Natus®, AABR ®, ABaer®, ALGO®, AOAE ®, AuDX®, Balance Manager®, Balance Master®, Biliband®, Bio-logic®, Ceegraph®, CHAMP ®, Cochlea Scan®, Cool Cap®, Ear Couplers ®, Echo Screen®, EquiTest®, Fischer-Zoth®, Flexicoupler®, MASTER®, Navigator®, neoBLUE ®, NeuroWorks®, Oxydome®, Sleepscan ®, Smart Scale®, Traveler®, Warmette®and VAC PAC® are registered trademarks of Natus Medical Incorporated. Accuscreen™, Bili-Lite Pad™, Bili-Lite™, Biomark™, Circumstraint™, Coherence™, Deltamed™, inVision™, MiniMuffs™, Neometrics™ and Smartpack™ are non-registered trademarks of Natus. Solutions for Newborn CareSM is a non-registered service mark of Natus. Neuromax ® and Sleeprite® are registered trademarks of Excel Tech Ltd. Xltek™ is a non-registered trademark of Excel Tech Ltd.

Overview

The following Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") supplements the MD&A in the Annual Report on Form 10-K for the year ended December 31, 2008 of Natus Medical Incorporated ("Natus," "we," "us," or "our Company"), and presumes that readers have read or have access to the discussion and analysis in our Annual Report. Management's discussion and analysis should be read in conjunction with our condensed consolidated financial statements and accompanying footnotes, the discussion of certain risks and uncertainties contained in Part II, Item 1A of this report, and the cautionary information regarding forward-looking statements at the end of this section. MD&A includes the following sections:

• Our Business. A general description of our business;

• 2009 First Quarter Overview. A summary of key information concerning the financial results for the three months ended March 31, 2009;

• Application of Critical Accounting Policies. A discussion of the accounting policies that are most important to the portrayal of our financial condition and results of operations and that require significant estimates, assumptions, and judgments;

• Results of Operations. An analysis of our results of operations for the periods presented in the financial statements;

• Liquidity and Capital Resources. An analysis of capital resources, sources and uses of cash, investing and financing activities, off-balance sheet arrangements, contractual obligations and interest rate hedging;

• Recent Accounting Pronouncements. See Note 1 to our Condensed Consolidated Financial Statements for a discussion of new accounting pronouncements that affect us; and

• Cautionary Information Regarding Forward-Looking Statements. Cautionary information about forward-looking statements.

Business

Natus is a leading provider of healthcare products used for the screening, detection, treatment, monitoring and tracking of common medical ailments in newborn care, hearing impairment, neurological dysfunction, epilepsy, sleep disorders, and balance and mobility disorders. Product offerings include computerized neurodiagnostic systems for audiology, neurology, polysomnography, and neonatalogy, as well as newborn care products such as hearing screening systems, phototherapy devices for the treatment of newborn jaundice, head-cooling products for the treatment of brain injury in newborns, and software systems for managing and tracking disorders and diseases for public health laboratories.

We have completed a number of acquisitions since 2003, consisting of either the purchase of a company, substantially all of the assets of a company, or individual products or product lines. The businesses we have acquired include Neometrics in 2003, Fischer-Zoth in 2004, Bio-logic, Deltamed, and Olympic in 2006, Xltek in 2007 and Sonamed Corporation, Schwarzer Neurology, a division of Schwarzer GmbH, and NeuroCom International, Inc. in 2008.

Product Families

We categorize our products into the following product families, which are more fully described in our Annual Report on Form 10-K for the year ended December 31 2008:

• Hearing - Includes products for newborn hearing screening and diagnostic hearing assessment.

• Monitoring Systems for Neurology - Includes products for diagnostic electroencephalography ("EEG"), diagnostic sleep analysis ("PSG"), electromyography ("EMG"), intra-operative monitoring ("IOM"), newborn brain monitoring, and assessment of balance and mobility disorders.

• Newborn Care - Includes products for the treatment of brain injury and jaundice in newborns.

Segment and Geographic Information

We operate in one reportable segment in which we provide healthcare products used for the screening, detection, treatment, monitoring and tracking of common medical ailments in newborn care, hearing impairment, neurological dysfunction, epilepsy, sleep disorders and balance and mobility disorders.

