Electromed, Inc. (ELMD) Q3 2019 Earnings Report, Transcript and Summary

Greetings, and welcome to Electromed's Third Quarter Fiscal 2019 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. It is now my pleasure to introduce your host, Kalle Ahl of The Equity Group. Please go ahead.

Thank you, Donna, and good morning, everyone. Electromed's third quarter fiscal 2019 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 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 8, 2019. 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 2019 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. Today, I will review our third quarter fiscal 2019 financial results, discuss the sales force restructuring we implemented in March of 2019, touch on the impressive leadership experience of Bud Reeves, our new Vice President of Sales, and recap our strategy to address the large and growing bronchiectasis market. Electromed's third quarter net revenue increased by 3.4% to $7.4 million reflecting 4.6% growth in home care revenue. These year-over-year comparisons were negatively impacted by lower average revenue per approval based on payor mix and below par sales performance in 2 of our 5 sales regions. We had an unusually high average selling price in the third quarter of fiscal 2018, so while our average selling prices this quarter was lower than prior period, it was in line with normal historical ranges. This is an example of the quarter-to-quarter variability inherent in our business and in our view, not a indication of a longer-term trend. The underlying cadence of our home care business remains solid. With approvals and shipments both increasing at double-digit rates in the third quarter. Referrals continue to increase, and we are achieving greater referral-to-approval percentages due to our sales team success educating physicians on reimbursement requirements. This quarter, we witnessed ongoing excellence in our reimbursement operations and good execution by our sales force across most of our territories. Briefly touching on the institutional side of our business, net revenue decline compared to the prior year period, but we are making progress developing relationships with the integrated delivery networks. The sales cycles are just taking longer than we anticipated, while today, our institutional segment represents a small percentage of our overall business, it is a very important focus of ours, because the high frequency chest wall oscillation or HFCWO brand used in the hospital is often the default brand prescribed when discharging a patient. HFCWO therapy with SmartVest keeps patient out of institutions aligning well with the strong economic incentives of hospitals to avoid high readmission penalties for COPD and pneumonia. We are repositioning our sales reps targeted accounts to include a higher number of call points in the hospital setting to encourage prescribing SmartVest at the time of patient discharge. On that note, we were very encouraged to see our discharge referrals from hospitals pacing this fiscal year to increase by 30% over the prior fiscal year. As a reminder, hospital discharge referrals are categorized as home care revenue. We are excited about these results since it demonstrates our confidence in focusing more energy on the hospital call point. Since we believe that a high percentage of bronchiectasis patients will be hospitalized with an exacerbation. We will focus our sales efforts primarily on SmartVest hospitals, where our brand is used with patients during their stay. In this situation both the physician and respiratory therapist understand the value of HFCWO and SmartVest, and are more likely to prescribe the SmartVest brand when patients need HFCWO therapy in the home setting. Shifting to expense management. We were pleased that this quarter's SG&A expenses grew at a slower rate than our revenues compared to the third quarter of the prior year. Our operating income was lower than the prior year period, primarily due to lower average revenue per approval based on payor mix as well as increased investment in R&D expenses for the development of an innovative, service-related product enhancement that will improve our patient's ability to access their SmartVest therapy adherence data. Moving on to our sales restructuring. In March of 2019, we reduced our direct sales staff count by 7 in 2 underperforming regions and realigned our regions from 5 to 4 to create an optimal foundation for strong and profitable revenue growth and drive greater overall sales productivity. We believe this initiative will deliver annualized cost savings of approximately $500,000 with minimal impact to revenue. Due to our restructuring, we ended the quarter with 42 total direct -- I'm sorry, 42 total field sales employees of which 36 were direct field staff. In our top-performing regions, we are growing through a combination of market development and market share gains. These productive regions have demonstrated careful account planning through targeting the right balance of competitive accounts and greenfield opportunities. The average sales rep in our successful geographies has at least 1 year of tenure, a rolodex of pulmonologist call points, a spirit of responsiveness, an ability to educate, to drive high-quality referrals and a desire to add value as an extension of the physician's office. By taking action and focusing our resources on more established, higher-performing regions, we believe we will more rapidly achieve our minimum sales productivity objective of annual home care revenue between $750,000 and $850,000 per direct field sales employee. We are confident about reaching these levels in fiscal 2020. Let me be clear, we won't add in a meaningful way to our sales team count until we do so. Once we reach and sustain adequate productivity levels, we will reassess the restructured underperforming territories and rebuild as appropriate in a moderate and controlled way. In the third quarter of fiscal 2019, home care revenue per average direct field sales employee decreased 3% to $167,000 from approximately $172,000 in the second quarter and is up 8% compared to third quarter of the prior year. In addition to narrowing our focus through sales restructuring, we took decisive steps to identify, recruit and attract an extremely talented leader in Bud Reeves, our new Vice President of Sales. We could not have found a better fit. Bud has over 2 decades of sales and marketing leadership experience in the healthcare industry and brings a history of strong execution of growth strategies and proven results, specifically in emerging, respiratory markets. Bud comes to us from Philips Healthcare, where he was responsible for sales activities through distribution partners, specialty distributors, rental companies and long-term acute care hospitals. Prior to Philip Healthcare, he oversaw all GPO, IDN and distribution management for Respironics, serving as Director of Sales, Corporate and Strategic accounts. We believe Bud will be instrumental in bringing additional momentum to our institutional and home care sales through the hospital discharge process. In his first 90 days, Bud will assess the sales organization by traveling throughout each region, visit our key prescribers and fine-tune our sales strategy. He will evaluate regional expansion and rebuild opportunities when the time is right. Bud is an engaging and collaborative sales leader, and we are thrilled to have him take the reins of our sales organization at this critical juncture when we are focused on enhancing sales productivity, revenue growth and profitability. While our sales strategy will evolve under Bud's leadership, we continue to strengthen our sales productivity plan, including improved direct sales rep profiling and assessment to recruit the right talent, upgrading direct sales reps evaluation and management coaching tools, enhance sale account planning tools, better CRM utilization, greater focus on home care referrals from hospitals and a stronger emphasis on deeper penetration at those strategic, high-prescribing clinics. In conclusion, I truly believe Electromed is in a fantastic position to gain market share and develop HFCWO market by increasing high-quality referrals in the adult pulmonology bronchiectasis segment, enhancing reimbursement support to provide best-in-class customer care, leveraging clinical evidence to increase utilization of SmartVest, developing innovative device features and growing institutional market share to support home care growth. We reiterate our expectations for double-digit revenue growth over the next few years, as we execute our strategic initiatives and we anticipate improved earnings through our cost-containment efforts. We are fortunate that non-cystic fibrosis bronchiectasis represents a significant and growing market opportunity, conservatively estimated at more than 4 million individuals in the United States. We believe that approximately 630,000 people with a bronchiectasis diagnosis could benefit from HFCWO therapy. Yet only an estimated 66,000 patients in the Medicare publishing have been treated with a device like SmartVest today. We have great people and a great product that helps people feel better and keeps them out of the hospital. All supported by a culture of excellence that supports the patient. We continue to believe the spirit and dedication to our patients will drive Electromed's future success and allow us to create long-term value for shareholders. With that, I will turn it over to Jeremy for a more detailed discussion of the financial results. Jeremy?

