Electromed, Inc.
Q3 2018 Earnings Call Transcript

Published: 9 May 2018

[Operator:]

Greetings, ladies and gentlemen, and welcome to the Electromed Incorporated Third 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. [Operator Instructions] As a reminder, this conference call is being recorded. It is now my pleasure to introduce your host, Kalle Ahl of The Equity Group. Please go ahead, sir.

[Kalle Ahl:]

Thank you, Jan, and good morning everyone. Electromed's third 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 Web site 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 to the company's future performance represent management's estimates as of today, May 9, 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 third quarter fiscal 2018 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 third quarter fiscal 2018 financial results. The total revenue this quarter increased by approximately 6% year-over-year reflecting homecare sales growth of 6% and the institutional sales growth of 16%. While homecare growth moderated due to lower sales productivity we took decisive action and achieved a meaningful uptick in sales productivity and referrals in March, which continued into April. It's important to note that sales productivity in referrals are a good reading indicator of future sales. In our Institutional segment, we hired a new sales leadership placed a renewed focused on key hospital relationship, and implemented a new strategic plan that positions the business for continued growth heading into fiscal 2019. Despite incurring a higher level investment in sales initiatives, we remain profitable, and generated positive operating cash flow in the third quarter. While we have noted some evidence of tightening labor market with lower unemployment rates and higher compensation requirements, we will continue to manage the business for profitability in 2019, and expect to benefit from operating leverage as their sales team matures and produces a higher level of revenue. We have invested heavily in our field sales staff, which increased from 35 a year ago to 48 at the end of the quarter, and have focused on penetrating large metropolitan areas. We are gaining traction with this strategy and although it is taking a bit longer than we anticipated to deliver enhanced growth, we remain extremely confident in the market opportunity across the United States. We estimate that sales -- new sales employees generally require about a year on the job to reach full productivity, and approximately half of our field staff has less than one year of tenure. In addition to the natural productivity ramp that comes with time, we have taken swift measures to improve sales productivity, and enhanced sales growth, and continued to drive our longer term sales growth strategies. Measures taken during the quarter include increasing leadership co-travel with new sales employees in the field; I have increased my interaction with clinicians this quarter along with other senior sales executives, reinforcing our commitment to cultivating new clinician relationships while building on existing ones. We raised the frequency of visits at strategic clinics to strengthen the level of service to the providers, which includes education on reimbursement criteria and further strengthens relationships with those key prescribers. We expanded and updated our training programs for new sales employees. These improvements included extending classroom training, weekly reinforcement calls, and additional certification testing. In support of our longer term sales growth strategies, we expanded the body of clinical evidence. Our evidence-based marketing approach provides sales employees with important tools to inform pulmonologists and other key decision-makers of the benefits of high frequency chest wall oscillation therapy using smart tests. In this regard, in the spring 2018 issue of respiratory therapy, we published longitudinal bronchiectasis outcomes-based study for HFCWO therapy, the first of its kind. Our study builds on previously published evidence and demonstrates that improved outcomes for bronchiectasis patients can be sustained 2.5 years after starting SmartVest treatment. We launched a new customer relationship management system. At our mid fiscal year sales meetings we introduced to our staff a new CRM database and software application that its designed to provide real time information on clinical referrals, patient status and shipments among other data. We believe the incremental expense of this system will deliver long-term benefits and help our team provide better customer service and feedback to clients. We reallocated reimbursement resources to provide additional sales and providers support. Our reimbursement team has sucked the bar higher for service to our clinics and our patients that recently realigned processes and people to geographically focused teams versus by function. Early feedback from providers and patients has been very positive and we believe we will lead to improvements to our revenue cycle process. Finally, we've