Natus Medical Incorporated

Good morning, everyone, and thank you for joining us today to review our results for the fourth quarter of 2021. On the call today from Natus is Thomas J. Sullivan, Natus President and Chief Executive Officer, and Drew Davis, Natus Executive Vice President and Chief Financial Officer. During the call, Mr. Sullivan will provide a brief overview of the fourth quarter 2021 and discuss the strategic direction of Natus. Drew will discuss the fourth quarter financial performance and 2022 guidance. 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 yesterday's press release and our periodic and annual reports filed with the SCC. Management's presentation of the financial results would 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 financial results on a GAAP versus non-GAAP basis in yesterday's earnings release. I will now like to turn the call over to Mr. Sullivan, President and Chief Executive Officer of Natus Medical. Mr. Sullivan?

Thank you, Carmen. Good morning, everyone. Thank you for investing your time to listen to our discussion of Natus' fourth quarter 2021 financial results, as well as an investment presentation of Natus' strategic review and go-forward clinical focus and business model. A copy of today's investor deck is available on the Investors Relations page of the Natus website at www.investor.natus.com. I am joined on today's call by our Executive Vice President and Chief Financial Officer, Drew Davies. Drew and I will refer to the presentation throughout our comments. On page three of the presentation, you will find the agenda for today's call. Following my brief introduction, Drew will review the fourth quarter and full year 2021 financial results. Following this, I will discuss our strategic review and the actions we are taking as a result. Drew will then provide our financial guidance for the full year 2022 and will turn it back to me for closing comments and Q&A. Today marks the completion of my ninth week with Natus Medical. I consider it an honor and a privilege to lead this company. Over the past two months, I've had the opportunity to engage teammates throughout Natus, and I have been impressed with the talent, experience, and passion that they bring to our company. I would like to thank them for their efforts for the patients whose lives are touched by Natus products every day. I've also been impressed with the breadth and depth of Natus' industry-leading products around the world. We are fortunate to be building from such a great position of strength. Yesterday, we reported the results for the fourth quarter of 2021. Our revenue and EPS for the quarter were at the high end of our guidance, bolstered by a strong finish to the end of the year despite continuing challenges from COVID and supply chain constraints. Our focus remains on ensuring that NADIS products are available for clinicians, which resulted in over $1.7 million in extraordinary costs in the fourth quarter. Unfortunately, these challenges are expected to continue into 2022, as we will describe later. At this time, I would like to turn the call over to our CFO, Drew Davies, and refer you to page four of the presentation. Drew?

