These studies indicate a wide range of potential prevalence of bronchiectasis patients from a low of 470,000 to as high as 4.2 million patients in the United States. We also believe that it is difficult to estimate from these studies which patients will need or benefit from HFCWO. The U.S. BRR indicated 15% of the patients included in the registry were prescribed HFCWO as part of their treatment plan. Using that study data, we estimate that, within the diagnosed Medicare population of 470,000,515,000, approximately 15% or 70,00077,000 have been prescribed HFCWO. We believe that bronchiectasis is underdiagnosed in the U.S. based on clinical study evidence. We also believe that HFCWO is under prescribed for bronchiectasis patients. By applying approximately 15% HFCWO penetration of diagnosed Medicare patients to the Weycker clinical study cited above to the estimated 4.2 million prevalence of bronchiectasis in the U.S., we derived that the HFCWO opportunity may be 630,000 forecasted units. (Seeunits (see Figure 1)1 below).

Estimated HFCWO Market Opportunity - Bronchiectasis Patients (U.S.) – Figure 1

The heightened awareness of bronchiectasis speaks to the growing body of clinical evidence supporting treatments to improve symptoms and manage disease progression. In 2019, an observational comparative retrospective cohort study published inBMC Pulmonary Medicineevaluated the efficacy of a treatment algorithm in 65 patients with radiographic and symptom confirmed bronchiectasis, centered on initiation of HFCWO therapy with the SmartVest System.⁴⁵ Patients were treated per the algorithm if they reported greater than two exacerbations in the previous year and symptoms, including chronic cough, sputum production, or dyspnea. Results show that at one-year: exacerbations requiring hospitalization and antibiotic use were significantly reduced and mean FEVmean-forced expiratory volume₁ remained stable post enrollment, suggesting early initiation of HFCWO therapy may slow the otherwise normal progression of the disease.

¹²Sievert C, et al. Using High Frequency Chest Wall Oscillation in a Bronchiectasis Patient Population: An Outcomes-Based Case Review.Respiratory Therapy Journal. 2016;11(4): 34–38.

²³Sievert C, et al. Cost-Effective Analysis of Using High Frequency Chest Wall Oscillation (HFCWO) in Patients with Non-Cystic Fibrosis Bronchiectasis.Respiratory Therapy Journal. 2017;12(1): 45–49.

³⁴Sievert C, et al. Incidence of Bronchiectasis-Related Exacerbation Rates After High Frequency Chest Wall Oscillation (HFCWO) Treatment — A Longitudinal Outcome-Based Study.Respiratory Therapy Journal. 2018;13(2): 38–41.

⁴⁵Powner J, et al. Employment of an algorithm of care including chest physiotherapy results in reduced hospitalizations and stability of lung function in bronchiectasis.BMC Pulmonary Medicine. 2019;19(82).

⁵⁶Aksamit T, et al. Bronchiectasis Research Registry C. Adult Patients With Bronchiectasis: A First Look at the US Bronchiectasis Research Registry.Chest. 2017;151:982-92.

⁶⁷Patel I.S., et al. Bronchiectasis, exacerbation indices, and inflammation in chronic obstructive pulmonary disease.Am J Respir Crit Care Med. 2004;170:400-7.

⁷⁸O’Brien C, et al. Physiological and radiological characterisationcharacterization of patients diagnosed with chronic obstructive pulmonary disease in primary care.Thorax. 2000;55:635-42.

⁸⁹Bafadhel M, et al. The role of CT scanning in multidimensional phenotyping of COPD.Chest. 2011;140:634-42.

⁹¹⁰Chalmers J. and Sethi S. Raising awareness of bronchiectasis in primary care: overview of diagnosis and management strategies in adults.NPJ Prim Care Respir Med. 2017;27:18.

¹⁰¹¹Henkle E, et al. Characteristics and Health-care Utilization History of Patients with Bronchiectasis in US Medicare Enrollees With Prescription Drug Plans, 2006 to 2014. Chest. 2018;154(6), 1311–1320.

¹²Seitz A, et al. Trends in Bronchiectasis Among Medicare Beneficiaries in the United States, 2000 to 2007.Chest. 2012;142(2), 432–439.

¹¹¹³Weycker D, Hansen G, Seifer F. Prevalence and incidence of noncystic fibrosis bronchiectasis among US adults in 2013.Chronic Respiratory Disease. 2017; 14(4):377-384.

Marketing, Sales and Distribution

Our sales and marketing efforts are focused on building market awareness and acceptance of our products and services with physicians, clinicians, patients, and third-party payers. Because the sale of the SmartVest System requires a physician’s prescription, we market to physicians and health care providers as well as directly to patients. The vast majority of our revenue comes from domestic home care sales through a physician referral model. We have established our own domestic sales force, which we believe is able to provide superior education, support and training to our customers. Our direct U.S. sales force works with physicians and clinicians, primarily pulmonologists, in defined territories to help them understand our products and services and the value they provide to their respective patients. As of June 30, 2019,2021, we had 4046 field sales employees, including fourfive regional sales managers, 3437 clinical area managers (“CAMs”) and two clinical educators. We also have developed a network of approximately 250 respiratory therapists and health care professionals across the U.S. to assist with in-home SmartVest System patient training on a non-exclusive, independent contractor basis. Virtual patient trainings are also available upon patient request. These independent contractors are credentialed by the National Board for Respiratory Care as either Certified Respiratory Therapists or Registered Respiratory Therapists.

Of the $30.6 million of our revenue derived from the U.S. in our fiscal year ended June 30, 2019 (“fiscal 2019”), approximately 95% represented home care and 5% represented hospital sales. Due to readmission penalties associated with the Patient Protection and Affordable Care Act, as reconciled by the Health Care and Education Reconciliation Act of 2010 (collectively the “PPACA”), for certain diseases and conditions including COPD and pneumonia, we believe opportunities for further growth exist for HFCWO therapy because the device used by a patient in a hospital may influence the choice of device prescribed at discharge. We expect to achieve future sales, earnings, and overall market share growth with increasing home care referrals by educating and building awareness of diseases and conditions that may benefit from HFCWO, like bronchiectasis, with physicians and patients and the value of the SmartVest System’s differentiated features and benefits.

