Electromed, Inc. 10-K

Item 8. Financial Statements and Supplementary Data. Index to Financial Statements Report of Independent Registered Public Accounting Firm F-2 Balance Sheets F-4 Statements of Operations F-5 Statements of Shareholders’ Equity F-6 Statements of Cash Flows F-7 Notes to Financial Statements F-8 F- 1 Report of Independent Registered Public Accounting Firm Shareholders and Board of Directors Electromed, Inc. Opinion on the Financial Statements We have audited the accompanying balance sheets of Electromed, Inc. (the Company) as of June 30, 2023 and 2022, the related statements of operations, shareholders' equity and cash flows for the years then ended, and the related notes to the financial statements. In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of June 30, 2023 and 2022, and the results of its operations and its cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America. Basis for Opinion These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits, we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion. Critical Audit Matter The critical audit matter communicated below is a matter arising from the current period audit of the financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective or complex judgments. The communication of the critical audit matter does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing separate opinions on the critical audit matter or on the accounts or disclosures to which it relates. Measurement of Customer Revenue Net of Adjustments As discussed in Note 2 to the financial statements, revenues are recognized at a point in time when control passes to the customer upon product shipment or delivery. Net patient revenues (patient revenue less estimated adjustments) are recognized at the estimated net realizable amounts from third-party payers and customers in exchange for the product. The Company has agreements with third-party payers that provide for payments at amounts different from its established rates. Each quarter, the Company estimates its adjustments for each sale based on the terms of third-party payer contracts and historical collections experience, then applies an estimate for an adjustment reserve percentage to the gross accounts receivable balances. We identified the measurement of the adjustment reserve related to customer revenue as a critical audit matter due to the audit effort, degree of auditor judgment, and subjectivity involved in evaluating the audit evidence related to management’s estimate. F- 2 Our audit procedures related to the Company’s measurement of the adjustment reserve included the following, among others. ● Selected a sample of product sales to inspect and compare to the underlying source documents and final cash collections to test the reasonableness of the contractual adjustment and collection percentage assumptions used in management’s estimate. ● Evaluated the reasonableness of management’s estimate of contractual and collection reserves by: o Comparing the estimates of realization percentages to historical net collection percentages for portfolio groups. o Recalculating the contractual and collection reserve estimates and compared them to the general ledger. o Evaluating whether quarterly historical realization percentages were reasonable and qualitatively consistent with internal and external independent data /s/ RSM US LLP We have served as the Company’s auditor since 2010. Rochester, Minnesota August 22, 2023 F- 3 Electromed, Inc. Balance Sheets June 30, 2023 and 2022 June 30, 2023 2022 Assets Current Assets Cash and cash equivalents $ 7,372,000 $ 8,153,000 Accounts receivable (net of allowances for doubtful accounts of $ 45,000 ) 24,130,000 21,052,000 Contract assets 487,000 286,000 Inventories 4,221,000 3,178,000 Prepaid expenses and other current assets 1,577,000 1,870,000 Total current assets 37,787,000 34,539,000 Property and equipment, net 5,672,000 4,568,000 Finite-life intangible assets, net 605,000 599,000 Other assets 161,000 120,000 Deferred income taxes 1,581,000 1,538,000 Total assets $ 45,806,000 $ 41,364,000 Liabilities and Shareholders’ Equity Current Liabilities Accounts payable $ 1,372,000 $ 1,261,000 Accrued compensation 3,018,000 2,742,000 Income tax payable 336,000 51,000 Warranty reserve 1,378,000 1,256,000 Other accrued liabilities 1,949,000 1,840,000 Total current liabilities 8,053,000 7,150,000 Other long-term liabilities 86,000 41,000 Total liabilities 8,139,000 7,191,000 Commitments and Contingencies (Note 11) Shareholders’ Equity Common stock, $ 0.01 par value, 13,000,000 shares authorized; 8,555,238 and 8,475,438 issued and outstanding, as of June 30, 2023 and June 30, 2022, respectively 86,000 85,000 Additional paid-in capital 18,788,000 18,308,000 Retained earnings 18,793,000 15,780,000 Total shareholders’ equity 37,667,000 34,173,000 Total liabilities and shareholders’ equity $ 45,806,000 $ 41,364,000 See Notes to Financial Statements. F- 4 Electromed, Inc. Statements of Operations Years Ended June 30, 2023 and 2022 Years Ended June 30, 2023 2022 Net revenues $ 48,067,000 $ 41,659,000 Cost of revenues 11,548,000 10,217,000 Gross profit 36,519,000 31,442,000 Operating expenses Selling, general and administrative 31,595,000 27,114,000 Research and development 916,000 1,356,000 Total operating expenses 32,511,000 28,470,000 Operating income 4,008,000 2,972,000 Interest income, net 78,000 25,000 Net income before income taxes 4,086,000 2,997,000 Income tax expense 920,000 692,000 Net income $ 3,166,000 $ 2,305,000 Income per share: Basic $ 0.37 $ 0.27 Diluted $ 0.36 $ 0.26 Weighted-average common shares outstanding: Basic 8,463,684 8,471,320 Diluted 8,700,833 8,768,703 See Notes to Financial Statements. F- 5 Electromed, Inc. Statements of Shareholders’ Equity Years Ended June 30, 2023 and 2022 Additional Total Common Stock Paid-in Retained Shareholders’ Shares Amount Capital Earnings Equity Balance as of June 30, 2021 8,533,209 $ 85,000 $ 17,409,000 $ 14,922,000 $ 32,416,000 Net income — — — 2,305,000 2,305,000 Issuance of restricted stock 49,400 1,000 — — 1,000 Issuance of common stock upon exercise of options 13,245 — — — — Taxes paid on stock option exercised on a net basis — — ( 77,000 ) — ( 77,000 ) Share-based compensation expense — — 976,000 — 976,000 Repurchase of common stock ( 120,416 ) ( 1,000 ) — ( 1,447,000 ) ( 1,448,000 ) Balance as of June 30, 2022 8,475,438 85,000 18,308,000 15,780,000 34,173,000 Net income — — — 3,166,000 3,166,000 Issuance of restricted stock, net 28,701 — — — — Issuance of common stock upon exercise of options 66,467 1,000 82,000 — 83,000 Taxes paid on stock option exercised on a net basis — — ( 310,000 ) — ( 310,000 ) Share-based compensation expense — — 708,000 — 708,000 Repurchase of common stock ( 15,368 ) — — ( 153,000 ) ( 153,000 ) Balance as of June 30, 2023 8,555,238 $ 86,000 $ 18,788,000 $ 18,793,000 $ 37,667,000 See Notes to Financial Statements. F- 6 Electromed, Inc. Statements of Cash Flows Years Ended June 30, 2023 and 2022 Years Ended June 30, 2023 2022 Cash Flows from Operating Activities Net income $ 3,166,000 $ 2,305,000 Adjustments to reconcile net income to net cash provided by (used in operating activities: Depreciation 550,000 503,000 Amortization of finite-life intangible assets 63,000 125,000 Share-based compensation expense 708,000 976,000 Deferred income taxes ( 43,000 ) ( 489,000 ) Changes in operating assets and liabilities: Accounts receivable ( 3,078,000 ) ( 4,020,000 ) Contract assets ( 201,000 ) 107,000 Inventories ( 1,033,000 ) ( 1,072,000 ) Prepaid expenses and other current assets 202,000 ( 1,322,000 ) Income tax payable 285,000 ( 237,000 ) Accounts payable and accrued liabilities 420,000 2,170,000 Accrued compensation 276,000 268,000 Net cash provided by (used in) operating activities 1,315,000 ( 686,000 ) Cash Flows from Investing Activities Expenditures for property and equipment ( 1,648,000 ) ( 1,425,000 ) Expenditures for finite-life intangible assets ( 68,000 ) ( 100,000 ) Net cash used in investing activities ( 1,716,000 ) ( 1,525,000 ) Cash Flows from Financing Activities Issuance of common stock upon exercise of options 83,000 — Taxes paid on stock options exercised on a net basis ( 310,000 ) ( 77,000 ) Repurchase of common stock ( 153,000 ) ( 1,448,000 ) Net cash used in financing activities ( 380,000 ) ( 1,525,000 ) Net decrease in cash ( 781,000 ) ( 3,736,000 ) Cash and cash equivalents Beginning of period 8,153,000 11,889,000 End of period $ 7,372,000 $ 8,153,000 Supplemental Disclosures of Cash Flow Information Cash paid for income taxes $ 676,000 1,418,000 Supplemental Disclosures of Noncash Investing and Financing Activities Property and equipment acquisitions in accounts payable $ 60,000 $ 44,000 Intangible asset acquisitions in accounts payable $ 4,000 $ 3,000 Lease assets obtained in exchange for new operating lease liabilities $ 120,000 $ 117,000 Demonstration equipment returned to inventory $ 10,000 $ 8,000 See Notes to Financial Statements. F- 7 Electromed, Inc. Notes to Financial Statements Note 1. Nature of Business and Summary of Significant Accounting Policies Nature of business: Electromed, Inc. (the “Company”) develops, manufactures and markets innovative airway clearance products that apply High Frequency Chest Wall Oscillation (“HFCWO”) therapy in pulmonary care for patients of all ages. The Company markets its products in the U.S. to the home health care and institutional markets for use by patients in personal residences, hospitals and clinics. The Company also sells internationally both directly and through distributors. International sales were $ 424,000 and $ 521,000 for the fiscal years ended June 30, 2023 (“fiscal 2023”) and June 30, 2022 (“fiscal 2022”), respectively. Since its inception, the Company has operated in a single industry segment: developing, manufacturing, and marketing medical equipment. Impacts of COVID-19 on the Company’s business The Company did not receive any direct financial assistance from any government program during fiscal 2022 or fiscal 2023 in connection with COVID-19 relief measures. In response to the COVID-19 pandemic and the U.S. federal government’s declaration of a public health emergency, the Centers for Medicare and Medicaid Services (“CMS”) implemented a number of temporary rule changes and waivers to allow prescribers to best treat patients during the period of the public health emergency. These waivers were made retroactively effective to March 1, 2020 and were in place for the duration of fiscal 2021 and fiscal 2022 and through May 11, 2023. Clinical indications and documentation typically required were not enforced for respiratory related products including the Company’s SmartVest® Airway Clearance System (“SmartVest System”) (solely with respect to direct Medicare covered patients) applicable for the Company’s home care prescriptions. The potential impact of the COVID-19 pandemic and its effects on our operational and financial performance will depend in large part on future developments, which cannot be reasonably estimated at this time. A summary of the Company’s significant accounting policies follows: Use of estimates : Management uses estimates and assumptions in preparing the financial statements in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”). Those estimates and assumptions affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities, and the reported revenues and expenses. Actual results could vary from the estimates that were used. The Company believes the critical accounting policies that require the most significant assumptions and judgments in the preparation of its financial statements include revenue recognition and the related estimation of variable consideration, inventory valuation, share-based compensation and warranty reserve. Revenue recognition : Revenue is measured based on consideration specified in the contract with a customer, adjusted for any applicable estimates of variable consideration and other factors affecting the transaction price, including noncash consideration, consideration paid or payable to customers and significant financing components. Revenue from all customers is recognized when a performance obligation is satisfied by transferring control of a distinct good or service to a customer. See Note 2 for information on revenue. Shipping and handling expense : Shipping and handling charges incurred by the Company are included in cost of revenues and were $ 896,000 and $ 982,000 for fiscal 2023 and 2022, respectively. Cash and cash equivalents : Cash and cash equivalents consist of cash in bank deposits and money market funds with original maturities of three months or less at the time of purchase. The Company has not experienced any losses in these accounts. Accounts receivable : The Company’s accounts receivable balance is comprised of amounts due from individuals, institutions and distributors. Balances due from individuals are typically remitted to the Company by third-party reimbursement agencies such as Medicare, Medicaid and private insurance companies. Accounts receivable are carried at amounts estimated to be received from patients under reimbursement arrangements with third-party payers. Accounts receivable are also net of an allowance for doubtful accounts. Management determines the allowance for doubtful accounts by regularly evaluating individual customer receivables and considering a customer’s financial condition and credit history. Receivables are written off when deemed uncollectible. Recoveries of receivables previously written off are recorded when received. The allowance for doubtful accounts was $ 45,000 as of June 30, 2023 and 2022. F- 8 Contract assets : Contract assets include amounts recognized as revenue that are estimates of variable consideration for Medicare appeals where the final determination of the insurance coverage amount is dependent on future approval of an appeal, or when the consideration due to the Company is dependent on a future event such as the patient meeting a deductible prior to the Company’s claim being processed by the payer. Contract assets are classified as current as amounts will turn into accounts receivable and be collected during the Company’s normal business operating cycle. Contract assets are reclassified to accounts receivable when the right to receive payment is unconditional. Inventories : Inventories are stated at the lower of cost (first-in, first-out method) or net realizable value. Work in process and finished goods are carried at standard cost, which approximates actual cost, and includes materials, labor and allocated overhead. Standard costs are reviewed at least quarterly by management, or more often in the event circumstances