Business Context and Reporting Period
Electromed, Inc. develops, manufactures and markets SmartVest airway-clearance systems using High Frequency Chest Wall Oscillation technology for home-care, institutional and international markets. The filing is a Form 10-Q for the quarter and nine months ended March 31, 2020; although the request metadata refers to “2019 Q3,” the filing reports fiscal 2020 third-quarter results. The financial statements are unaudited.
Key Financial Metrics
| Metric | Three Months Ended March 31, 2020 | Prior Year | Nine Months Ended March 31, 2020 | Prior Year |
|---|---|---|---|---|
| Net revenue | $8.744 million | $7.408 million | $25.593 million | $22.696 million |
| Gross profit | $6.594 million | $5.574 million | $19.611 million | $17.180 million |
| Gross margin | 75.4% | 75.2% | 76.6% | 75.7% |
| Operating income | $0.913 million | $0.465 million | $3.829 million | $1.341 million |
| Net income | $0.653 million | $0.353 million | $2.853 million | $0.891 million |
| Diluted earnings per share | $0.07 | $0.04 | $0.33 | $0.10 |
| Net cash provided by operating activities | Not separately provided | Not separately provided | $2.912 million | $1.172 million |
Revenue increased 18.0% in the quarter and 12.8% for the nine-month period. Home-care revenue rose 14.3% and 10.0%, respectively, while institutional revenue increased 46.9% and 39.8%. The company generated $0.416 million of home-care distributor revenue during the nine months from a new distribution channel. International revenue declined 3.4% in the quarter and 18.0% year to date.
At March 31, 2020, cash was $9.933 million, working capital was approximately $24.165 million, total assets were $32.973 million and shareholders’ equity was $29.327 million. Accounts receivable were $13.290 million and contract assets were $1.147 million. The company had no outstanding balance on its revolving credit facility and stated that the full $2.5 million facility was available.
Investing cash outflows were $0.850 million for the nine months, including $0.753 million for property and equipment and $0.097 million for patent costs. Financing activities provided $0.063 million from stock-option exercises. The company reported no off-balance-sheet arrangements.
Material Changes Versus the Prior Comparable Period
- Gross margin improved by 20 basis points in the quarter and 90 basis points year to date, primarily due to a more favorable payer mix and higher average allowable amounts.
- Operating income increased 96.5% in the quarter and 185.5% year to date, reflecting revenue growth and controlled operating expenses.
- SG&A increased 7.1% in the quarter but decreased 1.4% year to date. Year-to-date payroll and compensation costs declined 4.9%, partly due to fewer sales and administrative employees and lower share-based compensation.
- Research and development expense increased to $0.392 million in the quarter and $0.634 million year to date, compared with $0.171 million and $0.477 million, respectively.
- Operating cash generation increased substantially year to date, despite higher receivables, contract assets and income-tax receivables.
- The company adopted ASC 842 lease accounting effective July 1, 2019. The adoption produced approximately $0.101 million of operating lease liabilities and $0.100 million of right-of-use assets at March 31, 2020, with minimal impact on previously reported earnings.
- In September 2019, the company completed a New Prague facility expansion costing approximately $1.5 million, expected to reduce annual lease expense by approximately $0.130 million.
Guidance, Outlook, Risks and Unusual Items
The filing does not provide formal revenue or earnings guidance. Management expects research and development spending to increase in the fourth quarter for development of a next-generation device.
Management reported that COVID-19 began negatively affecting the business in the second half of March 2020. Healthcare-facility access restrictions reduced patient consultations and home-care referrals, while institutional orders were postponed. The company expects the impact on fourth-quarter fiscal 2020 results to be significant and potentially significant in subsequent periods, although it cannot reliably estimate the duration or magnitude.
In April 2020, the company initiated cost-containment measures, including reduced discretionary spending, lower use of contractors and temporary help, and employee furloughs. Management expects these actions to generate approximately $0.450 million of savings per quarter, with partial realization beginning in the quarter ending June 30, 2020.
On April 10, 2020, the company received a $0.913 million CARES Act Provider Relief Fund payment. Its ability to retain and use the full amount depends on applicable healthcare-expense and lost-revenue requirements.
Key risks include the duration and severity of COVID-19, disruption to healthcare referrals and institutional demand, potential supply-chain interruptions, changes in Medicare, Medicaid or commercial reimbursement, regulatory compliance, competition, international sales volatility, intellectual-property protection and renewal of the credit facility after its December 18, 2020 expiration if not renewed.
The company was in compliance with its credit-facility covenants at March 31, 2020. The facility is secured by substantially all tangible and intangible assets and includes a minimum tangible net worth covenant of $10.125 million. The company has a lifetime warranty for U.S. patient sales and a three-year warranty for institutional and non-U.S. individual sales; the warranty reserve was $0.780 million at March 31, 2020.
Facts Investors Should Verify
- Whether COVID-19 materially reduced fourth-quarter and subsequent home-care referrals, institutional orders, revenue, margins and operating cash flow.
- The eligibility and final accounting treatment of the $0.913 million CARES Act payment.
- Whether the projected $0.450 million quarterly cost savings were achieved and whether employee furloughs or reduced spending affect growth and product development.
- The collectability of $13.290 million of accounts receivable and $1.147 million of contract assets, which depend partly on third-party payer approvals and patient circumstances.
- The renewal or replacement of the $2.5 million revolving credit facility before December 18, 2020.
- The sustainability of recent revenue growth, particularly the favorable payer mix, new distributor channel and increased institutional sales.
- Progress, costs and commercial timing for the next-generation device and the effect of higher research and development spending.