●

Of the $35.1 million of our revenue derived from the U.S. in fiscal 2021, approximately 94% represented home care and 4% represented hospital sales. Due to readmission penalties associated with the Patient Protection and Affordable Care Act, as reconciled by the Health Care and Education Reconciliation Act of 2010 (collectively the “PPACA”), for certain diseases and conditions including COPD and pneumonia, we believe opportunities for further growth exist for HFCWO therapy because the device used by a patient in a hospital may influence the choice of device prescribed at discharge. We expect to achieve future sales, earnings, and overall market share growth with increasing home care referrals by educating and building awareness of diseases and conditions that may benefit from HFCWO, like bronchiectasis, with physicians and patients and the value of the SmartVest System’s differentiated features and benefits. We believe that service to our providers and patients is an additional key component of achieving future sales. Providers seek companies that are easy to work with, are responsive and care for their patients as an extension of their practices.

We generate sales leads through multiple channels that include visits to pulmonology clinics and medical centers, participation in medical conferences, maintenance of industry contacts to increase the visibility and acceptance of our products by physicians and health care professionals, participation with patient organizations such as the Cystic Fibrosis Foundation, as well as through patients by word of mouth and traffic to our website and social media channels. We continue to evaluate opportunities to offer the SmartVest System through selected Home Medical Equipment (“HME”) distributors. We entered into agreements with twofour HME distributors, one national and onethree regional, to distribute and sell the SmartVest systemSystem in the United States home care market. The Company expectsWe expect to continue itsour direct sales channel as itsour primary homecare revenue source. Sale of the SmartVest systemSystem through HME distributors has begunbegan in targeted geographies in the first quarter of our fiscal 2020.

year ended June 30, 2020 (“fiscal 2020”), and we had approximately $563,000 of revenue generated through these channels during fiscal 2021.

TheWe believe that the addition of anour HME distribution network would expandexpands our access to physicians and hospitals in certain areas of the United States and would be expected to supportsupports our other growth strategies. In addition, we place advertisements in leading medical magazines and journals.

Additionally, because the availability of reimbursement is an important consideration for health care professionals and patients, we must also demonstrate the effectiveness of our products to public and private insurance providers. The availability of reimbursement exists primarily due to an established Healthcare Common Procedure Coding System (“HCPCS”) code for HFCWO. A HCPCS code is assigned to services and products by the Centers for Medicare and Medicaid Services (“CMS”). Because our product has an assigned HCPCS code, a claim can be billed for reimbursement using that code.

International Marketing

Approximately 2.4%1.8% and 1.8%2.2% of our net revenues were from sales outside of the U.S. in our fiscal 20192021 and our fiscal year ended June 30, 2018 (“fiscal 2018”),2020, respectively. We sell our products outside of the U.S. primarily through independent distributors specializing in respiratory products. Through June 30, 2019,2021, the majority of our distributors operated in exclusive territories. Our principal distributors are located in Europe, the Arab states of the Persian Gulf, Europe, Southeast Asia, and South America and Central America. Units are sold at a fixed contract price with payments made directly from the distributor, rather than being tied to reimbursement rates of a patient’s insurance provider as is the case for domestic sales. Our sales strategy outside of the U.S. is to focus our corporate resources on maintainingmaintain our current distributors with less emphasis on contracting with new distributors.

Third-Party Reimbursement

In the U.S., individuals who use the SmartVest System generally will rely on third-party payers, including private payers and governmental payers such as Medicare and Medicaid, to cover and reimburse all or part of the cost of using the SmartVest System. Our homecarehome care revenue comes from reimbursement from commercial payors, Medicare, Medicaid, Veterans Affairs and direct patient payments. Reimbursement for HFCWO therapy and the SmartVest System varies among public and private insurance providers.

A key strategy to grow sales is achieving world class customer service and support for our patients and clinicians.clinicians and increasing the number of covered lives across a broad payer market. We do this with an established and effective reimbursement department working on behalf of the patient by processing physician paperwork, seeking insurance authorization and processing claims. The skill and knowledge gained and offered by our reimbursement department is an important factor in building our revenue and serving patients’ financial interests. Our payment terms generally allow patients to acquire the SmartVest System over a period of 1one to 15 months, which is consistent with reimbursement procedures followed by Medicare and other third parties. The payment amount we receive for any single referral may vary based on a number of factors, including Medicare and third-party reimbursement processes and policies. The patient retains the risk of reimbursement to the Company in the event of non-payment by third-party payers. The reimbursement department includes the payer relations function working directly with all payer types to increase the covered lives for the SmartVest System with national and regional private insurers and applicable state and federal government entities as well as to maintain all of the current licenses with state and federal government and payer contracts.

Our SmartVest System is reimbursed under HCPCS code E0483. Currently, the Medicare total allowable amount of reimbursement for this billing code is approximately $12,000.$13,000. The allowed amount for state Medicaid programs rangeranges from approximately $8,000 to $12,000,$13,000, which is similar to commercial payers. Actual reimbursement from third-party payers can vary and can be significantly less than the full allowable amount. Deductions from the allowable amount, includesuch as co-payments, deductibles and/or maximums on durable medical equipment, decrease the reimbursement received from the third-party payer. Collecting a full allowable amount depends on our ability to obtain reimbursement from the patient’s secondary and/or supplemental insurance if the patient has additional coverage, or our ability to collect amounts from individual patients.

Most patients are able to qualify for reimbursement and payment from Medicare, Medicaid, private insurance or combinations of the foregoing. We expect that subsequent generations of HFCWO products also will qualify for reimbursement under Medicare Plan B and most major health plans. However, some third-party payers must also approve coverage for new or innovative devices or therapies before they will reimburse health care providers who use the medical devices or therapies. In addition, we face the risk that new or modified products could have a lower reimbursement rate, or that the levels of reimbursement currently available for our existing products could decrease, which would hamper our ability to market and sell that product. Consequently, our sales will continue to depend in part on the availability of coverage and reimbursement from third-party payers, even though our devices may have been cleared for marketing by the FDA. The manner in which reimbursement is sought and obtained varies based upon the type of payer involved and the setting in which the procedure is furnished.

In response to the COVID-19 pandemic and the U.S. federal government’s declaration of a public health emergency in March 2020, CMS implemented a number of temporary rule changes and waivers to allow prescribers to best treat patients during the period of the public health emergency. These waivers are retroactively effective to March 1, 2020. Clinical indications and documentation typically required will not be enforced for respiratory related products including the SmartVest System (solely with respect to Medicare patients). 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 during such period, which is currently scheduled to expire in October 2021.

Research and Development

Our R&D capabilities consist of full-time engineering staff and several consultants. We periodically engage consultants and contract engineering employees to supplement our development initiatives. Our team has a demonstrated record of developing new products that receive the appropriate product approvals and regulatory clearances around the world.