managed our direct to patient's digital marketing initiative hiring a digital marketing firm experienced in medical device marketing and they will focus on education and increasing awareness of bronchiectasis and the value of Airway Clearance with clinicians and patients. Through these actions we envision a return to double-digit sales growth in fiscal 2019. We believe that focusing on sales force productivity is the prudent approach to managing our business for the significant long-term growth opportunity in front of us and as our productivity improves we will resume sales team expansion with a measured in methodical approach. To conclude the fundamental pieces of Electromed's growth opportunity remain as strong as ever. Conservatively we estimate that there are 400,000 Medicare only patients and up to $1.1 million total individuals in the United States that have non-cystic fibrosis bronchiectasis of which between 5% and 15% have been prescribed HFCWO therapy with devices like SmartVest has the only independent publicly traded manufacturer of these Airway Clearance devices designed for used in the Home Care setting. We are participating in the right market with the right product and service at the right time. We believe we are a critical part of the solution to improve quality of life and outcomes for an expanding number of patients with compromised pulmonary function while reducing health care 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 for Q3 of fiscal 2018 increased 6.35% to $7.1 million from $6.7 million in Q3 of fiscal 2017 driven by growth in Home Care and institutional sales. Homecare sales increased 6.4% to $6.5 million due to higher average selling price per device which was partially offset by a lower level of referrals and approvals as compared to the same quarter in fiscal 2017. Institutional revenue increased 15.8% to $506,000 from $437,000 in the prior year quarter and international revenue which is not a strategic growth area for Electromed total approximately $120,000 compared to a $155,000 in a prior year period, although quarter-to-quarter sales variability can be expected due to the nature of our business. We anticipate returning to double-digit revenue growth in fiscal 2019. Gross profit rose 5.4% to $5.6 million or 79% of net revenues in Q3 of fiscal 2018 from $5.3 million or 79.7% of net revenues in Q3 of fiscal 2017. The increase in gross profit primarily resulted from an increase in Home Care revenue. We believe that gross margins were range in the mid to upper 70s as we proceed in the fiscal 2019. Operating expenses, which include SG&A as well as R&D expenses totaled $5.1 million or 72.1% of net revenue in Q3 of fiscal 2018 compared to $4.3 million or 64.1% of net revenue in the same period of the prior year. SG&A expenses increased $28.9% to $5.1 million in Q3 of fiscal 2018 from $4.2 million in Q3 of fiscal 2017 primarily due to additional employees in sales, annual sales increases higher share based equity compensation expense, additional sales incentives, and higher revenue, and increases in certain professional fees. Research and development expenses totaled $43,000 in Q3 of fiscal 2018, compared to $81,000 in the same period the prior year. And our operating income in Q3 of fiscal 2018 decreased from $2,485,000 from $1 million in Q3 of fiscal 2017, primarily due to higher investments in SG&A and support of our revenue growth initiatives which more than offset growth in gross profit. Net income before income tax expense totaled $486,000 in Q3 of fiscal 2018 compared to $1 million in the prior year quarter and in Q3 of fiscal 2018 income tax expense totaled $173,000 compared to $380,000 in the same period of the prior year. Our effective tax rate for the third quarter of fiscal 2018 was 35.6% compared to 37% in the prior year period. I'd like to point out that our income tax expense during the third quarter of fiscal 2018 benefited from a reduced statutory corporate federal tax rate. During fiscal 2018 we will see a blended federal statutory rate of approximately 28% that will decrease to 21% in fiscal 2019. The reduction in the statutory corporal federal tax rate from 34% to 21% is due to the Tax Cut and Jobs Act that was enacted by the U.S. government on December 22nd, and became effective January 1 of 2018. Our net income in the third quarter of fiscal 2018 equaled $313,000 or $0.04 per diluted share compared to $648,000 or $0.08 per diluted share in the same period in the prior year. And now moving on to the balance sheet and operating cash flow. Our balance sheet at March 31, 2018 included cash of $7.1 million, current maturities of long-term debt of $1.1 million, working capital of $16.2 million, and shareholders equity of $20.5 million. Cash flow provided by operations in the third quarter fell to $342,000 compared to cash flows provided by operations of $767,000 in the same quarter of the prior year. Overall, we remain excited about where our business is heading. And this concludes my remarks. Operator, we can start the Q&A portion of the call, please.