Our end-user customer base includes hospitals, clinics, laboratories, physicians, nurses, audiologists, and governmental agencies. Most of our international sales are to distributors who resell our products to end-users or sub-distributors.

Information regarding our sales and long-lived assets in the U.S. and in countries outside the U.S. is contained in Note 11- Segment, Customer and Geographic Information of our condensed consolidated financial statements included in this report.

Revenue by Product Category

We generate our revenue either from sales of Devices and Systems, which are generally non-recurring, and from related Supplies and Services, which are generally recurring. The products that are attributable to these categories are described in our Annual Report on Form 10-K for the year ended December 31, 2008. Revenue from Devices and Systems, and Supplies and Services, as a percent of total revenue for the three months ended March 31, 2009 and 2008 is as follows:

                                            Three Months Ended
                                                 March 31,
                                            2009           2008
                  Devices and Systems           58 %           62 %
                  Supplies and Services         40 %           36 %
                  Other                          2 %            2 %

During the three months ended March 31, 2009 and 2008, no single customer or foreign country contributed to more than 10% of revenue, and revenue from services was less than 10% of revenue.

2009 First Quarter Overview

Our revenue decreased 9.5% to $33.4 million in the first quarter ended March 31, 2009, compared to $36.9 million reported in the comparable quarter of the previous year. Net income decreased 70% to $787,000, or $0.03 per diluted share, for the first quarter of 2009, compared with net income of $2.6 million, or $0.11 per diluted share, for the first quarter of 2008.

The severe worldwide economic downturn that started to impact our business in December 2008 continued to influence our results for the first quarter of 2009. In the quarter, hospitals in the United States reduced expenditures on capital equipment. This impacted sales of all the Company's product lines except the ALGO newborn hearing screening products. We also saw a reduction in capital equipment spending outside the United States. Revenue from our neurology,

balance and mobility, hearing diagnostic, and newborn care equipment products were all down by at least 15% year over year. We believe this trend will continue through the remainder of the year, but we believe the reduction in capital equipment purchases has stabilized and will not further deteriorate.

Application of Critical Accounting Policies

We prepare our financial statements in accordance with accounting principles generally accepted in the United States of America ("GAAP"). In so doing, we must often make estimates and use assumptions that can be subjective, and, consequently, our actual results could differ from those estimates. For any given individual estimate or assumption we make, there may also be other estimates or assumptions that are reasonable.

We believe that the following critical accounting policies require the use of significant estimates, assumptions, and judgments. The use of different estimates, assumptions, or judgments could have a material affect on the reported amounts of assets, liabilities, revenue, expenses, and related disclosures as of the date of the financial statements and during the reporting period:

• Revenue recognition

• Allowance for doubtful accounts

• Inventory is carried at the lower of cost or market value

• Carrying value of intangible assets and goodwill

• Liability for product warranties

• Share-based compensation

These critical accounting policies are described in more detail in our Annual Report on Form 10-K for the year ended December 31, 2008, under Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations. There have been no changes to these policies during the three months ended March 31, 2009.

Results of Operations

The following table sets forth, for the periods indicated, selected consolidated
statements of operations data as a percentage of total revenue. Our historical
operating results are not necessarily indicative of the results for any future
period.



                                                     Three Months Ended
                                                          March 31,
                                                     2009           2008
          Revenue                                     100.0 %        100.0 %
          Cost of revenue                              39.1           38.0

          Gross profit                                 60.9           62.0

          Operating expenses:
          Marketing and selling                        30.0           26.8
          Research and development                     11.1           10.4
          General and administrative                   16.5           13.2

          Total operating expenses                     57.6           50.4

          Income from operations                        3.3           11.6
          Other income, net                             0.4             -

          Income before provision for income tax        3.7           11.6
          Provision for income tax                      1.3            4.5

          Net income                                    2.4 %          7.1 %

Three Months Ended March 31, 2009 and 2008

Certain reclassifications have been made to the prior period classification of revenue as devices and systems or supplies and services to conform to the current presentation.

