Electromed, Inc.
Q2 2019 Earnings Call Transcript

Published: 13 Feb 2019

[Operator:]

Greetings, and welcome to the Electromed, Inc., Second Quarter Fiscal 2019 Financial Results Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host Kalle Ahl of Equity Group. Thank you. You may begin.

[Kalle Ahl:]

Thank you, Sherry, and good morning everyone. Electromed's second quarter fiscal 2019 financial results were released yesterday after the market closed. A copy of the earnings release can be found in the Investor Relations section of the company's website at www.smartvest.com. As a matter of formality, I need to remind participants that remarks made by management during the course of this call may contain forward-looking statements about the company's results and plans. Such statements are subject to risks and uncertainties that could cause actual performance or achievements to be materially different from those projected. The words believe, expect, plan, intent, estimate, anticipate, should or could, and similar expressions are words that are used to identify forward-looking statements, but their absence does not mean a statement is not forward-looking. In addition, any projections as to the company's future performance represent management's estimates as of today February 13, 2019. You should not place undue reliance on these forward-looking statements. We expressly do not undertake any duty to update forward-looking statements whether as a result of new information, future events or otherwise. We ask that you please refer to the company's SEC filings for further guidance on this matter. Joining us from Electromed this morning are Ms. Kathleen Skarvan, President and Chief Executive Officer; and Mr. Jeremy Brock, Chief Financial Officer. Kathleen will begin with some opening remarks, after which Jeremy will present a summary of the company's second quarter fiscal 2019 financial results, and then we'll open the call for questions. Now, it's my pleasure to turn the call over to Kathleen.

[Kathleen Skarvan:]

