Earnings Call Transcript - ELMD Q3 2020

Kalle Ahl, Host

Thank you, Rachel, and good morning everyone. Electromed’s third quarter fiscal 2020 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 you that some of the statements that management will make on this call are considered forward-looking statements, including statements about the company’s future operating and financial 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. Any such statements represent management’s expectations as of today’s date. You should not place undue reliance on these forward-looking statements and the company does not undertake any obligation to update or revise forward-looking statements whether as a result of new information, future events or otherwise. 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 2020 financial results, and then we will open the call for questions. Now, it’s my pleasure to turn the call over to Kathleen.

Kathleen Skarvan, CEO

Thank you, Kelly. Good morning, everyone, and thank you for joining us to discuss Electromed’s third quarter fiscal 2020 financial results and recent developments. Much has changed in the world since our last conference call in February. Coronavirus, or COVID-19, has disrupted global economies, healthcare systems, and people’s lives. Our thoughts are with those individuals whose health has been jeopardized by this crisis, and we extend our gratitude to the healthcare professionals fighting COVID-19 on the frontlines. I am proud of our team’s unwavering commitment to ensuring the seamless manufacturing and delivery of SmartVest airway clearance devices during these challenging times. Amidst the onset of the COVID-19 outbreak, we achieved strong revenue growth of 18% from the prior year period and a net income of $653,000 in our fiscal third quarter while prioritizing the health and safety of our employees, clinicians, and patients. Before discussing our financial results, I would like to review the measures we have taken to protect the well-being of our people and the actions we have taken to mitigate the impact of the COVID-19 pandemic on our business. Regarding our safety initiatives, we instituted staggered work shifts and created separate workstations to accommodate social distancing. We implemented a policy requiring all employees to wear masks and additionally gloves in our manufacturing areas. We encourage remote and flexible work arrangements for employees where feasible. We ceased all non-essential travel and we established strict on- and off-site sanitation and infection control practices. Regarding our actions to mitigate the impact of COVID-19 on Electromed’s business, we strengthened our communication to clinics via videoconference for virtual in-services, therapy demonstrations, and patient follow-up. We implemented virtual training options for patients to minimize contact. We focused on building awareness among practitioners of recent Centers for Medicare and Medicaid Services (CMS) waivers that modify certain rules for prescribing respiratory-related devices, of which SmartVest is included. Under the waiver, clinical indications and documentation typically required will not be enforced for respiratory-related products. This waiver applies only to Medicare patients with non-commercial Medicare plans. The minimum documentation now requires a valid order and documentation of a respiratory-related diagnosis. Face-to-face and in-person requirements for respiratory devices are being waived also. While it is difficult to quantify the precise impact of COVID-19 on Electromed’s operations, as we exited March and through April, many clinics closed temporarily, restricted their operating hours, or moved to virtual visits. Many consultations are now happening exclusively via telehealth. For those locations that remain open, pulmonologists are often working significant hours in hospitals treating COVID-19 patients, leaving less time for traditional consultations. Electromed’s home care referral pipeline and subsequent revenue have been negatively impacted as a result of fewer in-person visits during the onset of COVID-19. The CMS waivers I discussed earlier may somewhat offset the negative impact of fewer in-person consultations, and we have quickly reengaged face-to-face access to clinics and hospitals in those states where restrictions have started to ease. Clinicians who prescribe high-frequency chest wall oscillation (HFCWO) therapy ultimately are keeping individuals out of hospital emergency rooms and intensive care units, minimizing their exposure to coronavirus while freeing