Electromed, Inc. Q1 FY2020 Earnings Call

Greetings, and welcome to the Electromed, Inc.’s First Quarter Fiscal 2020 Financial Results Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Kalle Ahl of The Equity Group. Thank you. You may begin.

Thank you, Donna, and good morning, everyone. Electromed's first quarter fiscal 2020 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. Before we get started, I need to remind you that today’s call will contain forward-looking statements. Such statements are subject to risks and uncertainties that could cause actual performance or achievements to be materially different from those discussed in the forward-looking statements. Due to many factors including the risks and uncertainties identified in our earnings press release which we have furnished on a Form 8-K and in other filings with the Securities and Exchange Commission. 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 first quarter fiscal 2020 financial results, and then we will open the call for questions. Now, it's my pleasure to turn the call over to Kathleen.

Thank you, Kalle. Good morning, everyone, and thank you for joining us. We commenced fiscal 2020 with strong performance in the first quarter, which is typically a seasonally light period of the year for us. Our net revenue grew 14.1% year-over-year to $8.3 million driven by an 11.4% increase in Home Care revenue and a 49.2% increase in institutional revenue. In our Home Care market, all key revenue metrics improved year-over-year including referrals, approvals, and approvals as a percentage of referrals. This performance is attributed to our employees’ teamwork and their focus and passion for helping people breathe easier and live better. Additionally, the average selling price per device increased compared to the same period in the prior year coming in at the high-end of our normal range due primarily to payer mix. We anticipate that ASP will moderate from the above-average first-quarter level for the remainder of the fiscal 2020 year. Importantly, this quarter, we continued to deliver improved sales force productivity with approximately $879,000 of annualized Home Care revenue per direct field sales employee, well ahead of the comparable figure of $659,000 for the first quarter of fiscal 2019 and above our target range of between $750,000 and $850,000. We believe that we are benefiting from several actions initiated last fiscal year including the pause in our sales force expansion and the restructuring of our sales footprint from five to four regions. New sales leadership appointments, enhanced sales training programs, better communication of SmartVest patient wellness feedback to clinicians, improved targeting approaches and clinic call frequency, and the publication of a first-of-its-kind independent study published in BMC Pulmonary Medicine in April 2019, which concluded that early initiation of therapy with SmartVest decreases severe exacerbation, reduces antibiotic use, and stabilizes lung function for bronchiectasis patients. At quarter end, our field sales employees totaled 38, of which 32 were direct sales compared to 49 at the end of the first quarter of fiscal 2019, of which 41 were direct sales. Our plan remains to peak at approximately 38 direct sales reps in fiscal 2020, after which we do not plan to significantly add to our sales team count until we have demonstrated sustained productivity levels. We are confident about meeting or exceeding our target productivity levels of $750,000 to $850,000 for the full fiscal year as we continue to focus on those strategically high-prescribing clinics and Home Care referrals from hospitals, pursue the right balance of competitive accounts and Greenfield opportunities, enhance direct sales recruitment, assessment and evaluation practices, institute sales leadership co-travel with new field sales employees and leverage sales training programs, account planning tools, management coaching, and our CRM utilization. Our institutional revenue growth this quarter reflects our greater emphasis on strengthening relationships and winning business with integrated delivery networks targeting institutional accounts and a more experienced and better trained sales force. We also benefited this quarter from additional sales into the rental market with a new customer that purchased our devices for rental to hospital institutions and skilled nursing facilities. During the first quarter, we recruited another experienced institutional sales representative, bringing our dedicated institutional sales count from one to two full-time employees. We expect growth in our institutional business to augment our Home Care revenue as the High-Frequency Chest Wall Oscillation or HFCWO brand used in hospitals is often the default brand prescribed to start discharging a patient. This is why we have repositioned our sales reps' targeted accounts to include a higher number of call points in SmartVest hospitals where our brand is used with patients during their stay. We are encouraged as our discharge referrals from hospitals in the first quarter of fiscal 2020 increased compared to the same period in the prior fiscal year. As a reminder, hospital discharge referrals are categorized as Home Care revenue. Finally, in the first quarter, we recorded our initial Home Care distributor sales totaling approximately $120,000. As we have previously discussed, we are not anticipating our new relationships with Home Medical Equipment distributors to have a significant impact on Electromed’s top and bottom-line financial performance in fiscal 2020. We intend for our direct sales channel to remain our primary Home Care revenue source. The strategy to engage selected Home Care distributors supports our efforts to broaden the SmartVest brand, particularly in geographies where we have low market share such as certain areas of the Western United States. Shifting to the bottom line, we achieved strong first-quarter net income of approximately $1 million, or $0.12 per diluted share reflecting 14.1% revenue growth and significant operating margin improvement to 16.2%. While we are pleased that this quarter’s SG&A expenses again rose at a slower rate than our revenue growth, I’d like to point out that we also benefited on the cost side from open sales positions being recruited during the quarter. Our VP of Sales, Bud Reeves, has identified opportunities to upgrade talent, and he is working in a disciplined manner to bring on new hires. Additionally, one of our direct sales employees was promoted internally to a sales manager position. For the remainder of the year, we anticipate that our operating expenses will ramp up from the first quarter’s run rate as we plan to bring our total direct sales staff count to our previously disclosed target level of 38 and hire a new sales manager for the Western region. We also expect to increase our R&D spend in the second half of fiscal 2020 initiating development for a next-generation product, and we anticipate incurring some additional costs on clinical studies designed to educate physicians on SmartVest's value in improving quality of life and outcomes for non-cystic fibrosis bronchiectasis patients. Notwithstanding these incremental investments, we expect that our revenue growth will outpace expense growth in fiscal 2020 leading to operating margin improvement for the year. Furthermore, we expect to achieve our target sales productivity levels and low-double-digit revenue growth in the long term. In conclusion, we commenced fiscal 2020 on a strong note and are excited about our future. We continue to believe that non-cystic fibrosis bronchiectasis or NCFB represents a significant growing market opportunity, conservatively estimated at more than 4 million individuals in the U.S. We also believe that approximately 630,000 people with bronchiectasis diagnoses could benefit from HFCWO therapy. Yet only an estimated 70,000 patients in the Medicare population have been treated with a device like SmartVest today. The growing body of clinical evidence, combined with the powerful patient testimonials that we routinely hear supports the use of Electromed’s SmartVest Airway Clearance device as a standard of care among individuals with NCFB. We intend to continue to differentiate our solution, first with our therapy that consistently demonstrates delivery of lower oscillatory trough pressure and greater percent decompression than our competitors’ devices. Specifically, we deliver the lowest trough pressure at varying amplitude settings. Amplitude relates to the pressure a patient experiences while wearing our therapy; lower oscillatory trough pressure and greater percent decompression allows patients to take deeper breaths during their therapy, and our patients report a more comfortable treatment. And we continue to differentiate our solution with our best-in-class reimbursement team and a stronger, maturing sales organization that is achieving greater productivity. With that, I will turn it over to Jeremy for a more detailed discussion of our financial results.

