Natus Medical Inc: This BABY Has Some Growing Pains

By Brian Orelli Markets Fool.com

Natus Medical (NASDAQ: BABY) reported a rough first quarter on Wednesday, with profits from its legacy business falling, while newly acquired Otometrics added quite a bit of revenue growth, but little profit.

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Natus Medical results: The raw numbers

Metric

Q1 2017

Q1 2016

Year-Over-Year Change

Revenue

$124.7 million

$87.3 million

43%

Income from operations

$1.4 million

$11.2 million

(87%)

Earnings per share

$0.01

$0.26

(96%)

Data source: Natus Medical.

Image source: Getty Images.

What happened with Natus Medical this quarter?

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  • The revenue growth came from Otometrics, which became part of Natus Medical in the beginning of January. The new segment, which sells hearing-diagnostic, hearing-aid fitting, and balance-assessment products, was "slightly" profitable, so it didn't contribute much to the earnings line.
  • Management noted that it was the first time that Otometrics was profitable in the first quarter, so it's headed in the right direction under its new leadership. Otometrics is on its way to achieving a 10% adjusted operating profit margin this year with a goal of expanding that to 20% next year.
  • Management blamed the lack of revenue growth from the legacy business on lower birth rates and lower reimbursement for hearing screening done by Peloton, its hearing-services business.
  • The lower profitability was caused by continued costs to deal with the FDA warning letter at its facility in Seattle, which Natus Medical hopes to be resolved next year.

What management had to say

Management has a plan to increase margins at Peloton by adding additional services that hospitals might want to outsource, explained Jonathan Kennedy, Natus Medical's CFO, EVP, and general manager of newborn care:

To combat that, we've just introduced, this last quarter, a new service where we're going to screen the babies [for hearing], but then also there's an additional test that we do that we'll charge the hospital for just a flat fee per baby. So that will expand basically our offering and increase our margin there.

In hospitals where there aren't enough births, or reimbursement isn't high enough to produce a profit by offering outsourcing to the hospitals, Natus has the ability to switch back to just selling its hearing screener and make money from disposables. Kennedy noted:"We have to look at the overall profitability of that business and when it makes sense to pursue a service model or pursue a hardware-and-supplies model, and that's going to be in the hospital by hospital case."

Looking forward

Natus hit a triple whammy of lower birth rates, an ongoing warning letter that's reducing revenue and increasing costs, and a lower reimbursement for Peloton. It can't really do anything about the birth rates, and the warning letter should be resolved next year, which leaves increasing margins at Peloton as the most critical factor investors should be watching.

Fortunately, management made the smart move of acquiring Otometrics, which diversifies the company away from newborn screening and offers an opportunity to grow earnings by expanding the segment's operating profit margin.

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Brian Orelli has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Natus Medical. The Motley Fool has a disclosure policy.