Electromed, Inc.
Q2 2018 Earnings Call Transcript

Published: 14 Feb 2018

[Operator:]

Good morning and welcome to the Electromed Inc. Second Quarter Fiscal 2018 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. If anyone should require operator assistance during the conference, please press star, zero on your telephone keypad. As a reminder, this conference call is being recorded. It is now my pleasure to introduce your host, Kalle Ahl of The Equity Group. Thank you, you may begin.

[Kalle Ahl:]

Thank you, Michelle, and good morning everyone. Electromed’s second quarter fiscal 2018 financial results were released yesterday after the market close. 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, intend, 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 the company’s future performance represent management’s estimates as of today, February 14, 2018. 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 2018 financial results, 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 2018 financial results. We are very pleased with the continuing strong organic growth in our homecare sales, which increased by 18.2% year-over-year in the second quarter. We benefited from improvements in our reimbursement operations that led to a greater referral to approval percentage contributing to this quarter’s homecare sales growth. I’m also pleased to note that we significantly grew the footprint of clinics using our innovative SmartVest Connect wireless connectivity solution, and we continue to receive positive feedback from physicians and patients on its intuitive design. We believe SmartVest’s unique patient monitoring features, ease of use and comfort, along with our dedication to customer service, are helping to distinguish Electromed in the marketplace. Sales declines in our much smaller institutional and non-core international segments were a drag on total revenues, which increased approximately 10% year-over-year, somewhat masking the excellent growth of our homecare business. This quarter, we implemented initiatives to reinvigorate our institutional business, including the hiring of a new institutional sales director, and we expect to see improvements going forward. In the second quarter, we remained profitable, generated positive operating cash flow, and grew operating income by 5.6% year-over-year despite stepping up investments in marketing and sales initiatives to address the large under-penetrated bronchiectasis market. Our field sales employees grew by more than 20% to 43 at the end of this quarter, up from 35 at the end of the second quarter of fiscal 2017. Having completed most of our direct sales expansion for the fiscal year, our near term growth strategies are focused on improving sales force productivity, amplifying our direct-to-patient marketing, and expanding the body of clinical evidence supporting SmartVest’s benefits for bronchiectasis patients. Sales force productivity actions we are taking include increasing the frequency of visits at strategic clinics, reallocating reimbursement resources so that we can increase that sales and provider support, and leveraging our recently updated customer relations management system. Direct-to-patient marketing actions we are taking include stepping up targeted digital ads and launching a new website. As it relates to expanding the body of clinical evidence, we are initiating additional clinical outcome studies with bronchiectasis patients at larger adult pulmonology institutions. We see a tremendous opportunity to penetrate the large, underserved population of bronchiectasis patients in the United States. We believe that conservatively 400,000 - and this refers to Medicare-only patients - and 1.1 million total individuals in the United States have non-cystic fibrosis bronchiectasis, of which only a range of 5 to 15% have been prescribed high frequency chest wall oscillation therapy with devices like SmartVest. As we proceed through fiscal 2018, we will emphasize sales force productivity over sales force expansion and continue to focus on expense management and profitability. We believe this is the prudent approach to managing our business for the significant long term growth opportunity in front of us. Year-over-year revenue growth in the second half of fiscal 2018 is estimated to be line with fiscal 2017 growth levels as our near term focus is on improving sales force productivity. Once recently on-boarded sales representatives mature and overall referrals per sales employee attain our objectives, we’ll evaluate that next phase of our sales force expansion. As the only independent, publicly traded manufacturer of airway clearance devices designed for use in the homecare setting, we are singularly focused on high frequency chest wall oscillation therapy and the best-in-class service to our patients to grow the business. We remain confident in the SmartVest growth opportunity and are really excited about the direction Electromed is heading. We believe we are a critical part of the solution to improved quality of life and outcomes for an expanding number of patients with compromised pulmonary function while reducing healthcare utilization. I will now turn it over to Jeremy for a more detailed discussion of our financial results. Jeremy?