Thank you, Kathleen, and good morning, everyone. Our net revenue in the first quarter of fiscal 2020 increased 14.1% to $8.3 million from $7.3 million in the same period in the prior year driven primarily by Home Care revenue growth. Home care revenue increased 11.4% to $7.5 million, primarily due to a higher average allowable based on payer mix as compared to the prior year and a greater referral to approval percentage. Institutional revenue increased 49.2% to $625,000 from $419,000 in the same period in the prior year due to a higher average selling price per device and an increase in the number of devices we sold. Home care distributor revenue, which commenced this quarter with our first sales to Home Care Medical distributors, was approximately $120,000, and international revenue, which has not been a strategic growth area for us, totaled approximately $66,000 compared to $135,000 in the prior year period. As a reminder, quarter-to-quarter sales variability can be expected due to the nature of our business. Gross profit increased 14.4% to $6.3 million or 76.4% of net revenue in the first quarter of fiscal 2020 from $5.5 million or 76.2% of net revenue in the same period of the prior year. The increase in gross profit resulted primarily from an increase in Home Care revenue; a slight increase in gross profit as a percentage of net revenue was driven by a higher average allowable due to payer mix as compared to the same period in the prior year. Operating expenses, which include SG&A as well as R&D expenses, totaled $5 million or 60.1% of revenue in the first quarter of fiscal 2020, compared to $5.3 million or 73.4% of revenue in the same period of the prior year. In the first quarter of fiscal 2020, SG&A expenses decreased by $378,000 to $4.9 million from $5.3 million in the same period of the prior year. And as a percentage of revenue, SG&A expenses improved to 59%, compared to 72.5%, reflecting open positions in sales and administrative roles and our ongoing cost containment efforts. R&D expenses increased to $99,000 from $68,000 in the first quarter of fiscal 2019, and commencing in the second half of fiscal 2020, and continuing through fiscal 2021, we anticipate higher R&D expenses that will be approximately 2% to 4% of net revenue for the development of the next-generation product that Kathleen discussed earlier. Operating income in the quarter increased to $1.3 million from $202,000 in the same period in fiscal 2019 and net income before income tax expense totaled $1.4 million in the first quarter of fiscal 2020, compared to $215,000 in the prior year quarter. In the quarter, income tax expense totaled $374,000, compared to $58,000 in the same period of the prior year, and our effective tax rate in the first quarter of fiscal 2020 was 26.9%, compared to 27% in the prior year period. Our net income totaled $1 million or $0.12 per diluted share in the first quarter of fiscal 2020, compared to $157,000 or $0.02 per diluted share in the prior year period. Now moving on to the balance sheet and operating cash flow. Our balance sheet at September 30, 2019, included cash and cash equivalents of $8 million, no debt, working capital of $21.8 million, and shareholders' equity of $27 million. Cash flow from operations in the quarter totaled $629,000 compared to $303,000 in the prior year period. We are pleased to be debt-free and able to continue building our cash reserves to support Electromed's long-term growth strategies. As we discussed on prior calls, we have been working on a building expansion project here in New Prague which we completed during the first quarter and now occupy. The total cost of the project was approximately $1.5 million, and we believe it will save us over $130,000 in annual lease expenses, while providing us with sufficient infrastructure to support our long-term growth. Overall, we remain focused and confident in the direction of the business. And this concludes my remarks. Operator, please start the Q&A portion of the call.

