Electromed Inc (ELMD) 2017 Q3 法說會逐字稿

Greetings, and welcome to the Electromed Third Quarter Fiscal 2017 Financial Results Conference Call. (Operator Instructions) As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host, Mr. Kalle Ahl of Equity Group. Please go ahead.

Thank you, Darin, and good morning, everyone. Electromed's third quarter fiscal 2017 financial results were released yesterday after the market close. A copy of the earnings release can be found under 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 16, 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 opening remarks. After which, Jeremy will present a summary of the company's third 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.

Thank you, Kalle. Good morning, everyone, and thank you for joining us to discuss Electromed's third quarter fiscal 2017 results. We are very pleased with the traction our sales and reimbursement teams continued to gain this quarter, particularly in our home care segment.

Home care revenue grew 13.5% year-over-year quarter 3 fiscal 2017, which in turn drove 10.5% increase in total revenue and a 38.9% rise in net income compared to the same period last year.

Our institutional sales, while a relatively small portion of our net revenue, declined slightly year-over-year, creating a modest drag on our overall growth. We are working on several initiatives to reinvigorate institutional capital sales.

Clearly, our home care segment is benefiting from a larger, more productive sales team and solid execution by our reimbursement group. We ended the quarter with 35 field sales employees, up from 29 at the end of the same period last year. Our sales force continues to mature, with an increasing percentage of field reps having greater than 1-year tenure. Our expanded sales staff, combined with a higher level of referrals per sales employee, drove another quarter of record referrals and higher approvals as compared to the prior year period. We also continued to expand our payer coverage universe.

We believe our strengthening sales growth this quarter also reflects our ongoing strategy to build awareness among physicians of the benefits of SmartVest and high-frequency chest wall oscillation, or HFCWO, therapy for patients with non-cystic fibrosis bronchiectasis, principally through an evidence-based marketing approach.

If you recall, the most recent study we published in January 2017 demonstrated a 60% reduction in overall health care utilization and cost due to a material decrease in bronchiectasis-related exacerbations for a population of patients who use SmartVest. Additionally, secondary benefits, such as the potential to reduce hospital readmissions and the potential to impact deterring antibiotic resistance, may have even greater benefits than decreasing costs.

To further advance our bronchiectasis awareness efforts, this quarter, we formed an Electromed Physician Advisory Board, which will focus on engaging clinicians, payers and patients with evidence-based medical information, such as the findings of our January 2017 study. We expect to make a formal announcement of the advisory board's composition, which includes some of the country's preeminent medical scholars and practitioners specializing in patients with bronchiectasis at the end of the month.

We also continue to advance development of our wireless-enabled SmartVest SQL device called SmartVest Connect. To date, we have received overwhelmingly positive feedback from clinicians participating in our SmartVest Connect beta testing program. We believe SmartVest Connect's ease of use will appeal to both clinicians and patients, fostering improved therapy adherence and better outcomes.

We remain on target for a formal launch in June 2017. Initially, we envisioned a full launch to the pediatric market where physicians have been particularly vocal in asking for a feature to track therapy adherence and a more targeted launch for the adult market.

Finally, we were thrilled to announce our agreement with Monaghan Medical Corporation in February to distribute and sell Aerobika Oscillating Positive Expiratory Pressure, or OPEP, device into the U.S. home care market. 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. It is truly portable airway clearance solution for patients on the go and sells for $99. With Aerobika OPEP and SmartVest devices, Electromed now offers a continuum of airway clearance therapies for patients to use in their home.

In summary, the execution of our growth strategy is tracking on plan. We are strengthening our sales and reimbursement platforms, increasing physician and patient awareness of SmartVest for treatment on non-cystic fibrosis bronchiectasis and advancing meaningful product innovation. We continue to invest in our business and plan to expand our sales team in the coming quarters. In fiscal 2017, we are on target to achieve another year of organic revenue growth, higher quality referrals and higher reimbursement on referrals, while maintaining the highest standards of integrity, respect and privacy.

I'll now turn the call over to Jeremy for a more detailed discussion of our financial results. Jeremy?

Thank you, Kathleen, and good morning, everyone. Our net revenue for quarter 3 of fiscal 2017 increased 10.5% to $6.7 million from $6 million in quarter 3 of fiscal 2016, driven by strong growth in our home care sales. Home care revenue increased 13.5% to $6.1 million, primarily due to the increase in approvals and referrals, and the increase in referrals was predominantly due to the growth in the number of our field sales employees.

Institutional revenue was $437,000, approximately flat compared to $440,000 in the prior year quarter. And international revenue, which is not a strategic growth area for Electromed, totaled $155,000 compared to $240,000 in the prior year period. Although quarter-to-quarter sales variability can be expected due to the nature of our business, we anticipate another year of overall revenue growth in fiscal 2017 and continued revenue growth into fiscal 2018.