[Operator:]

Thank you. [Operator Instructions] Our first question comes from the line of Jenifer Taylor with MAC Funds. Please proceed with your question.

[Jenifer Taylor:]

Hi, good morning. Thank you for the opportunity here. I want to just touch upon a little bit of the CRM implementation, sort of tracking new customers, and in the Homecare line. Is that -- should we see some direct correlation just to sort of better manage that for it's growth. And then secondarily, I was also just wondering about the competitive landscape and if you could just review where we are and whether or not you're seeing any response competitively. Thank you.

[Kathleen Skarvan:]

Hi, Jenifer, it's great to have you on the call today. This is, of course, Kathleen. I appreciate your two questions here, and let me take the CRM first. And the response to your question around is it going to help us track our patients, track our clinics, and potentially advance our ability to move forward with our growth strategies. And the answer is absolutely. This is a CRM that's a bit unique. And it is customized for our needs. And as you know, since we are working in the homecare environment the service level to a patient is so critically important, not only for the patient, but for the provider to know that their patient is being responded to in a timely manner, that their product is being shipped, that the trainer has been there in the home. And so our sales team will have the same information that our reimbursement team has here on that whole process. And so, in addition to our people here at reimbursement and our corporate office, the sales team can be intimately involved in that communication and that responsiveness. Also, as you know, it will be used for generating leads and helping us to expand our footprint and the number of clinics that we're brining on and working with, with SmartVest. So we are really excited about it, and getting that positive feedback from our team and our providers. On the competitive landscape, again, I appreciate this question. And I would say that from an external -- externally the competition is certainly something that has been a force for us. And when you think about the tac [ph] that we took nine months ago in deciding that we needed to accelerate our growth with more people in the field selling our product, it was partially a response to the competitive forces. It also of course primarily is because we feel there's a great opportunity out there to identify bronchiectasis patients and the airway clearance is an appropriate therapy to help improve their quality of life. But with those two larger competitors, and then RespirTech being purchased by Phillips, we know that we're outnumbered in the field almost four to one. And in order for us to grow and stay relevant and to take our piece of this market and help grow it that was so important to put those people in the field. What we've seen in the last nine months is that our competition has taken notice of that, and they've also taken notice historically of our success and the growth rates that we've had. And so we are seeing a little more pressure in our stronghold clinics with our competition visiting and trying to sell their value. We're confident we can continue to protect our strongholds, and also sell on our value with going deeper into those clinics where there's more patients, but also to attack those competitive clinics as well. So hopefully that helps answer your question.

[Jenifer Taylor:]

Okay. And it does, thank you for the color. But when you're saying seeing pressure, I'm just wondering are they -- is it a pricing game they're trying to play, are they trying to -- I'm just kind of wondering really what the hand-to-hand combat is that you all may be experiencing.

[Kathleen Skarvan:]

Sure. I can certainly provide a little more specificity around that. Typically it wouldn't be pricing in the homecare environment, although the pricing is typically controlled by the contracts we have with commercial insurers and MCOs that could be through the state with Medicare and Medicaid. So as those contracts are renewed or we're seeking new contracts there can be pricing pressure there. I wouldn't say that's a major issue for us from a competitive standpoint. It's certainly something that's always out there and there can be some shifts there. Most of the pressure can come from the frequency that the competitors are visiting clinics. It can come from a service level, in that they may take strategic clinics and say something like, "I'm going to ship on the prescription and not wait until the patient's medical documentation is collected and I know for sure that we're going to receive an approval and be able to book revenue, they may take more risk on that." And the clinic may say, "Well, I want to get this to my patient as quickly as possible, and so I'm going to pick your device because of that responsiveness and that service level that you can provide." Now that may be a okay strategy for a quick switch or a change, but it's not sustainable because what typically can happen when you do that is that a clinic isn't going to be as responsive for you collecting the medical records that are needed for the patient to receive reimbursement and for us to book revenue. So it's a short-term strategy and one that can be used selectively. And we do it as well. But we've just seen a little tick up from the competition in certain areas with that approach.

[Jenifer Taylor:]

Okay, that's great. I appreciate it. From a reimbursement standpoint, could you describe in that you're, first, taking a more active stand which makes sense, how those conversations are going and where you would get pushback?

[Kathleen Skarvan:]

Jenifer, maybe I could just ask a follow-up question on that just for clarification. Would you be speaking more with our commercial payers as an example there, is that -- or something.

[Jenifer Taylor:]

Yes.

[Kathleen Skarvan:]

Okay. I'm going to let Jeremy take that relative to any of the pushback or pressure that we see from contracting.

[Jeremy Brock:]

And from a contracting standpoint we're very happy over the past five years, and really where we even went into this year from a contracting standpoint. Having the majority of everyone in the United States covered under a contract, so would be in network, there are a few medium-sized regional contracts or commercial payers, I should say, that we may not have a contract with. That doesn't mean that we don't get paid, it will -- it may be out of network or we may actually be working with them and doing one-off individual approvals. So from that standpoint we're very happy with that. And then from a contracting -- and the renewals, as Kathleen talked about, from an ancillary provider perspective, which is the type of a contract we would have with any of the major carriers, they are generally evergreen. And there isn't anything like an annual renewal with a discussion on pricing. It's set upfront. And it's generally from that point on that's your pricing going forward. And does that answer your question?

