Electromed, Inc. 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations. The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our unaudited Condensed Financial Statements and related notes thereto included in Part I, Item 1 of this Quarterly Report on Form 10-Q, and our audited financial statements and related notes thereto included in Part II, Item 8 of our Annual Report on Form 10-K for the fiscal year ended June 30, 2023 (“fiscal 2023”). Overview Electromed, Inc. (“we,” “our,” “us,” “Electromed” or the “Company”) develops and provides innovative airway clearance products applying High Frequency Chest Wall Oscillation (“HFCWO”) technologies in pulmonary care for patients of all ages. We manufacture, market and sell products that provide HFCWO, including the SmartVest® Airway Clearance System (“SmartVest System”) that includes our newest generation SmartVest Clearway® Airway Clearance System (“Clearway”), previous generation SmartVest SQL®, and related garments and accessories to patients with compromised pulmonary function. The SmartVest Clearway, which received 510(k) clearance from the U.S. Food and Drug Administration in December 2022, provides patients with proven quality of life outcomes while offering a state-of-the-art patient experience with a simple touch screen user interface, small footprint and lightest HFCWO generator on the market. Our products are sold in both the home health care market and the hospital market for inpatient use, which we refer to as “hospital sales.” Since 2000, we have marketed the SmartVest System and its predecessor products to patients suffering from bronchiectasis, cystic fibrosis, and other chronic pulmonary conditions which require external chest manipulation to enhance mucus transport. Additionally, we offer our products to a patient population that includes neuromuscular disorders such as cerebral palsy, muscular dystrophies, amyotrophic lateral sclerosis (“ALS”), patients with post-surgical complications or who are ventilator dependent and patients who have other conditions involving excess secretion and impaired mucus transport. The SmartVest System is often eligible for reimbursement from major private insurance providers, health maintenance organizations (“HMOs”), state Medicaid systems, and the federal Medicare system, which we believe is an important consideration for patients considering an HFCWO course of therapy. For domestic sales, the SmartVest System may be reimbursed under the Medicare-assigned billing code (E0483) for HFCWO devices if the patient has cystic fibrosis, bronchiectasis (including chronic bronchitis or COPD that has resulted in a diagnosis of bronchiectasis), or any one of certain enumerated neuromuscular diseases and myopathies, and can demonstrate that another less expensive physical or mechanical treatment did not adequately mobilize retained secretions. Private payers consider a variety of sources, including Medicare, as guidelines in setting their coverage policies and payment amounts. Critical Accounting Estimates For a description of our critical accounting estimates and assumptions used in the preparation of our financial statements, including the unaudited Condensed Financial Statements in this Quarterly Report on Form 10-Q, see Note 1 and Note 2 to our unaudited Condensed Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q and Part II, Item 7, and Note 1 to our audited financial statements included in Part II, Item 8, of our Annual Report on Form 10-K for fiscal 2023 . There were no material changes in our critical accounting estimates and assumptions since the filing of our Annual Report on Form 10-K for fiscal 2023. 12 Results of Operations Net Revenues Net revenues for the three months ended September 30, 2023 and 2022 are summarized in the table below. Three Months Ended September 30, 2023 2022 Increase (Decrease) Homecare Revenue $ 11,153,000 $ 9,632,000 $ 1,521,000 15.8 % Homecare Distributor Revenue 573,000 554,000 19,000 3.4 % Hospital Revenue 507,000 391,000 116,000 29.7 % International Revenue 91,000 81,000 10,000 12.3 % Total Revenue $ 12,324,000 $ 10,658,000 $ 1,666,000 15.6 % Homecare revenue . Homecare revenue increased by $1,521,000, or 15.8%, for the three months ended September 30, 2023 compared to the same period in fiscal 2023. The increase was primarily due to an increase in referrals, approvals and reimbursement rates. The increase in referrals was due to an increase in direct sales representatives and the increase in approvals was due to an increase in reimbursement personnel. Homecare distributor revenue . Homecare distributor revenue increased by $19,000, or 3.4%, for the three months ended September 30, 2023 compared to the same period in fiscal 2023. Hospital revenue. Hospital revenue increased by $116,000, or 29.7%, for the three months ended September 30, 2023 compared to the same period in fiscal 2023. This increase was primarily due to an increase in sales representatives focused on the hospital market. International revenue . International revenue increased by $10,000, or 12.3%, for the three months ended September 30, 2023 compared to the same period in fiscal 2023. Gross profit Gross profit increased to $9,498,000, or 77.1% of net revenues, for the three months ended September 30, 2023, from $8,331,000 or 78.2% of net revenues, in the same period in fiscal 2023. The increase in gross profit in dollars for the three months ended September 30, 2023 was primarily due to increased revenue. Gross margin rate decreased year over year as a result of increased material and labor costs. Operating expenses Selling, general and administrative expenses. Selling, general and administrative (“SG&A”) expenses were $9,150,000 for the three months ended September 30, 2023, representing an increase of $1,161,000 or 14.5%, compared to the same period in the prior year. Payroll and compensation-related expenses increased by $882,000, or 18.1%, to $5,766,000 for the three months ended September 30, 2023, compared to the same period in the prior year. The increase was primarily due to salaries and incentive compensation related to the higher average number of sales, sales support and marketing personnel, and reimbursement personnel to process higher patient referrals. We have also continued to provide regular merit-based increases for our employees and are regularly benchmarking our compensation ranges for new and existing employees to ensure we can hire and retain the talent needed to drive growth in our business. Field sales employees totaled 59 as of September 30, 2023, 51 of which were direct sales representatives, compared to 53 field sales employees and 44 direct sales representatives as of September 30, 2022. Travel, meals and entertainment expenses increased $23,000, or 2.6%, to $917,000 for the three months ended September 30, 2023, compared to the same period in the prior year. The increase was primarily due to the impacts of inflation on airfare and lodging and costs associated with our annual sales meeting as well as a higher average number of direct sales representatives. 