Electromed, Inc. Form 10-Q Summary
Business context and reporting period
Electromed develops, manufactures and markets High Frequency Chest Wall Oscillation airway-clearance products, primarily the SmartVest System, for home care, institutional and international markets. This quarterly report covers the three and six months ended December 31, 2019, the second quarter of fiscal 2020. The financial statements are unaudited and prepared under U.S. GAAP.
Key financial metrics
| Metric | Three months ended Dec. 31, 2019 | Three months ended Dec. 31, 2018 | Six months ended Dec. 31, 2019 | Six months ended Dec. 31, 2018 |
|---|---|---|---|---|
| Net revenue | $8.547 million | $8.012 million | $16.849 million | $15.288 million |
| Gross profit | $6.676 million | $6.062 million | $13.018 million | $11.605 million |
| Gross margin | 78.1% | 75.7% | 77.3% | 75.9% |
| Operating income | $1.567 million | $0.675 million | $2.916 million | $0.877 million |
| Operating margin | 18.3% | 8.4% | 17.3% | 5.7% |
| Net income | $1.185 million | $0.381 million | $2.200 million | $0.538 million |
| Net margin | 13.9% | 4.8% | 13.1% | 3.5% |
| Diluted EPS | $0.14 | $0.04 | $0.25 | $0.06 |
- Six-month operating cash flow was $2.024 million, compared with $0.821 million in the prior-year period.
- Six-month investing cash flow was an outflow of $0.701 million, including $0.670 million of property and equipment purchases and $0.031 million of patent costs.
- Six-month financing cash flow was $0.076 million, primarily from stock-option exercises. No principal payments on long-term debt were made during the period.
- Cash was $9.207 million at December 31, 2019, compared with $7.808 million at June 30, 2019. Working capital was approximately $23.293 million.
- Accounts receivable were $12.718 million and contract assets were $1.191 million at December 31, 2019. The warranty reserve was $0.770 million.
- The company had no outstanding balance on its $2.5 million revolving credit line. The full $2.5 million was available, subject to borrowing-base limits, and the facility expires December 18, 2020 if not renewed.
- Total liabilities were $3.033 million and shareholders’ equity was $28.454 million at December 31, 2019.
Material changes versus the prior comparable period
- Revenue increased 6.7% in the quarter and 10.2% for the six-month period. Home care revenue increased 4.6% and 7.9%, respectively, while institutional revenue increased 22.8% and 36.3%.
- Home care distributor revenue contributed $0.131 million in the quarter and $0.251 million for six months, reflecting the start of sales to home medical equipment distributors.
- International revenue declined 9.4% in the quarter and 23.0% for six months, principally reflecting the timing of distributor purchases.
- Gross margin improved by 2.4 percentage points in the quarter and 1.4 percentage points for six months, driven primarily by higher average allowable amounts and payer mix in domestic home care.
- SG&A expense declined 3.6% in the quarter and 5.4% for six months, primarily because of fewer sales and administrative employees and lower share-based compensation expense.
- Net income increased 211% in the quarter and 309% for six months. The improvement reflected higher revenue, improved gross margin, lower payroll-related costs and lower effective tax rates.
- The prior-year effective tax rates were elevated by discrete tax expense related to expired, fully vested stock options. The 2019 effective tax rates were 26.1% for the quarter and 26.5% for six months, versus 45.0% and 40.7% in the prior-year periods.
- The company adopted ASC 842 lease accounting on July 1, 2019. At December 31, 2019, it reported approximately $0.122 million of right-of-use assets and $0.123 million of operating lease liabilities.
- The company completed a New Prague facility expansion in September 2019. Total project cost was approximately $1.5 million and management expects annual lease savings of approximately $0.130 million.
Guidance, outlook, commentary and risks
- Management believes existing working capital and available credit will provide adequate liquidity for the next year.
- The company planned to expand its direct sales staff from 34 to 38 employees and add a regional sales manager, which is expected to increase payroll and compensation costs.
- Research and development spending was expected to rise to approximately 2% to 4% of revenue for the remainder of fiscal 2020 as the company develops a next-generation device.
- Management stated that planned equipment purchases are expected to be funded through operating cash flow or the revolving credit facility, but additional debt could be required if operating performance weakens or unexpected capital needs arise.
- Key risks include changes in Medicare, Medicaid and private insurance reimbursement; healthcare and medical-device regulation; competition; development of new distribution channels; international sales volatility; intellectual-property protection; and renewal or continued availability of credit.
- Revenue recognition relies on estimates of variable consideration, including payer appeals, installment payments, deductibles, coinsurance and potential changes in patient status or coverage. Contract assets increased to $1.191 million from $0.996 million at June 30, 2019.
- The company was involved in ordinary-course claims and disputes but reported no undisclosed litigation expected to have a material adverse effect. It reported no off-balance-sheet arrangements.
- Management concluded that disclosure controls and procedures were effective as of December 31, 2019, with no material changes to internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether revenue growth and improved payer mix are sustainable, particularly given reliance on Medicare, Medicaid and commercial reimbursement.
- The collectibility and ultimate realization of $12.718 million of receivables and $1.191 million of contract assets, including amounts subject to payer appeals and variable consideration estimates.
- Whether the planned sales-force expansion and next-generation device investment produce sufficient incremental revenue to offset higher operating expenses.
- The timing and economics of the $1.5 million facility expansion, including the expected $0.130 million annual lease savings.
- Continued compliance with the credit facility’s minimum tangible net worth covenant and the company’s ability to renew the facility before its December 2020 expiration.
- The adequacy of the $0.770 million warranty reserve and the potential effect of the company’s lifetime U.S. product warranty.
- The extent to which lower 2019 tax rates benefited from discrete items and whether the effective tax rate may normalize at a higher level.