Electromed, Inc. (ELMD) Q4 2017 Earnings Report, Transcript and Summary

Greetings and welcome to the Electromed’s Fourth Quarter Fiscal 2017 Financial Results Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions]. As a reminder, this conference is being recorded. I would now like to turn the conference over to Kalle Ahl of The Equity Group. Please go ahead.

Thank you, Rob and good morning everyone. Electromed’s fourth quarter fiscal 2017 financial results were released yesterday after the market closed. A copy of the earnings release can be found in the Investor Relations section of the Company’s website at www.smartvest.com. As a matter of formality, I need to remind participants that remarks made by management during the course of this call may contain forward-looking statements about the Company’s results and plans. Such statements are subject to risks and uncertainties that could cause actual performance or achievements to be materially different from those projected. The words belief, 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 predictions as to the Company’s future performance represents managements estimate as of today, September 06, 2017. 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 openings remarks after which Jeremy will present a summary of the Company’s fourth quarter fiscal 2017 financial results and then we’ll open the call for questions. Now, it’s my pleasure to turn the call over to Kathleen. Kathleen please go ahead.

Thank you, Kalle. Good morning everyone and thank you for joining us to discuss Electromed's fourth quarter fiscal 2017 results. This quarter our sales and reimbursement teams continued to gain excellent traction delivering a 16% year-over-year, I am sorry, year over increase in comparable homecare sales which along with a favorable Centers for Medicare and Medicaid services or CMS settlement agreement drove a 28% increase in total revenue and 181% rise in net income compared to the same period last year. Jeremy will touch on the CMS settlement agreement later in the call. We continued to expand our sales force which totaled 40 at quarter end up from 30 at the end of fiscal 2016 while investing in our reimbursement team and initiatives to increase covered lives. We also have taken deliberate measures to improve sales efficiency through carefully recruiting and training talented new hires, utilizing evidence based marketing tools or clinical studies that quantify SmartVest's ability to materially decrease bronchiectasis-related exacerbations, healthcare utilization and associated costs, and focusing our sales emphasis on adult pulmonology and the significant opportunity in non-cystic fibrosis bronchiectasis. As a result of our team's combined efforts, we achieved another quarter of higher referrals and higher approvals compared to the prior year period. Advancing bronchiectasis awareness is another key component of our sales strategy, and last month we were extremely pleased to formally announce the creation of a Bronchiectasis Advisory Board composed of three renowned experts in pulmonary medicine. In particular, the Board includes Dr. Chad Marion, an Assistant Professor and Associate Director of the adult cystic fibrosis program of medicine at Wake Forest Baptist Health and Board certified in Internal Medicine and Pulmonary Disease. Dr. Peadar Noone, a Professor of Medicine and Medical Director for the University of North Carolina Center for Bronchiectasis Care and Dr. Anne O'Donnell, the Professor of Medicine and Chief Division of Pulmonary Critical Care and Sleep Medicine at Georgetown University Medical Center. Together these global thought leaders will be a huge asset for Electromed as we continue to educate the healthcare community on the prevalence of bronchiectasis and the effectiveness and value of SmartVest and Airway Clearance therapy. In addition to advancing bronchiectasis awareness, the Advisory Board will help guide our development of clinical research plans and future airway clearance therapy innovations. On the topic of innovation we were thrilled to launch SmartVest Connect, our new wireless connectivity in patient monitoring for SmartVest SQL as planned in the fourth quarter. We received overwhelmingly positive feedback thus far on SmartVest Connect's ease of use and intuitive design. We rolled out SmartVest Connect to patients in pediatric and cystic fibrosis categories and plan to make it available to adult patients at select adult pulmonology clinics later in fiscal 2018. We believe SmartVest Connect will foster improved therapy adherence and better outcomes for our patients. We also have been innovative in how we think about our patients’ airway clearance needs. Our agreement earlier this year to distribute Monaghan Medical's Aerobika OPEP device in the U.S. homecare market is a win for everyone for Electromed, for Monaghan, for the clinician, and for the patient. While not a huge revenue contributor for us currently, Aerobika is strategically important in that it keeps us in front of and helps us more effectively serve two of our key customers, the physician and the patient. If you recall the Aerobika OPEP device is a best in class airway clearance therapy for patients with compromised pulmonary function that may not need SmartVest or qualify for HFCWO reimbursement. Aerobika OPEP also offers portability for their airway clearance needs. With Aerobika OPEP and SmartVest devices, Electromed now offers a continuum of airway clearance therapies that also may be complementary for patients to use in the home. While we made considerable progress in fiscal 2017 we still have more to accomplish. As we head into the coming fiscal year, our organic growth strategy remains largely unchanged, however, reflecting on increasingly -- our increasingly optimistic view of the significant under penetrated bronchiectasis market opportunity in front of us I would like to point out that in fiscal 2018 we intend to step up our level of investment in the business. A higher level of investment should contribute to increased SG&A expenses beginning in the first quarter of fiscal 2018 and drive enhanced revenue growth as we proceed to the back half of the year. As Electromed’s strong fourth quarter financial results attest, our growth strategies our materializing well as we enter the new fiscal year. In fiscal 2018 we will expand our sales force, build on our preeminent reimbursement platform and customer care group, we will continue investing in innovative device features and services, and launching additional marketing initiatives to increase physician and patient awareness to drive a higher number of quality referrals. While our management team and Board have agreed to emphasize revenue growth activities in the near term, we remain committed to profitability. We believe this strategy will enhance shareholder value as we strive to improve quality of life, for a greater number of patients with compromised pulmonary function and reduce overall healthcare utilization through SmartVest Airway Clearance therapy. I will now turn it over to Jeremy for a detailed discussion of our financial results, Jeremy.