indicate a change in cost has occurred. The reserve for obsolescence is determined by analyzing the inventory on hand and comparing it to expected future sales. Estimated inventory to be returned is based on how many devices that have shipped that are expected to be returned prior to completion of the insurance reimbursement process. Property and equipment : Property and equipment are stated at cost less accumulated depreciation. Depreciation is computed using the straight-line method over the estimated useful lives of the assets. Leasehold improvements are depreciated over the shorter of their estimated useful lives or the remaining lease term. The Company retains ownership of demonstration equipment in the possession of both inside and outside sales representatives, who use the equipment in the sales process. Leases : The Company determines if an arrangement is a lease at inception. Where an arrangement is a lease, the Company determines if it is an operating lease or a finance lease. At lease commencement, the Company records a lease liability and corresponding right of use ROU asset. Lease liabilities represent the present value of our future lease payments over the expected lease term, which includes options to extend or terminate the lease when it is reasonably certain those options will be exercised. The present value of the Company’s lease liability is determined using its incremental collateralized borrowing rate at lease inception. ROU assets represent the Company’s right to control the use of the leased assets during the lease and are recognized in an amount equal to the lease liability for leases with an initial term greater than 12 months. Over the lease term (operating leases only), the Company uses the effective interest rate method to account for the lease liability as lease payments are made and the ROU asset is amortized to consolidated statement of operations in a manner that results in straight line expense recognition. Finite-life intangible assets : Finite-life intangible assets include patents and trademarks. These intangible assets are amortized on a straight-line basis over their estimated useful lives, as described in Note 5. Long-lived assets : Long-lived assets, primarily property and equipment and finite-life intangible assets, are evaluated for impairment whenever events or changes in circumstances indicate the carrying value of an asset or asset group may not be recoverable. In evaluating recoverability, the following factors, among others, are considered: a significant change in the circumstances used to determine the amortization period, an adverse change in legal factors or in the business climate, a transition to a new product or service strategy, a significant change in customer base, and a realization of failed marketing efforts. The recoverability of an asset or asset group is measured by a comparison of the carrying value of the asset to future undiscounted cash flows. If the Company believes the carrying value is unrecoverable, then it recognizes an impairment charge necessary to reduce the unamortized balance to the estimated fair value of the asset or asset group. The amount of such impairment is charged to operations in the current period. Warranty liability : The Company provides a lifetime warranty on its products to the prescribed patient for sales within the U.S. and a three-year warranty for all institutional sales and sales to individuals outside the U.S. The Company estimates the costs that may be incurred under its warranty and records a liability in the amount of such costs at the time the product is shipped or delivered. Factors that affect the Company’s warranty liability include the number of units shipped, historical and anticipated rates of warranty claims, the product’s useful life, and cost per claim. The Company periodically assesses the adequacy of its recorded warranty liability and adjusts the amounts as necessary. F- 9 Changes in the Company’s warranty liability were as follows: Schedule of changes in warranty liability Years Ended June 30, 2023 2022 Beginning warranty reserve $ 1,256,000 $ 940,000 Accrual for products sold 416,000 494,000 Expenditures and costs incurred for warranty claims ( 294,000 ) ( 178,000 ) Ending warranty reserve $ 1,378,000 $ 1,256,000 Income taxes : Deferred taxes are provided on a liability method whereby deferred tax assets are recognized for deductible temporary differences and operating loss and tax credit carryforwards and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax bases. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. The Company reverses a valuation allowance if it determines, based on the weight of all available evidence, including when cumulative losses become positive income, that it is more likely than not that some or all of the deferred tax assets will be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment. The Company recognizes tax liabilities when the Company believes that certain positions may not be fully sustained upon review by tax authorities. Benefits from tax positions are measured at the largest amount of benefit that is greater than 50 percent likely of being realized upon settlement. To the extent that the final tax outcome of these matters is different than the amounts recorded, such differences impact income tax expense in the period in which such determination is made. Interest and penalties, if any, related to accrued liabilities for potential tax assessments are included in income tax expense. Research and development : Research and development costs include costs of research activities as well as engineering and technical efforts required to develop new products or make improvements to existing products. Research and development costs are expensed as incurred. Advertising costs : Advertising costs are charged to expense when incurred. Advertising, marketing and trade show costs for fiscal 2023 and 2022 were $ 1,244,000 and $ 936,000 , respectively. Share-based payments : Share-based payment awards consist of options to purchase shares of common stock and restricted shares of common stock issued to employees for services. Expense for options is estimated using the Black-Scholes pricing model at the date of grant and expense for restricted stock is determined by the closing price on the day the grant is made. Expense is recognized on a graded vesting basis over the requisite service or vesting period of the award, or at the time services are provided for non-employee awards. Fair value of financial instruments : The carrying values of cash and cash equivalents, accounts receivable, accounts payable and accrued expenses approximate their fair value due to the short-term nature of these instruments. Net income per common share : Net income is presented on a per share basis for both basic and diluted common shares. Basic net income per common share is computed using the weighted-average number of common shares outstanding during the period, excluding any restricted stock awards which have not vested. The diluted net income per common share calculation includes outstanding restricted stock grants and assumes that all stock options were exercised and converted into shares of common stock at the beginning of the period unless their effect is anti-dilutive. Common stock equivalents included in the calculation of diluted earnings