Thank you, Tom. For the fourth quarter of 2021, we reported revenue of $128.7 million, an 8.4% increase from the fourth quarter of 2020. Revenues grew in each of our businesses during the quarter, led by neural hardware and service contracts. Our backlog grew for the seventh consecutive quarter to $26 million from $25.6 million. 2021 full year revenue of $473 million increased 14% compared to 2020. Revenue from our neuro end market was $75.2 million or 58% of total revenue during the fourth quarter of 2021 compared to $68.1 million or 57% of total revenue during the same quarter last year. Revenue from the neuro business increased 10.5% compared to the same quarter last year The increase was driven by growth in devices and service. Revenue from our newborn care end market increased 0.3% to $28.3 million, or 22% of total revenue during the fourth quarter of 2021, compared to $28.2 million, or 24% of total revenue during the same quarter last year. Revenue from international screening grew during the quarter, offset by a decline in phototherapy device sales. Revenue from our hearing imbalance end market was $25.2 million, or 20% of total revenue during the fourth quarter of 2021, compared to $22.5 million, or 19% of total revenue during the same quarter last year. Hearing assessment and hearing fitting devices drove the year-on-year increase in hearing imbalance. Revenue from devices and systems contributed 77% of total revenue in the fourth quarter of 2021 compared to 75% in the 2020 period. Revenue from supplies and services was 23% of total revenue in the fourth quarter of 2021 compared to 25% in the 2020 period. Revenue from domestic sales was approximately 59% of total revenue and 41% from international in the fourth quarter of 2021 compared to 58% and 42%, respectively, in the same period last year. On a non-GAAP basis, our gross margin increased by 1.2% in the fourth quarter of 2021 to 59.3%, compared to 58.1% in the fourth quarter of 2020. The increase in gross margin was attributable to the positive leverage on increased revenues and lower operations overhead. The improvements in gross margin were offset by $1.7 million of unforecasted increases in freight and extraordinary costs associated with securing supply of semiconductors for our devices. GAAP gross margin increased 1.5% to 56.7% in the fourth quarter of 2021, compared to 55.3% in the same period last year. Non-GAAP gross margin for the full year of 2021 improved to 60% compared to 56.6% for 2020 on higher revenues and lower manufacturing overhead. GAAP gross margin for the full year of 2021 improved to 57.8% compared to 52.1% for 2020. Fourth quarter non-GAAP operating expenses increased by $1.4 million compared to the same quarter last year. The increase in expense was driven by higher incentive pay related to the increase in revenues and savings from last year from required time off that did not repeat this year. Our non-GAAP operating margin increased by 3.6% compared to the same quarter last year on the increase in revenues and the improvements in gross margin. Non-GAAP operating expenses for the full year of 2021 increased to $227 million compared to $217 million last year. Non-GAAP operating margin for the full year increased to 12% compared to 4.5% in 2020. Again, higher revenues and gross margins drove the improvement. Our other expense was $0.9 million for the fourth quarter driven by exchange rate fluctuations. Interest expense was $0.2 million during the quarter and $1.9 million for the full year. We expect interest expense for the full year of 2022 to be approximately $1.2 million. Our fourth quarter non-GAAP effective tax rate was 20.1%, and it was 22.2% for the full year. We anticipate our overall 2022 non-GAAP tax rate to be between 21 and 24 percent. On a GAAP basis, our fourth quarter 2021 net income was $1.7 million, or five cents per diluted share, compared to net income of $5.2 million the same quarter last year. Non-GAAP net income increased $3.1 million compared to the same quarter last year. Non-GAAP earnings per share was 47 cents. For the full year of 2021, GAAP net income was $13.2 million, or 39 cents, per diluted share. And non-GAAP net income was $40.8 million, or $1.20 per share. In the fourth quarter, we recorded $9.1 million of depreciation and amortization expense. Share-based compensation was $5.9 million during the fourth quarter. And now let's take a look at some highlights from the balance sheet and statement of cash flow. We ended the quarter with $75.6 million in cash. Cash flow from operations was $12.8 million during the quarter. For the full year of 2021, cash flow from operations was $64 million. Our day sales outstanding increased four days versus the same period in the prior year to 86 days. Non-GAAP shares outstanding increased at 34.1%. million shares compared to 33.9 million shares in the same period last year. I will now turn it back to Tom to discuss the strategic direction of Natus.