We acquired Sonamed in May 2008, Schwarzer Neurology in July 2008 and NeuroCom in October 2008. Where significant, we have noted the impact of these acquisitions on our results of operations for the three months ended March 31, 2009, as compared to the same period in 2008.

Revenue decreased $3.5 million, or 9.5%, for the three month period ended March 31, 2009 from the comparable 2008 period. The decrease was due primarily to lower capital equipment sales across all of our product lines. We believe that these lower sales resulted from weakness in demand due to the current economic recession and not a loss of market share. Schwarzer Neurology and NeuroCom contributed to $3.0 million of revenue offset by a $4.9 million decrease in capital equipment revenue and a $900,000 decrease in newborn care and neurology supplies revenue.

Device and systems revenue decreased $3.4 million, or 15.1%, to $19.5 million in the three months ended March 31, 2009, compared to $22.9 million in the same period in 2008. Schwarzer Neurology and NeuroCom contributed to $2.6 million of revenue from devices and systems offset by a $3.2 million decrease in revenue from other neurology products, a $2.3 million decrease in revenue from hearing products, and a $635,000 decrease in revenue from newborn care products. Revenue from devices and systems was 58% of consolidated revenue in the three months ended March 31, 2009 compared to 62% of consolidated revenue for the first quarter of 2008.

Supplies and services revenue increased $61,000, or 0.5%, to $13.3 million in the first quarter of 2009 compared to $13.2 million in the first quarter of 2008. Revenue from hearing screening supplies increased by $841,000, which was primarily offset by a decrease in revenue from neurology supplies. Revenue from services increased $81,000 to $2.2 million in the 2009 period. Revenue from supplies and services was 40% of consolidated revenue in the three months ended March 31, 2009 compared to 36% of consolidated revenue for the first quarter of 2008.

Revenue from sales outside the U.S. decreased $1.7 million, or 14.4%, to $10.4 million in the first quarter of 2009 compared to $12.1 million for the same period in 2008. Schwarzer Neurology and NeuroCom contributed to $1.5 million of international revenue. A $540,000 increase in international supplies and service revenue was offset by a $2.0 million decrease in international device and systems sales reflecting weakness in capital equipment demand in international markets.

Gross profit as a percentage of revenue was 60.9% for the three months ended March 31, 2009 compared to 62.0% for the respective period in 2008. The lower margin earned on products of Schwarzer Neurology, which we acquired at the beginning of the third quarter of 2008, and increased materials costs as a percentage of revenue reduced consolidated gross profit for the 2009 period as compared to the same period in 2008. Cost of revenue decreased $956,000, or 6.8%, to $13.0 million in the three months ended March 31, 2009, from $14.0 million in 2008, reflecting reduced sales in the 2009 period. Gross profit decreased $2.6 million, or 11.1%, to $20.3 million in 2009 from $22.9 million in 2008.

Total operating costs increased by $646,000 or 3.5%, to $19.2 million in the three months ended March 31, 2009, compared to $18.6 million in the same period in 2008. Excluding the operating costs of Schwarzer Neurology and NeuroCom, which were $2.1 million, total operating costs were approximately 10% lower, or $1.5 million, in the first quarter of 2009 compared to the same period in 2008. The reduction in operating expenses exclusive of Schwarzer Neurology and Neurocom reflect the impact of our 2008 restructuring plan and the implementation of tighter cost controls.

Marketing and selling expenses increased $111,000, or 1.1%, to $10.0 million in the three months ended March 31, 2009 compared to $9.9 million in the same period in 2008. The operations of Schwarzer Neurology and NeuroCom contributed $1.3 million of costs, which were offset by reductions in commission payments to sales personnel and distributors, personnel costs resulting from headcount reductions, and travel and outside service costs.

Research and development expenses decreased $113,000, or 3.0%, to $3.7 million for in the three months ended March 31, 2009 compared to $3.8 million in the same period of 2008. The operations of Schwarzer Neurology and NeuroCom contributed $369,000 of research and development expenses, which were offset by a reduction in salary and associated compensation costs resulting from restructuring activities completed in 2008. Research and development expenses as a percent of total revenue increased from 10.4% in the three months ended March 31, 2008 to 11.2% for the three months ended March 31, 2009 due to lower sales volume.