[Jeremy Brock:]

Thank you, Kathleen, and good morning everyone. Our net revenue in the second quarter of fiscal 2018 increased 9.6% to $7 million from $6.4 million in the second quarter of fiscal 2017. This was driven by strong growth in homecare sales. Homecare sales increased 18.2% to $6.5 million primarily due to the growth in approvals as a result of continued improvements in our reimbursement operations, which drove a higher referral to approval percentage. Institutional revenue was $313,000, down 48.3% compared to $605,000 in the prior year quarter. As Kathleen mentioned, this quarter we hired a new institutional sales director to reinvigorate our institutional business. International revenue, which is not a strategic growth area for Electromed, totaled $166,000 compared to $265,000 in the prior year period. Although quarter to quarter sales variability can be expected due to the nature of our business, we anticipate revenue growth in the second half of fiscal 2018 that’s in line with the revenue growth levels of fiscal 2017. Gross profit rose 13.4% to $5.6 million or 80% of net revenues in the second quarter of fiscal 2018 from $4.9 million or 77.3% of net revenues in the second quarter of fiscal 2017. The increase in gross profit primarily resulted from an increase in homecare revenue. We believe that gross margins will range in the mid to upper 70s in the second half of fiscal 2018. Operating expenses, which include SG&A as well as R&D expenses, totaled $4.8 million or 69% of net revenue in the second quarter of fiscal 2018 compared to $4.2 million or 65.9% of net revenue in the same period of the prior year. SG&A expenses increased 16.2% to $4.8 million in the second quarter of fiscal 2018, up from $4.1 million in the second quarter of fiscal 2017 primarily due to additional sales employees annual salary increases, higher shared-based equity compensation expense, and additional sales incentives on higher revenue. R&D expenses totaled $57,000 in the second quarter of fiscal 2018 compared to $101,000 in the prior year quarter. Operating income in the second quarter of fiscal 2018 increased 5.6% to $770,000 from $729,000 in the second quarter of the prior year, primarily due to higher gross profit on higher revenue, partially offset by higher investments in SG&A in support of our revenue growth initiatives. Net income before income tax expense totaled $765,000 in the second quarter of fiscal ’18 compared to $714,000 in the prior year quarter, and in the second quarter of fiscal 2018 income tax expense totaled $416,000 compared to $270,000 in the same period of the prior year. Our effective tax rate in the second quarter of fiscal 2018 was 54.4% compared to 37.8% in the prior year period. I’d like to point out that the income tax expense during the second quarter of fiscal 2018 included a discrete deferred tax expense of $160,000 as a result of re-measuring certain deferred tax assets and liabilities based on the rate at which they are expected to reverse in the future under the Tax Cuts and Jobs Act which was enacted by the U.S. Government on December 22, 2017. On a go-forward basis, the Tax Cuts and Jobs Act reduces the statutory corporate federal tax rate from 34% to 21%, effective January 1, 2018, and is estimated to benefit our after-tax net income by approximately 13% beginning in fiscal 2018, as well as positively impacting our earnings per share and cash flow. Our net income in the second quarter of fiscal 2018 totaled $349,000 or $0.04 per diluted share compared to $444,000 or $0.05 per diluted share in the second quarter of fiscal 2017. Now moving onto the balance sheet and operating cash flow, our balance sheet at December 31, 2017 included cash and cash equivalents of $6.8 million, current maturities of long-term debt totaling $1.1 million, working capital of $15.5 million, and shareholders equity of $19.9 million. Cash flow provided by operations in the second quarter of fiscal 2018 totaled $1.2 million compared to $1.3 million in the second quarter of fiscal 2017. Overall, we remain excited about the direction of our business and where we are headed, and this concludes my remarks. Operator, could we start the Q&A portion of the call, please?

[Operator:]

[Operator instructions] Our first question comes from the line of Paul Carter with Adaptable Capital Management. Please proceed with your question.

[Paul Carter:]

Good morning, thank you very much for taking my call. Just a question about your top line growth rate. In the first quarter you achieved, I think I was 15% year-over-year revenue growth, and then during the last call you stated that at a minimum, you were striving for 18% revenue growth going forward, so it sounds like your outlook for the next two quarters is revenue growth of 12% or so. Just curious what’s changed from November to cause this [indiscernible].