[Jenifer Taylor:]

Yes. No, that's great. Thank you. That's it from it. Thank you.

[Operator:]

Thank you. [Operator Instructions] Our next question comes from the line of Andy Summers with Summers Value Partners. Please proceed with your questions.

[Andy Summers:]

Good morning, Kathleen and Jeremy.

[Kathleen Skarvan:]

Good morning, Andy.

[Andy Summers:]

Just couple of question on my end, so, it sounds like there hasn't been sort of change in the overarching market dynamics in homecare. Is that -- that's correct?

[Kathleen Skarvan:]

I believe that I would agree with that, yes.

[Andy Summers:]

Okay. And price was positive in the quarter. So, your competitive intensity is increasing. You are seeing it in price yet, is that fair?

[Kathleen Skarvan:]

Absolutely, that is fair.

[Andy Summers:]

Okay. So just regarding the sales force's efficacy, you mentioned that you took some initiatives in the quarter. They don't sound overly profound. But so maybe just a little more color on what happened in the quarter will be helpful because your sales force is maturing, but at the same time your efficacy is declining every quarter. So, maybe just talk about what exactly happened in the quarter and why. What happened in March and April gives you confidence that those trends can be sustained going in the fiscal '19?

[Kathleen Skarvan:]

Sure. Thanks Andy for the question. So, just a reminder for everyone on the call that we measure sales productivity by the average number of referrals per sales person in a month, and of course that can be extrapolated for the quarter or the year, and we had specific goals set for sales productivity as we moved into the year and with the additional sales people that we plan to add. And so, as we saw that declining with the number of individuals that we were adding at the beginning of the year, we took actions to shore that up to understand what might be happening different than what we had planned. And then took these actions that you are seeing here. And although they may not seem profound, they have had a significant impact on being able to reverse a sales productivity trend that we had seen for the last quarter. And what -- when you talk about the sales force maturing, when we think about 50% of them are less than one-year old, one could say that yes, it's maturing. But, it's maturing a bit differently than we may have planned at the beginning of the year. And again, some of that's due to external factors like competition, paying more attention to our clinics. It's also due to internal factors where we may have somewhat underestimated the impact of adding new people and also that impact on your veteran camp because you are dividing a territory. And so, your veteran camps then are being asked to develop new clinics to improve their productivity as well as your new camps are going to be given some of the veteran camp clinics, but they are going to be asked to improve productivity as well with new clinics. And so, the amount of effort to develop new clinics or to go deeper with our current clinics was a more of a challenge than we had anticipated. And the measures that we have taken that I explained today are all those measures that have been now helping us to improve that productivity both in March and April. And we're confident that can be sustained with the maturity, as you are saying, of the sales force.

[Andy Summers:]

Okay. Thank you. And the sales force has had some turnover issues, I believe, in the last couple of quarters. Do you feel like you have that under control now?

[Kathleen Skarvan:]

We are more confident that we do, Andy. And it's a combination of the actions that we have taken to help a camp realize success sooner. So, they are gaining the confidence to continue to grow their sales. And, it also is looking overall at our compensation for those camps as well. And although you are not -- we are not going to see some changes in compensation here through the remainder of the fiscal 2018, we are anticipating that our overall sales comp will be higher as we move into 2019. And that will be helpful for our turnover as well.

[Andy Summers:]

Okay, great. And then, one last housekeeping question for Jeremy. You have about a $1.1 million in short-term debt on the balance sheet. Can you just talk about your plans for that debt? Are you going to be paying it off in the quarter or so? Or how should we be thinking about that? Thanks.

[Jeremy Brock:]

Yes, at this time a final decision for what we are going do with that has not been made. I think there is a likelihood that it will be paid off in the future. And, the due date for that is December 31 as far as when it would come due, which would be the likely point when we would pay it off.

[Andy Summers:]

Great. Thank you.

[Operator:]

Thank you. Our next question comes from the line of Mike Geisler [ph] with MNX [ph] Holdings. Please proceed with your question.