During fiscal 20192021 and 2018,2020, we incurred R&D expenses of approximately $583,000$1,722,000 and $251,000,$1,050,000, or 1.9%4.8% and 0.9%3.2% of our net revenues, respectively. As a percentage of sales, we expect spending on R&D expenses to remain relatively consistentdecrease slightly during the fiscal year ended June 30, 2020 (“fiscal 2020”)2022 as compared with fiscal 2019 with engineering resources focusing2021, as we conclude the design and testing of our next generation device in preparation for an anticipated fiscal 2023 product launch. Product enhancements were driven by voice of customer survey and in-person information focused on patient useability and device portability. We also estimate that the next generation product enhancements and other market opportunities, includingwill be a lower cost bill of material compared to the SmartVest Connect with Bluetooth technology and supporting mobile applications.SQL.

Intellectual Property

As of June 30, 2019,2021, we held 17 U.S.15 United States and 2544 foreign issued patents covering the SmartVest System and its underlying technology and had 1964 pending U.S.United States and foreign patent applications. These patents and patent applications offer coverage in the field of air pressure pulse delivery to a human in support of airway clearance. One of our foreign patents will expire during fiscal 2020.

We generally pursue patent protection for patentable subject matter in our proprietary devices in foreign countries that we have identified as key markets for our products. These markets include the European Union, Canada, Japan, and other countries.

We also have received ten U.S. trademark and service mark registrations, and one SmartVest registration in each of Canada, Peru, and Japan, one pending international registration and one through the Madrid Protocol for India.

Manufacturing

Our headquarters in New Prague, Minnesota includes a dedicated manufacturing and engineering facility of more than 10,00014,000 square feet and we are certified on an annual basis to be compliant with ISOInternational Organization for Standardization (“ISO”) 13485 quality system standards. Our site has been audited regularly by the FDA and the International Organization for Standardization (“ISO”),ISO, in accordance with their practices, and we maintain our operations in a manner consistent with their requirements for a medical device manufacturer. While components are outsourced to meet our detailed specifications, each SmartVest System is assembled, tested, and approved for final shipment at our manufacturing site in New Prague, consistent with FDA, Underwriters Laboratory, and ISO standards. Many of our vendorsstrategic suppliers are located within 100 miles of our headquarters, which enables us to closely monitor our component supply chain. We maintain established inventory levels for critical components and finished goods to assure continuity of supply. During fiscal 2021 we experienced longer lead times for critical electronic components, certain plastic raw materials and packaging material related to worldwide shortages due to COVID-19 and the related U.S. economic recovery. We did not experience any material disruptions to customer shipments in fiscal 2021.

Product Warranties

We provide a warranty on the SmartVest System that covers the cost of replacement parts and labor, or a new SmartVest System in the event we determine a full replacement is necessary. For each home care SmartVest Systems initially purchased and currently located in the U.S. and Canada, we provide a lifetime warranty to the individual patient for whom the SmartVest System is prescribed. For sales to institutions and HME distributors within the U.S., and for all international sales, except Canadian home care, we provide a three-year warranty.

Competition

The original HFCWO technology was licensed to American Biosystems, Inc. (now Advanced Respiratory, Inc. (“ARI”), part of Hill-Rom Holdings, Inc.) (“Hillrom”), which, until the introduction of our original MedPulse Respiratory Vest System^® in 2000, was the only manufacturer of a product with HFCWO technology cleared for market by the FDA (ARI’s(Hillrom’s The Vest^®Airway Clearance System). ARIHillrom has also received FDA 510(k) clearance for the Monarch™Monarch^®™ Airway Clearance System, a mobile device that uses pulmonary oscillating discs.  Respiratory Technologies, Inc., doing business as (now RespirTech, part of Koninklijke Phillips N.V.) received FDA clearance to market their HFCWO product, the inCourage^® Airway Clearance Therapy. In August 2017, Royal Phillips acquired RespirTech.Therapy in 2005. Both ARIHillrom and RespirTech employ a direct-to-patient model, and recently Royal Phillips announced plans to offer its HFCWO device through selected HME distributors.

The AffloVest^® (the “AffloVest”) from International Biophysics Corporation (“IBC”) also participates in the same market as our SmartVest System. IBC received FDA 510(k) clearance for its device in 2013. IBC primarily sells its device through DME companies who distribute home care medical devices and supplies. Clinical and cost-effective evidence, technology innovations, including wireless connectivity, and HFCWO product features and benefits, such as size, weight of the generator, reputation for patient and reimbursement services, and sales effectiveness of field personnel, have become the key drivers of HFCWO product sales.

Based on annual revenue, we estimate that Hillrom maintains the highest market share in HFCWO followed by RespirTech with Electromed in the third position followed by IBC.

Alternative products for administering pulmonary therapy include: Positive Expiratory Pressure; OPEP; Intrapulmonary Percussive Ventilation; CPT and breathing techniques. Physicians may prescribe some or all of these devices and techniques, depending upon each patient’s health status, severity of disease, compliance, or personal preference.

We believe our primary competitive advantages over alternative treatments are patient comfort, ease of use, and the effectiveness of HFCWO treatment. Because HFCWO is not “technique dependent,” as compared to most other pulmonary therapy products, therapy begins automatically once power is provided and remains consistent and controlled for the duration of treatment.

Governmental Regulation

Medicare and Medicaid

Recent government and private sector initiatives in the U.S. and foreign countries aim at limiting the growth of health care costs, including price regulation, competitive pricing, coverage and payment policies, comparative effectiveness of therapies, technology assessments, and managed-care arrangements, and are causing the marketplace to put increased emphasis on the delivery of more cost-effective medical devices that result in better clinical outcomes. Government programs, including Medicare and Medicaid, have attempted to control costs by limiting the amount of reimbursement the program will pay for particular procedures or treatments, restricting coverage for certain products or services, and implementing other mechanisms designed to constrain utilization and contain costs. Many private insurance programs look to Medicare as a guide in setting coverage policies and payment amounts. These initiatives have created an increasing level of price sensitivity among our customers.

Home Medical Equipment Licensing

Although we do not fall under competitive bidding for Medicare, we often must satisfy the same licensing requirements as other DME providers that qualify for competitive bidding. In response to out-of-state businesses winning the competitive bidding process, which had a significant impact on small local DME businesses, many states have enacted regulations that require a DME provider to have an in-state business presence, specifically through state HME licensing boards or through state Medicaid programs. In order to do business with any patients in the state or to be a provider for the state Medicaid program, a DME provider must have an in-state presence. In addition to Minnesota, the location of our corporate headquarters, we have a licensed in-state presence in fourthree other states. We also maintain an in-state presence in California in order to meet their state Medicaid requirements. In-state presence requirements are differentvary from state to state, but generally require a physical location that is staffed and open during regular business hours. We are licensed to do business in all states except for Hawaii.