General and administrative expenses increased $648,000, or 13.3%, to $5.5 million in the three months ended March 31, 2009 compared to $4.9 million in the same period in 2008. The operations of Schwarzer Neurology and NeuroCom contributed $406,000 of general and administrative expenses, coupled with higher payroll, insurance and outside accounting costs.

We adopted an integration and restructuring plan in February 2008 that was designed to reduce redundant costs resulting from prior acquisitions and to improve efficiencies in operations. These actions were phased in during the first nine months of 2008. Costs under the plan, which were primarily for severance benefits, stay bonuses, and duplicative salaries, totaled approximately $700,000. These expenses were incurred approximately ratably from the time employees were notified of the plan through their targeted separation-of-employment date. The plan is expected to result in annual operating cost reductions of approximately $2.4 million in 2009 and beyond. Pursuant to the plan, we accrued $96,000 of employee termination benefits in the three months ended March 31, 2008. We had no similar costs in the respective period in 2009.

Other income, net consists of investment income from our investment portfolio, interest expense, net currency exchange gains and losses, and other miscellaneous income and expenses. We reported net other income of $126,000 in the three months ended March 31, 2009, compared to $1,000 in the same period in 2008 due primarily to interest income in 2009 as compared with investment income and net currency gains offset by interest expense in the first quarter of 2008.

We recorded income tax expense of $442,000 in the three months ended March 31, 2009, compared to $1.7 million in the same period in 2008. Our effective tax rate in the first quarter of 2009 was 36.0% compared to an effective rate of 38.9% in the first quarter of 2008. The lower effective tax rate in 2009 was primarily attributable to discrete tax adjustments as we expect that our effective tax rate for the full-year 2009 will be approximately 38%.

Effective January 1, 2009, the Company's Canadian subsidiary, Xltek changed its functional currency to the U.S. dollar. The change in functional currency reflects the fact that Xltek now conducts the majority of its business transactions in U.S. dollars and maintains a significant portion of its balance sheet in U.S. dollar denominated accounts.

Liquidity and Capital Resources

Liquidity is our ability to generate sufficient cash flows from operating activities to meet our obligations and commitments. In addition, liquidity includes the ability to obtain appropriate financing or to raise capital. Therefore, liquidity cannot be considered separately from capital resources that consist of our current funds and the potential to increase those funds in the future. We plan to use our capital resources in meeting our commitments and in achieving our business objectives.

As of March 31, 2009, we had cash and cash equivalents of $61.4 million, short-term investments of $795,000, stockholders' equity of $228.2 million, and working capital of $105.5 million, compared with cash and cash equivalents of $56.9 million, stockholders' equity of $226.5 million, and working capital of $102.3 million as of December 31, 2008.

We believe that our current cash, cash equivalents, and short-term balances, including cash generated from operations, will be sufficient to meet our ongoing operating and capital requirements for the foreseeable future. We completed three acquisitions in 2008, one in 2007, and three in 2006. We intend to continue to acquire additional technologies, products or businesses, and these acquisitions could be significant. These actions would likely affect our future capital requirements and the adequacy of our available funds. We may be required to raise additional funds through public or private financings, strategic relationships, or other arrangements. Any equity financing may be dilutive to stockholders, and debt financing, if available, may involve restrictive covenants and increase our cost of capital.

On September 2, 2008, we executed a second amendment to our Amended and Restated Credit Agreement (the "Second Amendment") with Wells Fargo Bank, National Association ("Wells Fargo"). The Second Amendment increases the borrowing limit of our revolving line of credit to $25 million and makes other changes to the terms of the credit facility. The credit facility contains covenants, including covenants relating to liquidity and other financial measurements, and provides for events of default, including failure to pay any interest when due, failure to perform or observe covenants, bankruptcy or insolvency events and the occurrence of a material adverse effect. We have granted Wells Fargo a security interest in all of our assets.

