comprehensive line of neurodiagnostic equipment offered by any global manufacturer today, offering a full line of EEG, EMG, and PSG solutions. Overall, our neuro business grew by 19% year-over-year during the third quarter. led by EEG and EMG sales, which increased by 27% and 22%, while neurosurgery products increased by 16%. Our hearing and balance products include devices and supplies used by audiologists, hospitals, and EMT to diagnose hearing disorders, assist in the fitting and tuning of hearing aids, and for the diagnosis of balance disorders. Revenue from hearing and balance grew by 6% versus the same quarter last year, led by an 11% increase in hearing assessment product revenue and a 33% increase in our hearing aid fitting product revenue. Supply constraints led revenue from our balanced products to decrease by 52% versus the prior year. Natus' market-leading newborn care product family is used by hospitals worldwide. Major product categories in this family include our newborn hearing screening solutions, neonatal eye imaging, and brain injury monitoring. video streaming services, and phototherapy solutions. Overall, newborn care revenues declined by 5% versus the third quarter of 2020, but primarily from order delays affecting certain international customers that use our newborn hearing screen products. In summary, we're very pleased with the growth that we had during the quarter. We remain focused on our strategy of investing to refresh our market-leading products and deliver new innovations, which we believe will drive our growth and future financial performance. 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? Thank you, Jonathan.

As Jonathan stated, we reported third quarter revenue of $113.9 million, an 11% increase from the third quarter of 2020. Supply constraints did impact our revenue results this quarter. However, we believe demand for our products remains healthy as evidenced by our backlog quarter of $25.6 million. Revenue from our neuroend market was $70 million, or 62% of total revenue, during the third quarter of 2021, compared to $58.8 million, or 50% of total revenue during the same quarter last year. Revenue from the neuro business increased 19.2% compared to the same quarter last year. The increase was driven by growth in devices, supplies, and service. Revenue from our newborn care end market decreased 4.8% to 24.5%, or 21% of total revenue during the third quarter of 2021, compared to $25.7 million, or 25% of total revenue during the same quarter last year. The decrease was primarily attributable to lower revenue from supplies related to the number of births and device supply constraints. Revenue from our hearing imbalance end market was $19.4 million, or 17% of total revenue during the third quarter of 2021, compared to $18.3 million, or 18% of total revenue during the same quarter last year. Hearing assessment and hearing fitting devices led to year-on-year increase in hearing imbalance. In total, revenue from devices and systems contributed 74% of total revenue in the third quarter of 2021 compared to 71% in the 2020 period. Revenue from supplies and services was 26% of total revenue in the third quarter of 21 compared to 29% in the 2020 period. Revenue from domestic sales was approximately 63% of total revenue and 37% from international sales in the third quarter of 2021, compared to 62% and 38%, respectively, for the same period last year. On a non-GAAP basis, our gross margin increased by 4.8 percentage points in the third quarter of 2021 to 61%, compared to 56.2% in the third quarter of 2020. The increase in gross margin was attributable to the higher mixed of North American neurosales, lower operations overhead, and the increase in revenue compared to the third quarter last year, offset by increases in materials cost. GAAP gross margin increased 13.3 percentage points to 59.5% in the third quarter of 2021, compared to 46.2% in the same period last year. The increase in GAAP gross margin was also impacted by an intangible asset impairment in the prior year that did not repeat this year. Third quarter non-GAAP operating expenses increased $2.8 million compared to the same quarter last year. The increase in expenses was driven by higher incentive pay related to the increase in revenues and the savings last year from required time off that did not repeat this year. Our non-GAAP operating margin increased by 7.4% compared to the same quarter last year on the increases in revenue and the improvements in gross margin. Other expense was $700,000 for the third quarter of 2021, driven by exchange rate fluctuations. Interest expense was $300,000 during the quarter. We expect interest expense in the fourth quarter of 2021 to be the same. and for the full year to be approximately $2 million. Our third quarter of 2021 non-GAAP effective tax rate was 24.9%. We anticipate our overall 2021 non-GAAP tax rate to be between 21 and 25%. On a GAAP basis, third quarter 2021 net income was $5.6 million or 16 cents per diluted share compared to a net loss of $9.3 million in the same quarter last year. Non-GAAP net income increased $6.1 million to $9.3 million compared to the same quarter last year. Non-GAAP earnings per diluted share was 28 cents. In the third quarter of 2021, we recorded $7 million of depreciation and amortization expense. Share-based compensation was $2.6 million during the third quarter of 2021. And now let's take a look at some of the highlights from the balance sheet and cash flow. We ended the quarter with $68.8 million in cash. Cash flow provided by operations was $7.1 million during the quarter. Our day sales outstanding increased five days versus the same period in the prior year to 77 days. Non-GAAP diluted shares outstanding increased to 33.9 million shares compared to 38.9 33.8 million shares in the same period last year. Now turning to guidance. Compared to last year, we've seen demand for our products and services increase in every quarter this year. Historically, we experience our highest quarterly revenue for the fourth quarter, and we expect that to hold true this year. With increases in revenues, we also expect to benefit from positive leverage resulting in higher gross margin, and income. With this in mind, we expect our revenues for the fourth quarter of 2021 to be between $124 million and $128 million. Gab net income is expected to be in the range of $9.5 million to $11.6 million for the fourth quarter of 2021, or 28 to 33 cents per diluted share. Non-GAAP net income is expected to be in the range of $13.8 million to $15.5 million, or $0.41 to $0.46 per diluted share. And with that, we will now open it up for questions.