Product Regulations

Our medical devices are subject to regulation by numerous government agencies, including the FDA and comparable foreign regulatory agencies. To varying degrees, each of these agencies requires us to comply with laws and regulations governing the development, testing, manufacturing, labeling, marketing, and distribution of our medical devices, and compliance with these laws and regulations entails significant costs for us. Our regulatory and quality assurance departments provide detailed oversight in their areas of responsibility to support required clearances and approvals to market our products.

In addition to the clearances and approvals discussed below, we obtained ISO 13485 certification in January 2005 and receive annual certification of our compliance withto the current ISO quality standards.

FDA Requirements

We have received clearance from the FDA to market our products, including the SmartVest System. We may be required to obtain additional FDA clearance before marketing a new or modified product in the U.S., either through the 510(k) clearance process or the more complex premarket approval process. The process may be time consuming and expensive, particularly if human clinical trials are required. Failure to obtain such clearances or approvals could adversely affect our ability to grow our business.

Continuing Product Regulation

In addition to its approval processes for new products, the FDA may require testing and post-market surveillance programs to monitor the safety and effectiveness of previously cleared products that have been commercialized and may prevent or limit further marketing of products based on the results of post-mark surveillance results. At any time after marketing clearance of a product, the FDA may conduct periodic inspections to determine compliance with both the FDA’s Quality System Regulation (“QSR”) requirements and/orand current medical device reporting regulations. Product approvals by the FDA can be withdrawn due to failure to comply with regulatory standards or the occurrence of unforeseen problems following initial market clearance. The failure to comply with regulatory standards or the discovery of previously unknown problems with a product or manufacturer could result in fines, delays or suspensions of regulatory clearances, seizures or recalls of products (with the attendant expenses), the banning of a particular device, an order to replace or refund the cost of any device previously manufactured or distributed, operating restrictions and criminal prosecution, as well as decreased sales as a result of negative publicity and product liability claims.

We must register annually with the FDA as a device manufacturer and, as a result, are subject to periodic FDA inspection for compliance with the FDA’s QSR requirements that require us to adhere to certain extensive regulations. In addition, the federal Medical Device Reporting regulations require us to provide information to the FDA whenever there is evidence that reasonably suggests that a device may have caused or contributed to a death or serious injury or, if a malfunction were to occur, could cause or contribute to a death or serious injury. We also must maintain certain certifications to sell products internationally, and we undergo periodic inspections by notified bodies to obtain and maintain these certifications.

Advertising and marketing of medical devices, in addition to being regulated by the FDA, are also regulated by the Federal Trade Commission and by state regulatory and enforcement authorities. Recently, promotional activities for FDA-regulated products of other companies have been the subject of enforcement action brought under health care reimbursement laws and consumer protection statutes. Competitors and others also can initiate litigation relating to advertising and /orand/or marketing claims. If the FDA determines thatwere to determine our promotional or training materials constitute promotion of an unapproved or uncleared claim of use, it is possible we maywould need to modify our training or promotional materials or be subject to regulatory or enforcement actions that maycould result in civil fines or criminal penalties. Other federal, state or foreign enforcement authorities mightcould also take similar action if they were to determine that our promotional or training materials constitute promotion of an unapproved use, which could result in significant fines or penalties.

European Union and Other Regions

European Union rules require that medical products receive the right to affix the CE marking, demonstrating adherence to quality standards and compliance with relevant European Union Medical Device Directives.Directives (“MDD”). Products that bear CE marking can be imported to, sold or distributed within the European Union. We obtained clearance to use CE marking on our products in April 2005. Renewal of CE marking is required every five years, and our notified body performs an annual audit to ensure that we are in compliance with all applicable regulations. We have maintained our CE marking in good standing since originally receiving it and most recently renewed it in January 2015.2020. The renewal of our MDD certificate will allow us to continue to CE mark and sell our SmartVest SQL device, with no substantial changes, in the European Union until the certificate expires in May 2024. We are currently working on finalizing updates to the quality system to achieve full compliance with Regulation (EU) 2017/745 (EU MDR) which came into effect in May 2021. We also require all of our distributors in the European Union and other regions to comply with their home country regulations in our distributor agreements.

The 2010 Healthcare Reform Legislation, medical device excise tax and Federal Physician Payments Sunshine Act

U.S. healthcare reform legislation (“PPACA”), was enacted into law in March 2010. The PPACA imposes a 2.3% excise tax on certain domestic sales of medical devices by manufacturers. To the extent that third-party payers and institutions will not absorb increased costs represented by the tax because of reimbursement or contract limitations, we are not able to offset the tax with increased revenue.

Beginning with the third quarter of our fiscal year ended June 30, 2016, we realized a positive impact to operating profit with the adoption of the recent Consolidated Appropriations Act, 2016, which includes a two-year moratorium on the medical device excise tax effective as of January 1, 2016.

On May 22, 2018, we concluded an examination with the Internal Revenue Service (“IRS”) related to federal medical device excise taxes paid on revenue associated with our sales of the SmartVest during our tax periods ended June 30, 2014 through December 31, 2015. As a result, it was determined the SmartVest was eligible for the retail exemption from the medical device excise tax, resulting in the IRS agreeing to a refund of approximately $406,000. This refund was recognized in fiscal 2018 results and full payment was received in July 2018. Furthermore, we expect we will be exempt from the medical device tax after the conclusion of the current two-year medical device tax moratorium, which is scheduled to end on December 31, 2019.

Federal Physician Payments Sunshine Act

The Federal Physician Payments Sunshine Act (Section 6002 of the PPACA, thePPACA) (the “Sunshine Act”) was adopted on February 1, 2013, to create transparency for the financial relationship between medical device companies and physicians and/or teaching hospitals. In January 2021, the Sunshine Act was expanded to cover payments made to physician assistants, nurse practitioners, clinical nurse specialists, certified nurse anesthetists, and certified nurse midwives. The Sunshine Act requires all manufacturers of drugs and medical devices to annually report to the CMS any payments or any other “transfers of value” made to physicians and teaching hospitals, including but not limited to consulting fees, grants, clinical research support, royalties, honoraria, and meals. This information is then posted on a public website so that consumers can learn how much was paid to their physician by drug and medical device companies. The Sunshine Act requires ongoing data collection and annual management and reporting by us.us and imposes civil penalties for manufacturers that fail to report timely, accurately, or completely to CMS.