Gross profit increased 14.8% to $5.3 million or 79.7% of net revenue in quarter 3 of fiscal 2017. That was up from $4.6 million or 76.7% of net revenue in quarter 3 of fiscal 2016. The increase in gross profit resulted from increases in our domestic home care revenue and a decrease in our manufacturing cost of the SmartVest SQL as compared to the prior year fiscal quarter.

While this quarter, we approached the 80% gross margin threshold, we believe gross margins will return to the mid to upper 70s, which is more in line with our previously communicated expectations, in part, reflecting new contracts that we have signed and planned for. At a lower-than-average reimbursement allowable, these new payer contracts will help us broaden our ability to grow revenue and our gross profit dollars and improve the utilization of our resources as individual patients who were out of network will become in-network.

Operating expenses, which include SG&A as well as R&D expenses, totaled $4.3 million or 64.1% of revenue in quarter 3 of fiscal 2017 compared to $3.9 million or 64.5% of revenue in the same period of the prior year. SG&A expenses increased 10.2% to $4.2 million in quarter 3 of fiscal 2017 from $3.8 million in quarter 3 of fiscal 2016. That's primarily due to the higher payroll and compensation-related expenses and travel, meals and entertainment expenses. R&D expenses totaled $81,000 in quarter 3 of fiscal 2017 compared to $84,000 in quarter 3 of fiscal 2016.

Operating income increased 40.9% to $1 million in quarter 3 of fiscal 2017, up from $376,000 (sic) [$736,000] in quarter 3 of fiscal 2016, again, primarily due to increased gross profit driven by higher revenue, which was partially offset by higher payroll and compensation-related expenses in sales and admin positions.

Net income tax -- net income before income tax expense rose 42.3% to $1 million in quarter 3 of fiscal 2017, up from $723,000 in the prior year quarter. In quarter 3 of fiscal 2017, income tax expense totaled $380,000 compared to $256,000 in the same period of the prior year. Our effective tax rate in quarter 3 of fiscal '17 was 37% compared to 35.4% in the prior year.

Our net income increased 38.9% to $648,000 or $0.08 per basic and diluted share in quarter 3 of fiscal '17, up from $467,000 or $0.06 per basic and diluted and in prior year quarter.

Briefly recapping our 9 months year-to-date fiscal 2017 financial performance. For the first 9 months of fiscal 2017, revenue increased 7.4% to $18.6 million from $17.3 million in the same period of fiscal 2016. And gross margins were 78.4% compared to 77.4% in the same period of the prior year, while net income was $1.3 million or $0.15 per diluted share compared to $1.9 million or $0.23 per diluted share in the same period of the prior year.

Now moving to the balance sheet and operating cash flow. Our balance sheet at March 31, 2016 (sic) [2017], included cash and cash equivalents of $5.4 million; long-term debt, including current maturities, of $1.2 million; working capital of $14.6 million; and stockholders' equity of $18 million.

Cash flows from operations in quarter 3 of fiscal 2017 totaled $767,000 and was up 52.4% compared to $503,000 in the prior year quarter. Overall, we're very pleased with the direction of our business and where we are heading, and this concludes my remarks.

Operator, could we start the Q&A portion of this call, please?

(Operator Instructions) Our first question comes from Brooks O'Neil of Lake Street Capital Markets.

I'm curious if you could talk just a little bit about your sales strategy. Clearly, the expanded sales force and more productivity is great, but can you just talk about how you're achieving that and what your focus is going to be from a sales perspective over the next 12 months or so?

Thank you, Brooks. I'll take that question. So our sales strategy is really going to be similar to what we just described and what we've been doing over the last year. And it's really about going out and talking about the product differentiation. We did an engineering-related study comparing all 3 devices relative to the feel for the patient. And the idea there was our peak-and-trough pressures really give the patient a more comfort feeling. So we're using that differentiation and that study with the physicians along with the clinical evidence of the cost savings that can be realized and the reduced infections and use of antibiotics. So those studies that were published, as we mentioned, in January are those that we're focusing on as well. And then thirdly, we're really going after more strategic accounts. Because we have that evidence. We have those differentiated studies, we can go after more strategic clinics that are larger that we think we can leverage more quickly related to our referral growth. So -- and then, of course, we'll continue to grow our sales strategy. But that, I think, helps summarize that true way that we're out there selling.

Good. So I just want to be clear in my own mind. So you're targeting individual physicians and physician groups with this strategy?

That is correct. We're -- our primary focus is on adult pulmonologists. And we’ve certainly continued to support pediatrics, which has -- cystic fibrosis is important, but the real growth is in that adult pulmonology field of -- for people suffering from bronchiectasis or more severe chronic obstructive pulmonary disease. And so those group physician practices are certainly our target and in the higher populated areas across the United States.