[Kathleen Skarvan:]

Hi Paul, it is great--thank you for your question. How I would describe that change is around that drag from institutional - I’d start with that, as you can see how that impacted us this quarter. That was the primary reason that we saw that change in quarter-over-quarter--or year-over-year quarter growth. We expect that that drag will moderate in the second half of this year, but it may still create some drag for us going forward, so that issue. Then secondly, we talked about our focus on sales productivity. We have found that some of our new hires--we typically talk about productivity, our sales group reaching productivity in anywhere from six to 12 months, and we start seeing that return on investment. There are certain territories where that can lengthen a bit if it’s a territory where we haven’t been calling on pulmonologists for a period of time. As you know, this is a market development sale we are working to--which is highly relational, and so as we work with pulmonologists, we have to develop that relationship, that trust, we have to talk to them about that prevalence of bronchiectasis. We’re also educating them on the criteria for reimbursement, and so we have found that in certain areas with our expansion, that is stretching out slightly. We’re very confident, though, in the model and that we will get to the productivity, but that has caused us to think a little differently about that growth rate in the second half of the year. Hopefully that helps to answer your question, but please if you have a follow-up, please go ahead.

[Paul Carter:]

Yes, that’s helpful, and you’ve been very clear in the past about how you expect a sales rep to take six to 12 months to get into that productive stage, but how many of your 43 reps right now would you consider in that, for lack of a better term, unproductive bucket currently?

[Kathleen Skarvan:]

Sure, so we think about that two ways. One, of course, are those newer cams [ph] that have come on board, and I will add that we had planned on a certain amount of attrition this year and that’s slightly greater than what we anticipated. It’s not something that I’m concerned about, but that has added to the thinking about our cams that are in training or aren’t productive. We would categorize that in that 20 to 25% category.

[Paul Carter:]

Okay, great. That’s it, thanks very much.

[Kathleen Skarvan:]

You’re very welcome, thank you.

[Operator:]

Thank you. Once again, if you would like to ask a question, please press star, one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. Our next question comes from the line of Beth Lilly with Crocus Hill Partners. Please proceed with your question.

[Beth Lilly:]

Good morning Kathleen and Jeremy.

[Kathleen Skarvan:]

Hi Beth, how are you doing?

[Beth Lilly:]

Good, how are you?

[Kathleen Skarvan:]

We’re great, thank you.

[Beth Lilly:]

I just wanted to ask about sales force productivity and the reinvestment back into the business. You said you’re very confident in the outlook for the model. Can you just give us a sense or some more qualitative aspects to why you’re confident in the expansion in the sales force and your ability to drive to top line faster?

[Kathleen Skarvan:]

Sure, I’d be glad to do that. Qualitatively, it still is around the studies and the clinical evidence around bronchiectasis. We remain confident that that size of the market and the growth in that market and the prevalence of bronchiectasis--you know, the pulmonologists we talk to, when they’re looking at high resolution scans for patients with severe to moderate COPD, there is bronchiectasis, and if they’re looking for it, it’s there. We just had a meeting with our advisory board on January, and they continue to reinforce that bronchiectasis is there and they are seeing more awareness, more education around that for pulmonologists and for patients, and also the value of airway clearance because for those individuals that aren’t able to clear mucus like their bodies should be able to do on their own, this is exactly what they need to change that vicious cycle of infection, is if they’re able to clear their mucus, they’re less likely to have infections in the hospital, so really, we see all that evidence out there. We continue to see our veteran cams be able to break into new pulmonologists and new clinics, and those newer cams, there are cams that are coming up that productivity curve like we expect and then there’s others that are taking longer; but again, that can be territory specific as well. So again, we’re very confident in that conservatively there is a million; if you go on the other end of this spectrum, there have been studies that have said it could be as high as 52% of the moderate to severe COPD patients that have bronchiectasis. All of that still seems to line up, and that’s why we remain confident in the market opportunity.

[Beth Lilly:]

Are the early indications with this sales force expansion that in fact you are generating further penetration?

[Kathleen Skarvan:]

Yes, we are generating further penetration. We have had referral growth, so that helps us to remain confident in that area as well.

[Beth Lilly:]

Is the sale to the pulmonologist, or are you trying to spread it out even further, more to the general practitioners, or is this expansion, these sales people are specifically going to the pulmonologists, correct?