Fraud and Abuse Laws

Federal health care laws apply to the marketing of our products and when we or our customers submit claims for items or services that are reimbursed under Medicare, Medicaid or other federally-funded health care programs. The principal applicable federal laws include:

There are often similar state false claims, anti-kickback, and anti-self-referral and insurance laws that apply to state-funded Medicaid and other health care programs and private third-party payers. In addition, the U.S. Foreign Corrupt Practices Act can be used to prosecute companies in the U.S. for arrangements with physicians, or other parties outside the U.S. if the physician or party is a government official of another country and the arrangement violates the law of that country. Enforcement of all of these regulations has become increasingly stringent, particularly due to more prevalent use of the whistleblower provisions under the False Claims Act, which allow a private individual to bring actions on behalf of the federal government alleging that the defendant has submitted a false claim to the federal government and to share in any monetary recovery. If a governmental authority were to conclude that we are not in compliance with applicable laws and regulations, we and our officers and employees could be subject to severe criminal and civil penalties and disbarment from participation as a supplier of product to beneficiaries covered by Medicare or Medicaid.

HIPAA/HIPAA, HITECH and Other Privacy Regulations

Federal and state laws protect the confidentiality of certain patient health information, including patient records, and restrict the use and disclosure of such information. The Health Insurance Portability and Accountability Act of 1996 and its implementing regulations (“HIPAA”) and the Health Information Technology for Economic and Clinical Health Act (“HITECH”) set forth privacy and security standards that govern the use and disclosure of protected electronic health information by “covered entities”,entities,” which include healthcare providers, health plans and healthcare clearinghouses. Because we provide our products directly to patients and bill third-party payers such as Medicare, Medicaid, and insurance companies, we are a “covered entity” and must comply with these standards. Failure to comply with HIPAA/HIPAA and HITECH or any state or foreign laws regarding personal data protection may result in significant fines or penalties and/or negative publicity. In addition to federal regulations issued under HIPAA/HIPAA and HITECH, some states have enacted privacy and security statutes or regulations that, in some cases, are more stringent than those issued under HIPAA/HIPAA and HITECH. In those cases, it may be necessary to modify our planned operations and procedures to comply with the more stringent state laws. If we fail to comply with applicable state laws and regulations, we could be subject to additional sanctions.

The HIPAA/HIPAA and HITECH health care fraud and false statement statutes also prohibit, among other things, knowingly and willfully executing, or attempting to execute, a scheme to defraud any health care benefit program, including private payers, and knowingly and willfully falsifying, concealing or covering up a material fact or making any materially false, fictitious or fraudulent statement or representation in connection with the delivery of or payment for health care benefits, items or services.

Environmental Laws

We are subject to various environmental laws and regulations both within and outside the U.S. Like other medical device companies, our operations involve the use of substances regulated under environmental laws, primarily manufacturing, sterilization, and disposal processes. We do not expect that compliance with environmental protection laws will have a material impact on our results of operations, financial position, or cash flows.

EmployeesCybersecurity and Data Privacy

Protecting the privacy of customer and personnel information is important to us, and we maintain security protocols and processes, including training and education for all personnel, designed to combat the risk of unauthorized access or inadvertent disclosure. Our business operations involve confidential information, including patient health information subject to regulation as discussed under “HIPAA, HITECH and Other Privacy Regulations” above. Our information technology infrastructure is designed to offer reliability, scalability, performance, security and privacy for our personnel, clients and third-party contractors.

We maintain comprehensive compliance and security programs designed to help safeguard and ensure the integrity of the confidential information we possess, which includes both organizational and technical control measures. We also have programs in place to monitor the safety of confidential information as well as plans for immediate, coordinated action in the event of a potential security incident.  We routinely conduct employee trainings on important information security procedures and engage with independent third-party firms to test and measure compliance on these security measures. In addition, we have maintained appropriate cyber insurance policies that limit the financial risk of any potential incident. Our cyber insurance policies include dedicated support for remediating a specific cybersecurity or data privacy incident and limit the potential financial risk associated with an actual incident.

Even though we have implemented administrative, physical and technical safeguards designed to help protect the confidential data we possess and the integrity of our information systems and infrastructure, these safeguards may not be effective in preventing future cybersecurity incidents or data breaches.

Data Privacy Incident

In June 2021, we determined that an unauthorized third party gained access to a limited number of our files. Upon discovery, we immediately initiated an investigation and engaged third-party advisors to assist in investigating the source and scope of the unauthorized activity, and to further secure our information systems. From the investigation, we determined that certain files containing certain information of customers, employees, and some third-party contractors were accessed. There has been no indication that any of this information has been used inappropriately and we are working to mitigate any impact on the Company. Individuals whose information may have been involved in the data privacy incident were specifically contacted by the Company. The Company has a cyber insurance policy which we believe will cover most of the costs associated with this specific data incident.  To help prevent a similar incident from occurring in the future, we further enhanced the security of our systems, and will continue to review and, where appropriate enhance, our security protocols and processes, and training and education.  

Human Capital

We believe that our dedicated, talented employees are our most valuable resource and a key strength in accomplishing our collective mission and goals. As of June 30, 2019,2021, we had 119 employees. Twelve132 employees, an increase of 8.2% from fiscal 2020, who are located in 24 states throughout the United States.  10 of our employees were respiratory therapists licensed by appropriate state professional organizations, including all the employees in our Patient Services Department. We also retainhad approximately 250 respiratory therapists and health care professionals retained on a non-exclusive, independent contractor basis to provide training to our customers in the U.S. None of our employees are covered by a collective bargaining agreement. We believe our relations with our employees are good.

We are committed to attracting, retaining, and developing diverse and high-performing talent that includes a strong focus on performance and development, total rewards, diversity, inclusion and equity, and employee safety. These serve as the pillars to our human capital management framework.

We understand that our success and growth depends on attracting, retaining, and developing talent across all levels of the organization. Our recruitment strategies are continuously reviewed with leadership and partners to ensure our practices align with our mission, purpose, and values.

We believe in ensuring that employees understand our mission, purpose, and goals as well as their impact on our success. We use an annual performance review process to support development and performance discussions with employees. In addition, every employee is eligible to participate in our incentive plan, which allows for us to share the rewards of the company with the people who significantly contribute to our success.

To cultivate a learning culture that provides enhancement and growth for our people, we offer educational assistance, online training, seminars, specific skill training, and participation in business and industry organizations. We are also committed to contributing our talents and resources to serve the communities in which we live and work through various charitable campaigns, employee programs and volunteerism. We believe that this commitment assists in our efforts to attract and retain employees.

