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ELMD > SEC Filings for ELMD > Form 10-Q on 14-May-2014All Recent SEC Filings

Show all filings for ELECTROMED, INC.

Form 10-Q for ELECTROMED, INC.


14-May-2014

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Some of the statements in this report may contain forward-looking statements made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 that reflect our current view on future events, future business, industry and other conditions, our future performance, and our plans and expectations for future operations and actions. In some cases, you can identify forward-looking statements by the following words: anticipate, believe, continue, could, estimate, expect, intend, may, ongoing, plan, potential, predict, project, should, will, would, or the negative of these terms or other comparable terminology, although not all forward-looking statements contain these words. Our forward-looking statements in this report primarily relate to the following: our expectations regarding international markets and their impact on our sales; our beliefs regarding the effect of new products on our revenues; our expectations regarding contract renewal and negotiation; our expectations regarding long-term margins; our expectations regarding research and development expenses; our expectations regarding sales growth, future efficiencies and profitability with the increase in our sales force; our expectations regarding capital expenditures; our expectations regarding insurance coverage for incurred litigation expenses; our beliefs regarding the benefits of our products; our beliefs regarding realization of deferred tax assets and the associated valuation allowance; our beliefs regarding the sufficiency of working capital; and our ability and intention with regard to future financing and compliance with financial covenants in our current credit facility. These statements involve known and unknown risks, uncertainties and other factors that may cause our results or our industry's actual results, levels of activity, performance or achievements to be materially different from the information expressed or implied by these forward-looking statements. Forward-looking statements are only predictions and are not guarantees of performance. These statements are based on our management's beliefs and assumptions, which in turn are based on currently available information.

You should read this report thoroughly with the understanding that our actual results and actions may differ materially from those set forth in the forward-looking statements for many reasons, including the reasons described in this report. These factors include, but are not limited to: the competitive nature of our market; the risks associated with expansion into international markets; changes to Medicare, Medicaid, or private insurance reimbursement policies; changes to health care laws; changes affecting the medical device industry; our need to maintain regulatory compliance and to gain future regulatory approvals and clearances; our ability to recruit, train and retain an effective sales force, reimbursement staff, and patient services staff; our ability to protect our intellectual property; the effect of litigation, including legal expenses, which may arise with respect to our intellectual property in the ordinary course of business or otherwise; the impact of tight credit markets on our ability to continue to obtain financing on reasonable terms; and general economic and business conditions.

Overview

Electromed, Inc. ("we," "us," "our," the "Company" or "Electromed") was incorporated in 1992. We are engaged in the business of providing innovative airway clearance products applying High Frequency Chest Wall Oscillation ("HFCWO") therapy in pulmonary care for patients of all ages.

We manufacture, market and sell products that provide HFCWO, including the Electromed, Inc. SmartVest® Airway Clearance System ("SmartVest System") and related products, to patients with compromised pulmonary function. The products are sold for both the home health care market and the institutional market for use by patients in hospitals, which are referred to as "institutional sales." For approximately twelve years, we have marketed the SmartVest System and its predecessor products to patients suffering from cystic fibrosis, bronchiectasis
(including chronic bronchitis or chronic obstructive pulmonary disease (COPD)
that has resulted in a diagnosis of bronchiectasis), or any one of certain enumerated neuro-muscular diseases. Reimbursement often requires the patients with these conditions to demonstrate that another less expensive physical or mechanical treatment did not adequately mobilize retained secretions. Additionally, we offer such products, upon physician prescription to a patient population that includes post-surgical and intensive care patients, patients with end-stage neuromuscular disease, and ventilator-dependent patients. Our goal is to be a consistent innovator with unmatched customer service in providing HFCWO to patients with impaired pulmonary function.

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On December 30, 2013, we announced that we had received clearance from the FDA to market the SmartVest ® SQL™ ("SQL"), our newest product in the SmartVest family. SQL offers significant improvements in terms of lighter weight, quieter operation and an overall smaller footprint while utilizing the same wearable garment as previous Electromed products. Additionally, new features include programmable ramping, an enhanced pause feature and more user-friendly graphics. These are improvements that have been long requested by both patients who use and medical practitioners who prescribe HFCWO therapy devices. We believe these improvements will increase the likelihood that patients will adhere to their prescribed therapy regimen, resulting in better outcomes and lower treatment costs in the long term as therapy adherence reduces the potential for adverse events such as respiratory infections and pneumonia. We believe the features and benefits of the SQL make it an attractive option within the HFCWO market. We commenced selling the SQL into the domestic homecare market in January 2014. Due to the length of the reimbursement process for HFCWO as discussed in the Revenue section below, we believe the SQL will have minimal impact on revenue over the short term.