The floor is now open for questions. Our first question is coming from Kyle Bauser of Dougherty & Company. Please go ahead.

Hi. Good morning, Kathleen and Jeremy.

Good morning.

Good morning, Kyle.

Really strong quarter here. Appreciate all the updates and you gave some nice color on how we should approach the financials this year. So, maybe I’ll focus on the market opportunity. It still sounds like significant business opportunities here; bronchiectasis is obviously highly under-diagnosed. So, if we look at your sales year-to-date, ballpark, what sort of percentage do you think is share gains from competitors versus the percentage from increased market penetration?

Thanks for the question, Kyle. As we’ve talked to our shareholders in the past, getting that detailed information can be rather difficult as you are increasing the size of the pie as well as looking at taking competitive share. So, typically, we think about that as probably a higher percentage of market development right now and a little less on the competitive side. I think as we bring on these new salespeople that we are talking about here this quarter and probably throughout some into next quarter, but that focus will be stronger on that competitive share and taking that since we find that new salespeople is often the best approach to reaching productivity at a faster pace. So, I’d probably put that at maybe an estimate of about 70% market development and 30% share.

Okay. That’s helpful. And if we stick with the bucket for the increased market penetration. Those are sales from physicians that didn’t prescribe HFCWO previously, is that right?

Well, it’s typically a combination of two things, Kyle. One is it would be from physicians that aren’t traditionally or routinely prescribing and it also can be a physician that now is finding and identifying more patients with bronchiectasis in their practice. So, it’s two-fold from a market development standpoint. We called out a little bit of that latter go deeper strategy to help that physicians see that if 50% of the COPD population that has severe and very severe COPD, likely have bronchiectasis and these are our physicians that are more mindful of that.

Okay. Understood. Just trying to kind of get at the total market opportunity, maybe in terms of prescribers and on the COPD market is over $15 million and bronchiectasis is $4 million or so. So, how many relevant physicians are - maybe I’ll ask it this way, are prescribing HFCWO actively and how many do you think aren’t but would be a target of yours?

So, we would estimate a range of pulmonologists that prescribe HFCWO to be probably over 50% of the pulmonologists, and that number is in the 10,000 to 15,000. And, so, that could help give you a little bit of a feel for what we are looking at.