Thank you, Kathleen, and good morning, everyone. Our net revenue in the third quarter of fiscal 2019 increased 3.4% to $7.4 million from $7.2 million in the third quarter of fiscal 2018, driven by growth in home care revenue. Home care revenue increased 4.6% to $6.9 million, primarily due to an increase in referrals and approvals, driven by greater productivity from our field sales staff and improved reimbursement processes. As Kathleen noted, during the third quarter of fiscal 2019, home care revenue was negatively impacted by lower average revenue per approval based on the payor mix. Institutional revenue decreased from 400 -- decreased to $414,000 from $496,000 in the prior year quarter. And international revenue, which is not a strategic growth area for Electromed, totaled approximately $142,000 compared to $119,000 in the prior year period. With the restructuring of our sales force behind us, we are well positioned for double-digit revenue growth in fiscal 2020 as we execute our organic growth strategy, although quarter-to-quarter sales variability can be expected due to the nature of our business. Gross profit increased 1.2% to $5.6 million or 75.2% of net revenue in the third quarter of fiscal 2019 from $5.5 million or 76.9% of net revenue in the third quarter of fiscal 2018. The increase in gross profit resulted primarily from an increase in home care revenue. And the decrease in gross profit as a percentage of net revenue was driven primarily by the lower average revenue per approval based on payor mix. Operating expenses, which include SG&A as well as R&D expenses, totaled $5.1 million or 66.7% of revenue in the third quarter of fiscal 2019 compared to $4.9 million or 68.2% of revenue in the same period of the prior year. SG&A expenses increased by 1.1% to slightly above $4.9 million in the third quarter of fiscal 2019, primarily due to higher sales incentives, which was is partially offset by lower professional fees. As a percentage of revenue, SG&A expenses improved to 66.7% compared to 68.2% reflecting our ongoing cost containment efforts. R&D expenses increased to $171,000 from $43,000 in the third quarter of the prior year due to the work on innovative product feature design to improve patients' access to treatment adherence data. And operating income in the third quarter of fiscal 2019 decreased to $462,000 from $578,000 in the third quarter of fiscal 2018, primarily due to the lower average revenue per approval based on payor mix. Net income before income tax expense totaled $489,000 in the third quarter of fiscal 2019 compared to $578,000 in the prior year quarter. And in the third quarter of fiscal 2019, income tax expense totaled $139,000 compared to $202,000 in the same period of the prior year. And our effective tax rate in the third quarter of 2019 was 28.4% compared to 34.9% in the prior year period. Our net income totaled $350,000 or $0.04 per diluted share in the third quarter of fiscal 2019 compared to $376,000 or $0.04 per diluted share in the prior year third quarter. Now moving to the balance sheet and operating cash flow. Our balance sheet in March 31, 2019 included cash and cash equivalents of $7.5 million, no debt, working capital of $20.8 million and stockholders equity of $24.5 million. Cash flow from operations in the third quarter of 2019 totaled $351,000 compared to $342,000 in the third quarter of fiscal 2018. We are very pleased to be debt-free and in a position to continue building our cash reserves to support Electromed's long-term growth strategies. As I discussed on our last call, we have commenced a billion expansion project here in New Prague. We expect the project to cost $1.5 million to $1.7 million when complete, and we'll save over $130,000 in annual lease expense, while providing us with sufficient infrastructure for our long-term growth. We believe the new building will be finished in the first quarter of fiscal 2020. Overall, we remain focused and confident in the direction of the business and this concludes my remarks. Operator, could we start the question-and-answer portion of the call, please.