the capacity of healthcare professionals to care for the sickest COVID-19 patients. With the CMS waiver, we believe that a higher than average percentage of the Medicare patient referrals we receive will convert to approvals; non-commercial Medicare referrals represent about 55% of our business typically. Overall, due to the inherent uncertainty of the unprecedented and rapidly evolving situation, we are unable to predict with confidence the likely impact of the COVID-19 pandemic on our future business and financial performance. Given these uncertainties, we are implementing cost savings measures, which include reducing discretionary and variable spending such as travel, the use of contractors, consultants, temporary help, and employee furloughs in our manufacturing and general and administrative functions in response to the lower near-term demand for our products. We expect these cost reductions will lead to approximately $450,000 of savings per quarter, which we expect to partially realize in our fiscal fourth quarter. With the interim situation while it is uncertain, we remain confident that we can achieve longer-term double-digit revenue growth once the impact of COVID-19 subsides. We are hopeful that this current scenario will be temporary. However, if this pandemic persists for an extended period or worsens, we are in a strong position to weather the storm. First, Electromed is considered an essential business under federal guidelines. Second, we have a strong balance sheet, with approximately $9.9 million in cash, no debt and future cash flow on accounts receivable of approximately $13.3 million at the end of March. We also have $2.5 million of availability under our credit facility, providing us with extra financial flexibility if needed. Finally, we participate in a growing industry with favorable long-term tailwinds. Now, moving on to our financial results for the third quarter of fiscal 2020, starting with our home care business, net revenue increased 14.3% year-over-year, primarily reflecting a higher average selling price per device due to payer mix and a greater percentage of referrals getting approved. At quarter-end, our field sales employees totaled 44, of which 37 were direct sales, compared to 41 at the end of the third quarter of fiscal 2019, of which 35 were direct sales. We produced approximately $880,000 of annualized home care revenue per direct field sales employee, well ahead of the comparable figure of $669,000 for the third quarter of fiscal 2019 and above our target range of between $750,000 and $850,000. Our institutional business logged another strong performance, with revenue up approximately 47% compared to last year's third quarter, driven by higher average selling price and increased volume, which was driven by the COVID-19 pandemic. Shifting to the bottom line, we achieved strong third quarter net income of approximately $653,000, or $0.07 per diluted share, underscored by a year-over-year improvement in operating margin of 10.4%. We accomplished improved margins despite increases in consulting and professional fees and more than doubling our investment in R&D during the quarter for our next-generation product. I would like to make a brief comment on our CFO transition. As announced in March, Jeremy Brock has agreed to continue in the CFO role until July 1, 2020. First of all, I want to thank Jeremy for his many significant contributions to Electromed over the last eight years. He has been an invaluable part of the team and will be missed. Our national search process is progressing well. We have identified and interviewed an impressive group of candidates. We remain on track to bringing a new CFO on board prior to July 1 and plan to provide an update soon. In closing, we wrapped up a strong first nine months of fiscal 2020, and our employees have responded admirably during the COVID-19 pandemic. Our long-term thesis remains intact. Non-cystic fibrosis bronchiectasis represents a significant and growing market opportunity, conservatively estimated at more than 4 million individuals in the United States. Serving our patients, particularly at this time when healthcare systems may be overwhelmed by COVID-19 patients, is critically important to improve their airway clearance, enhance respiratory function, and reduce hospitalizations. As the nation emerges from this crisis, we anticipate Electromed returning to the strong cadence of profitable growth that we achieved in the last several quarters. With that, I will turn it over to Jeremy for a detailed discussion of our financial results.