And are you doing things with the payers as well? It sounds like you offer a tremendous benefit to payers in terms of improved care for the patients as well as potentially significantly lower costs.

No, it's very true, Brooks. So of course, we are licensed to do business in every state in the United States. And part of that is that we then support Medicaid. We also, of course, do business with Medicare across the United States. And then there are those individual payer -- commercial payers. And we continue to bring on new lives covered through the commercial payer segment of the -- of our -- of that group. And Jeremy, maybe if there's some additional information you would like to provide there on the commercial payer coverage.

Yes. So we provide, as Kathleen said, the ability to do business in the 50 states, which, as a DME company, does get more complicated with all the rules and regulations that we must follow. So that ability gives us a strong foothold on what's going throughout the United States and really shows what we can do to the payers. We do have the significant majority of lives in the United States covered under contract. There are contracts that we don't have that we continue to work to get. None of them are any -- they are not the major players across the U.S., but we continue to work with them. And we have seen a significant portion or increase in our ability to gain contracts this year and add covered lives, which is important because the patient then becomes in-network, and our product shows up as an in-network product for them versus having to work through going out of network. And you can understand how difficult through your own or people you know has experienced trying to get a service from a provider that was out of network. So that's something we continue to work hard on, we continue to execute on, and we will continue to see the benefits from what we have done in the lives we have added under network coverage this year.

Great. And then the last question from me. I understand that institutional is a small part of your business. But can you just talk a little bit about what you're seeing there and what opportunities you think you have to kind of turn that business around?

Sure. Thank you. So our institutional business, as you mentioned, is a small percentage. It is not as strong of a focus, but it's important to us because typically, the brand that's used in the hospital critical care is often what that particular physician will prescribe, and it's what the patient wants to use if they are then discharged with HFCWO therapy. We do run into occasionally capital purchase issues that the hospital is dealing with. As you've probably heard, hospital systems throughout the United States are having a lot of budgetary issues. About 1/3 of the company -- of the hospitals are going to be probably having to merge or be acquired because of their losses. Another 1/3 may go out of business just because of the same situation. And so that becomes one of the challenges for us. So we're continuing to look at our business proposals to understand how we can best provide the right business proposal for those hospitals so that they can afford this therapy that is very important for them to control their readmissions from diseases or conditions like pneumonia or COPD. And we also naturally think that, that could move in a more positive direction. As we continue to expand our sales force, the territories will become smaller, which is going to provide more opportunity for those sales people to renew their focus in some of these institutions. So that hopefully helps answer your question, Brooks.

Our next question comes from Beth Lilly of Crocus Hill Partners.

So I wanted to ask -- I wanted to follow up on Brooks' questions in terms of the institutional market, and I want to just gain better visibility into that market. And then I also wanted to ask about your margins in the quarter. I mean, you have come in a very long way in a very short period of time in terms of your margin structure. And in this quarter, your operating margins were 15.5%. And it sounds like, based on Jeremy's comments, a lot of that is due to the expansion on the gross margin line, which is going to trend downwards. So if you look at your operating margin on a 3-month basis, it's 15.5%; but on a 9-month basis, it's 10.8%. So can you talk, as you look out over the next, let's call it, 2 to 3 years, where you see operating margins going?

So Beth, let me start there, and I think Jeremy will have some additional details to add. We're going to -- we think that there could be a little more pressure on margins as we continue to focus on taking advantage of the opportunities that there are in this adult pulmonology market. So we're real mindful of our profitable growth strategy. And so we're always balancing that growth versus continuing to show strong margins. We think, though, that as we continue to add sales people in the corresponding needs that we have here internally, as we want to find -- or build additional evidence for the cost utilization and the great effectiveness of this particular product, that we could see a little more pressure there. So Jeremy, what would you like to add on that as well?

Yes. I would agree with what Kathleen said. And I would also add that, as I spoke about earlier, that we will be seeing, on a portion of additional added revenue that we see, we will see some slippage in our ASP or allowable amount in order to get in, in certain geographical regions and to some of their regional players as far as who's providing DME or who the intermediary here that may be providing DME. While we don't think it's a majority or even close to getting to that point, there will be some slippage to that as we go along, which will be somewhat offset by our focus on Medicare and our Medicare patients, which is one -- Medicare being one of the higher allowable amounts. So we believe there will be some offset, but not a significant amount.

Okay. So for the 9 months, your operating margins are 10.8%. So do you think over the next, let's call it, over the next 6 quarters, we're going to start to see those margins expand or will they stay flat?

Our expectations is they would be right in within the range of the 3 months to the 9 months over the foreseeable future. And a lot of that -- and it will fluctuate just like our revenue does on a quarter-to-quarter basis. Our margins go right along with that based on the referrals that we get and the insurance or the provider that those individual patients have.