Critical Accounting Policies and Estimates

Our critical accounting policies and estimates are disclosed in Part II, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," and Note 1 to our Audited Consolidated Financial Statements, included in Part II, Item 8, of our Annual Report on Form 10-K for the fiscal year ended June 30, 2013. The critical accounting policies used in the preparation of the financial statements as of March 31, 2014 have remained unchanged from June 30, 2013.

Some of our accounting policies require us to exercise significant judgment in selecting the appropriate assumptions for calculating amounts contained in the financial statements. Such judgments are subject to an inherent degree of uncertainty. These judgments are based upon our historical experience, known trends in our industry, terms of existing contracts and other information from outside sources, as appropriate. We believe the critical accounting policies that require the most significant assumptions and judgments in the preparation of its consolidated financial statements include: revenue recognition and the estimation of selling price adjustments, allowance for doubtful accounts, inventory obsolescence, share-based compensation, income taxes, and warranty reserve.

Results of Operations

Three Months Ended March 31, 2014 Compared to Three Months Ended March 31, 2013

     Revenues

     Revenue results for the three month periods are summarized in the table
below (dollar amounts in thousands).


                                       Three Months Ended March 31,          Increase (Decrease)
                                         2014                2013

Total Revenue                       $         3,956     $         3,199   $      757           23.7 %

Home Care Revenue                   $         3,227     $         2,611   $      616           23.6 %

International Revenue               $           289     $           215   $       74           34.4 %

Government/Institutional Revenue    $           440     $           373   $       67           18.0 %

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Home Care Revenue. Home care revenue was approximately $3,227,000 for the three months ended March 31, 2014, representing an increase of approximately $616,000, or 23.6%, compared to the same period in 2013. The increase in revenue was caused by an increase in approvals and a higher average selling price based on the mix of referrals, as compared with the same period in the prior year. There continues to be added administrative procedures implemented by third party payers in the insurance claims process, which has lengthened the approval process compared to the prior year. In fiscal 2013, one of the largest domestic third party payers, Blue Cross and Blue Shield, decentralized its contracting process. The decentralization has required significantly more administrative efforts on our part to complete the necessary contracts to maintain our national coverage with that payer. We have completed the majority of the contracts with the Blue Cross and Blue Shield affiliates that had a large historical referral base, and we will continue to work with the remaining affiliates to become in-network providers.

International Revenue. International revenue was approximately $289,000 for the three months ended March 31, 2014, representing an increase of approximately $74,000, or 34.4%, compared to the same period in 2013. International sales can be affected by the timing of distributor purchases and cause fluctuation on a quarterly basis.

Government/Institutional Revenue.Government/institutional revenue was approximately $440,000 for the three months ended March 31, 2014, representing an increase of approximately $67,000, or 18.0%, compared to approximately $373,000 during the same period in the prior year. This resulted from a $6,000 increase in government sales, which increased to approximately $75,000 for the three months ended March 31, 2014. Institutional revenue, which includes sales to distributors, group purchasing organization (GPO) members, and other institutions, also increased by $61,000 compared to the same period the prior year. The overall increase in institutional and government sales was the result of the continued focused efforts of our sales force.

Gross profit

Gross profit increased to approximately $2,520,000, or 63.7% of net revenues, for the three months ended March 31, 2014, from approximately $2,442,000, or 76.3% of net revenues, in the same period in the prior year. The decrease in gross profit percentage was primarily the result of the mix of referrals which included a lower percentage of approvals on an increase in the number of units shipped, and, as is often the case with new products, we have not yet reached full efficiency in sourcing and manufacturing the SQL and this directly impacted our gross margin in the quarter. We believe that as we grow sales, we will be able to continue to leverage manufacturing costs and gross margins, over the long-term, will return to approximately 70%.

