Natus Medical Inc. Serves Up a New Business Model

By Markets Fool.com

Natus Medical continues to fire on all cylinders. It's hard to find something to complain about the medical device maker specializing in neurology and care for newborns. Even the numbers that don't look good have positive causes.

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Take, for instance, the fact that the company's fourth-quarter adjusted earnings grew by 9% year over yearwhile adjusted earnings per share increased by just 5%, from $0.38 per share to $0.40. The difference involves the growing number of outstanding shares, even though Natus actually repurchased$1.2 millionof company stock during the quarter. Outstanding shares increased because Natus has to count its stock options that are now in the money.

That will happen when your share price increases by over 62% in a year. Investors can't really complain about owning a slightly smaller piece of a much larger pie.

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The key to sustaining that share price appreciation will come from increasing operating margin. Natus hit its goal of 16% operating margin in 2014 and is shooting for 18% this year on the way to its stated target of 20% in 2016.

Peloton, Natus' newborn hearing testing service, will contribute substantially to increasing margins as it ramps up. The service added 19 hospitals in the fourth quarter, bringing the total number of hospitals under contract to 58. The service is still being established in more than half of those hospitals,so they're costing the company money for training without generating revenue. As they come online in the coming quarters, Peloton will start contributing to the bottom line.

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With a relatively flat birth rate in the U.S., moving to a service-based model is a good way to increase revenue for the newborn hearing screening portion of its business. Instead of making $10 per baby on disposables used when a hospital runs a test on Natus' ALGO hearing screeners, Natus makes $100 or more per child running the test for the hospital. It loses the sale of the ALGO machine to the hospital and has to pay the technician to perform the test, so the increase isn't all profit, but it will still give a nice boost to earnings.

Natus expects to have 100 hospitals under contract by the end of this year. The company could seemingly expand faster -- there are about 3,000 hospitals in the U.S. that are large enough to justify outsourcing their hearing tests -- but growing steadily controls costs, keeping the margins going in the right direction.

Natus also moved toward the service business model in its neurology business with the acquisition this week of Global Neuro-Diagnostics. The company had been a Natus customer, using its equipment to run video electroencephalogram, or EEG, tests in patients' homes or physician offices, making it more comfortable -- and probably cheaper -- than performing the test in a hospital.

Global Neuro-Diagnostics operated largely out of Texas and had about$7 million in revenue last year. Natus is set up nicely to expand the service to the rest of the U.S., as Natus has existing relationships with private neurology groups that buy itsneurology devices.

The Global Neuro-Diagnostics acquisition and also the purchase of NicView, which provides video monitoring in neonatal intensive care units so friends and families can see the new fragile baby, allowed Natus to increase its 2015 revenue guidance to$373 million-$375 millionfrom the previous guidance of$367 million-$369 million. Adjusted earnings per share for the year are now expected in the range of$1.42 to $1.46, a year-over-year increase of 12.7% at the low end.

Doesn't seem like we're going to have much to complain about this year, either.

The article Natus Medical Inc. Serves Up a New Business Model originally appeared on Fool.com.

Brian Orelli has no position in any stocks mentioned. The Motley Fool recommends Natus Medical. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.