Thank you Kathleen and good morning everyone. Our net revenue in Q4 of fiscal 2017 increased 27.8% to $7.3 million from $5.7 million in Q4 of fiscal 2016 driven by strong growth in homecare sales. Homecare sales increased 29.5% to $6.7 million primarily due to an increase in approvals and referrals driven by a higher number of field sales employees as well as a settlement agreement with the Centers for Medicare & Medicaid Services or CMS with respect to approximately 700 Medicare Fee-For-Service claims in appeals that were submitted between calendar year 2012 and 2015. The CMS settlement agreement resulted in approximately $700,000 of net recognized revenue during the quarter. Excluding the favorable impact of the settlement agreement with CMS, underlying home care revenue in Q4 of fiscal 2017 increased 15.8%. Institutional revenue was $370,000 down 10.8% compared to $415,000 in the prior year quarter. And international revenue which is not a strategic growth area for Electromed totaled approximately $229,000 compared to $122,000 in the prior year period. Although quarter-to-quarter sales variability can be expected due to the nature of our business, we anticipate enhanced revenue growth in the back half of fiscal 2018 as the impact of our increased level of investment and sales initiatives begins to take hold. Gross profit increased 33.6% to $6 million or 82.5% of net revenue in Q4 of fiscal 2017, up from $4.5 million or 78.9% of net revenue in Q4 of fiscal 2016. The increase in gross profit resulted from one, an increase in homecare revenue; two, the settlement we reached with CMS; and three, lower manufacturing costs for SmartVest SQL as compared to the prior fiscal year quarter. While this quarter we expected -- we exceeded the 80% gross margin threshold we believe gross margins were returned to the mid to upper 70's which is more in line with our previously communicated expectations in part reflecting several new contracts that we signed that are planned for at a lower average ASP. These new paired contracts will broaden our ability to grow revenue and gross profit dollars and improve the utilization of our resources as individual patients who are out of network become in network. Operating expenses which include SG&A as well as R&D expenses totaled $4.5 million or 61.7% of revenue in Q4 of fiscal 2017 compared with $4 million or 69.4% of revenue in the same period of the prior year. SG&A expenses increased 17.8% to $4.4 million in Q4 of fiscal 2017 from $3.8 million in Q4 of fiscal 2016 primarily due to one, higher payroll and compensation related expenses; two, increased recruiting fees driven by expansion of our sales employees; and three, increased travel and meals entertainment expenses. While we are not providing and do not plan on providing formal guidance, in fiscal 2018 we expect incremental investments and growth initiatives to impact SG&A expenses and believe our operating margin percent may increase compared to -- a decrease compared to fiscal 2017. As Kathleen mentioned previously we view these investments in the business as a key part of our strategy to improve our top line growth rate beyond fiscal 2017's growth rate targeting near to historical growth levels. R&D expenses totaled $64,000 in Q4 of 2017 compared to $197,000 in Q4 of the prior year. Operating income in Q4 of fiscal 2017 increased 181% to $1.5 million from $539,000 in Q4 of fiscal 2016 primarily due to increased gross profit driven by higher revenue which was partially offset by higher payroll and compensation expenses in sales and administrative positions. Net income before income tax expense rose 187.7% to 1.5 million in Q4 of fiscal 2017 from 523,000 in the prior year quarter. In Q4 of fiscal 2017 net income tax expense totaled $559,000 compared to $186,000 in the same period of the prior year. Our effective tax rate in Q4 of fiscal 2017 was 37.1% compared to 35.5% in the prior year period. Our net income increased 180.7% to $946,000 or $0.11 per diluted share in Q4 of fiscal 2017 from $337,000 or $0.04 per diluted share in Q4 of fiscal 2016. Now briefly recapping our full year fiscal 2017 financial performance. In fiscal 2017 revenue increased 12.5% to $25.9 million up from $23 million in fiscal 2016 and homecare revenue in fiscal 2017 increased 14.1% to 23.4 million from $20.5 million in fiscal 2016. Gross margins were 79.5% compared to 77.7% in the prior period while net income was $2.2 million or $0.26 per diluted share compared to 2.2 million or $0.27 per diluted share in the prior fiscal year. Moving on to the balance sheet and operating cash flow, our balance sheet at June 30, 2017 included cash of $5.6 million, long-term debt including current maturities of $1.1 million, and working capital of $15.6 million and stockholders equity of $19.1 million. Cash flow from operations in Q4 of fiscal 2017 totaled $385,000 compared to $497,000 in Q4 of fiscal 2016 and cash flows from operations for the full fiscal year 2017 totaled $1.2 million compared to $2.2 million in fiscal 2016. Overall we remain pleased with the direction of our business and this concludes my remarks. Operator we can start the Q&A portion of the call please.