Thank you, Drew, and thank you for your stewardship of Natus' financials during the transition. I appreciate our partnership. On page nine of the investor deck, I would like to begin by highlighting that our review and resulting strategic refinement are being accomplished from a position of strength. Natus is an industry leader in several categories including neurodiagnostics, pediatric retinal imaging, and infant hearing screening. Additionally, our hearing assessment and hearing instrument fitting, balance, and intracranial pressure monitoring and drainage offerings are also highly competitive. Our robust technology platforms are brought to our customers through a 700-person strong commercial organization, including marketing, field sales, and service, complemented by over 700 teammates in operations, research and development, quality, regulatory, and administration. Our teammates possess an excellent understanding of our customers and disease states in which we operate. Turning to page 10, there are, however, some historical limitations that I believe have hindered Natus' growth and profitability. Natus is a company built by acquisition, and that history has resulted in a broad and complex product portfolio. While some of these acquisitions have led to our industry-leading positions, many products lack strategic synergies other than the customer call point, resulting in a disparate mix of technologies. The consolidation of our infrastructure these past three years did reduce duplication in cost. However, the resulting centralization diminished entrepreneurial focus and attention on margin improvement. Additionally, the legacy focus on neuro, newborn care, and hearing imbalance has resulted in a site-of-care driven sales approach that somewhat diluted emphasis on key product lines and our competitive advantages in technology. We believe that a refinement to our commercial approach as well as internal alignment changes can enable us to create shareholder value as described on page 11. Specifically, we aspire to pursue long-term growth in the upper mid-single digits, and to do so, we must increase international penetration in large medical device countries, drive sales of our consumables, accelerate internal innovation and product development, increase our commercial focus on differentiated natus products, and pursue inorganic growth in technology-driven, higher-value product segments, those that are strategically vital, have greater growth potential, or offer improved margin dynamics that are strategically aligned and where natus can be a leader. In addition to growth, we believe we can expand long-term gross and EBITDA margins by containing costs to a rate of growth less than sales growth. driving growth on key product lines, and reducing our reliance on lower margin, non-differentiated products, strengthening our presence in larger countries, improving our international execution, and by integrating acquisitions that are strategically aligned, enable synergies, and are acquired in an attractive ROIC. To create the plan to accomplish these objectives, our Natus leadership has embarked on a strategic planning process that started with an affirmation of Natus values. On page 12 of the presentation, we share our Natus values, and I call your attention specifically to our Natus pledge, where we describe our focus as a company on six key stakeholders. We believe the values described in this document bring to life the holistic management approach we will bring to Natus, consistent with many environmental, social, and governance best practices. Our Natus teammates take great pride in our culture, and we believe that the Natus neighborhood is an ideal place for them to build their professional home. The second component of our strategic plan is our Natus vision. Our new tagline on page 13 sums it up very succinctly and is uniquely us. Natus, making sense of the body's signals. Described more broadly, Natus delivers innovative and trusted solutions, products, education, and service to screen, diagnose, and treat disorders affecting the brain, neural pathways, and eight sensory nervous systems with the goal of advancing the standard of care and ultimately improving patient outcomes and quality of life. On the right, you can see our new logo showcasing the brain, neural pathways, both the central nervous and peripheral nervous systems, in eight sensory nervous systems, hearing, vision, balance, smell, touch, taste, proprioception, or a sense of the body in space, and interoception, or a sense of the body itself. We believe that this vision builds upon Natus's capabilities and product strengths while expanding the areas in which we may compete into potentially faster growing technology-driven markets. This vision gives us the freedom to define a new business model for Natus and to focus our efforts in specific clinical areas. On page 14, we describe this in more detail. Let me first provide you with an overview of the business model, and then we will describe each clinical area of focus in more detail. Natus will offer hardware, advanced software and algorithms, and consumables that provide stimulus to the body, acquire and monitor physiological signals, capture the body's response, and translate this data into actionable information for clinicians. Our products will do this to screen, diagnose and treat disorders of the brain, neural pathways, and eight sensory nervous systems. We are committed to best-in-class service, field support, and education to complement our solutions. We believe that there is a treasure of data