Thank you, Kalle. Good morning, everyone, and thank you for joining us to discuss Electromed's second quarter fiscal 2019 financial results. This quarter, our net revenue grew by approximately 15% year-over-year, reflecting 13% growth in home care revenue and the 31% increase in institutional revenue. Home care growth was driven by an increase in referrals generated by our expanded field sales team and greater referral to approval percentage due to our sales team success educating physicians on reimbursement requirements, resulting in more quality referrals as well as ongoing operational excellence in our best in class reimbursement teams. Our institutional revenue grew by continuing to focus on integrated delivery networks. By expanding our institutional market share, it will also support our home care growth strategies. Our focus on the institutional market on hospitals where patients are being treated, gives Electromed direct access to the healthcare professionals who manage the discharge patients. Often the high frequency chest wall oscillation brand used in the hospital is the default brand prescribed when discharging a patient. At Electromed, our strategies are focused on perfect synergy, building our brand in the hospital setting and making SmartVest the preferred HFCWO product used by patients at home. Shifting to expense management, we were pleased that this quarter's SG&A expenses grew at a slower rate than our revenues compared to the second quarter of the prior year. Our operating income was lower than the prior year period, primarily due to an increased investment in the sales team over the past few months and R&D expenses this past quarter. R&D investment is for the development of an innovative service related product enhancement that will improve our patient’s ability to access their SmartVest therapy adherence data. We are excited about this project because physicians are interested in knowing if their patients are feeling better after being prescribed SmartVest. With this enhancement we will provide an improved patient interface for our wireless patient monitoring that we believe will drive more patients to utilize SmartVest Connect supporting greater therapy adherence. We expect spending on R&D expenses in the second half to be similar to the first half of our fiscal year, reflecting incremental expenditures to conclude this project as well as begin other device innovations. As I've stated in previous earnings calls, we are focused on improving the productivity of our expanded sales team. We ended the quarter with 52 total field sales employees, of which 44 were direct field staff and we don't anticipate any significant increase to our sales team in the next several quarters. In the second quarter of fiscal 2019, we achieved a sequential uptick in productivity compared to the first quarter, as home care revenue per average direct field sales employee increased 4% from approximately $165,000 to $172,000. We will be closely monitoring this metric in the coming quarters and are taking decisive actions to progress toward our long-term objective of reaching annual revenue of $750,000 to $850,000 per direct field sales employee. Leadership travel with our newer sales employees in the field, upgraded sales training programs, enhanced sales account planning tools and better CRM utilization all remain key elements of our sales productivity plan. There are five additional very important strategic steps we are taking to improve Electromed’s sales productivity; enhancing our sales leadership, intensifying our efforts to grow home care referrals from hospitals, focusing on the strategic high prescribing clinics, consistently delivering information on patients feedback and wellness to physicians to support SmartVest value and increase awareness and demonstrating exceptional service to providers and patients consistent with our core growth strategy. Regarding sales leadership, last month we agreed to accept the resignation of our Vice President of Sales, John Kowalczyk. We want to thank John for his contributions to Electromed over the past three years. We currently are interviewing candidates and hope to announce our next Vice President of Sales by the end of March. To ensure a smooth transition, I am overseeing the sales program on the interim basis. Working directly with our regional sales managers and director of strategic accounts I've been pleased with the team's engagement, dedication and focus on growing our home care referrals with our current prescribers and taking market share to serve more patients with SmartVest. This team is committed to the execution of our strategic initiatives and driving for improved sales productivity from our newest sales reps to our most experienced top sales people. With respect to intensifying our efforts to secure home care referrals from hospitals, we intend to take advantage of the growing focus by institutions on avoiding readmission penalties under the Affordable Care Act and growing awareness among the practitioners of COPD’s overlap with Non-Cystic Fibrosis Bronchiectasis or NCFB. HFCWO therapy with SmartVest keeps patients out of institutions aligning well with the strong economic incentives of hospitals to avoid high readmission penalties. We are repositioning our sales reps targeted accounts to include a higher number of call points in hospital setting to encourage prescriptions of SmartVest at the time of patient discharge. In our view, prescribing SmartVest achieves better outcomes for everyone. It is better for the patient, better for the hospital, better for the health care system, and better for us. Considering most NCFB patients funnel through hospitals building this channel has the potential to increase our long-term sales team productivity in a meaningful way. This isn't a new sales strategy, but a strategy we have strengthened and believe is increasingly gaining acceptance as hospitals dedicate more resources to avoid the high cost of readmission penalties. Our sales team places its biggest emphasis on strategic accounts and visit frequency to drive further market share gains in each of our territories. By prioritizing high prescribing clinics over greenfield opportunities, we believe sales productivity will improve. And we expect sales productivity to improve with the maturation of our sales team and through consistent blocking and tackling under our core growth strategy. The five pillars to our growth strategy remain unchanged. First, increase high quality referrals in adult pulmonologist bronchiectasis segment. Second, enhance reimbursement support to provide best in class customer care. Third, leverage clinical evidence to increase utilization of SmartVest. Fourth, continuously evaluate and develop innovative device features. And fifth, grow institutional market share to support home care growth. In conclusion, we reiterate our expectations for double digit revenue growth over the next few years, as we execute on the strategic initiatives and anticipate improved earnings through our cost containment. We are fortunate that NCFB represents a significant and growing market opportunity, conservatively estimated at more than $4 million individuals in the United States. A clinical study published in 2017 using data from the U.S. bronchiectasis research registry indicated approximately 15% of registered patients were prescribed HFCWO, as part of their treatment plan. Using that study data we estimate that within the diagnosed Medicare population of 440,000 approximately 15% or 66,000 of the Medicare population have been prescribed HFCWO. We believe that bronchiectasis is under diagnosed in the U.S. based on clinical study evidence. We also believe that HFCWO is under prescribed for bronchiectasis patients. By applying approximately 15% of HFCWO penetration of diagnosed Medicare patients to the estimated 4.2 million prevalence of bronchiectasis in the U.S. according to the Weicker Clinical Study [ph], we believe approximately 630,000 with bronchiectasis diagnosis could benefit from HFCWO therapy. Yet far fewer as I just mentioned an estimated 66,000 patients in the Medicare population have been treated with a device like SmartVest today. We believe all boats will rise as the industry continues to build awareness of the merits of HFCWO therapy as an effective standard of care for NCFB. Moreover Electromed stands out from our peers, which reside within larger complex organizations. In addition to being nimbler than our counterparts we are 100% focused on SmartVest. All of our time, resources and energy go to serving our patients with the highest quality device and customer care possible. At the end of the day we believe the spirit and dedication to our patients will drive Electromed’s future success and allow us to create long-term value for our shareholders. With that, I will turn it over to Jeremy for a detailed discussion of our financial results. Jeremy?

