Electromed, Inc. — Form 10-Q Summary
Business context and reporting period
Electromed develops, manufactures and markets airway-clearance products using High Frequency Chest Wall Oscillation technology, including the SmartVest system. Products are sold in U.S. home-care and institutional markets and internationally through direct sales and distributors. This unaudited report covers the three and six months ended December 31, 2016, the second quarter and first six months of fiscal 2017, compared with the corresponding fiscal 2016 periods.
Financial highlights
| Metric | Three months ended Dec. 31, 2016 | Three months ended Dec. 31, 2015 | Six months ended Dec. 31, 2016 | Six months ended Dec. 31, 2015 |
|---|---|---|---|---|
| Net revenue | $6.372 million | $6.262 million | $11.918 million | $11.263 million |
| Gross profit | $4.926 million | $4.899 million | $9.254 million | $8.758 million |
| Gross margin | 77.3% | 78.2% | 77.7% | 77.8% |
| Operating income | $729,459 | $1.250 million | $1.018 million | $1.835 million |
| Net income | $443,861 | $1.068 million | $635,032 | $1.409 million |
| Diluted EPS | $0.05 | $0.13 | $0.08 | $0.17 |
| Net cash from operations | Not separately provided | Not separately provided | $38,712 | $1.167 million |
Second-quarter revenue increased 1.8%, while first-half revenue increased 5.8%. Second-quarter operating income declined approximately 41.6%, and first-half operating income declined approximately 44.5%. Net income declined approximately 58.4% in the quarter and 54.9% for the first six months.
- Revenue mix: Six-month home-care revenue was $10.635 million, up 6.5%; institutional revenue was $951,000, up 2.9%; and international revenue was $332,000, down 5.7%.
- Operating expenses: Six-month SG&A increased 14.1% to $7.784 million, driven primarily by additional sales and administrative personnel, compensation, sales incentives, professional fees, recruiting and travel. R&D increased to $451,641 from $98,634.
- Cash and liquidity: Cash was $4.822 million at December 31, 2016, compared with $5.123 million at June 30, 2016. Working capital was approximately $13.749 million.
- Debt: Total debt, including current maturities and net of issuance costs, was approximately $1.171 million. The term loan principal was approximately $1.178 million, with a 3.88% interest rate and a final payment of approximately $1.085 million due December 18, 2018.
- Credit availability: The renewed revolving line of credit provides up to $2.5 million, all of which was available at December 31, 2016. There was no outstanding balance.
Material changes versus the prior comparable period
- Revenue growth was partially offset by a $212,000 retroactive repayment to a state Medicaid program after the program reinterpreted its reimbursement process and reduced allowable payments. Management characterized the item as a one-time event.
- Home-care revenue in the prior-year quarter benefited by approximately $250,000 from processing a backlog of referrals, creating an unfavorable comparison for 2016.
- Gross margin was broadly stable for the first six months but declined 90 basis points in the second quarter, partly reflecting the Medicaid repayment.
- Profitability was pressured by higher personnel, sales, professional, recruiting, travel and R&D costs. The six-month period also included approximately $111,000 of expense from abandoning certain patents.
- The prior-year periods included a discrete tax benefit of approximately $294,000 from releasing the valuation allowance on U.S. deferred tax assets. The 2016 six-month period included a smaller $22,000 tax benefit related to the lapse of the statute of limitations on uncertain tax positions.
- Cash from operations fell to $38,712 from $1.167 million, primarily because of increases in accounts receivable and inventory and a decrease in accounts payable and accrued liabilities.
- The term loan was refinanced in December 2016, reducing the interest rate from 5.00% to 3.88%.
Guidance, outlook, risks and unusual items
- Management believes existing working capital and available credit will provide adequate liquidity for the next year. No formal revenue or earnings guidance was provided.
- The Company expects to launch a wireless connectivity feature for its HFCWO device by the end of fiscal 2017. Management expects related R&D spending to decrease over the next few quarters after the majority of development work was completed, although spending may rise as new projects begin.
- Approximately $190,000 of software development costs related to the wireless connectivity project was capitalized during the quarter.
- Key risks include changes in Medicare, Medicaid and private-insurance reimbursement; healthcare laws and medical-device regulations; competition; regulatory approvals; intellectual-property protection; international-market expansion; and the ability to renew or access credit.
- The credit agreements require minimum tangible net worth of $10.125 million and restrict certain additional indebtedness and dividends. The Company was in compliance at December 31, 2016. A future covenant breach could accelerate debt maturities, restrict borrowing or prevent renewal of the revolving facility.
- The Company maintains a $660,000 warranty reserve for lifetime U.S. patient warranties and three-year institutional and non-U.S. warranties.
- No material undisclosed litigation or off-balance-sheet arrangements were reported. Management concluded disclosure controls were effective, with no material changes to internal control over financial reporting.
Important facts for investors to verify
- Whether revenue growth and home-care approvals continue after the Medicaid repayment and the prior-year referral-backlog effect.
- Whether elevated SG&A and R&D spending produces sustained sales-force growth and successful wireless-feature commercialization.
- Accounts-receivable collection, operating cash conversion and the sustainability of liquidity given the sharp decline in operating cash flow.
- Compliance with the $10.125 million tangible-net-worth covenant and availability or renewal of the $2.5 million revolving credit facility before December 18, 2017.
- The timing and cash impact of the approximately $1.085 million term-loan final payment due December 18, 2018.
- Future reimbursement-policy changes, warranty-cost experience, patent strategy and the potential effects of pending accounting standards, including revenue recognition and leases.