flowing through the vast Natus ecosystem, and we hope to transform it into knowledge that will enable us to advance the standard of care and innovate new business opportunities. On page 15, we describe our brain solutions, including our EEG or electroencephalography, PSG or polysomnography, neurocritical care, and brain injury product lines. We offer exceptional brands and have been rewarded with high customer loyalty. Our largest area of focus, representing 42% of Natus' 2021 revenue, Brain Solutions offer a range of technologies to support neurologists, epileptologists, sleep specialists, ENT specialists, neurointensivists, and neurosurgeons in their efforts to address seizures, epilepsy, brain tumors, stroke, head injuries, sleep disorders, sleep apnea, restless leg syndrome, narcolepsy, insomnia, and intracranial pressure and drainage. Natus is uniquely positioned with the scale, product offering, and the largest and most knowledgeable neurodiagnostic sales and service team to maintain and grow our industry-leading positions. On page 16, we describe our strong global presence in devices, supplies, and software solutions for assessing nerve and muscle function in our neural pathways area of focus. Our comprehensive solutions are offered in both private practice and hospital settings to neurologists and technicians to address carpal tunnel syndrome, muscle disorders, and peripheral neuropathy. While the smallest clinical area of focus at 16% of revenue, These exceptional brands have leading industry positions and high customer loyalty. Our third area of focus is sensory nervous system solutions, as portrayed on page 17. Today, Natus offers solutions in hearing screening and assessment, hearing fitting, eye imaging, and balance. With products found in the acute care, audiologist offices, and retail settings, our differentiated portfolio has strong brand recognition and customer loyalty. We engage audiologists, ophthalmologists, neonatologists, neurologists, and ENTs across a range of sensory disorders. Representing 32% of revenue, we offer innovative solutions that are changing the paradigm of care. Our fourth and final area of focus on page 18 is other solutions, and represents traditional NADIS assets that, while not directly linked to our new NADIS vision, are nonetheless highly regarded product lines. For example, our NICVUE live video streaming of newborns in the NICVUE and NEOmetrics, our newborn metabolic screening database system and hearing case management service are both leaders in their respective industries. We are currently assessing the best path to shareholder value creation in all of these product lines. Collectively, other solutions represent 10% of Natus' revenue. As a result of our strategic review, we have restructured our commercial organization to increase the focus on key product lines in brain, neural pathway, and sensory nervous systems to align with the new Natus vision. On page 19, we describe our five focused U.S. sales teams. We have strengthened our brain team with the addition of neurocritical care specialists, added incremental territory support in our neural pathways team, and increased our inside sales team by 75% to drive consumables and product in our other areas of focus. Driven by our vision, we have made the strategic decision to move away from our legacy neurosurgery and newborn care sales forces and formed a new sensory field sales team focused on key product lines in vision, hearing, and balance. This action will increase the number of representatives selling our industry-leading infant hearing screening and pediatric eye imaging product lines by 43%. as well as increase our hearing, fitting, and assessment representation by 25%. The restructuring will save approximately $4.8 million in operating expense, which has been incorporated into our guidance. Complementing these changes we have made to our commercial organization, we've begun the transition to a matrix organization throughout Natus to restore a focus on entrepreneurial growth while maintaining Natus-wide centralized support. Collaboration and innovation teams will be formed around like product lines and technologies to enable us to leverage expertise while deploying resources and decisions closer to the action, empowering our teams to accelerate innovation. The transition to our matrix structure will occur over the coming months, and we believe it will be critical to driving long-term organic growth. In summary, In summary, on page 22, Natus is the clear worldwide leader in neurodiagnostics, pediatric retinal imaging, and infant hearing screening. We're also a leading company in hearing assessment and hearing instrument fitting, balance, and intracranial pressure monitoring. Our debt-free balance sheet and strong, stable cash flows afford us the capital to pursue synergistic acquisitions in area clinical focus and adjacencies. We have opportunities for increased growth as we prioritize faster-growing product segments, increase international penetration, accelerate growth in consumables, and increase the pace of new product development. We intend to thoughtfully manage cost as we drive growth to improve our overall margins. Now, turning to 2022 guidance, as a result of our strategic alignment, as well as the supply chain challenges that we continue to face, especially involving the availability of semiconductor chips, we will transition to annual guidance at this time. With this as background, I refer you to page 21, and we'll turn it back to our CFO, Drew Davies, to provide guidance for the full year of 2022. Drew?