13 Total discretionary marketing expenses increased $274,000, or 108.3%, to $527,000 for the three months ended September 30, 2023, compared to the same period in the prior year. The increase was primarily due to an investment in market research, direct-to-consumer and direct-to-physician marketing. Professional fees decreased $120,000, or 8.4%, to $1,311,000 for the three months ended September 30, 2023, compared to the same period in the prior year. Professional fees are primarily for services related to legal costs, shareowner services and reporting requirements, information technology technical support and consulting fees. The decrease was primarily due to legal fees in Q1 fiscal 2023 related to a reimbursement project that did not recur in Q1 fiscal 2024. Research and development expenses. Research and development (“R&D”) expenses decreased $92,000, or 30.9%, to $206,000 for the three months ended September 30, 2023 compared to the same period in the prior year. The decrease was primarily due to reduced costs associated with our SmartVest Clearway platform development which has now been launched into the Homecare market. Interest income, net Net interest income increased $73,000, or 1,820.2%, to $77,000 for the three months ended September 30, 2023, compared to the same period in the prior year. The increase is due to increased savings rates associated with cash balances. Income tax expense Income tax expense was estimated at $64,000 for the three months ended September 30, 2023 and the income tax benefit was estimated at $33,000 for the three months ended September 30, 2022. The effective tax rates were 29.3% and (68.8%) for the three months ended September 30, 2023 and 2022, respectively. The income tax expense for the three months ended September 30, 2022 included a discrete tax benefit of $44,000 related to the exercise of stock options. Net income Net income for the three months ended September 30, 2023 was $155,000 compared to $81,000 for the same period in the prior year. The increase in net income was primarily due to increased revenue. Liquidity and Capital Resources Cash Flows and Sources of Liquidity Cash Flows from Operating Activities For the three months ended September 30, 2023, net cash used in operating activities was $244,000. Cash flows provided by operating activities consisted of net income of $155,000, non-cash expenses of $585,000, a decrease in accounts receivable of $675,000 and a decrease of prepaid expenses of 901,000. These cash flows from operating activities were offset by a decrease in accrued compensation of $1,174,000, a decrease in accounts payable and other accrued liabilities of $863,000, an increase in inventory of $240,000, an increase in contract assets of $57,000 and a decrease in income tax payable of $226,000. The decrease in accrued compensation was primarily due to the payment of annual incentives. Cash Flows from Investing Activities For the three months ended September 30, 2023, cash used in investing activities was $133,000. Cash used in investing activities consisted of $109,000 of expenditures for property and equipment and $24,000 in expenditures for intangible asset costs. Cash Flows from Financing Activities For the three months ended September 30, 2023, cash provided by financing activities was $29,000, consisting of cash received upon stock option exercises. 14 Adequacy of Capital Resources Our primary working capital requirements relate to adding employees to our sales force and support functions, continuing infrastructure investments, and supporting general corporate needs, including financing equipment purchases and other capital expenditures incurred in the ordinary course of business. Based on our current operational performance, we believe our working capital of $30,419,000 and available borrowings under our existing credit facility will provide sufficient liquidity to meet our anticipated working capital and other liquidity needs for the next twelve months from the date of this report. Our credit facility provides us with a revolving line of credit. Interest on borrowings on the line of credit accrues at the prime rate (8.50% on September 30, 2023) less 1.00% and is payable monthly. There was no outstanding principal balance on the line of credit as of September 30, 2023 or June 30, 2023. The amount eligible for borrowing on the line of credit is limited to the lesser of $2,500,000 or 57.00% of eligible accounts receivable, and the line of credit expires on December 18, 2023, if not renewed. As of September 30, 2023, the maximum $2,500,000 was available under the line of credit. Payment obligations under the line of credit are secured by a security interest in substantially all of our tangible and intangible assets. The documents governing our line of credit contain certain financial and nonfinancial covenants that include a minimum tangible net worth of not less than $10,125,000 and restrictions on our ability to incur certain additional indebtedness or pay dividends. Any failure to comply with these covenants in the future may result in an event of default, which if not cured or waived, could result in the lender accelerating the maturity of our indebtedness, preventing access to additional funds under the line of credit, requiring prepayment of outstanding indebtedness, or refusing to renew the line of credit. If the maturity of the indebtedness is accelerated or the line of credit is not renewed, sufficient cash resources to satisfy the debt obligations may not be available and