Electromed, Inc. — Fiscal 2018 Second-Quarter Form 10-Q
Reporting period: Three and six months ended December 31, 2018; fiscal year ended June 30. The interim financial statements are unaudited and prepared under U.S. GAAP. Electromed develops, manufactures and sells SmartVest high-frequency chest wall oscillation airway-clearance systems in home care, institutional and international markets.
Key Financial Metrics
| Metric | Three Months Ended Dec. 31, 2018 | Year-over-Year | Six Months Ended Dec. 31, 2018 | Year-over-Year |
|---|---|---|---|---|
| Net revenue | $8.012 million | +15.1% | $15.288 million | +15.2% |
| Gross profit | $6.062 million | +12.2% | $11.605 million | +15.0% |
| Gross margin | 75.7% | Down from 77.6% | 75.9% | Down from 76.1% |
| Operating income | $672,215 | Down from $770,651 | $871,155 | Approximately flat |
| Net income | $377,736 | Down from $419,757 | $532,129 | Up from $500,707 |
| Diluted EPS | $0.04 | Down from $0.05 | $0.06 | Flat |
| Cash flow from operations | Not separately provided | — | $820,589 | Down from $1.530 million |
Revenue mix: Six-month home care revenue was $14.053 million, institutional revenue was $821,000, and international revenue was $414,000. Home care revenue increased 13.3%, institutional revenue increased 36.6%, and international revenue increased 55.1% versus the recast prior-year period.
Expenses and margins: Six-month SG&A expense increased 14.6% to $10.428 million, primarily due to additional sales and administrative personnel, higher sales incentives, salary increases, management bonus accruals and share-based compensation. R&D expense increased to $306,028 from $127,458. Six-month net income benefited from revenue growth but was partially offset by higher operating expenses.
Liquidity and capital structure: Cash was $7.211 million at December 31, 2018, compared with $7.456 million at June 30, 2018. Working capital was approximately $19.949 million. The company had no outstanding balance on its renewed $2.5 million revolving credit line, and the full amount was available subject to borrowing-base limitations. The term loan matured on December 18, 2018 and was repaid using cash; the company had no remaining term-loan obligations.
Balance sheet: Total assets were $26.882 million and shareholders’ equity was $23.811 million at December 31, 2018. Accounts receivable were $11.937 million, contract assets were $781,806, and inventory was approximately $2.736 million. The warranty reserve was $790,000.
Material Changes Versus the Prior Comparable Period
- Revenue growth was driven primarily by higher home care referrals from a larger field sales force and improved reimbursement operations, which increased the referral-to-approval percentage.
- Institutional growth reflected increased sales of single-patient-use garments and devices, partly offset by lower average selling prices per device.
- International revenue increased substantially, although management noted that distributor purchase timing can cause quarterly volatility.
- Gross margin declined because of lower institutional selling prices.
- SG&A and R&D spending increased materially as the company invested in sales capacity, support functions and product development.
- Operating cash flow declined despite higher net income, reflecting increases in inventory and accounts receivable, lower taxes payable and reductions in accounts payable and accrued liabilities.
- The company adopted ASC 606 using the full retrospective method effective July 1, 2018. Adoption accelerated revenue recognition for certain SmartVest sales and increased retained earnings by approximately $0.8 million as of July 1, 2017; prior periods were recast.
- The company discontinued direct distribution of the Aerobika OPEP device in November 2018 after determining that the offering was unlikely to reach the intended broader patient population.
Guidance, Outlook, Risks and Unusual Items
- Management believes existing working capital and available credit will provide adequate liquidity for the next year. Planned equipment purchases are expected to be funded by operating cash flow or the credit facility.
- Management expects R&D spending as a percentage of revenue to remain consistent with fiscal-year-to-date run rates through June 30, 2019.
- The revolving credit line expires December 18, 2019 if not renewed. It is secured by substantially all tangible and intangible assets and includes a minimum tangible net worth covenant of $10.125 million, as well as restrictions on additional debt and dividends. The company reported compliance at December 31, 2018.
- Revenue and contract assets depend on estimates of variable consideration, including payer appeals, insurance coverage changes, patient deductibles, discontinued use, hospitalization and death. Changes in these estimates could affect revenue and cause reversals.
- Key business risks include changes in Medicare, Medicaid and private-insurance reimbursement; healthcare-law and regulatory changes; competition; international-market expansion; intellectual-property protection; product development; and availability or renewal of credit.
- Income tax expense included a $126,000 discrete deferred tax expense related to expired vested stock options and a $9,000 current tax benefit related to option exercises. These items increased the effective tax rate by 17.0% for the quarter and 13.0% for the six-month period.
- The company estimated a $2.2 million increase in taxable income from its ASC 606 tax accounting-method change, with approximately $140,000 of first-year tax liability recognized over four years.
- The company reported no material undisclosed litigation, no off-balance-sheet arrangements and effective disclosure controls as of the evaluation date.
Investor Verification Checklist
- Verify whether referral growth and reimbursement-processing improvements continue to support home care revenue.
- Monitor institutional pricing and its effect on gross margin.
- Assess collection performance, payer appeals, contract-asset realizations and future revenue adjustments under ASC 606.
- Track operating cash conversion, inventory growth and accounts receivable aging.
- Confirm renewal or replacement of the revolving credit facility before its December 2019 expiration and continued covenant compliance.
- Evaluate the sustainability of higher SG&A, R&D and share-based compensation expenses relative to revenue growth.
- Review the effect of the Aerobika discontinuation and international distributor purchase timing on future revenue comparability.