Thank you, Tom. In the first quarter of 2022, Natus will realign its commercial organization on the clinical focus areas of brain, neural pathways, and 8th century nervous systems. The company will transition to a matrix infrastructure on non-commercial resources in support of innovation and entrepreneurial growth in each clinical focus area in the coming months while reviewing its cost structure. As a result of these changes, The company is only providing annual guidance at this point, which excludes the impact of acquisitions or divestitures. For the full year of 2022, the company's revenue is expected to be between $491 million and $499 million. GAAP earnings are expected to be between $0.90 and $1.03 per share, and non-GAAP earnings per share is expected to be between $1.36 and $1.49. 2022 guidance includes an assumed incremental $16 million of extraordinary costs associated with acquiring semiconductors and other components outside of our normal supply chain due to their constrained availability, and $6 million of cost reductions associated with commercial realignment and other savings. Additional unforeseen constraints could further impact our profitability. While these extraordinary costs negatively impact profitability in the near term, a return to more normal supply chain conditions could positively impact profitability in the future. At this time, we do not anticipate semiconductor and component constraints to impact revenue. And with that, I will turn it back to Tom for some additional comments.

Thank you, Drew. I echo Drew's comments regarding the negative impact of incremental supply chain costs included in our 2022 guidance. While we will attempt to further mitigate these costs and remain hopeful that supply will improve and our acquisition cost of these technologies will return to more reasonable levels, we remain committed to ensure that Natus products will be available for clinicians despite the short-term COGS impact. Excluding these costs, We are pleased with the progress we believe we are making in improving gross margins, complementing the improvement we are seeing in operating expenses. Both of these areas will continue to be a focus for us. Returning briefly to page 20, we compared our new clinical areas of focus to the previous revenue categorizations. We'll begin reporting our revenue in this manner on a go-forward basis as we believe it better reflects the underlying segments and technology dynamics that Natus will pursue. We believe there are growth prospects in each of these areas. Compared to a COVID impacted 2020, in 2021, neural pathways growth led the way up 29%, brain up 21%, and sensory systems up 8%. Our other solutions area was down 10% on the year. We believe that the movement away from the slower growth newborn care segment is the first step in the pursuit of higher growth areas where Natus technology-driven products can make a difference. In summary, as I stated earlier on page 22, Natus is the clear worldwide leader in several categories. We intend to thoughtfully manage our costs and drive growth to improve overall margins as we invest in each of our key areas of focus. We've begun our journey and believe that the long-term prospects for Natus are good in our core product lines, as well as new opportunities enabled by the wealth of data in the Natus ecosystem. We look forward to updating you on our progress as we continue the implementation of our strategic refinement. At this time, Drew and I will be happy to respond to questions. Carmen?

Thank you. And to ask a question and get in the queue, simply press star 1 on your telephone. To withdraw the question, press the pound or hash key. Please stand by while we compile the Q&A roster. Question from Jason with Raymond James. Please go ahead.

Hi, good morning, guys. Can you hear me okay? Yeah, yeah. Hi, Jason. Morning, Jason. Hi. Good morning. I have to admit, after a long learning season, you've thrown a lot at us this morning, but I certainly appreciate all the detail and the comprehensive slide deck here. So I guess maybe just to start, one of the things you talked about, Tom, was pursuing upper single-digit top-line growth longer term. And I think you identified international penetration, higher consumable sales, and deals. And I guess my first question is just which one of these factors is most critical for natives to reach upper single-digit growth?

Upper mid-single-digit growth, Jason, and thank you for the question. They all have to be done concurrently, Jason. We definitely want to look to grow the business outside the U.S. in areas particularly where our market share is not as strong as it is in the United States. And we believe that there are a lot of opportunities in the largest medical device countries around the world. But we also believe that our consumable portfolio has opportunities for us to drive growth. And we have a number of technologies that are the standard of care that we believe with the right clinical focus we can drive greater adoption of that standard of care. So those are executional-oriented aspects of the portfolio. At the same time, we want to accelerate internal innovation. We're looking to speed our new product development process to continue to keep our technologies as the best in class. And then we are looking strategically at inorganic growth but really being sensitive to acquiring product lines or technologies that are consistent with our vision, that fit where we see great opportunities in faster-growing areas of the business, and that really can also give us strategic synergies as we make them part of the Natus family. So there's no one of those that's the single right lever. It's a question of trying to manage all those levers concurrently. Okay.

Okay. And just more definitional, upper mid-single, is that 5% to 6%? Yeah, I think that's a good range. Okay. And then just, I guess, on the M&A bucket, Tom, what's the appetite for taking on some leverage and just some of the M&A criteria you look at?

Well, first of all, Drew's done a great job with the balance sheet here at Natus. And with $75 million in cash and no debt today, we have a lot of firepower available for assets. But we don't just want to acquire assets, Jason. We're really looking for assets that are technology-driven, that have a market that is faster growing than traditional Natus markets, where we have an opportunity to either move into adjacencies that are highly attractive or increase our strength in the areas where we're currently focused on. We also think that any acquisition we bring in, we're going to look for strategic synergies with them, particularly if it's in existing markets that we already play in. And, you know, the criteria we're going to use is to make sure that, first, it's strategically right, but then, secondly, there is a long-term ROIC that is attractive for our shareholders.