As a reminder, to ask a question, you will need to press star 1 on your telephone. To answer your question, press the found or hash key. Thank you. Your first question concerns the line of Jason Bedford is Raymond James. Please go ahead.

Hi, good morning guys. I guess just a few quick questions. First on the supply constraints, it was mentioned a few times specifically on balance. So if there's any way you could detail kind of what is the issue that you're seeing out there and when will it be alleviated?

Yeah, we've got our balanced product, the ICS impulse. We've got some supply chain delays there, and we expect to start getting more supply late in the fourth quarter or in the first quarter next year.

Okay. Drew, maybe, how big is that business? I think you said it was balancing down 55%. I'm not sure what the impact of that was. And frankly, the supply constraints, are they confined to balance? Are they impacting revenue in other areas of the business?

Hey, Jason, that's about a $2.5 million a quarter business per quarter for that business. And so half of that We do have sporadic both supply constraints and freight constraints and logistic constraints of other sorts that have just built our backlog and what I think everybody has seen in the market, I would categorize it that way. We have a few subcomponents that are unique, and we've had some issues with them as well, and that keeps us from being able to ship the balanced products. We do believe, though, that we have a pretty good line of sight of of when that will come back. And as Drew said, probably late in the fourth quarter, early in the first quarter, we should be able to get those back in shipping mode.

So it sounds like balance is kind of the only area of the business that's being impacted from a revenue generation standpoint. I realize I'm assuming there's probably some cost pressure on the expense side, but from an ability to shift product and generate revenue, the only supply constraint seems like it's on the balance. Is that fair?

Uh, balance is the, is one of the bigger pieces, but we do have a few others in, uh, in the, in, in hearing diagnostics and, and, um, hearing aid fitting that are, that are less impactful, but we do have, if you look at our, our, um, you know, where our orders are that we were unable to ship during the quarter, that growth wasn't here in a balance. And to some extent in, uh, Newborn Care and Neuro, we've been pretty good. We manufacture those products and keep a pretty good lead of inventory in those areas. But if you think of like hearing a balance, it's a little more of a supply and a larger flow and a larger volume. And so it's a little bit more impacted by either shipping constraints or supply constraints where it's a little more of an ongoing business as opposed to, you know, a hardware heavy where, you know, you can stock the inventory and ship it when you're ready.

Red Cam, any way to quantify the contribution in the quarter and just kind of the demand profile going forward for the new device?

Yeah, we got the Red Cam back in the market during the quarter. We were constrained on the lenses. We got the lens fixed and we got them back into the market during during the quarter and they began shipping again. But we could have, you know, had we had more lenses, we could have shipped more. You know, we we did envision in total, we usually do anywhere from three to $5 million a quarter. And this this last quarter, we did about to $2.7 million in vision for the for the quarter. So we could have definitely had higher revenue had we had more lenses. And we're building a nice backlog, and the customer acceptance and customer interest in that product is very high.

Okay. I'd have to go back to my notes here, but I don't think the word COVID was mentioned, which was refreshing. Okay. And I realize that the supply constraints are kind of knock-on effects of that. But I guess the question here is, when you look at the end market for your products out there, was there a disruptive impact from the flare-up of Delta in the U.S.? And then just how is the end market feeling today versus where it was, say, in third quarter?

You know, there was a little bit of noise about that. I'd be hesitant to point to a material impact from Delta and the clog up at hospitals during the third quarter that impacted us anyway. Since you mentioned it, yeah, COVID definitely has a lot of follow-on effects, which we described in the supply constraints and the logistic issues. But in terms of hospital sentiment, I think we are in a fairly decent place. I will say the one thing that still remains unusual versus maybe times past is access to customers. So that's still virtual. There's still less than times past of face-to-face customer interaction. We've moved a lot of that online to webinars and all the virtual ways you do it, and that has seemed to suffice, but I think that's the piece that's finally missing that we don't know when we'll see that coming back to normal, but definitely not yet.

Okay. And then just lastly... your balance sheet is in a really good spot here. Um, what, what are the priorities in terms of, uh, capital allocation at this point?

Yeah. Uh, thanks for the compliment of the balance. You know, we've worked really hard to, um, bring working capital down and cash up. We have, uh, you know, cleared, uh, all the debts. So we're the cash you see there is, is, uh, unencumbered cash. Our priorities remain, you know, we still have, um, uh, an interest in building the business and acquisitions. There's a few opportunities in the pipeline that we continue to evaluate and sort of tuck in businesses that would be complementary to what we already do. Second to that, opportunities to return shareholders' cash through share buybacks is probably the next rung down and and something that we had done prior to COVID and pulled back as we faced some uncertainty, but something that we would be willing to discuss, you know, over time here as the business recovers. Okay. All right, great. Thanks, guys.

Thanks, Jason. Thank you, Jason.

With all the questions we have, I would like to hand the conference back to Mr. Kennedy.

Thank you, Operator. I'd like to thank all of our employees, partners, and customers for the outstanding efforts again during the quarter and look forward to finishing the year in a strong way. Thank you, everybody, and have a great day.

This concludes today's conference call. Thank you for participating. You may now disconnect.