[Operator Instructions] Our first question is coming from Kyle Bauser of Dougherty & Company. Please go ahead.

Kathleen and Jeremy, can you hear me okay?

Yes. We can.

Great. So the home setting is a nice opportunity here as you said and it's key to get into the hospitals first to really drive referrals into the home channel. As part of the new strategy, do you feel like you have the relationships with enough hospitals at this point and are more focused on driving referrals within these accounts? Or is there still runway to develop new relationships with other high-volume hospitals?

Yes. Thank you for the question, Kyle. It's first of all, when we think about the home care discharge referral, again, just to be clear, we have a high amount we have a higher number of hospitals where SmartVest already is being used in patient, in their intensive care unit primarily. And so, as I said in my comments, that's where we're going to target first for that growth in the home care referral discharge patients. And yes, we have a strong presence in a high volume of hospitals across the United States and those are, interestingly enough, a combination of it being used in adult hospitals and also pediatric intensive care units. So we're excited about building on that foundation. The other area -- and within those hospitals, there still is institutional business that can grow. So that is where we look first for the ability to grow the institutional business, either within additional generator, which can be a capital sale and also increasing their use of the single-patient used wraps, which is the recurring revenue that we look for in that institutional sales area. So those are all great opportunities for growth and then there still are greenfield hospitals that are looking for opportunities for productivity improvement from their respiratory therapist or they have not used HFCWO in the past and they see it as an opportunity to help send their patients home with clear lungs, so that they won't be coming -- and part of their COPD navigator programs, so that they aren't being readmitted within 30 days, and then also, of course, then to work on should that patient be discharged with HFCWO or SmartVest. So I know that's a bit of a long winded answer, but there are of course, 3 or 4 opportunities here for increasing revenue.

Got it. And you touched on this in your remarks, Kathleen, after reducing the sales force and realigning the regions from 5 to 4., does the now 36 reps kind of sustain the business for, say, another 12 to 24 months? In other words, from what you're seeing in the field, is there enough bandwidth amongst these 36 reps to stay at this number for a while?

You're going to see that number fluctuate a bit by 2 to 3, and that's because right now we would include a couple of territories that are open, that we are currently looking to fill. So -- but, again, the trigger point will be when we reach that productivity or sales per direct TAM or sales rep. And you'll be seeing that as well, when we're reporting every quarter and as that ticks up, and we get in that range then we'll start talking about expanding.

Okay. And you've spoken about this previously, but I'm just curious, can you provide an update on the service-related product enhancement that you've been working on and what sort of metrics it will track to inform adherence outcomes?

So our current wireless patient monitoring feature is cellular-based and it is already tracking their frequency that they're using with their device, the pressures, the amount of time that they use it for each session and also the number of sessions each day. So that will remain intact. The enhancement is really adding features for that patient so that they're more likely to use the device or the application and potentially can even bring it in and show their physician. Not all physicians are tapping into the wireless monitoring, but we believe that through the patient's interaction, they can pull the physician in and the patient can be more proud of the therapy adherence that they have and hopefully it'll improve their therapy adherence because of the interactive nature of the enhancement.