[Jeremy Brock:]

Thank you, Kathleen. Good morning, everyone. Our net revenue in the second quarter of fiscal 2019 increased 15.1% to $8 million from $7 million in the second quarter of fiscal 2018, driven by growth in home care revenue. Home care revenue increased 13% to $7.3 million, primarily due to an increase in referrals and approvals driven by a higher number of field sales employees and improved reimbursement processes. Institutional revenue increased 30.9% to $402,000 from $307,000 in the prior year quarter. International revenue which is not a strategic growth area for Electromed totaled $279,000 compared to $166,000 in the prior year period, although quarter-to-quarter sales variability can be expected due to the nature of our business. We anticipate double digit revenue growth in fiscal 2019 as we execute our organic growth strategy. Gross profit increased 12.2% to $6.1 million or 75.7% of net revenue in the second quarter of fiscal 2019 from $5.4 million or 77.6% of net revenue in the second quarter of fiscal 2018. The increase in gross profit resulted primarily from an increase in home care revenue. The decrease in gross profit as a percentage of net revenue was driven by a lower selling price per device in our institutional market. Operating expenses, which include SG&A as well as R&D expenses totaled $5.4 million or 67.3% of revenue in the second quarter of fiscal 2019 compared with $4.6 million or 66.5% of revenue in the same period of the prior year. SG&A expenses increased 12.6% to $5.2 million from $4.6 million in the second quarter of fiscal 2018, primarily due to higher payroll and compensation related expense, travel, meals and entertainment expenses, both related to the expansion of our sales team. Research and development expenses increased to $238,000 in the second quarter of fiscal 2019 from $57,000 in the second quarter of fiscal 2018. This was driven by the product development project that Kathleen discussed previously. Operating income decreased to $672,000 in the second quarter of fiscal 2019 from $771,000 in the prior year quarter, primarily due to the increased operating expenses mainly for the sales team expansion and R&D expenses, which more than offset the increased gross profit driven by higher revenue. Net income before income tax expense totaled $689,000 in the second quarter of fiscal 2019 compared to $766,000 in the prior year quarter. And income tax expenses totaled $311,000 compared to $346,000 in the same period of the prior year. Our effective tax rate in the second quarter of fiscal 2019 was 45.2% the same as the prior year period. Estimated income tax expense this quarter did include a discrete deferred tax expense of approximately $126,000 related to unexercised fully vested stock options that expired on November 24th. Estimated income tax expense in the prior year second quarter included a discrete deferred tax expense of approximately $160,000 as a result of remeasuring certain deferred tax assets and liabilities based on the rate at which they are expected to reverse in future periods under the tax act. Our net income totaled $378,000 or $0.04 per diluted share in the second quarter of fiscal 2019 compared to $420,000 or $0.05 per diluted share in the second quarter of fiscal 2018. Now moving to the balance sheet and operating cash flow. Our balance sheet at December 31, 2018 included cash and cash equivalents of $7.2 million, no long-term debt, working capital of $19.9 million and stakeholders' equity of $23.8 million. During the quarter we did make the balloon payment of approximately $1 million to pay-off our term loan, which matured on December 18th. Cash flow from operations in the second quarter of fiscal 2019 totaled $518,000 compared to $1.2 million in the second quarter of fiscal 2018. Cash flow from operations in the prior year quarter did benefit from receipts from Medicare of approximately $563,000 related to a settlement of older claims that were in appeals. Finally, we are very pleased to be debt free and to be in a position to continue building our cash reserves to support Electromed’s long-term growth strategies. For the foreseeable future, we plan to retain our cash as we firm our plans that would require increased capital spending later this year. Specifically, we are contemplating a billion expansion project here in New Prague with the potential to break ground as early this spring. We have a very carefully mapped out plan that would give us the infrastructure we need on very favorable terms to support our future growth objectives. But we have not yet concluded this deal. We expect to be able to give you an update on these objectives on our next conference call. Overall, we remain focused and confident with the direction of this business. And this concludes my remarks. Operator could we start the Q&A portion of the call, please?