[Kathleen Skarvan:]

Right. Let me just--if you wouldn’t mind, I’m going to come back to the question about penetration because I do want to elaborate on that a little bit more. We have two ways of penetrating this market. One is calling on pulmonologists that don’t prescribe, and--actually, I’ll say three

[Beth Lilly:]

Okay, great. As you’ve spent this money and you’ve expanded the sales force, you’re seeing clearly an impact on your profitability, so as we move forward to next year, should we expect your top line growth to go back to, let’s call it 15% and then to start to see the operating margin expand back to where it was?

[Kathleen Skarvan:]

I think you’re thinking appropriately on the top line, Beth. I think when it comes to the profitability, I think there’s still going to be a bit of a range as we move into fiscal ’19, and I think we’ve talked about that range before. I’m going to have Jeremy share that, but I think we’ve talked more in that 7 to 11% margin rate, and we think quarter to quarter it could fluctuate but I think overall, that’s what we’re still thinking we can accomplish as we move into ’19.

[Beth Lilly:]

Okay, and then just in terms of the sales force, so you’re at 43 today, is that correct?

[Kathleen Skarvan:]

That is correct.

[Beth Lilly:]

And ideally, Kathleen, what’s the number that you want to get the sales force to?

[Kathleen Skarvan:]

Yes, and let me just correct that - that 43 would be at the end of the fiscal year, so that would have been end of December. We have a handful of reps that have started in the January time frame, so I guess you could say that that’s going to be in that 45 to 48 range likely in this quarter.

[Beth Lilly:]

All right, and do you expect that number to go to 60 over time, or are you at the right level now?

[Kathleen Skarvan:]

Well, we’re at the right level for the foreseeable future. As we monitor that productivity and as we continue to implement actions that will bring that productivity up, I think it’s fair to say that when that productivity gets to the objective or to the goal that we’ve set for them relative to the expectation on return on investment, then we’ll start initiating a next phase of growth for the sales force, so we’ll look at that in a measured step function approach. So as we move into the next few years, we could see that--you know, I think it’s fair to say that that--when we think about the sales force expansion, we definitely have our plan in place for where we want to take that. If you think about our competition right now, we’re outnumbered about four to one when you think about the other two competitors, so we want to probably cut that in half. We don’t want to be outnumbered more than two to one, say, so that gives you some expectation if they aren’t expanding their sales force.

[Beth Lilly:]

Okay, great. I have one last question, if you don’t mind. Can you talk about just the competitive environment, and I’m trying to remember - I think it’s Hill-Rom now that has brought out a fairly new product to the market. Is that correct?

[Kathleen Skarvan:]

Yes, that’s a great question. I’d be glad to talk a little bit about the competitive environment, so let’s start with Hill-Rom. Hill-Rom has brought out a product called Monarch, and Monarch is a portable battery-operated device so that individuals, if they choose to, can walk around with that device untethered, is how I like to describe it. What we’re hearing about that device is that it is appealing primarily to those individuals that already have high frequency chest wall oscillation and they’re purchasing it as a second device for that mobility, or I call it more mobility than portability. We did hear, though, that there was a recent recall on that device from Hill-Rom for about 60 devices that were in the field, and we also have heard that they may not have a reimbursement code for that device right now as well. Of course, it was targeted at people age 15 and above, so that’s a little bit about what’s going on with Hill-Rom and that new device. With RespirTech, it’s been a little quiet. Of course, you know that they were purchased by Phillips a few months ago, and we’re not hearing a lot of new or changes in their go-to-market strategy.

[Beth Lilly:]

Okay, great. Those are all my questions, thanks very much.

[Kathleen Skarvan:]

Thank you, Beth.

[Operator:]

Thank you. Once again as a final reminder, if you would like to ask a question, please press star, one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment please while we poll for more questions. There are no further questions at this time. I would like to turn the call back over to Ms. Skarvan for any closing remarks.

[Kathleen Skarvan:]

Thank you all for your participation on the call this morning. We look forward to reporting back to you in May when we will release our third quarter fiscal 2018 financial results. Have a great day.

[Operator:]

Thank you. This concludes today’s teleconference. You may disconnect your lines at this time. Thank you for your participation and have a wonderful day.