Jeremy Brock, CFO

Thank you, Kathleen, and good morning everyone. As Kathleen shared, our net revenue in the third quarter of fiscal 2020 increased 18% to $8.7 million from $7.4 million in the third quarter of fiscal 2019, driven by growth in home care revenue. Home care revenue increased 14.3% to $7.8 million, primarily due to higher average allowable based on payer mix and a greater percentage of referrals getting approved. Institutional revenue increased 46.9% to $609,000 from $414,000 in the prior year period due to higher average selling price per device and an increase in volume of devices and garments sold. In the first quarter of fiscal 2020, we began selling into home medical equipment distributors. Distributor revenue totaled $165,000 during the third quarter of fiscal 2020. To reiterate, our direct sales channel remains our primary focus. We believe the home care distributor channel is complementary to our core business, particularly in those areas of the country where our SmartVest brand is under recognized, and we see opportunities for accelerating growth on a supplemental basis. International revenue, which is not a strategic growth area for Electromed, totaled approximately $137,000 compared to $142,000 in the prior year period. Quarter-to-quarter sales variability can be expected due to the nature of our business, and the COVID-19 outbreak will likely have a temporary overall negative impact on our revenue. That said, we anticipate a resumption of long-term double-digit revenue growth on the back end of this pandemic. Gross profit increased 18.3% to $6.6 million, or 75.4% of net revenue in the third quarter of fiscal 2020, from $5.6 million, or 75.2% of net revenue in the third quarter of fiscal 2019. The increase in gross profit resulted primarily from an increase in home care revenue and the increase in gross profit as a percentage of net revenue was driven by a higher average allowable based on payer mix as compared to the prior year, and we expect our long-term gross margins to continue to range in the mid-to-high 70s. Operating expenses, which include SG&A as well as R&D, totaled $5.7 million, or 65% of revenue in the third quarter of fiscal 2020, compared to $5.1 million, or 69% of revenue in the same period of the prior year. SG&A expenses increased 7.1% to $5.3 million in the third quarter of fiscal 2020 from $4.9 million in the third quarter of fiscal 2019, primarily due to higher consulting and professional fees. R&D expenses increased to $392,000 in the third quarter of fiscal 2020 from $171,000 in the prior year period, and we expect R&D expenses in our fiscal fourth quarter will be slightly higher than this quarter based on the timing of projects related to our continued investment in new product development. Operating income increased to $913,000 in the third quarter of fiscal 2020 from $465,000 in the third quarter of the prior year. Net income before income tax expense totaled $947,000 in the third quarter of fiscal 2020 compared to $492,000 in the prior year quarter. In the quarter, income tax expense totaled $294,000 compared to $139,000 in the same period of the prior year. Our effective tax rate in the third quarter of fiscal 2020 was 31% compared to 28.3% in the prior year period. Our net income totaled $653,000, or $0.07 per diluted share, in the third quarter of fiscal 2020 compared to $353,000, or $0.04 per diluted share, in the prior year period. Moving to the balance sheet and operating cash flow, our balance sheet at March 31, 2019, included cash of $9.9 million, no long-term debt, working capital of $24.2 million, and shareholders' equity of $29.3 million. Cash flows from operations in the third quarter of fiscal 2020 totaled $889,000 compared to $351,000 in the third quarter of fiscal 2019. We are very pleased to be debt-free and we continue building our cash reserves, which will support Electromed’s long-term growth strategies. Moreover, given uncertainty surrounding the COVID-19 crisis, we are fortunate to have the financial flexibility that our balance sheet affords us. I would like to point out that subsequent to the quarter end, we received a stimulus payment in the amount of $913,000 related to the Coronavirus Aid Relief and Economic Securities Act (CARES Act), and it was related to the Provider Relief Fund, which may partially offset losses in revenue due to the impact of the COVID-19 pandemic. Our ability to utilize the full amount receivable is dependent on the guidelines and rules of the CARES Act, such as the costs incurred to support healthcare-related expenses or lost revenue attributable to the COVID-19 pandemic. Finally, as this will be my last earnings call with Electromed, I would like to thank our shareholders for their support during the past eight years. It’s been a great journey, and I look forward to watching Electromed’s business continue to thrive in the years to come. This concludes our prepared remarks. Operator, please start the Q&A portion of the call.

Kyle Bauser, Analyst

Hi, good morning, Kathleen and Jeremy. Thanks for taking the questions. So, maybe first on the relaxed CMS guidelines regarding the waiver. I imagine this has been very useful in the institutional channel, but just curious, are you utilizing that more in the institutional setting or home care setting? What's been the implication of that? Thanks.

Kathleen Skarvan, CEO

Well, good morning, Kyle, and thank you for the question. The waiver is going to assist patients and pulmonologists, primarily in the home care environment, and also that will help us with the discharge patients. So as people are admitted to the hospital, maybe if they have COVID-19 suffering from a lower respiratory infection, they are being discharged. Many of those patients are being discharged into a long-term healthcare facility or a skilled nursing home, and from there they are being discharged home. So, this would primarily be for our home care part of the business, because it really has to do with the requirements for prescribing and the medical documentation that’s needed in order to qualify for reimbursement.