We believe that sharing rewards is essential to increasing employee engagement and improving morale and creating a positive culture. We also offer our employees a competitive salary and benefits package and are committed to continuous review of these programs. These benefits include but are not limited to retirement savings, a variety of health insurance options and other benefits programs, including dental and vision, disability insurance, contributions to health savings accounts, paid maternity/paternity leave, and wellness resources. In addition, we offer opportunities for remote work and flexible schedules and location, depending on business needs and the specific role.

We are committed to ensuring a diverse workforce in a safe environment by maintaining compliance with applicable employment laws and governmental regulations. Treating employees with dignity and equality is of utmost importance in everything we do. We take pride in the fact that women represent 52% of our total managerial roles and comprise 37.5% of our executive leadership team. We pride ourselves on accepting, hearing, and celebrating multiple approaches and points of view and building on an inclusive and diverse culture.

Safety is a vital aspect to the success of our people and business. We are proud of our employees’ collective commitment to secure and maintain safe work practices that have resulted in zero lost time injuries within our manufacturing operations. We also provide wellbeing services to support each employee’s physical and mental health and will continue to emphasize the importance of the safety and health of our employees in all we do.

Available Information

Our Internet address is www.smartvest.com. We have made available on our website, free of charge, our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and, if applicable, amendments to those reports, as soon as reasonably practicable after we electronically file these materials with, or furnish them to, the Securities and Exchange Commission.SEC. Reports of beneficial ownership filed by our directors and executive officers pursuant to Section 16(a) of the Exchange Act are also available on our website. We are not including the information contained on our website as part of, or incorporating it by reference into, this Annual Report on Form 10-K. The SEC also maintains an Internet site that contains our reports, proxy and information statements, and other information we file or furnish with the SEC, available at www.sec.gov.

Item 1A.   Risk Factors.

As a smaller reporting company, we are not required to provide disclosure pursuant to this item.

Item 1B.   Unresolved Staff Comments.

As a smaller reporting company, we are not required to provide disclosure pursuant to this item.

Item 2.      Properties.

We own our principal headquarters and manufacturing facilities, consisting of approximately 24,00037,000 square feet, which are located on an approximately 2.3-acre parcel in New Prague, Minnesota. This owned property was subject to a mortgage (see Note 6 to the Financial Statements, included in Part II, Item 8, of this Annual Report on Form 10-K for further information). We also had leased approximately 20,000 square feet of warehouse and office space in a building adjacent to our manufacturing facilities through June 30, 2019. In April 2019, we entered into an agreement to expand our New Prague, Minnesota facility. The expansion commenced in April 2019 and we anticipate it will be complete in the first quarter of fiscal 2020. Total project costs are estimated to range between $1,500,000 and $1,700,000. We have spent approximately $1,090,000 on the project through June 30, 2019. We believe that our facilities after taking into consideration the pending expansion project, are satisfactory for our long-term growth plans.

Item 3.      Legal Proceedings.

We may be party to legal actions, proceedings, or claims in the ordinary course of business. We are not aware of any actual or threatened litigation that would have a material adverse effect on our financial condition or results of operations.

Item 4.      Mine Safety Disclosures.

None.

PART II

Item 5.      Market For Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

Market Information

Our common stock is listed on the NYSE American under the symbol “ELMD”.

As of August 26, 2019,20, 2021, there were 7865 registered holders of our common stock.

Dividends

We have never paid cash dividends on any of our shares of common stock. We currently intend to retain any earnings for use in operations and do not anticipate paying cash dividends to our shareholders in the foreseeable future. The agreement governing our credit facility restricts our ability to pay dividends.

Recent Sales of Unregistered Equity Securities

None.

PurchasePurchases of Equity Securities by the Company and Affiliated Purchasers

None.On May 26, 2021, our Board of Directors approved a stock repurchase authorization. Under the authorization, we may repurchase up to $3.0 million of outstanding shares of our common stock through May 26, 2022. The shares of our common stock may be repurchased on the open market or in privately negotiated transactions subject to applicable securities laws and regulations. The following table sets forth information concerning purchases of shares of our common stock for three months ended June 30, 2021:

Item 6.      Selected Financial Data.

As a smaller reporting company, we are not required to provide disclosure pursuant to this item.

Item 7.      Management’s Discussion and Analysis of Financial Condition and Results of Operations.

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our financial statements and the accompanying notes included elsewhere in this Report.Annual Report on Form 10-K. The forward-looking statements include statements that reflect management’s good faith beliefs, plans, objectives, goals, expectations, anticipations and intentions with respect to our future development plans, capital resources and requirements, results of operations, and future business performance. Our actual results could differ materially from those anticipated in the forward-looking statements included in this discussion as a result of certain factors, including, but not limited to, those discussed in the section entitled “Information Regarding Forward-Looking Statements” immediately preceding Part I of this Report.Annual Report on Form 10-K.

Overview

Electromed develops and provides innovative airway clearance products applying HFCWO technologies in pulmonary care for patients of all ages.

We manufacture, market and sell products that provide HFCWO, including the SmartVest System and related products, to patients with compromised pulmonary function. The SmartVest SQL is smaller, quieter and lighter than our previous product (the SmartVest SV2100), with enhanced programmability, and ease of use.use, wireless technology, and a personalized HFCWO therapy management portal for patients with compromised pulmonary function. Our products are sold in both the home health care market and the institutional market for use by patients in hospitals, which we refer to as “institutional sales.” The SmartVest SQL has been sold in the domestic home care market since 2014. In 2017, we launched the SmartVest SQL with SmartVest Connect™Connect wireless technology.

The SmartVest System is often eligible for reimbursement from major private insurance providers, health maintenance organizations (“HMOs”), state Medicaid systems, and the federal Medicare system, which is an important consideration for patients considering an HFCWO course of therapy. For domestic sales, the SmartVest System may be reimbursed under the Medicare-assigned billing code for HFCWO devices if the patient has cystic fibrosis, bronchiectasis (including chronic bronchitis or chronic obstructive pulmonary disease that has resulted in a diagnosis of bronchiectasis), or any one of certain enumerated neuromuscular diseases, and can demonstrate that another less expensive physical or mechanical treatment did not adequately mobilize retained secretions. Private payers consider a variety of sources, including Medicare, as guidelines in setting their coverage policies and payment amounts.

We employ a direct-to-patient and provider model, through which we obtain patient referrals from clinicians, manage insurance claims on behalf of our patients and their clinicians, deliver our solutions to patients and train them on proper use in their homes. This model allows us to directly approach patients and clinicians, whereby we disintermediate the traditional durable medical equipment channel and capture both the manufacturer and distributor margins.

