Electromed, Inc. Form 10-Q Summary
Reporting period: Three months ended September 30, 2018, the first quarter of fiscal 2019. The unaudited interim statements are presented under U.S. GAAP. Electromed develops, manufactures and markets SmartVest high-frequency chest wall oscillation airway-clearance systems for home care, institutional and international markets.
Key Financial Metrics
| Metric | Q1 FY2019 | Q1 FY2018 | Change |
|---|---|---|---|
| Net revenue | $7.276 million | $6.304 million | 15.4% increase |
| Gross profit | $5.543 million | $4.691 million | 18.2% increase |
| Gross margin | 76.2% | 74.4% | 180 basis-point increase |
| Operating income | $199,000 | $99,000 | Increase |
| Operating margin | 2.7% | 1.6% | Improved |
| Net income | $154,000 | $81,000 | Increase |
| Net margin | 2.1% | 1.3% | Improved |
| Net cash from operating activities | $303,000 | $328,000 | Decrease |
- Revenue growth was led by home care revenue of $6.722 million, up 13.8%, reflecting higher referrals and approvals, a larger field sales staff and improved reimbursement operations.
- Institutional revenue increased 42.0% to $419,000, driven by higher single-patient-use garment and device sales, partially offset by lower device selling prices.
- International revenue increased 33.7% to $135,000; distributor purchasing timing may cause quarterly fluctuations.
- SG&A increased 16.7% to $5.276 million, primarily due to additional sales and administrative personnel, higher incentives, salary increases, share-based compensation and management bonus accruals.
- Research and development expense was $68,000, or 0.9% of revenue, versus $71,000, or 1.1%, in the prior-year quarter. Management expects R&D spending to increase during the remainder of fiscal 2019.
- Cash was $7.747 million at September 30, 2018, compared with $7.456 million at June 30, 2018. Working capital was approximately $18.906 million.
- Cash used in investing activities was $32,000, including $10,000 for property and equipment and $22,000 for patent costs.
- Cash provided by financing activities was $21,000, consisting of $34,000 from option exercises, partially offset by $13,000 of debt principal payments.
- The company had approximately $1.090 million of term-loan principal outstanding and no borrowings under its $2.5 million revolving line of credit at September 30, 2018.
Material Changes Versus the Prior Comparable Period
- Revenue, gross profit and net income increased materially year over year, although SG&A grew faster than revenue and continued to constrain operating leverage.
- Gross margin improved primarily because of a higher level of revenue recognized per new device placement, partly offset by manufacturing costs for SmartVest SQL with SmartVest Connect wireless technology.
- Net interest changed from approximately $4,000 of expense to $13,000 of income.
- The prior-year tax provision benefited from an approximately $25,000 discrete research and development tax credit benefit. The current-quarter effective tax rate was 27.3%, compared with 14.7% in the prior-year quarter.
- Electromed adopted ASC 606 effective July 1, 2018 using the full retrospective method. Adoption increased retained earnings by approximately $0.8 million as of July 1, 2017 and changed the timing of revenue recognition, particularly for installment, appealed and uncertain-reimbursement contracts. Prior-period amounts were recast.
- Under the related tax accounting method change, the company estimates approximately $2.2 million of additional taxable income recognized over four years, with approximately $140,000 of first-year tax liability reclassified to current income tax payable.
Guidance, Outlook, Risks and Unusual Items
- Management believes cash, operating cash flow and available credit will provide adequate liquidity for the next year based on recent operating performance.
- The revolving credit facility expires December 18, 2018 if not renewed. The company stated that it intended to make the approximately $1.085 million final term-loan payment on or before that date and was evaluating renewal and repayment requirements.
- The company was in compliance with its debt covenants at September 30, 2018, including the minimum tangible net worth covenant of $10.125 million. Failure to comply or failure to renew the line could result in acceleration, loss of borrowing access or foreclosure on secured assets.
- Electromed planned to discontinue direct distribution of the Aerobika OPEP device before December 1, 2018 after determining that the product was unlikely to reach a broader patient population as originally planned.
- Key operating risks include changes in Medicare, Medicaid and private-payer reimbursement; healthcare and medical-device regulation; competition; development of sales channels; intellectual-property protection; international expansion; and access to credit.
- Revenue and contract assets depend on estimates of variable consideration, including payer appeals, patient deductibles, insurance changes, hospitalization, death and discontinued product use. Actual collections could differ from estimates.
- The warranty reserve was $730,000 at September 30, 2018. The company provides lifetime U.S. patient warranties and three-year warranties for institutional and non-U.S. sales.
- Management reported no material undisclosed litigation and no off-balance-sheet arrangements. Disclosure controls were concluded to be effective.
Important Facts for Investors to Verify
- Confirm renewal or replacement of the revolving credit facility and repayment of the term loan due December 18, 2018.
- Monitor payer reimbursement trends, claim appeals, contract-asset collections and potential revenue reversals under ASC 606.
- Assess whether home-care referral and approval growth can offset rising sales, administrative and compensation costs.
- Track the effect of discontinuing Aerobika distribution and the commercial adoption of SmartVest Connect.
- Review inventory growth, warranty adequacy and the company’s ability to convert reported revenue and contract assets into cash.
- Consider that the quarter’s results are interim and may not be indicative of full-year performance.