Okay. In terms of just kind of getting back to the new buckets of revenue here, specifically brain, neural, and sensory, which can you just maybe give us an idea as to the end market growth rate of each of those buckets?

It's a little different to pin down one specific growth rate for the markets because they represent a variety of different clinical areas. But roughly, we look at the brain marketplace as being the lower mid-single digits, sort of that 3% to 5% range is what we see out there in the market. The neural pathways market is very similar to that. The sensory market, while the hearing aid market is seen as faster growing, the capital infrastructure that we play a role in, as opposed to the hearing instrument itself, grows a little bit less than that overall market growth rate. So it, too, would be probably in the 3% to 4% range is our main estimate. So they're all in the lower side of the mid-single digits or the upper lower single digits, but we do believe that there are growth opportunities both in the U.S. and outside of the U.S. for us from a market share perspective.

Okay. And just on share, I realize it's difficult, but what would be your approximate share today in brain, neural, and sensory?

It's not something that's easy for us to put out there, Jason, because it really starts to get into the subspecialties, and we're not prepared to go to that level of detail today. Okay.

Okay. I guess you identified the other segment as an area where you're looking at. How long will it take you to make decisions or find new homes for the products in these other segments? I'm just kind of curious as to how far – along the path, are we?

Yeah, you know, Jason, there are terrific assets in the other category. They're just, they're not necessarily directly consistent with our natus vision. And in particular, the Neometrics and the NICVU lines are market leaders in their space. So these are highly attractive assets that we're looking at what are the best paths for us to generate strategic value for them for our shareholders. You know, we're evaluating all options, you know, including organically maintaining growth on them, But we want to make sure that they don't distract us from the focus on the key clinical areas of brain, neural pathways, and eight sensory nervous systems. So our initial approach is now to step back. Let's assess them. What will it take to make them highly successful as a part of Natus? And how do they fit our overall portfolio? Even our phototherapy line at 2% of overall Natus revenue is a very nice product line. There's a variety of the other things that make up the remaining 4% of Natus' overall revenue, and we're going through the process to assess each of them. My expectation is in the next three months we'll have plans for each of them that we'll be able to describe more fully to our investors.

Okay. That's helpful. And then I guess maybe lastly for me, and I need to think about a lot of the new information you've disclosed here, but it seems like you're certainly lifting the perceived clinical importance of the technology in the portfolio. Is there a period of accelerated spending that goes along with that, or can you achieve this step up in technology with the current cost structure?

Jason, it's an excellent question. And the first thing I would say is, You know, we did step back and we restructured the sales organization to fit this, and that yielded a cost savings of $4.8 million, as I've already described and Drew has included in our guidance. You know, as we now implement the part two of that, which is the matrix organizations and building our collaboration innovation teams, we don't know that answer yet. It's only been nine weeks that we've been here, and we're starting to drive that now. We want to make sure that these teams are resourced properly and that they have the talent from an engineering perspective, that they have the competencies to really accelerate long-term organic growth. Now, we're going to go through and obviously attempt to be as cost-sensitive as we can as we do that, but we are open to making the appropriate investments if we believe it's in the long-term best interest of our shareholders. So we don't have a distinct answer on that yet. We're in the process of evaluating it, but we wanted to begin the journey today and make the same announcements to our own organization, and we'll have an update in the next three months. Okay.

And Just on the Salesforce restructuring, if it's 700 people strong today, what was it before the restructuring?

It was over 700. We don't get any more specific than that, Jason. I'm sorry. Okay. That's okay. All right. I'll get back in queue. Thank you. Thank you, Jason. I appreciate your questions and engagement. Thanks.

Thank you. And I will turn the call back to Mr. Sullivan for any final remarks.

Thank you, Carmen. Thank you, everyone, for joining today's investor call. In closing, I would like to again thank our Natus teammates for their efforts every day in enabling clinicians to improve patient outcomes and quality of life. We also appreciate our investors' investment in us as a company and look forward to growing Natus to generate shareholder return. Thank you, and have a great day.

Thank you, and this concludes today's conference call. Thank you for participating, and you may now disconnect.