Electromed, Inc. annual report, FY2015

Electromed, Inc. Fiscal 2015 Form 10-K Summary

Reporting period: Fiscal year ended June 30, 2015, compared with fiscal 2014 ended June 30, 2014. The request references 2014 Q4, but the supplied filing is an annual report covering fiscal 2015.

Business Context

Electromed develops, manufactures, markets and sells SmartVest high-frequency chest wall oscillation airway-clearance systems and related products for patients with compromised pulmonary function. Sales are primarily generated through the U.S. home-care market and depend significantly on physician referrals and third-party reimbursement from commercial insurers, Medicare and Medicaid.

• Fiscal 2015 revenue was approximately 90% U.S. and 10% international and institutional/governmental sales combined.
• The SmartVest SQL, launched domestically in fiscal 2014, was introduced into institutional and certain international markets in the fourth quarter of fiscal 2015.
• The Company had 97 employees, including 94 full-time employees, at June 30, 2015.

Financial Performance and Key Metrics

Metric	Fiscal 2015	Fiscal 2014	Change
Net revenue	$19.408 million	$15.488 million	+25.3%
Gross profit	$13.600 million	$10.634 million	+27.9%
Gross margin	70.1%	68.7%	+140 basis points
Operating income (loss)	$1.310 million	$(0.741) million	Improved
Net income (loss)	$1.092 million	$(1.289) million	Improved
Diluted earnings (loss) per share	$0.13	$(0.16)	Improved
Cash flow from operations	$2.781 million	$2.067 million	+34.6%

• Home-care revenue increased 27.8% to $16.615 million, driven by higher referrals, improved reimbursement processes, new payer contracts, faster approval cycles, higher average selling prices and a higher referral-to-approval rate.
• International revenue increased 6.6% to $854,000. Growth in Central and South America was partly offset by lower sales in the Middle East and Asia.
• Governmental and institutional revenue increased 14.7% to $1.939 million. Institutional revenue rose 22.5% to approximately $1.504 million, while government sales declined to approximately $435,000.
• SG&A expense increased 9.8% to $11.974 million, primarily due to higher compensation, commissions, bonuses, recruiting and the $232,000 medical-device excise tax. Advertising and marketing expense declined 32.7% to $336,000.
• Research and development expense declined to $316,000 from $466,000 as SQL development and testing were substantially completed.
• Interest expense increased to $86,000 from $79,000.
• The effective tax rate reported in the financial statements was 10.8%; the Company maintained a full valuation allowance against its net U.S. federal and state deferred tax assets.

Liquidity, Cash Flow and Debt

• Cash increased to $3.598 million at June 30, 2015 from $1.503 million at June 30, 2014.
• Working capital was approximately $10.3 million. Total current assets were $12.587 million, compared with current liabilities of $2.279 million.
• Operating cash flow of $2.781 million exceeded capital expenditures and patent and trademark spending of $624,000.
• Capital expenditures were $523,000, down from $895,000 in fiscal 2014; patent and trademark spending was $101,000.
• Total debt was approximately $1.251 million, including a $1.241 million mortgage note and a $10,000 capital lease obligation. The Company made approximately $46,000 of principal payments during the year.
• The $2.5 million revolving credit line had no outstanding balance at year-end, with approximately $2.5 million available subject to borrowing-base limits. The line expired on December 18, 2015 if not renewed.
• The term loan bears interest at 5.0%, requires monthly payments of approximately $8,600 and has a final principal and interest payment of approximately $1.095 million due December 18, 2018.
• The Company was in compliance with its credit-facility covenants at June 30, 2015. The facility restricts additional indebtedness and dividend payments and requires minimum tangible net worth of $10.125 million.

Material Changes and Unusual Items

• Profitability improved materially, with the Company returning to positive operating income and net income after a fiscal 2014 loss.
• Gross margin benefited from higher domestic average selling prices, improved reimbursement outcomes and lower SQL manufacturing costs.
• Fiscal 2015 cost of revenue included approximately $118,000 of impairment charges for tooling no longer needed after manufacturing-process changes.
• The Company recorded a $110,000 reserve for obsolete SV2100 parts in the fourth quarter because expected SQL cost reductions were expected to accelerate the phase-out of SV2100 production. Management expected approximately $30,000 of additional future cost-reduction-related charges.
• Inventory declined to $2.072 million, while the obsolescence reserve increased to $140,000 from $30,000.
• Revenue recognized under the installment method increased to $1.487 million from $1.100 million. Estimated unrecognized installment sales, net of discounts, were $2.053 million at June 30, 2015.
• The Company obtained certification during fiscal 2015 to recondition and resell returned units.

Outlook, Risks and Contingencies

Management’s fiscal 2016 priorities were profitable growth, higher-quality referrals, improved reimbursement rates, continued customer-service investment and expansion of institutional coverage. Longer-term goals included increasing awareness of HFCWO therapy, particularly for bronchiectasis, expanding payer coverage, strengthening reimbursement support and expanding the institutional geographic footprint. Management stated that long-term gross margins were expected to remain approximately 70%, subject to reimbursement mix and other short-term fluctuations.

• Revenue is materially dependent on Medicare, Medicaid and private-payer coverage, approval rates, reimbursement amounts, deductibles, co-payments and patient collections.
• The revolving credit line required renewal after December 18, 2015. Management expected renewal but stated that additional financing might not be available on favorable terms, or at all.
• Failure to satisfy debt covenants could lead to acceleration of debt, loss of borrowing availability or foreclosure on secured assets.
• The medical-device business is subject to FDA, international regulatory, quality-system, privacy, healthcare fraud-and-abuse and promotional-marketing requirements.
• Competition includes Hill-Rom/Advanced Respiratory, RespirTech and other HFCWO manufacturers, as well as alternative airway-clearance therapies.
• Certain U.S. and foreign patents were expected to begin expiring in calendar 2016, creating intellectual-property protection and competitive risks.
• The Company had a lifetime warranty for U.S. home-care systems and a three-year warranty for U.S. institutional and international sales. The warranty reserve was $660,000 at June 30, 2015.
• The Company reported no material pending litigation, no off-balance-sheet arrangements and no material adverse impact expected from environmental compliance.
• Adoption of new revenue-recognition guidance was expected beginning in fiscal 2019; the filing states that the impact was still being evaluated.

Important Facts for Investors to Verify

• Whether the revolving credit facility was renewed before its December 18, 2015 expiration and on what terms.
• Whether SQL adoption and manufacturing-cost reductions produced the anticipated margin benefits without additional material impairment or inventory charges.
• Trends in referral volume, reimbursement approval rates, average selling prices, payer mix and patient collection performance.
• Whether the full deferred-tax valuation allowance was subsequently released and the resulting effect on tax expense and earnings.
• The effect of patent expirations beginning in 2016 and the Company’s ability to protect its SmartVest technology.
• Progress in institutional, international and bronchiectasis-related growth initiatives.
• Future warranty claims, obsolete inventory exposure and installment-revenue collectability.