All right. Okay. And just lastly, Jeremy, can you remind me again what's in the tax expense line, it's come down considerably from last quarter, so I think there was a deferred tax expense before, is that still in there? And how should we think about this line item going forward?

Yes. I think the way we're looking at on a go-forward basis is we will be hovering more around the federal rate plus the state rate, which is then between the 20% and 30% on a go-forward basis.

[Operator Instructions] Thank you. Our next question is coming from Tim Chatard of Quantum Capital. Please go ahead.

Just a question on the sales issues. The difficulty reaching the sales rep productivity, I guess I'm trying to get a sense for what that revolves around. Is it the type of sale that the reps are trying to make is nontraditional? Or what they had been doing before, I know there are different types of never having been one, I can't speak personally, but capital equipment versus more consumable-type items lend themselves towards different types of sales professionals or sales processes. Anything along those lines that you can give me some color on?

Tim, thank you for the question. And so when we talk about sales productivity, we are referring only to our home care revenue as a ratio of the number of reps that we have. And the challenge in the home care revenue sale is twofold. One is the challenge of access to a physician and then being able to talk to them about their patient population, and identifying patients that would qualify for reimbursement and need high frequency chest wall oscillation or airway clearance as an ongoing therapy for their chronic condition. And so, in these territories that we vacated for a period of time now or temporarily I believe, we're not seeing the home care revenue that we would have expected. And so it was in my view the best approach to vacate those regions at this or those territories at this time and focus on the territories where we were seeing higher productivity and strength in our opportunity to grow. And that focus then will give us a foundation to build on, that will then be something to rebuild on as we expand then further once we see that productivity per sales person strengthen. So hopefully, that gives you a little more color on what we're focused on and why.

Yes. It sounds like access to the pulmonologist sort of on a very basic level, they need to be talking about what is your patient population, looked like very much a -- you need to be in partnership with local pulmonologist or pulmonologists or just trying to get a sense for how that work sometimes and how that doesn't work...

Well, in that -- yes, and sorry to interrupt, but that's a good -- that's a very helpful comment. Once you are able to establish access and you establish access by bringing value. And so, how are we bringing value, we bring value 2 ways. One, we're helping that physician help their patient with an airway clearance product that keeps them out of the hospital and helps them feel better. And then we also help them by making the prescription or the prescribing of our device and managing the medical records. So, we can receive reimbursement for the patient as easy as possible for that provider and for that office. Those are really the 2 ways we add value for the physician and the provider. And -- so our reps are, as I said, in my comments, they're adding value by being an extension of that office for the patient and for reimbursement and we handle all the reimbursement. So typically, what the provider needs to help us with is, of course, writing a prescription and then helping us collect the medical records on behalf of that patient, so then we can receive the authorization and the approval from the payor.

Yes. Is there a revenue opportunity for the pulmonologist that needs to be changed? Or maybe there's an opportunity to change or tinker with the current model. I'm just thinking about behavior on the ground with the physician.

Well, in the pulmonologist office, there is little economic benefit for the physician to prescribe this device. What we want to be doing is sharing with that pulmonologist that this is an airway clearance that can help their patient, again, feel better and stay out of the hospital, have higher quality of life. And we believe that the majority of pulmonologists, or physicians in general, want to help their patients feel better and improve their quality of life. And so, again, our job is to make it as easy as possible to prescribe this device and for them to believe that we are helping their patient long term. In the hospital environment, there is an economic reason to use HFCWO for their patients, in the hospital setting as an inpatient, this device, our therapy, is going to help that patient clear their lungs, hopefully faster and more effectively. And then when they are sent home with HFCWO or SmartVest that's going to help keep them out of the hospital and help them feel better as well. So that's economic value to the hospital, especially when it comes to COPD or pneumonia readmission penalties, which can occur if that particular patient is readmitted within 30 days after their discharge.

Okay. Do you anticipate any change to the operating expense structure going forward with -- from looking at your percentage of revenue on G&A related to the sales force reduction? Or is that probably not wise to model in a reduction given that you might make changes?

Actually, no, thank you for that question, Tim. We have modeled in about $500,000 savings from the restructuring annually and that could change, of course, as our strategies change for expansion. But, again, we'll be speaking to that each quarter.

At this time, I'd like to turn the floor back over to Kathleen Skarvan for closing comments.

Thank you all for participating on our call this morning. We look forward to reporting back to you in September, when we will release our fourth quarter fiscal 2019 financial results. Have a good day.

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