Business Context and Reporting Period
Electromed, Inc. develops, manufactures and markets SmartVest airway-clearance systems using High Frequency Chest Wall Oscillation therapy for home-care, institutional and international markets. This unaudited Form 10-Q covers the three and six months ended December 31, 2014, the second quarter and first half of fiscal 2015, compared with the corresponding fiscal 2014 periods.
Key Financial Metrics
| Metric | Three Months Ended December 31, 2014 | Three Months Ended December 31, 2013 | Six Months Ended December 31, 2014 | Six Months Ended December 31, 2013 |
|---|---|---|---|---|
| Net revenues | $4.882 million | $3.501 million | $9.652 million | $6.919 million |
| Gross profit | $3.403 million | $2.523 million | $6.698 million | $4.879 million |
| Gross margin | 69.7% | 72.1% | 69.4% | 70.5% |
| Operating income (loss) | $447,388 | $(308,793) | $845,369 | $(885,997) |
| Net income (loss) | $422,711 | $(239,262) | $800,240 | $(574,667) |
| Net margin | 8.7% | (6.8%) | 8.3% | (8.3%) |
| Diluted EPS | $0.05 | $(0.03) | $0.10 | $(0.07) |
Six-month cash flow from operating activities was $1.273 million, compared with $1.132 million in the prior-year period. Investing activities used $286,000, primarily for property and equipment, while financing activities used $38,000 for debt principal and deferred financing fees. Cash increased to $2.452 million from $1.503 million at June 30, 2014.
At December 31, 2014, working capital was approximately $9.8 million. Total debt was approximately $1.275 million, consisting principally of a $1.261 million term loan; there was no balance on the $2.5 million revolving credit line. Total assets were $16.681 million and total equity was $13.559 million.
Material Changes Versus the Prior Comparable Period
- Quarterly revenue increased 39.4% and six-month revenue increased 39.5%, driven primarily by domestic home-care revenue.
- Quarterly home-care revenue increased 52.8% to approximately $4.458 million; six-month home-care revenue increased 44.1% to approximately $8.299 million.
- Quarterly international revenue declined 72.8% to approximately $40,000, although six-month international revenue increased 48.3% to approximately $439,000. Management attributed the quarterly decline partly to European Union distributors pulling purchases into the prior quarter because of delayed RoHS 2 compliance.
- Government and institutional revenue declined 12.4% in the quarter but increased 5.9% for the six-month period.
- Gross margin declined because of approximately $107,000 of impairment charges for SmartVest SQL tooling. Management expects approximately $180,000 of additional future charges related to current cost-reduction projects.
- SG&A increased 4.9% for the quarter and 4.2% for the six-month period, primarily from higher payroll, commissions and bonuses associated with improved revenue and profitability. Research and development expense declined 47.4% for the six-month period as SmartVest SQL development and testing were substantially completed.
- The company reported no income tax expense for the six-month period because net operating loss carryforwards offset taxable income. The company retained a full valuation allowance against its deferred tax assets.
Guidance, Outlook, Risks and Unusual Items
- Management expects to offer SmartVest SQL to institutional and international markets, but had not established a specific timeframe.
- Management expected RoHS 2 compliance and resumed shipments to European Union distributors during the second half of fiscal 2015.
- Management expects long-term gross margins to return to levels above 70% as manufacturing costs decline and sales scale improves. Long-term research and development spending is expected to be approximately 2% to 4% of revenue.
- Management believes cash, operating cash flow and available borrowing capacity will provide adequate liquidity for the next year. The revolving line expires December 18, 2015 if not renewed; management expected renewal or alternative financing but stated that favorable financing cannot be assured.
- The credit facility requires minimum tangible net worth of $10.125 million and restricts certain additional debt and dividends. The company was in compliance at December 31, 2014. A future covenant breach could permit acceleration of debt, restrict borrowing or lead to foreclosure on secured assets.
- The company provides lifetime warranties for prescribed U.S. patients and three-year warranties for institutional and non-U.S. sales. The warranty reserve remained $700,000 at December 31, 2014.
- Key risks include reimbursement changes, regulatory compliance and approvals, international market expansion, competition, sales-force execution, intellectual-property matters, litigation, credit availability and general economic conditions. The filing states that no undisclosed litigation was expected to have a material adverse effect.
Investor Verification Points
- Verify whether domestic home-care growth and reimbursement-process improvements are sustainable.
- Monitor RoHS 2 compliance and the timing and volume of resumed European Union shipments.
- Assess the remaining SmartVest SQL tooling charges and whether gross margins recover above 70%.
- Review renewal or refinancing of the revolving credit line before December 18, 2015 and continued compliance with debt covenants.
- Evaluate the realizability of deferred tax assets and the adequacy of the $700,000 warranty reserve.
- Consider the effect of revenue concentration in home care, reimbursement policy changes and the company’s ability to scale manufacturing and sales operations.