Cash provided by operations increased by $4.5 million for the three months ended March 31, 2009 to $6.6 million, compared to $2.1 million for the same period in 2008. The sum of our net income and non-cash expense items, such as reserves, depreciation and amortization, and stock based compensation, was approximately $5.0 million in the 2009 period, compared to $4.9 million in 2008. The overall impact of changes in certain operating assets and liabilities on total operating cash flows resulted in a cash inflow of $1.6 million in 2009 compared with a cash outflow of $2.8 million in 2008.

Cash used in investing activities was $2.4 million for the three months ended March 31, 2009 compared to $1.4 million for the same period in 2008. We recorded $174,000 of internal use software development costs in 2009, compared to $479,000 in the same period of 2008.

Cash used in financing activities was $39,000 during the three months ended March 31, 2009, compared to $538,000 in the same period in 2008. We raised cash through sales of our stock pursuant to our stock awards plans and our employee stock purchase plan in the amount of $5,000 and $466,000 in the three months ended March 31, 2009 and 2008, respectively. We also realized an excess tax benefit of $203,000 on the exercise of employee stock options for the three months ended March 31, 2008 that was recorded as an increase to stockholders' equity, with no comparable tax benefit in the first quarter of 2009. During the three months ended March 31, 2008, we increased our borrowings under our credit facility by $1.0 million and made payments on our long-term debt in the amount of $2.2 million resulting in a net cash outflow of $1.2 million for the three months ended March 31, 2008, compared with payments of $44,000 for the three months ended March 31, 2009.

Our future liquidity and capital requirements will depend on numerous factors, including the:

• Amount and timing of revenue;

• Extent to which our existing and new products gain market acceptance;

• Extent to which we make acquisitions;

• Cost and timing of product development efforts and the success of these development efforts;

• Cost and timing of marketing and selling activities; and

• Availability of borrowings under line of credit arrangements and the availability of other means of financing.

Commitments and Contingencies

In the normal course of business, we enter into obligations and commitments that require future contractual payments. The commitments primarily result from firm, noncancellable purchase orders placed with contract vendors that manufacture some of the components used in our medical devices and related disposable supply products, as well as commitments for leased office, manufacturing, and warehouse facilities. There have been no material changes to the table of contractual obligations presented in Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations, of our Annual Report on Form 10-K for the year ended December 31, 2008.

Under our bylaws, we have agreed to indemnify our officers and directors for certain events or occurrences arising as a result of the officer or director serving in such capacity. We have a directors' and officers' liability insurance policy that limits our exposure and enables us to recover a portion of any amounts paid resulting from the indemnification of our directors and officers. In addition, we enter into indemnification agreements with other parties in the ordinary course of business. We believe the estimated fair value of these indemnification agreements is minimal and we have not recorded a liability for these agreements.

Recent Accounting Pronouncements

See Note 1 to our Condensed Consolidated Financial Statements for a discussion of new accounting pronouncements that affect us.

Cautionary Information Regarding Forward Looking Statements

This report contains forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 about Natus Medical Incorporated. These statements include, among other things, statements concerning our expectations, beliefs, plans, intentions, future operations, financial condition and prospects, and business strategies. The words "may," "will," "continue," "estimate," "project," "intend," "believe," "expect," "anticipate," and other similar expressions generally identify forward-looking statements. Forward-looking statements in this Item 2 include, but are not limited to, statements regarding the following:
our effective tax rate for 2009, our expectation that the reduction in capital equipment purchases has stabilized and will not further deteriorate, our expectation regarding expansion of our international operations, our expectations regarding our new products, the sufficiency of our current cash, cash equivalents, and short-term investment balances, and any cash generated from operations to meet our ongoing operating and capital requirements for the foreseeable future, and our intent to acquire additional technologies, products, or businesses

Forward-looking statements are not guarantees of future performance and are subject to substantial risks and uncertainties that could cause the actual results predicted in the forward-looking statements as well as our future financial condition and results of operations to differ materially from our historical results or currently anticipated results. Investors should carefully review the information contained under the caption "Risk Factors" contained in Part II, Item 1A of this report for a description of risks and uncertainties. All forward-looking statements are based on information available to us on the date hereof, and we assume no obligation to update forward-looking statements.