Electromed, Inc. — Form 10-Q Summary
Reporting period: Quarterly and six-month periods ended December 31, 2017; fiscal year ended June 30. The financial statements are unaudited and should be read with the fiscal 2017 Form 10-K.
Business Context
Electromed develops, manufactures and markets airway-clearance products using High Frequency Chest Wall Oscillation technology, principally the SmartVest system. Products are sold through U.S. home-care and institutional channels and internationally through direct sales and distributors. SmartVest Connect wireless technology was expanded to certain targeted adult pulmonary clinics beginning in November 2017.
Key Financial Metrics
| Metric | Three Months Ended Dec. 31, 2017 | Three Months Ended Dec. 31, 2016 | Six Months Ended Dec. 31, 2017 | Six Months Ended Dec. 31, 2016 |
|---|---|---|---|---|
| Net revenue | $7.0 million | $6.4 million | $13.4 million | $11.9 million |
| Gross profit | $5.6 million | $4.9 million | $10.5 million | $9.3 million |
| Gross margin | 80.0% | 77.3% | 78.7% | 77.7% |
| Operating income | $0.8 million | $0.7 million | $0.9 million | $1.0 million |
| Net income | $0.3 million | $0.4 million | $0.5 million | $0.6 million |
| Diluted earnings per share | $0.04 | $0.05 | $0.05 | $0.08 |
- Revenue mix: Six-month home-care revenue increased 17.4% to $12.5 million. Institutional revenue declined 35.4% to $0.6 million, and international revenue declined 19.6% to $0.3 million.
- Operating expenses: Six-month SG&A increased 21.6% to $9.5 million, primarily from additional sales and administrative personnel, compensation, professional fees, recruiting and travel. R&D declined to $0.1 million from $0.5 million.
- Taxes: Six-month income tax expense was $0.5 million, producing a 49.1% effective tax rate. The rate included an approximately $160,000 discrete deferred tax expense from remeasuring deferred tax balances under the Tax Cuts and Jobs Act.
- Cash flow: Six-month operating cash flow was $1.5 million, compared with $0.04 million in the prior-year period. Investing cash use was $0.2 million, principally property and equipment purchases. Financing cash use was $0.03 million for debt principal payments.
- Liquidity: Cash was $6.8 million at December 31, 2017, compared with $5.6 million at June 30, 2017. Working capital was approximately $15.5 million.
- Debt: Term-loan principal was approximately $1.1 million, with a final payment of approximately $1.1 million due December 18, 2018. No amount was drawn on the $2.5 million revolving credit line.
- Warranty reserve: The reserve increased to $0.7 million from $0.6 million at June 30, 2017.
Material Changes Versus Prior Comparable Period
- Revenue increased 9.6% in the second quarter and 12.2% for the six-month period, driven primarily by higher home-care referrals, approvals and sales-force capacity.
- Gross margin improved by 270 basis points in the quarter and 100 basis points for the six months, despite added manufacturing costs for SmartVest Connect.
- Net income declined 21.3% in the quarter and 25.9% for the six months, principally because SG&A growth exceeded gross-profit growth and the Tax Act created a $160,000 discrete tax expense.
- The prior-year periods included an approximately $212,000 retroactive repayment to a state Medicaid program; management characterized that event as nonrecurring.
- Institutional and international revenue weakened materially, partly offsetting home-care growth. International results may fluctuate based on distributor purchase timing.
- The Company adopted inventory and stock-compensation accounting updates during fiscal 2018 with no material impact. The Company was evaluating the potential impact and adoption approach for the new revenue-recognition standard.
Outlook, Risks and Unusual Items
- Management expects working capital, operating cash flow and available credit to provide adequate liquidity for the next year and expects R&D spending as a percentage of revenue to remain generally consistent through fiscal 2018.
- The revolving credit facility expires December 18, 2018 unless renewed. The term loan has a substantial final payment due on the same date.
- Credit agreements contain financial and nonfinancial covenants, including a minimum tangible net worth of $10.125 million and restrictions on additional debt and dividends. The Company reported compliance at December 31, 2017.
- Failure to comply with covenants or renew the credit line could permit acceleration of debt, restrict borrowing and potentially affect planned operations. Debt is secured by substantially all tangible and intangible assets and, for the term loan, the Company’s real property.
- Key business risks include reimbursement changes affecting Medicare, Medicaid and private insurers; competition; regulatory compliance and approvals; intellectual-property protection; international expansion; and access to credit.
- The Company provides a lifetime warranty for prescribed U.S. patients and a three-year warranty for institutional and non-U.S. sales. Warranty estimates depend on claims history, product life and repair costs.
- No material undisclosed litigation, off-balance-sheet arrangements or material changes in internal control were reported. Disclosure controls were deemed effective.
Important Facts for Investors to Verify
- Whether the strong home-care growth can continue while institutional and international revenue remain below prior-year levels.
- The timing and funding plan for the approximately $1.1 million term-loan maturity in December 2018 and renewal of the revolving credit facility.
- The effect of the Tax Cuts and Jobs Act on future effective tax rates, including the stated blended federal rate of approximately 28% for fiscal 2018 and 21% thereafter.
- The adoption method and financial impact of the new revenue-recognition standard, which management was still evaluating.
- The sustainability of the 78.7% six-month gross margin as SmartVest Connect manufacturing costs and sales-force investments continue.
- The filing contains inconsistent disclosures regarding the applicable prime rate on the revolving facility: the financing note states 4.25% at December 31, 2017, while MD&A states 4.50%; this should be reconciled against the credit agreement.