Our primary goals for the We have engaged a limited number of regional durable medical equipment distributors focused on respiratory therapies as an alternate sales channel. Revenue through this channel was less than 2% of our total revenues in fiscal 2020, include:2021.

Our key growth strategies for fiscal 2022 include the fiscal 2020 include:following:

Critical Accounting Policies and Estimates

During the preparation of our financial statements, we are required to make estimates, assumptions and judgments that affect reported amounts. Those estimates and assumptions affect our reported amounts of assets and liabilities, our disclosure of contingent assets and liabilities, and our reported revenues and expenses. We update these estimates, assumptions and judgments as appropriate, which in most cases is at least quarterly. We use our technical accounting knowledge, cumulative business experience, judgment and other factors in the selection and application of our accounting policies. While we believe the estimates, assumptions and judgments we use in preparing our financial statements are appropriate, they are subject to factors and uncertainties regarding their outcome and therefore, actual results may materially differ from these estimates. The following is a summary of our primary critical accounting policies and estimates. See also Note 1 to the Financial Statements, included in Part II, Item 8, of this Report.Annual Report on Form 10-K.

COVID-19 Pandemic and CARES Act Funding

In March 2020, the World Health Organization designated COVID-19 as a global pandemic. The COVID-19 pandemic created significant volatility, uncertainty and economic disruption that negatively impacted business in our industry starting in March 2020 and continuing to varying degrees throughout fiscal 2021. 

We consider our business to be essential under applicable governmental orders due primarily to our role in manufacturing and supplying needed medical devices to patients with respiratory related issues and remained fully operational for the duration of fiscal 2021. 

We also took measures to ensure the safety of our employees and to comply with applicable governmental orders, including transitioning employees to remote work where possible, adhering to Centers for Disease Control (“CDC”) guidelines for mask wearing and social distancing, and implementing enhanced cleaning practices in the office. During the fourth quarter of fiscal 2021, as COVID-19 vaccines became more widely available in the United States, we reviewed our guidelines for corporate offices and manufacturing and adjusted our safety guidelines to align with CDC guidelines for mask wearing and social distancing. Additionally, we provided direction to employees on their work schedules, balancing business productivity and flexibility for employees and maintaining the highest level of safety in the workplace.

The home care market was impacted by COVID-19 primarily due to certain healthcare facilities and clinics restricting access to their clinicians, and patients reducing in-person visits to clinics for consultations and treatments. The degree of clinic access limitations and in-person patient visit reductions varied throughout fiscal 2021 based on multiple variables, including the number of daily COVID-19 cases occurring in key geographies, the degree of state and local government restrictions, and the availability and deployment of vaccines. During fiscal 2021, our sales team developed and utilized a hybrid selling approach that combined virtual and face-to-face clinician interactions, which helped mitigate the market disruption caused by COVID-19.

Our institutional business was negatively impacted by COVID-19 through fiscal 2021 as     hospitals and long-term care facilities adjusted their operating protocols and procurement management in response to the pandemic.  Limiting the spread of airborne particles was a priority in institutional settings during fiscal 2021, and airway clearance therapies usage, including HFCWO, induces coughing in patients.

In response to the negative impacts of the COVID-19 pandemic on our business, in April 2020 we initiated cost-containment measures, which included reducing discretionary and variable spend, such as travel, and the use of contractors, consultants, temporary help and employee furloughs in our manufacturing and general and administrative functions due to lower near-term demand for our products.  As our referral volumes returned to near pre-pandemic levels in July 2020, all furloughed employees returned to work by August 2020, and we continued to make all planned strategic investments in our business throughout fiscal 2021 in both selling, general and administrative (“SG&A”) and R&D.  

We did not receive any direct financial assistance from any government program during fiscal 2021. We received a one-time $913,000 payment under the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) in the fourth quarter of fiscal 2020, which partially offset lower profitability related to the revenue decline caused by the COVID-19 pandemic during the period. The amount received from the CARES Act is subject to compliance with certain terms and conditions and reporting requirements, and such report may be audited by a federal agency for compliance with the program’s terms and conditions.

Overall, we believe that these and other responses by healthcare systems had a negative impact on our operating results and cash flows during the fourth quarter of fiscal 2020 and the first quarter of fiscal 2021, and then again in the third quarter of fiscal 2021 as Covid-19 cases and hospitalization spiked during that time period. We believe that we benefited during the most recent fiscal year from our sales organization adapting to innovations in contacting physicians, such as through virtual meetings, and from the waiver implemented by CMS in response to the public health emergency.

In response to the COVID-19 pandemic and the U.S. federal government’s declaration of a public health emergency, CMS implemented a number of temporary rule changes and waivers to allow prescribers to best treat patients during the period of the public health emergency. These waivers were made retroactively effective to March 1, 2020 and were in place for the duration of fiscal 2021. Clinical indications and documentation typically required were not enforced for respiratory related products including the SmartVest System (solely with respect to direct Medicare covered patients) applicable for our home care prescriptions. The minimum documentation now requires a valid order and documentation of a respiratory related diagnosis. Face-to-face and in-person requirements for replacement respiratory devices are being waived during such period, both of which are currently scheduled to expire in October 2021. A temporary suspension of a 2% tax on Medicare payments was also initiated in May 2020 and has been extended through December 2021. 

The impact of the COVID-19 pandemic on our business remains uncertain and its effects on operational and financial performance will depend in part on future developments, which cannot be reasonably estimated at this time. Such future developments include, but are not limited to, the duration, scope and severity of the COVID-19 pandemic in geographic areas in which we operate or in which our patients live, actions taken to contain or mitigate its impact, the impact on governmental healthcare programs and budgets, the deployment of treatments or vaccines, and the resumption of widespread economic activity. Due to the inherent uncertainty of the unprecedented and evolving situation, we are unable to predict with confidence the likely impact of the COVID-19 pandemic on our future operations.

Revenue Recognition and Allowance for Doubtful Accounts

We measure revenue based on consideration specified in the contract with a customer, adjusted for any applicable estimates of variable consideration and other factors affecting the transaction price, including noncash consideration, consideration paid or payable to customers and significant financing components. Revenue from all customers is recognized when a performance obligation is satisfied by transferring control of a distinct good or service to a customer.