Operating expenses

Selling, general and administrative expenses. Selling, general and administrative (SG&A) expenses were approximately $2,634,000 for the three months ended March 31, 2014, representing a decrease of approximately $400,000, or 13.2%, compared to SG&A expenses of approximately $3,034,000 for the same period the prior year. Payroll and compensation-related expenses were approximately $1,449,000 for the three months ended March 31, 2014, representing a decrease of approximately $137,000, or 8.6%, compared to approximately $1,586,000 in the same period the prior year. This decrease was due to a 2.9% reduction in full time equivalent employees including certain higher compensated employees.

Professional fees for the three months ended March 31, 2014 were approximately $126,000, a decrease of approximately $194,000 compared to approximately $320,000 in the same period in the prior year. These fees are for services related to legal costs, reporting requirements, expenses related to information technology security and backup, and expenses for printing and other shareowner services. The decrease in fees over the same period last year was primarily due to one-time consulting fees related to upgrading our information technology infrastructure that occurred in the prior year, as well as a shareholder's proposal at our 2013 Annual Meeting of Shareholders and the resulting litigation, which was concluded by settlement of the parties in the first quarter of fiscal year 2014. We have insurance for professional fees and expenses incurred in connection with the litigation and are working with our insurance carrier on coverage matters. During April 2014 we received approximately $100,000 of reimbursement from insurance and we believe there is a possibility of receiving additional reimbursement, however, there can be no guarantee of any specific additional coverage amount.

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Advertising and marketing expenses, including tradeshows and event sponsorships, for the three months ended March 31, 2014 decreased by approximately $56,000 to approximately $100,000, compared to approximately $156,000 in the same period in the prior year due to onetime costs associated with our website redesign in the prior year. Travel, meals and entertainment expenses were approximately $281,000 for the three months ended March 31, 2014, representing a decrease of approximately $32,000, or 10.2%, compared to expenses of approximately $313,000 for the same period in the prior year. This decrease was primarily due to eliminating the Company's winter sales event.

In addition, selling, general and administrative expenses increased approximately $14,000 compared to the same period in the prior year as a result of the medical device excise tax, which increased due to increased revenue.

Research and development expenses. Research and development expenses were approximately $103,000 for the three months ended March 31, 2014, representing an increase of approximately $2,000, or 2.0%, compared to approximately $101,000 in the same period the prior year. Research and development expenses for the three months ended March 31, 2014 were 2.6% of revenue, compared to 3.2% of revenue in the same period the prior year. As a percentage of revenue, we expect to spend approximately 3.0% to 5.0% of revenue on research and development expenses over the long term.

Interest expense

Interest expense was approximately $24,000 for the three months ended March 31, 2014, representing a decrease of approximately $6,000, or 20.0%, compared to approximately $30,000 for the same period the prior year. The decrease resulted from a decrease in average debt outstanding and a lower interest rate on the debt refinanced on December 18, 2013.

Income tax benefit

Income tax expense was estimated at approximately $764,000 for the three months ended March 31, 2014, compared to income tax benefit of $292,000 in the same period in the prior year. The income tax expense for the three months ended March 31, 2014 includes a current tax expense of $310,000 and a discrete tax expense of $454,000 due primarily to our decision to record a full valuation allowance against all of our net US federal and state deferred tax assets at March 31, 2014. The effective tax rates excluding the adjustment for the valuation allowance for the three months ended March 31, 2014 and 2013 were 32.9% and 40.4%, respectively.

Net loss

Net loss for the three months ended March 31, 2014 was approximately $1,004,000 compared to net loss of approximately $431,000 for the same period the prior year. The net loss was primarily the result of our decision to record a full valuation allowance against our net US federal and state deferred tax assets at March 31, 2014. Excluding the adjustments for the valuation allowance included in tax expense our adjusted net loss for the three months ended March 31, 2014 was approximately $161,000, a decrease of approximately $270,000 from the same period the prior fiscal year. The smaller adjusted net loss was due to an increase in revenues and a decrease in certain selling, general and administrative expenses offset by higher cost of revenues. We believe this non-GAAP measure of adjusted net loss is useful because it excludes the significant one-time expense related to the recording of the valuation allowance expense that is considered to be non-operational and of a non-cash nature. This non-GAAP measure thereby allows us to evaluate our current performance and make comparisons to past performance on a consistent basis.

