Electromed, Inc. — Q1 Fiscal 2018 Form 10-Q Summary
Business context and reporting period
Electromed develops, manufactures and markets airway-clearance products using High Frequency Chest Wall Oscillation technology, principally the SmartVest Airway Clearance System. Products are sold in U.S. home-care and institutional markets and internationally through direct sales and distributors. The filing covers the three months ended September 30, 2017, compared with the three months ended September 30, 2016. The financial statements are unaudited.
Key financial metrics
| Metric | Q1 FY2018 | Q1 FY2017 | Change |
|---|---|---|---|
| Net revenue | $6.382 million | $5.545 million | 15.1% increase |
| Gross profit | $4.936 million | $4.328 million | 14.1% increase |
| Gross margin | 77.3% | 78.1% | 0.8 percentage-point decrease |
| Operating income | $162,000 | $289,000 | 43.8% decrease |
| Operating margin | 2.5% | 5.2% | 2.7 percentage-point decrease |
| Net income | $121,000 | $191,000 | 36.7% decrease |
| Diluted earnings per share | $0.01 | $0.02 | Decrease |
| Cash from operating activities | $328,000 | $(1.216) million | $1.544 million improvement |
| Capital expenditures and intangible additions | $102,000 | $71,000 | Increase |
Home-care revenue was $5.980 million, up 16.5%, primarily due to increased approvals and referrals associated with a larger field sales force. Institutional revenue declined 13.0% to $301,000, while international revenue increased 50.7% to $101,000; international results may fluctuate based on distributor purchase timing.
SG&A expense increased 27.5% to $4.704 million, driven by additional sales and administrative personnel, compensation increases, higher share-based compensation, sales incentives, management bonus accruals, professional fees and recruiting costs. R&D expense decreased to $71,000 from $351,000, but management expects R&D spending to increase toward historical levels during the remainder of fiscal 2018.
Cash was $5.787 million at September 30, 2017, compared with $5.574 million at June 30, 2017. Working capital was approximately $15.936 million. Total assets were $23.206 million and shareholders’ equity was $19.379 million.
The company had approximately $1.141 million of principal outstanding under its term loan, reported on the balance sheet net of current maturities and debt issuance costs. The $2.5 million revolving line of credit had no outstanding balance, and the full $2.5 million was available at September 30, 2017. The term loan bears interest at 3.88% and requires a final principal and interest payment of approximately $1.085 million on December 18, 2018.
Material changes versus the prior comparable period
- Revenue increased 15.1%, led by home-care growth, but higher SG&A more than offset the additional gross profit.
- Gross margin declined because of additional manufacturing costs for SmartVest SQL with SmartVest Connect wireless technology.
- Operating income and net income declined despite higher revenue.
- Operating cash flow improved substantially, primarily due to favorable changes in accounts receivable, inventory and accrued liabilities relative to the prior-year quarter.
- Share-based compensation increased to approximately $190,000 from $109,000. Unrecognized compensation expense was approximately $1.170 million at quarter-end, expected to be recognized over approximately one year.
- The inventory obsolescence reserve increased from approximately $180,000 at June 30, 2017 to $260,000 at September 30, 2017.
- The warranty reserve increased from $640,000 to $690,000. The company provides a lifetime warranty for U.S. sales to prescribed patients and a three-year warranty for institutional and non-U.S. individual sales.
- A $25,000 discrete research-and-development tax credit benefit reduced the current-quarter effective tax rate to 23.4%.
Guidance, outlook, risks and unusual items
Management believes working capital and available credit will provide adequate liquidity for the next year. The company expects to fund planned equipment purchases with operating cash flow or credit-facility borrowings, but may require additional debt if operating performance weakens or unforeseen capital needs arise.
SmartVest Connect was launched in June 2017 for pediatric and cystic-fibrosis patients, with planned expansion to targeted adult pulmonary clinics during November 2017. Management expects R&D spending to increase during the remainder of fiscal 2018 as engineering resources focus on product enhancements and market opportunities.
The revolving credit facility expires on December 18, 2017 unless renewed. The debt agreements include a minimum tangible-net-worth covenant of $10.125 million and restrictions on additional indebtedness and dividends. The company was in compliance at September 30, 2017. Failure to comply or failure to renew the line could restrict liquidity and permit acceleration of secured debt.
Principal risks include reimbursement changes affecting Medicare, Medicaid and private insurers; competition; healthcare-law and medical-device regulatory changes; required regulatory approvals; protection of intellectual property; international-market expansion; and the availability or renewal of credit. The filing reports no material undisclosed litigation and no off-balance-sheet arrangements.
The company adopted inventory measurement guidance and new stock-compensation accounting guidance effective July 1, 2017; neither adoption had a material impact. The company was still evaluating the potential impact and adoption approach for the new revenue-recognition standard.
Investor verification checklist
- Verify renewal or replacement of the $2.5 million revolving credit facility before its December 18, 2017 expiration.
- Assess whether home-care revenue growth can offset rising SG&A and planned increases in R&D spending.
- Monitor gross-margin effects from SmartVest Connect manufacturing costs.
- Review warranty and inventory-obsolescence reserves for further increases.
- Evaluate the timing and commercial adoption of SmartVest Connect, including expansion into adult pulmonary clinics.
- Confirm future reimbursement policies and coverage requirements for HFCWO devices.
- Track the term-loan maturity payment of approximately $1.085 million due December 18, 2018.
- Review the company’s eventual assessment and implementation of the new revenue-recognition standard.