per share were 237,149 and 297,383 shares for fiscal 2023 and 2022, respectively. Common stock equivalents excluded from the calculation of diluted earnings per share because their impact was anti-dilutive were 194,154 and 113,646 shares for fiscal 2023 and 2022, respectively. F- 10 Recently Issued Accounting Standards In June 2016, the Financial Accounting Board issued Accounting Standards Update (“ASU”) 2016-13, Financial Instruments -- Credit Losses: Measurement of Credit Losses on Financial Instruments, which was subsequently amended by ASU 2018-19, ASU 2019-04, 2019-05, 2019-10, 2019-11, and 2020-02. The standard introduces new accounting guidance for credit losses on financial instruments within its scope, including trade receivables. This new guidance adds an impairment model that is based on expected losses rather than incurred losses. It is effective for interim and annual reporting periods beginning after December 15, 2022, with early adoption permitted. Adoption of the standard is not expected to have a material impact on the financial statements. Note 2. Revenues Revenue is measured based on consideration specified in the contract with a customer, adjusted for any applicable estimates of variable consideration and other factors affecting the transaction price, including consideration paid or payable from customers and significant financing components. Revenue from all customers is recognized when a performance obligation is satisfied by transferring control of a distinct good or service to a customer, as further described below under Performance obligations and transaction price . Individual promised goods and services in a contract are considered a performance obligation and accounted for separately if the individual good or service is distinct (i.e., the customer can benefit from the good or service on its own or with other resources that are readily available to the customer and the good or service is separately identifiable from other promises in the arrangement). If an arrangement includes multiple performance obligations, the consideration is allocated between the performance obligations in proportion to their estimated standalone selling price, unless discounts or variable consideration is attributable to one or more but not all the performance obligations. Costs related to products delivered are recognized in the period incurred, unless criteria for capitalization of costs under Accounting Standards Codification (“ASC”) 340-40, “Other Assets and Deferred Costs” (“ASC 340”), or other applicable guidance are met. The Company includes shipping and handling fees in net revenues. Shipping and handling costs associated with the shipment of the SmartVest System after control has transferred to a customer are accounted for as a fulfillment cost and are included in cost of revenues in the Statements of Operations. The timing of revenue recognition, billings and cash collections results in accounts receivable on the Balance Sheets as further described below under Accounts receivable and Contract assets . Disaggregation of revenues. In the following table, revenue is disaggregated by market: Schedule of disaggregated revenue Years Ended June 30, 2023 2022 Home care $ 43,945,000 $ 38,004,000 Institutional 2,080,000 1,660,000 Home care distributor 1,618,000 1,474,000 International 424,000 521,000 Total $ 48,067,000 $ 41,659,000 F- 11 In the following table, home care revenue is disaggregated by payer type: Years Ended June 30, 2023 2022 Commercial $ 18,481,000 $ 14,937,000 Medicare 18,682,000 16,692,000 Medicare Supplemental 5,000,000 4,484,000 Medicaid 941,000 1,028,000 Other 841,000 863,000 Total $ 43,945,000 $ 38,004,000 Revenues in the Company’s home care, home care distributor and international markets are recognized at a point in time when control passes to the customer upon product shipment or delivery. Revenues in the Company’s institutional market include sales recognized at a point in time upon shipment or delivery. Performance obligations and transaction price. A performance obligation is a promise in a contract to transfer a distinct good or service to the customer and is the unit of account under ASC 606, “Revenue From Contracts With Customers” (“ASC 606”). A contract’s transaction price is allocated to each distinct performance obligation in proportion to the standalone selling price for each and recognized as revenue when, or as, the performance obligation is satisfied. The Company’s performance obligations and the timing or method of revenue recognition in each of the Company’s markets are discussed below: Home care market . In the Company’s home care market, its customers are patients who use the SmartVest System. The various models of the SmartVest System are comprised of three main components - a generator, a vest and a connecting hose - that are sold together as an integrated unit. Accordingly, in contracts within the home care market, the Company regards the SmartVest System to be a single performance obligation. The Company makes available to its home care patients limited post-sale services that are not material in the context of the contracts, either individually or taken together, and therefore does not consider them to be performance obligations. The costs associated with the services are accrued and expensed when the related revenues are recognized. As such, transactions in the home care market consist of a single performance obligation: the SmartVest System. Home care patients generally will rely on third-party payers, including commercial payers and governmental payers such as Medicare, Medicaid and the U.S. Department of Veterans Affairs to cover and reimburse all or part of the cost of the SmartVest System. The third-party payers’ reimbursement programs fall into three types, distinguished by the differences in the timing of payments from the payer, consisting of either (i) outright sale, in which payment is received from the payer based on standard terms, (ii) capped installment sale, under which the SmartVest System is sold for a series of payments that are capped not to exceed a prescribed or negotiated amount over a period of time or (iii) installment sale, under which the SmartVest System is paid for over a period of several months as long as the patient continues to use the SmartVest System. Regardless of the type of transaction, provided criteria for an enforceable contract are met, it is the Company’s long-standing business practice to regard all home care agreements as transferring control to the patient upon shipment or delivery, in spite of possible payment cancellation under government or commercial programs where the payer is controlling the payment over specified time periods. For home care sales that feature installment payments, the ultimate amount of consideration received from Medicare, Medicaid or commercial payers can be significantly less than expected if the contract is terminated due to changes in the patient’s status, including insurance coverage, hospitalization, death or otherwise becoming unable to use the SmartVest System. However, once delivered to a patient who needs the SmartVest System, the patient is under no obligation to return the SmartVest System should payments be terminated as a result of the described contingencies. As a result, the Company’s product sales qualify for point in time revenue