Thank you. [Operator Instructions]. Thank you, our first question today comes from the line of Brooks O'Neil with Lake Street Capital. Please proceed with your questions.

Well, good morning and congratulations on the strong finish to the year. I was hoping to just ask a little bit about your decision to invest in top line growth and sort of how you all thought about that and perhaps maybe you could just say a little bit more about sort of the magnitude of investment, what do you think that might do in the first couple of quarters of the year, and then what you're hoping to achieve kind of as a result of your initiatives?

Well, good morning Brooks, good to hear from you. This is a great question, we appreciate it. So I think it's a twofold answer to your question about this focus on revenue growth at a stronger level. It starts with the thorough understanding of this market opportunity and we've tried to – we’ve addressed that in our 10-K as well looking at it from two different sources. One has been a source around a study done and published in CHEST Magazine looking at Medicare patients that suffer from bronchiectasis. And looking at the extrapolation of that study and the growth rates showing that it could be as high as 400,000 people just this year suffering from bronchiectasis and how under penetrated it is for the use of airway clearance. And the second study is one where it's looking at the bronchiectasis prevalence within the COPD population and looking conservatively at those statistics and saying that that prevalence of bronchiectasis within COPD could be as high as a million and that's at a conservative level. So we look at that market opportunity and how under penetrated it is and believe that now is the time for a stronger investment. And the second portion of that is the confidence we have in our leadership team and our employees and their skill level and the work that they've done over the past three to four years and the confidence that we have in the growth we've seen already. So that really is how we've been thinking about why it's important for us now to accelerate our investment and focus more strongly on that top line. And I'll ask Jeremy if he might comment a little more about that how we think about that investment, relative to the range there.

Yeah, I think when you're looking at the investment that we're going to put into next year we're going to make investments and a significant portion of our investments will go into growing our sales force and really being able to increase that first level of our sale which is the referrals. We’ll also be making an investment in our reimbursement. We have been relatively flat over the last several years from a reimbursement standpoint as far as our headcount. And this year we're going to be making what we would consider a step investment for the future in that team and adding a few people in that team as well. And then finally from an overall standpoint I think, well Kathleen pointed out earlier, I think it's important to say that we are still very committed to profitability but from an operating margin standpoint we do believe that our operating margins through this year especially due to the investment and the timeframe that it does take to get our sales force and a new sales hire up to speed which can be anywhere from nine to twelve months that will decrease our operating margin percentage for the full year.

And I'll add one other point on that investment and that is around the marketing initiatives. The continued innovation on features and benefits of airway clearance all around raising awareness and education of the need for airway clearance within bronchiectasis and those could include clinical studies as well.