we may not be able to continue operations as planned. If we are unable to repay such indebtedness, the lender could foreclose on these assets. For the three months ended September 30, 2023 and 2022, we spent $109,000 and $241,000, respectively, on property and equipment. We currently expect to finance planned equipment purchases with cash flows from operations. We may need to incur additional debt if we have an unforeseen need for additional capital equipment or if our operating performance does not generate adequate cash flows. While the impact of the macroeconomic factors such as inflation are difficult to predict, we believe our cash, cash equivalents and cash flows from operations will be sufficient to meet our working capital, capital expenditure, operational cash requirements for fiscal 2024 and the foreseeable future. We will continue to evaluate our projected expenditures relative to our available cash and evaluate financing alternatives in order to satisfy our working capital and other cash requirements. Information Regarding Forward-Looking Statements Statements contained in this Quarterly Report on Form 10-Q that are not statements of historical fact should be considered forward-looking statements within the meaning of the safe harbor provisions of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Forward-looking statements include, but are not limited to, statements regarding: our business strategy, including our intended level of investment in R&D and marketing activities; our expectations with respect to earnings, gross margins and sales growth, industry relationships, marketing strategies and international sales; estimated sizes of markets into which our products are or may be sold; our business strengths and competitive advantages; our ability to grow additional sales distribution channels; our intent to retain any earnings for use in operations rather than paying dividends; our expectation that our products will continue to qualify for reimbursement and payment under government and private insurance programs; our intellectual property plans and practices; the expected impact of applicable regulations on our business; our beliefs about our manufacturing processes; our expectations and beliefs with respect to our employees and our relationships with them; our belief that our current facilities are adequate to support our growth plans; our expectations with respect to ongoing compliance with the terms of our credit facility; our expectations regarding the ongoing availability of credit and our ability to renew our line of credit; enhancements to our products and services; expected excise tax exemption for the SmartVest System; and our anticipated revenues, expenses, capital requirements and liquidity. Words such as “anticipate,” “believe,” “continue,” “could,” “estimate,” “expect,” “intend,” “may,” “ongoing,” “plan,” “potential,” “project,” “goal,” “target,” “should,” “will,” “would,” and similar expressions, including the negative of these terms, are intended to identify forward-looking statements but are not the exclusive means of identifying such statements. Although we believe these forward-looking statements are reasonable, they involve risks and uncertainties that may cause actual results to differ materially from those projected by such statements. Such statements involve known and unknown risks, uncertainties and other factors that may cause our actual results or our industry’s actual results, levels of activity, performance or achievements to be materially different from the information expressed or implied by the forward-looking statements. 15 Factors that could cause actual results to differ from those discussed in the forward-looking statements include, but are not limited to, the following: • ability to obtain reimbursement from Medicare, Medicaid, or private insurance payers for our products including potential adverse impact with an expiration of the Centers for Medicare and Medicaid Services waiver for certain respiratory diseases; • component or raw material shortages, changes to lead times or significant price increases; • adverse changes to state and federal health care regulations; • our ability to maintain regulatory compliance and to gain future regulatory approvals and clearances; • entry of new competitors including new drug or pharmaceutical discoveries; • adverse economic and business conditions or intense competition; • the risks associated with our planned salesforce expansion; • wage and component price inflation; • technical problems with our research and products; • the risks associated with cyberattacks, data breaches, computer viruses and other similar security threats; • changes affecting the medical device industry; • our ability to develop new sales channels for our products such as the homecare distributor channel; • adverse international health care regulation impacting current international business; • our ability to renew our line of credit or obtain additional credit as necessary; and • our ability to protect and expand our intellectual property portfolio. This list of factors is not exhaustive, however, and these or other factors, many of which are outside of our control, could have a material adverse effect on us and our results of operations. Therefore, you should consider these risk factors with caution and form your own critical and independent conclusions about the likely effect of these risk factors on our future performance. Forward-looking statements speak only as of the date on which the statements are made, and we undertake no obligation, and expressly disclaim any such obligation, to update any forward-looking statement for any reason other than as required by law, even if new information becomes available or other events occur in the future. You should carefully review the disclosures and the risk factors described in this and other documents we file from time to time with the Securities and Exchange Commission (the “SEC”), including our Annual Report on Form 10-K for fiscal 2023. All forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by the cautionary statements set forth herein. Item 3. Quantitative and Qualitative Disclosures About Market Risk. As a smaller reporting company, we are not required to provide disclosure pursuant to this Item.