recognition. Control transfers to the patient, and revenue is recognized, upon shipment or delivery of the SmartVest System. At this point, physical possession and the significant risks and rewards of ownership are transferred to the patient and either a current or future right to payment is triggered, as further discussed under Accounts receivable and Contract assets below. F- 12 The Company’s contractually stated transaction prices in the home care market are generally set by the terms of the contracts negotiated with insurance companies or by government programs. The transaction price for the Company’s products may be further impacted by variable consideration. ASC 606 requires the Company to adjust the transaction price at contract inception and throughout the contract duration for the estimated value of payments to be received from insurance payers based on historical experience and other available information, subject to the constraint on estimates of variable consideration. Transactions requiring estimates of variable consideration primarily include (i) capped installment payments, which are subject to the third-party payer’s termination due to changes in insurance coverage, death or the patient’s discontinued use of the SmartVest System, (ii) contracts under appeal and (iii) patient responsibility amounts for deductibles, coinsurance, copays and other similar payments. Although estimates may be made on a contract-by-contract basis, whenever possible, the Company uses all available information including historical collection patterns to estimate variable consideration for portfolios of contracts. The Company’s estimates of variable consideration consist of amounts it may receive from insurance providers in excess of its initial revenue estimate due to patients meeting deductibles or coinsurance during the payment duration, changes to a patient’s insurance status, changes in an insurance allowable, claims in appeals with Medicare and amounts received directly from patients for their allowable or coinsurance. The Company believes it has representative historical information to estimate the amount of variable consideration in relevant portfolios considering the significant experience it has with each portfolio and the similarity of patient accounts within a portfolio. The analysis includes steps to ensure that revenue recognized on a portfolio basis does not result in a material difference when compared with an individual contract approach. The Company also leverages its historical experience and all available relevant information for each portfolio of contracts to minimize the risk its estimates used to arrive at the transaction price will result in a significant reversal in the amount of cumulative revenue recognized when the uncertainty associated with the variable consideration is subsequently resolved. Variable consideration is included in the transaction price if, in the Company’s judgment, it is probable that a significant future reversal of cumulative revenue under the contract will not occur. For contracts in which the Company believes the criteria for reimbursement under government or commercial payer contracts have been met but for which coverage is unconfirmed or payments are under appeal, the Company has significant observable evidence of relatively consistent claims recovery experience over the prior three to five years. The Company believes the low volatility in historical claims approval rates for populations of patients whose demographics are similar to those of current patients provides reliable predictive value in arriving at estimates of variable consideration in such contracts. Similarly, historical payment trends for recovery of claims subject to payer installments and payments from patients have remained relatively consistent over the past five years. No significant changes in patient demographics or other relevant factors have occurred that would limit the predictive value of such payment trends in estimating variable consideration for current contracts. As a result, the Company believes its estimates of variable consideration are generally not subject to the risk of significant revenue reversal. For each type of variable consideration discussed above, there are a large number of contracts with similar characteristics with a wide range of possible transaction prices. For that reason, the Company uses the probability-weighted expected value method provided under ASC 606 to estimate variable consideration. The Company often receives payment from third-party payers for the SmartVest System sales over a period of time that may exceed one year. Despite these extended payment terms, no significant financing component is deemed to exist because the purpose of such terms is not to provide financing to the patient, the payer or the Company. Rather, the extended payment terms are mandated by the government or commercial insurance programs, the fundamental purpose of which is to avoid paying the full purchase price of equipment that may potentially be used by the patient for only a short period of time. Home care distributors. Sales to distributors, who sell direct to patients, are made at fixed contract prices and may include tiered pricing structures or volume-based rebates which offer more favorable pricing once certain volumes are achieved per the negotiated contract. The distributor’s purchases accumulate to give the distributor a right to a higher discount on purchases in excess of the specified level within the contract period. As a result, to the extent the Company expects the distributor to exceed the specified volume of purchases in the annual period, it recognizes revenue at a blended rate based on estimated total annual volume and sales revenue. This effectively defers a portion of the transaction price on initial purchases below the specified volumes for recognition when the higher discount is earned on purchases in excess of specified volumes. Transfer of control of the products occurs upon shipment or delivery to the distributor as applicable. F- 13 Institutional market. The Company’s institutional sales are made to hospitals and home health care centers, pulmonary rehabilitation centers and other clinics. Sales to these institutions are negotiated with the individual institution or with group purchasing organizations, with payments received directly from the institution. No insurance reimbursement is involved. Generators are either sold or leased to the institutions and associated hoses and wraps (used in institutional settings rather than vests) are sold separately. Accordingly, each product is distinct and considered a separate performance obligation in sales to institutional customers. The agreements with institutions fall into two main types, distinguished by differences in the timing of transfer of control and timing of payments: ● Outright sale – Under these transactions, the Company sells its products for a prescribed or negotiated price. Transfer of control of the product, and associated revenue recognition, occurs at the time of shipment and payment is made within normal credit terms, usually within 30 days. ● Wrap usage agreements – Under these transactions, the Company provides a generator device at no cost to the hospital in return for a fixed annual commitment to purchase consumable wraps. These agreements are