[Unidentified Analyst:]

Yes, good morning guys. How are you? Just a couple of quick thoughts; as you know, I am a long-term holder as a many that I deal with. I just want to chime in about the refocusing on institutional. I think that's a good idea. And of course, the geographic focus for your folks both in-house and in the field, I think is terrific. Having had decades of experience doing those things myself. Just two quick things, you spoke about the blended tax rate at 28%. Just wondering it was not coming down faster during this year. Is that -- that's blended fiscally I get that, so that would mean the holdover. So therefore, next year you'll I guess realize that full drop to the 21% on the federal level. And that's how we get the blend two quarters at the higher rate and two quarters at the lower. Is that correct?

[Jeremy Brock:]

Yes, you would be doing the math correct on that.

[Unidentified Analyst:]

Okay. Just want to make sure. And then, you had said that 2019 you expect to see return to double digit growth. I am hopeful that that doesn't mean fourth quarter '18 is going to be a throwaway quarter. And you need not comment on that. It is just my comment. And then, lastly, as a long-term holder of most of the things I do, I just want to know when we spoke and we have spoken before about the Rovoco products and which is obviously a terrific, in my opinion, product. Of course, it's not a revenue generator per se, huge import. My question would be since your competitor one of them has introduced a portable line. And I believe on the last conference call you had mentioned describing that. The item is really not a replacement for the SmartVest quality product, but more a function of like an add-on product for many patients. Is there down the road an opportunity for looking at selling that? Some of sort -- or at least in terms of R&D looking ahead to some sort of portability product as an add-on that would be a less expensive device but part of a packaged item that could be put together for patients so that when your presentations are made both at the clinician level as well as to the patient directly, you are providing the SmartVest connect quality S2L quality product. And then saying in addition here's another idea we have for you. And if you combine these two products, it will give you the 110% service that we always give and will still allow you the flexibility for those occasions when you go visit your kids on the coast and/or are not available or whatever, you can use the product portably. And then, of course, that would generate additional revenues. I realize there is some cost involved. But is that something that could be considered down the road? And I don't mean necessarily in the next two quarters, but certainly in the next 10 quarters?

[Kathleen Skarvan:]

Hello, Mike. Thank you for being a long-time shareholder. And we appreciate your question. First of all, I want to address your comment about a throwaway quarter. This is absolutely not a throwaway quarter. We are working diligently to continue growth. And we want all the shareholders and investors to understand that is our focus. As far as the Monarch, which is the kilogram [ph] portable device, it is primarily being sold as a second device to cystic fibrosis patients, although we have heard occasionally of docs prescribing it for elderly bronchiectasis patients, we think that is less of a market based on its weight. And for bronchiectasis patients, being able to really utilize the portability of walking outside, and taking it to work as an example, we think that is more suited for cystic fibrosis patients as a second device. When we think about Electromed and what our plans are for the future, we are really focused this year on collecting an assessing and researching sound voice of the customer when it comes to what our next-generation device should look like, and what the needs of that patient are. And often what we're hearing. And this focus is primarily on our bronchiectasis patients because that is where the growth opportunity is from our viewpoint. They want something that is somewhat un-tethered, so that if they're using their treatment twice-a-day that if the doorbell rings they can go, open the doorbell without having to unplug or unhook their device, or they might be able to answer the phone. So those are some of the early pieces of information we are collecting, and we certainly are going to incorporate that, also understanding what the competitors are doing into that next-generation. So be assured that we are paying attention and that is going to be met with some very deep due diligence here as we see exit the quarter and think about our plans for '19.

[Unidentified Analyst:]

Okay, thank you. Just on that line, I guess you are looking at guidance like a quick release, quick re-plug in, and pause buttons et cetera, so those two examples you gave about doorbell and telephone…

[Kathleen Skarvan:]

Yes. They could go around that, yes.

[Unidentified Analyst:]

Right, just things as you speak. In any case if I have any further issues, I will be happy to give Jeremy a call. I want to thank you for the time, and good luck this quarter.

[Kathleen Skarvan:]

Thank you, Mike.

[Jeremy Brock:]

Thank you.

[Unidentified Analyst:]

Okay. Bye-bye.

[Operator:]

Thank you. [Operator Instructions] It appears there are no further questions at this time. I would like to turn the floor back to Kathleen for any closing comments.

[Kathleen Skarvan:]

Thank you all for participating on our call this morning. We look forward to reporting back to you in September when we release our fourth quarter fiscal 2018 financial results. Have a good day.

[Operator:]

Thank you. Ladies and gentlemen, this concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.