Okay. And just sticking with that, so do you - you talked about new targeting approaches and just new sales tactics that are clearly ramping up the productivity of the sales force. Can you just talk about how you are identifying key new targets? I mean, do you have access to procedure, prescription data to help you identify the high-volume account or are you kind of more focused on driving utilization with existing accounts? Just kind of wondering about more color on these sales strategies.

Sure. I’d be glad to share that with you. We have databases that provide us information on pulmonologists that are prescribing HFCWO under the E0483 reimbursement code from CMS. We also have lists of pulmonologists in the United States, so we can compare who is prescribing and who isn’t. Those that do prescribe are primarily our targets and that would be from a competitive standpoint and then also those physicians that may have multiple pulmonologists in their facility or their clinic. Those would also be a target for us. And then the other area that we look at is what’s called J-codes or those J-codes are often those of a COPD diagnosis. So, we are looking for population centers where there is a high incident rate of those J-code diagnoses because again, we know we should be fishing, so to say, in those population areas where there is high incident of COPD because that’s where the bronchiectasis patients are as well. So, hopefully that helps you.

Yes. Yes. Yes. That’s really helpful. And then, just lastly if I may, regarding the first-of-its-kind UAB study of assets in the past, but just wanted to get an update a couple of months later here, how that has maybe won share or helped in the sales process in new business?

Yes, so I think for those physicians that may be skeptical of the value of High Frequency Chest Wall Oscillation, this is a compelling study for them and it does help them to sit up and notice what we used then if – then we have the opportunity for them to prescribe and to see firsthand what the value of HFCWO can be for their bronchiectasis patients or a patient with other lung function disorders that qualified for reimbursement. Once we can help them to start with one patient, then we provide them our wellness check feedback on that patient so they can see firsthand with their patients how those outcomes are making a difference for their specific patient. That helps us to – we believe help that physician in looking for bronchiectasis and diagnosing it and then prescribing more of a routine. So, we think it’s been very helpful for us in looking and addressing a physician as I just described.

Okay. Thank you. I’ll jump back in queue. Congrats on the great quarter.

Thank you, Kyle.

The next question is coming from Tim Chatard of Meros Investments. Please go ahead.

I have a question related to reimbursement and – I don’t know if I am barking up the wrong tree, but is there a competitive bidding ongoing for 2020? And if so, how many collectives or competitive bidding areas are you participating in? Are you part of that process with your medical equipment?

Well, hello, Tim. Thank you for the question. High Frequency Chest Wall Oscillation or the E0483 code has not been involved in any form of discussions around competitive bidding. And we don’t – we have not seen anything to indicate that that’s in the foreseeable future.

Okay. Somehow I got it in my head that the code, the relevant code was D0467; I was just doing some work on something else. But if I have mistaken that, it wouldn’t be a surprise. Okay, that’s fine. That’s all I’ve got. Thanks.

Thank you, Tim.

Thank you. Our next question is coming from Mike Dessler of MNX Holdings. Please go ahead.

Yes. Good morning, Kathleen and Jeremy. This is really fast. I have been on virtually every call since you’ve been there, Kathleen, perhaps longer. The – I just want to say both of you very clear presentations are always very forthcoming, and we love it. Congrats on a great quarter. You just have to listen to me for one more minute. I am glad to see in here that the – that hospital first contact that we’ve discussed in years past is leading to that stickiness and it’s kind of showing up in those numbers now. So, that’s terrific. Congratulations on your new digs. And good luck on the next-generation with your R&D development this year and thanks for listening to me.

Well, thank you very much, Mike.

Thanks, Mike.

Appreciate your comments.

Absolutely. Thank you.

At this time, I would like to turn the floor back over to Ms. Skarvan for closing comments.

In conclusion, I want to thank our Electromed team of employees for their passion and their commitment to helping more patients receive our SmartVest Airway Clearance System so that these patients may breathe easier and live better. Thank you all for participating on our call this morning. We look forward to reporting back to you in February when we will release our second quarter fiscal 2020 financial results. Have a good day.

Ladies and gentlemen, thank you for your participation. This concludes today's event. You may disconnect your lines at this time and have a wonderful day.