cancellable upon at least sixty days prior written notice by either party. If cancelled, the generator is returned to the Company, where it can be refurbished and used again at a later date. Revenue for the consumable wraps is recognized when control transfers to the customer. International market. Sales to international markets are made directly to a number of independent distributors at fixed contract prices that are not subject to further adjustments for variable consideration. Transfer of control of the products occurs upon shipment or delivery to the distributor as applicable. Product warranty. The Company offers warranties on its products. These warranties are assurance type warranties not sold on a standalone basis or are otherwise considered immaterial in the context of the contract, and therefore are not considered distinct performance obligations under ASC 606. The Company estimates the costs that may be incurred under its warranties and records a liability in the amount of such costs at the time the product is sold. Accounts receivable. The Company’s accounts receivable balance is comprised of amounts due from individuals, institutions and distributors. Balances due from individuals are typically remitted to the Company by third-party reimbursement agencies such as Medicare, Medicaid and private insurance companies. Accounts receivable are carried at amounts estimated to be received from patients under reimbursement arrangements with third-party payers. Accounts receivable are also net of an allowance for doubtful accounts. Management determines the allowance for doubtful accounts by regularly evaluating individual customer receivables and considering a customer’s financial condition and credit history. Receivables are written off when deemed uncollectible. Contract assets. Contract assets include amounts recognized as revenue that are estimates of variable consideration for Medicare appeals where the final determination of the insurance coverage amount is dependent on future approval of an appeal, or when the consideration due to the Company is dependent on a future event such as the patient meeting a deductible prior to the Company’s claim being processed by the payer. Contract assets are classified as current as amounts is expected to turn into accounts receivable and be collected during the Company’s normal business operating cycle. Contract assets are reclassified to accounts receivable when the right to receive payment is unconditional. Contract balances. The following table provides information about accounts receivable and contracts assets from contracts with customers: Schedule of contract assets June 30, 2023 2022 Receivables, included in “Accounts receivable, net of allowance for doubtful accounts” $ 24,130,000 $ 21,052,000 Contract Assets $ 487,000 $ 286,000 F- 14 Significant changes in contract assets during the period are as follows: Year Ended June 30, 2023 Year Ended June 30, 2022 Increase (decrease) Increase (decrease) Contract assets, beginning $ 286,000 $ 393,000 Reclassification of contract assets to accounts receivable ( 1,220,000 ) ( 833,000 ) Contract assets recognized 1,351,000 784,000 Increase (decrease) as a result of changes in the estimate of amounts to be realized from payers, excluding amounts transferred to receivables during the period 71,000 ( 58,000 ) Contract assets, ending $ 488,000 $ 286,000 Note 3. Inventories The components of inventory were as follows: Schedule of components of inventories June 30, 2023 2022 Parts inventory $ 3,420,000 $ 2,672,000 Work in process 470,000 100,000 Finished goods 323,000 469,000 Estimated inventory to be returned 265,000 228,000 Less: Reserve for obsolescence ( 257,000 ) ( 291,000 ) Total $ 4,221,000 $ 3,178,000 Note 4. Property and Equipment Property and equipment were as follows: Schedule of property and equipment, including assets under capital leases Estimated Useful Lives June 30, (Years) 2023 2022 Building and building improvements 15 - 40 $ 3,427,000 $ 3,420,000 Land N/A 200,000 200,000 Land improvements 15 - 20 173,000 162,000 Equipment 3 - 10 3,024,000 2,356,000 Software 3 - 7 2,166,000 396,000 Demonstration and rental equipment 3 1,090,000 1,036,000 Construction in progress N/A 8,000 957,000 10,088,000 8,527,000 Less: Accumulated depreciation ( 4,416,000 ) ( 3,959,000 ) Net property and equipment $ 5,672,000 $ 4,568,000 Note 5. Finite-life Intangible Assets The carrying value of patents and trademarks includes the original cost of obtaining the patents, periodic renewal fees, and other costs associated with maintaining and defending patent and trademark rights. Patents and trademarks are amortized over their estimated useful lives, generally 15 and 12 years, respectively. Accumulated amortization was $ 224,000 and $ 433,000 as of June 30, 2023 and 2022, respectively. F- 15 The activity and net balances of finite-life intangible assets were as follows: Schedule of activity and balances of finite-life intangible assets Years Ended June 30, 2023 2022 Balance, beginning $ 599,000 $ 663,000 Additions 69,000 61,000 Amortization expense ( 63,000 ) ( 125,000 ) Balance, ending $ 605,000 $ 599,000 Based on the carrying value as of June 30, 2023, future amortization is expected to be as follows: Schedule of future amortization of finite-life intangible assets Fiscal years ending June 30: 2024 $ 46,000 2025 44,000 2026 44,000 2027 43,000 2028 41,000 Thereafter 387,000 Total $ 605,000 Note 6. Financing Arrangements The Company has a credit facility that provides for a revolving line of credit and a term loan. Effective December 17, 2021 , the Company renewed its $ 2,500,000 revolving line of credit. There was no outstanding principal balance on the line of credit as of June 30, 2023 or June 30, 2022. Interest on borrowings under the line of credit, if any, accrues at the prime rate ( 8.25 % as of June 30, 2023) less 1.0 % and is payable monthly. The amount eligible for borrowing on the line of credit is limited to the lesser of $ 2,500,000 or 57.0 % of eligible accounts receivable and the line of credit expires on December 18, 2023 , if not renewed before such date. As of June 30, 2023, the maximum $ 2,500,000 was eligible for borrowing. Payment obligations under the line of credit, if any, are secured by a security interest in substantially all of the tangible and intangible assets of the Company. The documents governing the line of credit contain certain financial and nonfinancial covenants that include a minimum tangible net worth covenant of not less than $ 10,125,000 and restrictions on the Company’s ability to incur certain additional indebtedness or pay dividends. Note 7. Common Stock Authorized shares: The Company’s Articles of Incorporation, as amended, have established 15,000,000 authorized shares of capital stock consisting of 13,000,000 shares of common stock, par value $ 0.01 per share, and 2,000,000 shares of undesignated stock. On May 26, 2021 the Company’s Board of Directors (the “Board”) approved a stock repurchase authorization. Under the authorization, the Company was originally able to repurchase up to $ 3.0 million of shares of common stock through May 26, 2022. On May 26, 2022, our Board of Directors removed the date limitation. As of June 30, 2023, a total of 239,995 shares have been repurchased and retired under this authorization for a total cost of $ 2,725,000 , or $ 11.36 per share. Repurchased shares have been retired and constitute authorized but unissued shares. Note 8. Share-Based Compensation Share-based compensation expense for fiscal 2023 and 2022 was $ 708,000 and $ 976,000 , respectively, related to employee stock options and restricted stock awards. This expense is included in selling, general and administrative expense in the Statements of Operations. As of June 30, 2023, the Company had $ 296,000 of unrecognized compensation expense related to non-vested equity awards, which is expected to be recognized over a weighted-average period of 1.5 to 1.84 years related to restricted stock awards and employee stock options, respectively. F- 16 Employee options: The Company has historically granted stock options to employees as long-term incentive compensation. Options expire ten years from the grant date and vest over a period of three years. In November 2017, the Company’s shareholders approved the 2017 Omnibus Incentive Plan (the “2017 Plan”) which superseded the 2014 Equity Incentive Plan (the “2014 Plan”). The 2017 Plan allows the Board to grant stock options, stock appreciation rights, restricted stock, restricted stock units and other stock-based awards, as well as cash incentive awards to all employees, non-employee directors, and advisors or consultants of the Company. The vesting schedule and term for each award are determined by the Board upon each grant. Upon vesting, and the Company’s determination that any necessary conditions precedent to the exercise of shares (such as satisfaction of tax withholding and compliance with applicable legal requirements) have been satisfied, shares purchased are delivered to the participant in a manner prescribed or permitted by the Board. The maximum number of shares of common stock available for issuance under the 2017 Plan is 900,000 . There were 163,500 options granted under the 2014 Plan and prior plans outstanding as of June 30, 2023. There were 288,070 options issued under the 2017 Plan outstanding and 291,245 shares available for grant under the 2017 Plan as of June 30, 2023. The Company recognizes compensation expense related to share-based payment transactions in the financial statements based on the estimated fair value of the award issued. The fair value of each option is estimated using the Black-Scholes pricing model at the time of award grant. The Company estimates the expected life of options based on the expected holding period by the option holder. The risk-free interest rate is based upon observed U.S. Treasury interest rates for the expected term of the options. The Company makes assumptions with respect to expected stock price volatility based upon the historical volatility of its stock price. Forfeitures are accounted for as they occur. The following assumptions were used to estimate the fair value of options granted: Schedule of assumptions used to estimate fair value of options granted Years Ended June 30, 2023 2022 Risk-free interest rate 2.88 - 4.23 % 0.89 - 2.52 % Expected term (years) 6 6 Expected volatility 53 - 54 % 55 - 64 % The following table presents employee stock option activity for fiscal 2023 and 2022: Schedule of stock option transactions Number of Shares Weighted-Average Grant Date Fair Value Weighted-Average Exercise Price Weighted-Average Remaining Contractual Life (in Years) Options outstanding as of June 30, 2021 468,049 $ 4.61 $ 4.98 5.82 Granted 81,901 $ 6.63 $ 11.52 — Exercised ( 32,000 ) $ 3.70 $ 5.44 — Canceled or forfeited ( 15,866 ) $ 6.63 $ 11.30 — Options outstanding as of June 30, 2022 502,084 $ 3.71 $ 5.82 5.35 Options exercisable as of June 30, 2022 429,888 $ 3.16 $ 4.77 4.76 Granted 104,325 $ 5.35 $ 9.93 — Exercised ( 101,357 ) $ 1.44 $ 2.21 — Canceled or forfeited ( 53,482 ) $ 6.33 $ 11.29 — Options outstanding as of June 30, 2023 451,570 $ 4.28 $ 6.93 5.53 Options exercisable as of June 30, 2023 377,875 $ 4.00 $ 6.25 4.90 The intrinsic value of a stock option is the amount by which the fair value of the underlying stock exceeds its exercise price. At June 30, 2023, the weighted average remaining contractual term for all outstanding stock options was 5.5 years and their aggregate intrinsic value was $ 1,862,000 . Outstanding at June 30, 2023 were 451,570 stock options issued to employees, of which 377,875 were vested and exercisable and had an aggregate intrinsic value of $ 1,820,000 . F- 17 Restricted stock: The 2017 Plan permits the Personnel and Compensation Committee of the Board to grant other stock-based awards, including shares of restricted stock. The Company makes restricted stock grants to key employees and non-employee directors that vest over six months to three years following the applicable grant date. The Company issued restricted stock awards to employees totaling 32,400 and 31,400 during fiscal 2023 and 2022, respectively, with a vesting term of one to three years and a fair value of $ 9.92 and $ 11.48 per share, respectively. The Company issued restricted stock awards to directors totaling 21,000 and 18,000 during fiscal 2023 and 2022, respectively, with a vesting term of six months and a fair value of $ 9.86 and $ 12.09 per share for fiscal 2023 and 2022, respectively. Restricted stock transactions during the years ended June 30, 2023 and 2022 are summarized as follows: Schedule of restricted stock transactions Shares of Restricted Stock Weighted-Average Grant Date Fair Value per Share Outstanding as of June 30, 2021 30,503 $ 12.57 Granted 49,400 $ 11.70 Vested ( 45,219 ) $ 11.61 Outstanding as of June 30, 2022 34,684 $ 12.59 Granted 53,400 $ 9.90 Vested ( 45,152 ) $ 11.05 Canceled or forfeited ( 24,699 ) $ 11.33 Outstanding as of June 30, 2023 18,233 $ 10.23 Note 9. Income Taxes Components of the provision for income taxes were as follows: Schedule of components of the provision for income taxes Years Ended June 30, 2023 2022 Current: Current Federal $ 744,000 $ 891,000 Current State 219,000 290,000 Total Current 963,000 1,181,000 Deferred: Deferred Federal ( 20,000 ) ( 348,000 ) Deferred State ( 23,000 ) ( 141,000 ) Total Deferred ( 43,000 ) ( 489,000 ) Total Income Tax Expense $ 920,000 $ 692,000 F- 18 Actual income tax expense differs from the expected tax expense, computed by applying the statutory federal income tax rate to the Company’s earnings before income taxes, as follows: Schedule of effective income tax reconciliation Years Ended June 30, 2023 2022 Tax expense at statutory federal rate $ 858,000 $ 629,000 State income tax expense, net of federal tax effect 155,000 105,000 Share based compensation (212,000 ) (10,000 ) Change in valuation allowance on deferred tax assets 11,000 27,000 Other permanent items 108,000 ( 59,000 ) Income tax expense $ 920,000 $ 692,000 The effective tax rates for fiscal 2023 and 2022 were 22.5 % and 23.1 %, respectively. The significant components of deferred income taxes were as follows: Schedule of significant components of deferred income taxes June 30, 2023 2022 Deferred tax assets: Revenue recognition and accounts receivable reserves $ 1,292,000 $ 917,000 Accrued liabilities 252,000 325,000 Finite-life intangible assets 126,000 — Stock options 516,000 532,000 Tax credits 221,000 152,000 Other 35,000 51,000 Subtotal 2,442,000 1,977,000 Less: Valuation allowance ( 221,000 ) ( 152,000 ) Net deferred tax assets 2,221,000 1,825,000 Deferred tax liabilities: Finite-life intangible assets — ( 41,000 ) Property and equipment ( 640,000 ) ( 246,000 ) Total deferred tax liabilities ( 640,000 ) ( 287,000 ) Net deferred tax assets $ 1,581,000 $ 1,538,000 The Company has research and development state tax credit carryforwards of $ 221,000 and $ 152,000 as of June 30, 2023 and June 30, 2022, respectively. Based on the historical use of the credits, management believes it is more likely than not these credits will begin to expire between fiscal years 2025 and 2038. As of June 30, 2023 and June 30, 2022, the Company had a valuation allowance of $ 221,000 and $ 152,000 , respectively, related to its research and development state tax carryforwards. The Company applies the accounting standard for uncertain tax positions pursuant to which a more-likely-than-not threshold is utilized to determine the recognition and derecognition of uncertain tax positions. Once the more-likely-than-not threshold is met, the amount of benefit to be recognized is the largest amount of tax benefit that is greater than 50 percent likely of being ultimately realized upon settlement. It further requires that a change in judgment related to the expected ultimate resolution of uncertain tax positions be recognized in earnings in the period of such a change. The Company does not believe that it has any material uncertain tax positions as of June 30, 2023 and June 30, 2022. The Company is subject to U.S. federal income tax as well as income tax of multiple state jurisdictions. With limited exceptions, the Company is no longer subject to federal and state income tax examinations by tax authorities for fiscal year ended prior to June 30, 2020. The Internal Revenue Service has completed its examination of the Company’s U.S. federal income tax return for the fiscal year ended June 30, 2020 without proposing any adjustments. The Company is not under any current income tax examinations by any other state or local taxing authority. If any issues addressed in the Company’s tax audits are resolved in a manner not consistent with management’s expectations, the Company could be required to adjust its provision for income taxes in the period such resolution occurs. F- 19 Note 10. Leases The Company has leases for office and warehouse space and office equipment that require monthly payments. These leases have payments ranging from $ 200 to $ 5,300 per month which expire through December 2025 and are recognized on a straight-line basis over the life of the lease. All leases are classified as operating leases which do not include renewal options. The Company currently does not have any variable lease costs. The Company elected the practical expedient to calculate the present value of the fixed payments without having to perform an allocation to lease and non-lease components. The Company has recognized right of use assets associated with its operating leases of $161,000 and $120,000 as of June 30, 2023 and June 30, 2022, respectively, which is included in other assets on the Company’s balance sheet. Operating lease liabilities were $ 161,000 and $ 120,000 as of June 30, 2023 and June 30, 2022, respectively, which are included in other accrued liabilities and other long-term liabilities on the Company’s balance sheet. As of June 30, 2023, the Company has a weighted-average lease term of 1.5 years for its operating leases, which have a weighted-average discount rate of 4.0 %.Operating lease payments of $ 82,000 are included in operating cash flows in fiscal 2023. Maturities of lease liabilities, which are included in other accrued liabilities and other long-term liabilities on the Balance Sheet, are as follows: Schedule of maturities of lease liabilities Fiscal years ending June 30: 2024 $ 80,000 2025 80,000 2026 8,000 2027 — 2028 — Total lease payments 168,000 Less: Interest ( 7,000 ) Present value of lease liabilities $ 161,000 Note 11. Commitments and Contingencies Litigation: The Company is occasionally involved in claims and disputes arising in the ordinary course of business. The Company insures certain business risks where possible to mitigate the financial impact of individual claims and establishes reserves for an estimate of any probable cost of settlement or other disposition. On September 8, 2021, a state court putative class action lawsuit was filed in Minnesota against the Company asserting injury resulting from the previously announced data breach that impacted the Company’s customer protected health information and employee personal information and seeking compensatory damages, equitable relief, and attorneys’ fees and costs. On October 6, 2021, the proceeding was removed to the District of Minnesota. The Company believes the plaintiff was not injured as a result of the data privacy incident and, as a result, the claims are without merit. Accordingly, on November 11, 2021, the Company moved to dismiss the complaint in its entirety. Prior to the hearing on the motion to dismiss, the parties agreed in principle to settle the case. The parties have executed a settlement agreement and submitted a motion to settle the class action. During January 2023, the settlement was preliminarily approved. The hearing for final approval took place on June 5, 2023. Following the final approval hearing, the court issued a judgment on July 10, 2023 granting a motion for final approval of the settlement. As a result of the judgement, there was no additional impact on the financial statements as of or for the year ended June 30, 2023. F- 20 401(k) Profit Sharing Plan: The Company has an employee benefit plan under Section 401(k) of the Internal Revenue Code covering all employees who are 21 years of age or older. The Company matches each employee’s salary reduction contribution, not to exceed four percent of annual compensation. Total employer contributions to this plan for fiscal 2023 and 2022 were $ 524,000 and $ 461,000 , respectively. Employment Agreements: The Company has entered into formal employment agreements with its President and Chief Executive Officer and its Chief Financial Officer, as may be amended from time to time. These agreements provide these officers with, among other things, twelve and eighteen months, respectively, of base salary upon a termination without “Cause” or in the event the employee resigns for “Good Reason” or within twelve months of a “Change in Control,” as such terms are defined in the respective employment agreements. Note 12. Related Parties The Company uses a parts supplier whose founder and president was a director of the Company through November 12, 2021. The Company made payments to the supplier of $ 1,857,000 and $ 360,000 during fiscal year 2023 and 2022, respectively. Amounts due to the supplier were $ 247,000 and $ 160,000 on June 30, 2023 and June 30 2022 respectively, which were included in accounts payable on the Balance Sheets. Note 13. Subsequent Events The Company evaluates, as of each reporting period, events or transactions that occur after the balance sheet date through the date the financial statements are issued for either disclosure or adjustment to the Company’s financial results. Except as described below, there have been no events subsequent to June 30, 2023 which would require recognition in the Financial Statements or Notes to the Financial Statements. F- 21 Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure. None.