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Nine Months Ended March 31, 2014 Compared to Nine Months Ended March 31, 2013

     Revenues

     Revenue results for the nine month periods are summarized in the table
below (dollar amounts in thousands).


                                       Nine Months Ended March 31,          Increase (Decrease)
                                          2014              2013

Total Revenue                        $       10,876    $       11,086    $      (210 )         (1.9 )%

Home Care Revenue                    $        8,987    $        9,492    $      (505 )         (5.3 )%

International Revenue                $          585    $          552    $        33            6.0 %

Government/Institutional Revenue     $        1,304    $        1,042    $       262           25.1 %

Home Care Revenue. Home care revenue was approximately $8,987,000 for the nine months ended March 31, 2014, representing a decrease of approximately $505,000, or 5.3%, compared to the same period in 2013. The decrease in revenue was caused by a lower average selling price from continued downward pricing pressure and a decrease in referral counts as compared with the same period in the prior year. There also continues to be added administrative procedures implemented by third party payers in the insurance claims process, which has lengthened the approval process compared to the prior year. In fiscal year 2013, one of the largest domestic third party payers, Blue Cross and Blue Shield, decentralized its contracting process. The decentralization has required significantly more administrative efforts on our part to complete the necessary contracts to maintain our national coverage with that payer. We have completed the majority of the contracts with the Blue Cross and Blue Shield affiliates that had a large historical referral base, and we will continue to work with the remaining affiliates to become in-network providers.

International Revenue.International revenue was approximately $585,000 for the nine months ended March 31, 2014, representing an increase of approximately $33,000, or 6.0%, compared to the same period in 2013. This increase resulted from an increase in sales to Europe.

Government/Institutional Revenue.Government/institutional revenue was approximately $1,304,000 for the nine months ended March 31, 2014, representing an increase of approximately $262,000, or 25.1%, compared to approximately $1,042,000 during the same period in the prior year. This resulted from a $163,000 increase in government sales, which increased to approximately $357,000 for the nine months ended March 31, 2014. Institutional revenue, which includes sales to distributors, group purchasing organization (GPO) members, and other institutions, also increased by $98,000 compared to the same period the prior year. The overall increase in institutional and government sales was the result of the continued focused efforts of our sales force.

Gross profit

Gross profit decreased to approximately $7,399,000, or 68.0% of net revenues, for the nine months ended March 31, 2014, from approximately $7,777,000, or 70.2% of net revenues, in the same period in the prior year. The decrease in gross profit percentage was primarily the result of lower average selling price, and, as is often the case with new products, we have not yet reached full efficiency in sourcing and manufacturing the SQL and this directly impacted our gross margin in the quarter. We believe that as we grow sales, we will be able to continue to leverage manufacturing costs and gross margins, over the long-term, will return to approximately 70%.

Operating expenses

Selling, general and administrative expenses. Selling, general and administrative (SG&A) expenses were approximately $8,097,000 for the nine months ended March 31, 2014, representing a decrease of approximately $754,000, or 8.5%, compared to SG&A expenses of approximately $8,851,000 for the same period the prior year. Payroll and compensation-related expenses were approximately $4,286,000 for the nine months ended March 31, 2014, representing a decrease of approximately $94,000, or 2.1%, compared to approximately $4,380,000 in the same period the prior year. This decrease was due to a 2.9% reduction in full time equivalent employees.

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Advertising and marketing expenses, including tradeshows and event sponsorships, were approximately $363,000 in the nine months ended March 31, 2014, representing a decrease of approximately $95,000, or 20.7%, compared to approximately $458,000 in the same period in the prior year. This decrease was primarily due to the elimination of industry training that was sponsored by Electromed as well as targeting more cost-effective advertising.

Professional fees for the nine months ended March 31, 2014 were approximately $571,000, a decrease of approximately $376,000 compared to approximately $947,000 in the same period in the prior year. These fees are for services related to legal costs, reporting requirements, expenses related to information technology security and backup, one-time consulting expenses, and expenses for printing and other shareowner services. The decrease in fees over the same period last year was primarily due to one-time consulting fees related to upgrading our information technology infrastructure that occurred in the prior year, as well as a shareholder's proposal at our 2013 Annual Meeting of Shareholders and the resulting litigation, which was concluded by settlement of the parties during the first quarter of fiscal year 2014. We have insurance for professional fees and expenses incurred in connection with the litigation and are working with our insurance carrier on coverage matters. During April 2014 we received approximately $100,000 of reimbursement from insurance and we believe there is a possibility of receiving additional reimbursement, however, there can be no guarantee of any specific additional coverage amount.