Kyle Bauser, Analyst

Great. So, 90% of sales come from that channel. That's great to hear. Are you right now during the pandemic – have you seen SmartVest being used in a lot of conditions outside of the normal call point, like bronchiectasis, cystic fibrosis, etc.?

Kathleen Skarvan, CEO

What we typically see that will qualify under the waiver that we may not have qualified or would have been approved previously would be COPD. That would be the primary diagnosis that we're seeing at this time. We have received some prescriptions with a COVID-19 diagnosis. They also would have typically other comorbidities or underlying issues they had even prior to contracting COVID-19. But we do think this is a wonderful opportunity for physicians and patients who normally wouldn't be able to access HFCWO or SmartVest to utilize the waiver to help more patients. It gives us an opportunity to follow those patients and understand how they too are showing improved quality of life and reduced hospitalization, so we're looking forward to understanding how this will continue to help more patients over the next few weeks.

Kyle Bauser, Analyst

Got it. And just a couple more here, if I may. Now that you expect a higher percentage of Medicare patients will convert over due to the waiver, can you remind me what the conversion rate was in the past? Can it go into the high 90s, even 100%? How should we think about that?

Kathleen Skarvan, CEO

We think in that Medicare population that will qualify for the waiver that, as you stated, it could be in the 90% or above, and that's been the experience we've seen in the last few weeks already. Again, if it's a respiratory-related disease and the doctor or physician has been clear about that, that will qualify.

Kyle Bauser, Analyst

Okay. And then you talked about a lot of clinics being closed or having restricted hours, but some have moved to being virtual. To the extent you can share, any sense as to what percentage of accounts, active accounts, have reopened and are reengaging?

Kathleen Skarvan, CEO

Thank you for that question. So, we have been doing pulse surveys with our clinics across all of our territories, and in the beginning of April versus the beginning of May, we have now started to see the number of offices opening start to increase and also the number of offices doing face-to-face visits increasing as well. I would say it's in the high single-digit percentage that has shifted, but it's a trend that we're watching very closely and will continue to do that. We conduct those pulse surveys, and that's how the sales organization is being made aware that they can then move out and visit those offices. They're contacting them regularly, and this way they can get back in and understand the rate of patients that they're seeing, how many appointments they're having per day, and we will see that gradually increase. We believe across the United States this will be dependent on the state and what the governor of that state has for specific orders about opening up their particular geographic area, but we're encouraged.

Kyle Bauser, Analyst

Okay, great. Thanks for the updates, and Jeremy, all the best. Thank you so much.

Jeremy Brock, CFO

Thanks, Kyle.

Unidentified Analyst, Analyst

Thank you. Good morning, folks. How are you? I just wanted to say I will be brief, as you guys know both you, Kathleen and Jeremy, as a very long-term shareholder, I just want to thank you again for your forthrightness and clarity on your presentations. It seems completely thorough and totally honest, and have been through the year. So thank you for that. And on a personal note, Jeremy, I am wishing you all the best in your future endeavors and your next adventure, maybe as wonderful as this one has been, and thank you as a shareholder, and that’s it, guys. I know how difficult this time is, and I think you are doing a fabulous job.

Kathleen Skarvan, CEO

Thank you so much, Mike, for those comments, and thank you for being a long-term shareholder. We very much appreciate it. Jeremy?

Jeremy Brock, CFO

Yes, thanks, Mike. We appreciate your support over the last eight-plus years.

Kalle Ahl, Host

Thank you. There are no further questions at this time. I will now turn the call back to Kathleen Skarvan for closing remarks.

Kathleen Skarvan, CEO

Thank you, Rachel. Thank you all for participating on our call this morning. While we won’t be on the road for investor conferences in the near term, given COVID-19, we remain accessible for one-on-one calls. Please reach out to our Investor Relations firm if you are interested in scheduling a follow-up call. We look forward to reporting back to you in August when we will release our fourth quarter fiscal 2020 financial results. Have a good day and stay well.

Kalle Ahl, Host

Thank you. This does conclude today’s conference. You may disconnect your lines. Thank you for participating.