Yes, okay. Great, that's helpful. Now the other thing I want to -- it's interesting, I was looking at your February slide deck, and this is just a follow-up to Brooks' comments in terms of the institutional question. It's interesting, it seems to me that the institutional marketplace is -- I mean, the majority of your revenues are the home care market and yet, the institutional market seems to me to be a much bigger market. So I'm wondering about your ability to penetrate that market more effectively.

I think that -- thank you for the questions around institutional. If you think about the total served market, the institutional market is a smaller percentage of the home care market. And even our largest competitor finds that home care to institutional market is not quite the same ratio as ours, but the home care is the great majority of that. And so our view would be a little different on that in that the home care market still is the much larger opportunity for growth. The amount of critical care units that still may not use HFCWO, though, still does present an opportunity for us. And I think the key there is being able to help them understand what that value proposition is around, sending people home with clear lungs, using something like HFCWO versus most institutions right now will use a handheld OPEP device similar to what we're going to be selling now to -- from Monaghan Medical. So they are using airway clearance. They're not using the same type of therapy in all of those -- in those hospital admissions. So that's really somewhat the story there. I really still think, though, that the home care market is much larger.

Our next question comes from [Mike Dessler], a private investor.

I spoke to you last quarter. Just a couple of quick follow-ups. In terms of the institutional market question, which Beth just asked you about. I think the point that I was looking to was just, and I think you made it before Ms. Skarvan, was that once the patient sees and recognizes the nameplate and goes home with it and/or has used it in the institution itself, it's an easy stickiness that sort of evolves and the nameplate goes home. And if they use the entire product line down the road, they're going to choose Electromed's SmartVest product line versus the competitor's. That's just a comment. My question, I watched the Aerobika device in a hospital recently with a family member, and it was convenient, terrific, wonderful. My question is just twofold, and it's really not urgent. But in terms of the boomers and the elderly currently and the boomers like myself who are going through that period in life when pneumonia becomes an issue, is that really just -- I mean, at a $99 price point, whatever the margins are, you have to sell an awful lot of those to have a meaningful revenue growth and/or profit growth. However, I do see it as a foot-in-the-door type product. And once again, as having another stepping stone in the stickiness proposition of Electromed's product line, is that the way I should view that going forward? Or is it strictly as an add-on to your current SmartVest line? You see what I'm saying?

Thank you for your -- Mike, thank you for your comment and for your question. You are describing just accurately what we believe that strategy is around the Aerobika OPEP device. It is really about offering a very best-in-class product for airway clearance, but it can be an access issue. It's the idea of being able to offer an alternative solution to the clinician and to the patient and that full continuum of airway clearance care. And we also believe that there will be individuals that will want both devices. They may need high-frequency chest wall oscillation, they'll qualify, they'll become reimbursed for it. But they will also say, "For $99, I want to have the Aerobika as well so that when I'm traveling, I'm going to use that device," or "Maybe when I'm feeling -- I'm not -- I don't have an infection, it's easier to use the Aerobika once a day, and then I'll use my HFCWO." I mean, there's just so many great opportunities for a patient to utilize both therapies to stay out of the hospital to reduce infection. So -- but I think you've got the sales strategy, the growth strategy well understood.

Great. One more little question, and I forgot from the last call. Why isn't Europe, like somewhere down the road through the long telescope across the pond, a future priority? What am I missing there in terms of the market potential, for example?

So we have approximately -- not quite a dozen distributors throughout the world that we continue to support with our SmartVest therapy. In Europe, in particular, we do have distributors, and they continue to buy from us periodically. What we found in Europe as well as other countries is that the home care reimbursement is not as well-established for this particular therapy as it is here in the United States. And so that's been a bit of a barrier in regard to moving forward with higher demand or higher sales or growth in Europe in particular. Europe also, and particularly in the U.K., tends to use manual chest percussion versus using high-frequency chest wall oscillation for airway clearance. And where most of our sales for distributors have been in Europe has been in the hospital system where they have seen the efficiencies of using this versus manual chest percussion. I think that it remains on our radar, and there could be a time where this becomes more of an opportunity internationally. But again, right now, with limited resources and the growth potential that we see in the United States, that remains our focus.

Well, you actually caught my next question before I even got to ask about the U.K. So we're all done. Great quarter. Thank you for your time and your due diligence, and keep up the great work. We'll speak to you next quarter.

Thank you.

(Operator Instructions) If there are no further questions, I would like to turn the call back over to Electromed's CEO, Kathleen Skarvan, for closing comments.

Thank you all for participating on the call this morning. We look forward to reporting back to you in September when we release our fourth quarter fiscal 2017 financial results. Have a good day.

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