[Operator:]

Yes thank you. [Operator Instructions] There are no questions at this time. I would like to turn the conference back over to Kathleen Skarvan for closing remarks. Actually, I'm sorry, we just got a question. And that is from Josh Peters from Sterling [ph] Advisors. Please proceed, Josh.

[Unidentified Analyst:]

Good morning, Kathleen and Jeremy. Good to speak with you this morning. Congratulations on the sales growth.

[Kathleen Skarvan:]

Thank you, Josh. Good to hear from you.

[Unidentified Analyst:]

Yes. I just wanted to ask a quick question about seasonality in the business certainly a very nice uptick, from last quarter. I know we talked about this in the past that it can be kind of hard to get a sense of what the real seasonal trends are there. But do you have any other insights that might help to evaluate what sales could look like over the next couple of quarters without explicitly giving guidance?

[Kathleen Skarvan:]

Thank you, Josh, for that question. You're absolutely correct in that, we have spoken about seasonality quite a bit regarding this business. And it is difficult to get true understanding of that based on other variables that we have in this business. Certainly, we know that the summertime seems to provide us fewer prescriptions due to many doctors taking time off vacations and less people potentially visiting for exacerbations. But of course, the challenge then is tracing that referral to when we actually have an approval or book revenue. And we know that that booking of the approval or revenue can range anywhere from two to six to eight weeks. Then if you throw appeals in there that can happen with commercial or Medicare, it does find us to be in a bit of a lumpy situation. I think though, if you look at revenue traditionally, you would see that our third and fourth quarter or second half of the year has had some traditional increases. And so that's a long winded answer, which I apologize for, but it is a bit of a complex story.

[Unidentified Analyst:]

Okay, well, that that does help any context that helps as we along the journey here. And one other question and then I'll let you go, on the expansion there in New Prague, what type of expansion are you contemplating? Are you adding manufacturing space or office space? What are you considering there?

[Jeremy Brock:]

Hi, Josh. Thanks for the question. Regarding the building addition, as we stated, we've carefully mapped out what the infrastructure that we need and believe that this project is actually going to have very favorable financial terms for us and support our future growth objectives. A little more color on the topic, the building addition that we're talking about, will allow us to eliminate the need for lease of office space that is the current home of our reimbursement team. We'll move from a space of proximity 20,000 square feet of which 8,000 square feet is occupied by the reimbursement team to a square foot layout of under 15,000 square feet. And the least that will be eliminated currently requires about $130,000 in base rent. So the Minneapolis, New Prague area, which has a strong economy and a very favorable payback period that we're seeing from this project as compared to the rent expense will also give us a quick residual value to the building as well. So I think the financial terms of this is very good and again it'll be mostly office space and combine common areas for the entire company for that building. Again, we haven't finalized the deal the deal and we will give you a further update on the next conference call.

[Unidentified Analyst:]

Okay, thank you very much.

[Operator:]

[Operator Instructions] Our next question is from Andy Summers with Summers Value Partners. Please proceed with your question.

[Andy Summers:]

Good morning, Kathleen and Jeremy.

[Kathleen Skarvan:]

Hi, Andy. How are you today?

[Andy Summers:]

I'm well, thank you. A couple quick questions if I may. Firstly, since you have a new Head of Sales in your institutional business, the performance there has really improved. Can you talk about where that business could go over the next three to five years?

