Electromed, Inc. — Form 10-Q Summary
Reporting period: Fiscal third quarter and nine months ended March 31, 2019. The financial statements are unaudited. Electromed develops, manufactures, and markets High Frequency Chest Wall Oscillation airway-clearance products, primarily the SmartVest system, for home care, institutional, and international markets.
Key Financial Metrics
| Metric | Q3 FY2019 | Q3 FY2018 | Nine months FY2019 | Nine months FY2018 |
|---|---|---|---|---|
| Revenue | $7.408 million | $7.167 million | $22.696 million | $20.434 million |
| Gross profit | $5.574 million | $5.510 million | $17.180 million | $15.603 million |
| Gross margin | 75.2% | 76.9% | 75.7% | 76.4% |
| Operating income | $462,000 | $578,000 | $1.333 million | $1.448 million |
| Operating margin | 6.2% | 8.1% | 5.9% | 7.1% |
| Net income | $350,000 | $376,000 | $882,000 | $877,000 |
| Net margin | 4.7% | 5.3% | 3.9% | 4.3% |
| Diluted EPS | $0.04 | $0.04 | $0.10 | $0.10 |
- Home care revenue was $6.852 million in Q3, up 4.6%, and $20.905 million for nine months, up 10.3%. Institutional revenue was $414,000 in Q3, down 16.5%, while international revenue was $142,000, up 19.3%.
- Nine-month operating cash flow was $1.172 million, compared with $1.872 million in the prior-year period. Investing cash flow was negative $241,000, and financing cash flow was negative $851,000.
- Cash was $7.536 million at March 31, 2019, compared with $7.456 million at June 30, 2018. Working capital was approximately $20.762 million.
- Accounts receivable were $12.276 million and contract assets were $844,000. Contract assets primarily represent estimated variable consideration related to payer appeals and other future collection conditions.
- The company had no outstanding balance on its $2.5 million revolving credit line. The approximately $1.103 million term loan outstanding at June 30, 2018 was repaid at maturity in December 2018. The company had no term-loan obligations at quarter-end.
- The credit facility expires December 18, 2019 if not renewed, is secured by substantially all tangible and intangible assets, and includes a minimum tangible net worth covenant of $10.125 million. The company reported compliance at March 31, 2019.
Material Changes Versus Prior Comparable Period
- Revenue increased 3.4% in Q3 and 11.1% for the nine-month period, driven principally by higher home care referrals, improved reimbursement approvals, and international sales.
- Growth was partially offset by lower average allowable amounts due to payer mix. Medicare home care revenue increased, while Medicaid revenue declined materially.
- Institutional Q3 revenue declined because targeted institutions had longer-than-expected sales cycles, partially offset by higher single-patient-use garment sales.
- Gross margin declined 170 basis points in Q3 and 70 basis points for nine months, primarily because of lower average selling prices associated with payer mix.
- SG&A increased 1.1% in Q3 and 9.9% for nine months, reflecting additional sales and administrative personnel, higher compensation and incentives, and increased share-based compensation. R&D expense increased to $171,000 in Q3 and $477,000 for nine months.
- Q3 operating income and net income declined despite revenue growth. Nine-month net income was approximately flat because higher gross profit was largely offset by increased operating expenses and R&D spending.
- Electromed adopted ASC 606 effective July 1, 2018 using the full retrospective method. Prior periods were recast, and retained earnings increased by approximately $800,000 as of July 1, 2017. The standard generally accelerates recognition of SmartVest revenue to shipment or delivery, subject to estimated variable consideration.
- The company discontinued direct distribution of the Aerobika OPEP device in November 2018 after determining that the product was unlikely to reach a broader patient population as planned.
Outlook, Risks, Contingencies, and Unusual Items
- Management stated that existing working capital and available credit were expected to provide adequate liquidity for the next year. No quantitative revenue or earnings guidance was provided.
- In April 2019, the company entered into an agreement to expand its New Prague, Minnesota facility. The project began in April 2019, is expected to be completed in the first quarter of fiscal 2020, and is estimated to cost $1.5 million to $1.7 million. Management expects the project to reduce annual lease expense by more than $130,000 and support long-term growth.
- The company expects to fund equipment purchases through operating cash flow or borrowings under its credit facility, but may require additional debt if operating performance or capital needs differ from expectations.
- Important operating risks include changes in Medicare, Medicaid, and commercial reimbursement policies; payer appeals and patient payment uncertainty; competition; regulatory compliance and product approvals; international expansion; intellectual-property protection; and renewal or availability of the revolving credit facility.
- Revenue estimates rely on historical collection patterns and assumptions regarding insurance coverage, patient status, appeals, deductibles, coinsurance, and copayments. A change in these assumptions could produce revenue reversals or collection shortfalls.
- The company maintains a $780,000 warranty reserve and provides lifetime warranties on U.S. patient sales and three-year warranties on institutional and non-U.S. sales.
- Nine-month income taxes included a $134,000 discrete deferred tax expense related to expired fully vested options and a $16,000 tax benefit related to option exercises. The nine-month effective tax rate was 36.5%, compared with 39.0% in the prior-year period.
- The company reported no material undisclosed litigation, no off-balance-sheet arrangements, and effective disclosure controls as of the evaluation date.
Investor Verification Items
- Verify the sustainability of home care growth, particularly referral volumes, reimbursement approval rates, Medicare exposure, and payer mix.
- Monitor gross-margin trends and the effect of lower average allowable amounts on profitability.
- Assess collection performance for the $12.276 million accounts receivable balance and $844,000 of contract assets under ASC 606.
- Confirm completion timing, final cost, and expected savings from the $1.5 million to $1.7 million facility expansion.
- Track renewal of the $2.5 million revolving credit facility before its December 18, 2019 expiration and continued compliance with its covenants.
- Evaluate whether higher sales, administrative, compensation, and R&D spending converts into sustained revenue and earnings growth.