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 therapy, including the SmartVest system. Products are sold in home-care, institutional, government and international markets. This filing covers the fiscal quarter and nine-month periods ended March 31, 2013, compared with the corresponding periods ended March 31, 2012. The financial statements are unaudited.
Financial performance and position
| Metric | Three months ended March 31, 2013 | Three months ended March 31, 2012 | Nine months ended March 31, 2013 | Nine months ended March 31, 2012 |
|---|---|---|---|---|
| Net revenue | $3.199 million | $4.774 million | $11.086 million | $14.944 million |
| Gross profit | $2.442 million | $3.369 million | $7.777 million | $10.919 million |
| Gross margin | 76.3% | 70.6% | 70.2% | 73.1% |
| Operating income (loss) | $(0.694) million | $0.226 million | $(1.386) million | $0.778 million |
| Net income (loss) | $(0.431) million | $0.095 million | $(0.913) million | $0.365 million |
| Basic EPS | $(0.05) | $0.01 | $(0.11) | $0.05 |
Approximate operating margins were negative 21.7% for the quarter and negative 12.5% for the nine-month period, compared with 4.7% and 5.2%, respectively, in the prior-year periods. Approximate net margins were negative 13.5% and negative 8.2%, compared with 2.0% and 2.4%.
- Quarterly revenue declined 33.0%, primarily because home-care revenue fell 40.1% to $2.611 million. International revenue increased 30.3% to $215,000, and government/institutional revenue increased 49.8% to $373,000.
- Nine-month revenue declined 25.8%. Home-care revenue fell 31.0% to $9.511 million, while international revenue rose 35.0% to $533,000 and government/institutional revenue rose 37.3% to $1.042 million.
- Quarterly gross margin improved because of a favorable referral and reimbursement mix and cost efficiencies. Management expects future gross margins to trend between 70% and 75%.
- Quarterly SG&A expense increased 4.4% to $3.034 million, although nine-month SG&A declined 6.2% to $8.851 million. Research and development expense declined 57.6% for the quarter and 55.8% for the nine-month period.
- At March 31, 2013, cash and cash equivalents were $505,000, compared with $1.702 million at June 30, 2012. Total assets were $18.845 million and total equity was $14.299 million.
- Accounts receivable were $9.198 million, inventories were $2.141 million and total current assets were $13.807 million at March 31, 2013.
- Current liabilities were $4.247 million. The company classified $1.389 million of debt as current, including the term note because of anticipated covenant compliance issues at June 30, 2013.
Cash flow, debt and liquidity
- For the nine months ended March 31, 2013, operating activities generated $990,000 of cash, compared with $1.679 million used in the prior-year period. The improvement was primarily driven by collections of accounts receivable and reductions in inventory.
- Investing activities used $743,000, including $707,000 for property and equipment and $36,000 for patents and trademarks.
- Financing activities used $1.445 million, including $1.208 million of repayments on the revolving line of credit and $237,000 of long-term debt principal payments.
- The company had approximately $1.937 million outstanding under its U.S. Bank facility at March 31, 2013, consisting of $560,000 on the revolving line and approximately $1.377 million on Term Loan A. Term Loan B was repaid in October 2012.
- The May 13, 2013 amendment reduced the revolving commitment from $2.5 million to $2.25 million. As of that amendment date, the company reported $415,000 outstanding and $1.835 million of net unused availability.
- The revolving line bears interest at LIBOR plus 3.50%, or 3.75% at March 31, 2013, and expires December 31, 2013 unless renewed. The facility is secured by substantially all company assets.
Material changes, outlook and risks
- Revenue deterioration was concentrated in domestic home-care operations. Management attributed the decline to lower reimbursement pricing, additional insurance-claim procedures and contracting delays caused by the decentralization of a major third-party payer.
- Management is pursuing cost reductions, including workforce reductions, while realigning the domestic sales force, updating branding and marketing, expanding institutional pricing options, and developing international distributor relationships.
- The company incurred covenant violations during the period. On May 13, 2013, U.S. Bank waived the minimum EBITDA covenant violation and amended the facility. The amendment removed the minimum EBITDA covenant for the June 30, 2013 quarter, established a 1.15-to-1 fixed-charge coverage requirement for that quarter and later periods, required weekly 13-week cash-flow forecasts, and required a financial-consultant review.
- Management nevertheless believed it might be out of compliance with covenants at June 30, 2013 and was negotiating further modifications. Failure to obtain relief could permit acceleration of debt, restrict borrowing or require repayment; the lender could foreclose on secured assets if obligations could not be repaid.
- Management stated that cash, operating cash flow and available borrowings were expected to provide adequate liquidity for the next year, but noted that financing may not be available on favorable terms if operating performance weakens.
- The company is involved in litigation involving a shareholder proposal, a former chairman and related counterclaims. Legal and professional expenses increased, and insurance coverage is being pursued, but the amount of reimbursement is uncertain.
- The warranty reserve increased to $680,000 at March 31, 2013 from $610,000 at June 30, 2012. The company provides lifetime warranties in the United States and Canada for prescribed patients, with shorter warranties in other markets.
Important facts for investors to verify
- Whether domestic home-care revenue and payer contracting delays improve during fiscal 2014.
- Whether the company achieves the amended June 30, 2013 and subsequent credit-facility covenants and renews or replaces the revolving line before its December 31, 2013 expiration.
- Actual cash availability, eligible receivables and borrowing capacity after applying the facility’s 60% borrowing-base limitation.
- Whether cost reductions and sales-force initiatives restore operating profitability without materially impairing growth or service levels.
- The ultimate insurance coverage and cash cost of the shareholder-related litigation.
- Whether gross margins normalize toward management’s stated 70% to 75% range after the favorable quarterly reimbursement mix.