Research and development expenses. Research and development expenses were approximately $405,000 for the nine months ended March 31, 2014, representing an increase of approximately $93,000, or 29.8%, compared to approximately $312,000 in the same period the prior year. The increase was due to finalizing the development and testing of the new SmartVest SQL. Research and development expenses for the nine months ended March 31, 2014 were 3.7% of revenue, compared to 2.8% of revenue in the same period the prior year. As a percentage of revenue, management expects to spend approximately 3.0% to 5.0% of revenue on research and development expenses over the long term.

Interest expense

Interest expense was approximately $70,000 for the nine months ended March 31, 2014, representing a decrease of approximately $38,000, or 35.2%, compared to approximately $108,000 for the same period the prior year. The decrease resulted from a decrease in average debt outstanding and a lower interest rate on the debt refinanced on December 18, 2013.

Income tax benefit

Income tax expense was estimated at approximately $418,000 for the nine months ended March 31, 2014, compared to income tax benefit of $564,000 in the same period in the prior year. The income tax expense for the nine months ended March 31, 2014 includes a current tax benefit of $36,000 and a discrete tax expense of $454,000 due primarily to our decision to record a full valuation allowance against all of our net US federal and state deferred tax assets at March 31, 2014. The effective tax rates excluding the adjustment for the valuation allowance for the nine months ended March 31, 2014 and 2013 were 36.0% and 38.2%, respectively.

Net loss

Net loss for the nine months ended March 31, 2014 was approximately $1,579,000 compared to net loss of approximately $913,000 for the same period the prior year. The net loss was primarily the result of our decision to record a full valuation allowance against all of our net US federal and state deferred tax assets at March 31, 2014. Excluding the adjustments for the valuation allowance included in tax expense our adjusted net loss for the nine months ended March 31, 2014, was approximately $736,000, a decrease of approximately $177,000 from the same period the prior fiscal year. The smaller adjusted net loss was due to a decrease in certain selling, general and administrative expenses offset by lower revenues and a higher cost of revenues. We believe this non-GAAP measure of net loss is useful because it excludes the significant one-time expense related to the recording of the valuation allowance that is considered to be non-operational and of a non-cash nature. This non-GAAP measure thereby allows us to evaluate our current performance and make comparisons to past performance on a consistent basis.

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Our focus remains on controlling costs in an environment of downward reimbursement pressure while implementing key growth strategies. These include marketing and selling our recently FDA-cleared SQL to the domestic homecare market, and strengthening our focus on the institutional market which includes the recent addition of a senior sales position better leverage our current contracts and adding new contracts.

Liquidity and Capital Resources

Cash Flows and Sources of Liquidity

Cash Flows from Operating Activities

For the nine months ended March 31, 2014, net cash provided by operating activities was approximately $1,020,000. Cash flows provided by operations consisted of approximately $1,579,000 in net loss, adjusted for non-cash expenses of approximately $1,080,000, offset by a decrease in accounts receivable and an increase in accounts payable and accrued liabilities of $2,544,000 and $184,000, respectively. In addition, inventories and prepaid expenses and other assets increased approximately $1,171,000 and 38,000, respectively.

For the nine months ended March 31, 2013, net cash provided by operating activities was approximately $990,000. Cash flows provided by operations consisted of approximately $913,000 in net loss, adjusted for non-cash expenses of approximately $627,000, offset by decreases in accounts receivable, inventories, and trade payables and accrued liabilities of $1,653,000, $251,000, and $5,000, respectively. In addition, prepaid expenses and other assets increased by approximately $632,000.

Cash Flows from Investing Activities

For the nine months ended March 31, 2014, cash used in investing activities was approximately $634,000. During this period we paid approximately $626,000 for purchases of property and equipment. We also paid approximately $8,000 for patent related costs.

For the nine months ended March 31, 2013, cash used in investing activities was approximately $743,000. During this period we paid approximately $707,000 . . .

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