Sure, could you just refresh my memory on the competitive environment you face out there in the marketplace and to what extent you feel you have a pretty wide open opportunity to go after this huge market opportunity?

Absolutely, so we think about the competitive environment in two ways; one is there are a number of airway clearance devices and therapies out on the market. So definitely we compete against those but, there also is competition with individuals that -- or companies that are offering high frequency chest wall oscillation in addition to ourselves. And of course we speak about Hill-Rom who has the number one market share. There is Respitek who is number two. We're number three. One might be concerned about being number three, I am less concerned about that because of the large market opportunity and our optimism around bronchiectasis and how unpenetrated it is with bronchiectasis. And so we think that there is opportunity to not only develop this market but to grow market share as well.

Great, could you just talk also a little bit about SmartVest Connect, I think that’s an interesting initiative?

We are as I said earlier in my remarks so excited about SmartVest Connect because it offers the opportunity for the clinician, the patient, and our company as well to be all working together on supporting that patient in their therapy and helping them to stay on track with their therapy and therefore realize the improved quality of life and a reduction in healthcare utilization which we have shown with previously published studies. So we have as I said earlier offered this now to all of our pediatric patients and all of our cystic fibrosis patients, be they pediatric or adult. And the initial feedback that we are receiving from patients and clinicians is overwhelmingly positive in regard to how simple it is to use, how intuitive, and how beneficial they believe it will be as they're able to see on a daily, weekly, monthly basis a summary of their therapy adherence based on how many times per day they're using, how many minutes per day, also the output of the machine relative to pressure and their frequencies that they're using. It also gives the patient an opportunity to interact with their clinician and share information about how they're feeling that day or to say I didn't use it today because I exercised, and so it also is a wonderful way not only to receive that personal feedback for the patient and help them adhere, but also to help the clinic and ourselves to be part of that care management team.

Great, thank you very much and again congratulations on a good finish to the year.

Thanks Brooks.

Thank you. [Operator Instructions]. The next question is from the line of Jennifer Taylor with MaxLens [ph]. Please proceed with your question.

Hi, good morning. Thank you and I’ll chime in on a nice end of the year and quarter. I guess the one thing I want to revisit just a little bit, it sounds like and I completely understand the opportunity that you'd like to try and capture here, how many sales people would you like to try and ramp or add to and just the time and leverage you would hope to sort of see them up and running at a full sort of run rate, I'm just curious about what your experience thus far might indicate in terms of driving that top line which already sounds like you're making some nice penetration into? Thank you.

Well, good to hear from you Jennifer, thank you and I will respond to that question. When we think about our sales force we believe that ending the year here at 40, the previous year we ended at 30 that we will at least add that many individuals. And based on our increased and accelerated expenses that we talked about earlier could go beyond that number this year. What we share typically around the on boarding and when we expect our salespeople to be productive, that can take anywhere from six to twelve months depending on the territory that we're placing those individuals in. And so if it's a territory which we've been covering more expansively previously and then we divide, that productivity can be a little quicker. It also depends on the type of sales person we hire if they already have worked in the respiratory space and may have relationships already with clinicians. But, it can vary anywhere from six to 12 months and so therefore you can see we will see that acceleration of our sales force but may not realize the benefits of that or that return for a period of time.

Okay and I guess I just and without getting into, I understand you are not giving guidance, but in terms of the compression on the operating margin that I imagine -- I mean is there a longer term goal that we sort of should look to the historical levels of the recent year to how long you might invest ahead of time I understand but just trying to understand what you might be looking for is the target range for the longer-term holders?

Yeah, I believe that over the short-term we could if you go back a couple years and you look at where operating margins, we could go back down to those levels from an operating margin standpoint. But I think that is during our investment phase. I believe that after as we go through these investments that from a long term standpoint at any point when we would stop the growth and the investments at the same level that we're planning on this year you will really start to see the uptick back to current or better operating margins than we have right now.

Okay, great. Thank you.

Thank you. At this time there are no additional questions and let's turn the floor back to Kathleen Skarvan for closing remarks.

We’d like to thank everyone for participating on our call this morning. We look forward to reporting back to you in November when we will release our first quarter fiscal 2018 financial results. Have a good day.

Thank you. This concludes today's teleconference. Thank you for your participation. You may now disconnect your lines at this time.