[Kathleen Skarvan:]

Yes, I'd be happy to talk a little bit more about that. As I mentioned too in our comments the institutional opportunity we think is a great one for us as all bronchiectasis patients funnel through the hospital and we are able to -- the hospitals are recognizing the value of a therapy like high frequency chest wall like SmartVest in their in patients critical care units as well. So they can send people home with clear lungs, which hopefully helps them to stay healthy and not see those readmission penalties. But the idea that they can identify the COPD phenotype -- COPD bronchiectasis phenotype is really catching on as well as hospitals are putting in these readmission penalty programs to continue to keep people with pneumonia and COPD the respiratory care out of the hospital or from being readmitted of course. But as far as hospital revenue overall, this is for now more of a market share gain for us. Do we think that we can -- we will have double digit growth here as well. Could it be on the higher end of the home care. I think that's potential.

[Andy Summers:]

So am I thinking about it correctly that the institutional revenue growth is somewhat of a leading indicator for your home care revenue growth, or is that not the right way to think about it?

[Kathleen Skarvan:]

I think that could -- could be actually for sure be the right way to think about it, Andy. The more opportunity we have in that hospital the more growth we see there, the more as we said that perfect synergy where then our brand is being used in the hospitals so the physicians are using it, they have more exposure and that gives us also that access to talk to those physicians about the value and then help them work on how do we make this more of a standard of care then for discharging. Well first, diagnosing bronchiectasis and then discharging those patients with SmartVest. So we're as I said in my comments very excited about the opportunity.

[Andy Summers:]

Okay great. And then last question for me, I appreciate the additional color you provided on the sales productivity initiatives. But if we look out over the next three to five years and assume that those initiatives do bear fruit. What do you see as the potential for the EBIT margin of this business over that time period. You have been sort of mid-teens historically, but where do you see this going over the next three to five years if your initiatives pay-off?

[Jeremy Brock:]

Hi Andy, it's Jeremy. And I think when we look at getting the leverage and the increase in the revenue without having to add the expenses I think it is our belief that we can get back to the mid-teens and depending on the current growth opportunities that we have at that time, at any given time in the future and they invest other investments that we're making ex. any of those other investments we can meet those same mid-teen numbers.

[Andy Summers:]

Okay, thank you very much.

[Jeremy Brock:]

Thank you, Andy.

[Operator:]

[Operator instructions] Our next question is from Salim Najim [ph], Private Investor. Please proceed with your question.

[Unidentified Analyst:]

Good morning. So I just have a quick question on the home medical equipment distributor opportunity that has been identified in the past and it's also in the 10-K, just wanted to get an update I guess having continuing conversations and exploring that channel as an opportunity for increased sales.

[Kathleen Skarvan:]

Thank you, Salim [ph] for asking that question. We are actively involved in conversations with a handful of home medical equipment distributors and when we do have something more material to speak about that and how it might be beneficial for our longer term growth we will definitely share that with you. It's certainly something that we think has been worth exploring in regard to being able to expand our brand and particularly in those parts of the country or regions or territories where our brand may not be as strong from a market share standpoint. So thank you for the question and that’s where we are at this point.

[Unidentified Analyst:]

Maybe a follow on to that, if I may, is the opportunity with those distributors for the home care end market or is it for the institutional market?

[Kathleen Skarvan:]

Right now we would be targeting exclusively the home care market, those home medical equipment distributors do have relationships with hospitals as well and those relationships are often for serving a discharge patient with portable oxygen or non-invasive ventilation. And so those relationships could be beneficial, but again would be for the home care market.

[Unidentified Analyst:]

Thank you.

[Kathleen Skarvan:]

Thank you.

[Operator:]

[Operator Instructions] There are no more questions at this time, I would like to turn the call back over to Kathleen Skarvan for closing remarks.

[Kathleen Skarvan:]

Thank you all for participating on our call this morning. We look forward to reporting back to you in May when we release our third quarter fiscal 2019 financial results. Have a good day.

[Operator:]

Thank you this concludes today’s conference. You may disconnect your lines at this time and thank you for your participation.