Individual promised goods and services in a contract are considered a performance obligation and accounted for separately if the individual good or service is distinct (i.e., the customer can benefit from the good or service on its own or with other resources that are readily available to the customer and the good or service is separately identifiable from other promises in the arrangement). If an arrangement includes multiple performance obligations, the consideration is allocated between the performance obligations in proportion to their estimated standalone selling price, unless discounts or variable consideration is attributable to one or more but not all the performance obligations. Costs related to products delivered are recognized in the period incurred, unless criteria for capitalization of costs under Accounting Standards Codification (“ASC”) 340-40, “Other Assets and Deferred Costs”,Costs,” or the requirements under other applicable accounting guidance are met.

We include shipping and handling fees in net revenues. Shipping and handling costs associated with the shipment of each SmartVest SystemsSystem after control has transferred to a customer are accounted for as a fulfillment cost and are included in cost of revenues.

Accounts receivable are also net of an allowance for doubtful accounts, which are accounts from which payment is not expected to be received. Management determines the allowance for doubtful accounts by regularly evaluating individual customer receivables and considering a customer’s financial condition and credit history. Receivables are written off when deemed uncollectible. Recoveries of receivables previously written off are recorded when received.

We request that customers return previously-soldpreviously sold units that are no longer in use to us in order to limit the possibility that such units would be resold by unauthorized parties or used by individuals without a prescription. The customer is under no obligation to return the product; however, we do reclaim the majority of previously sold units upon the discontinuance of patient usage. We are certified to recondition and resell returned SmartVest System units. Returned units are typically reconditioned and resold and continue to be used for demonstration equipment and warranty replacement parts.

Valuation of Long-Lived and Intangible Assets

Long-lived assets, primarily property and equipment and finite-life intangible assets, are evaluated for impairment whenever events or changes in circumstances indicate the carrying value of an asset may not be recoverable. In evaluating recoverability, the following factors, among others, are considered: a significant change in the circumstances used to determine the amortization period, an adverse change in legal factors or in the business climate, a transition to a new product or service strategy, a significant change in customer base, and a realization of failed marketing efforts. The recoverability of an asset or asset group is measured by a comparison of the unamortized balance of the asset or asset group to future undiscounted cash flows. If we believe the unamortized balance is unrecoverable, we would recognize an impairment charge necessary to reduce the unamortized balance to the estimated fair value of the asset group. The amount of such impairment would be charged to operations at the time of determination.

Property and equipment are stated at cost less accumulated depreciation. We use the straight-line method for depreciating property and equipment over their estimated useful lives, which range from 3three to 39 years. Our finite-life intangibles consist of patents and trademarks and their carrying costs include the original cost of obtaining the patents, periodic renewal fees, and other costs associated with maintaining and defending patent and trademark rights. Patents and trademarks are amortized over their estimated useful lives, generally 15 and 12 years, respectively, using the straight-line method.

Allowance for Excess and Slow-Moving Inventory

An allowance for potentially slow-moving or excess inventories is made based on our analysis of inventory levels on hand and comparing it to expected future production requirements, sales forecasts and current estimated market values.

Income Taxes

We recognize deferred tax assets and liabilities based on the differences between the financial statement carrying amounts and the tax basis of assets and liabilities. We provide a valuation allowance for deferred tax assets if we determine, based on the weight of available evidence, that it is more likely than not that some or all of the deferred tax assets will not be realized. We would reverse a valuation allowance if we determine, based on the weight of all available evidence, including when cumulative losses become positive income, that it is more likely than not that some or all of the deferred tax assets will be realized.

Warranty Reserve

We provide a warranty on the SmartVest System that covers the cost of replacement parts and labor, or a new SmartVest System in the event we determine a full replacement is necessary. For each home care SmartVest SystemsSystem initially purchased and currently located in the U.S. andor Canada, we provide a lifetime warranty to the individual patient for whom the SmartVest System is prescribed. For sales to institutions within the U.S., and for all international sales, except Canadian home care, we provide a three-year warranty. We estimate, based upon a review of historical warranty claim experience, the costs that may be incurred under our warranty policies and record a liability in the amount of such estimate at the time a product is sold. The warranty cost is based uponon future product performance and durability and is estimated largely based uponon historical experience. We estimate the average useful life of our products to beis approximately five years. Factors that affect our warranty liability include the number of units sold, historical and anticipated rates of warranty claims, the product’s useful life, and cost per claim. At our discretion, based upon the cost to either repair or replace a product, we have occasionally replaced such products covered under warranty with a new or refurbished model. We periodically assess the adequacy of our recorded warranty liability and make adjustments toadjust the accrual as claims data and historical experience warrant.

Share-Based Compensation

Share-based payment awards consist of options and restrictedto purchase shares of our common stock issued to employees and directors for services.employees. Expense for options is estimated using the Black-Scholes pricing model at the date of grant and expense for restricted stock is determined by the closing price on the day the grant is made.grant. The portion of the option award that is ultimately expected to vest is recognized on a straight-line basis over the requisite service or vesting period of the award and adjusted upon completion of the vesting period. In determining the fair value of our share-based payment awards, we make various assumptions using the Black-Scholes pricing model, including expected risk-free interest rate, stock price volatility, life and forfeitures. See Note 8 to the Financial Statements included in Part II, Item 8, of this Annual Report on Form 10-K for a description of these assumptions.

Results of Operations

Fiscal Year Ended June 30, 20192021 Compared to Fiscal Year Ended June 30, 20182020

Revenues

Revenue for the twelve-month periodsfiscal years ended June 30, 2021 and 2020 are summarized in the table below (dollar amounts in thousands).

Home Care Revenue. Our home Home care revenue increased by 10.3%12.5%, or approximately $2,693,000,$3,663,000, for fiscal 2019,2021 compared to fiscal 2018. Home2020.. The growth versus prior year was primarily driven by an increase in referrals and approvals. The increase in referrals compared to the prior year periods was due to the sales team adapting to a hybrid virtual and face-to-face selling model implemented to combat clinic access limitations due to the COVID-19 pandemic, benefits of the CMS waiver on the non-commercial Medicare portion of our home care revenue, increased year-over-year predominantly due to a higherand an increase in direct sales representatives.

The CMS waiver benefited the non-commercial Medicare portion of our home care revenue by increasing the number of referrals per fieldand the approval percentage for non-covered diagnoses. We believe that our ongoing sales employee,team execution, along with the expected return to pre-COVID-19 levels of patient face-to-face engagement with physicians and clinic access for our sales team, has the potential to mitigate the impact of a higher number of field sales employees and a greater referral to approval percentage.CMS waiver expiration, which is currently effective until October 2021.

Institutional Revenue. Institutional revenue increaseddecreased by 3.4%22.6%, or approximately $53,000,$451,000, in fiscal 20192021 compared to fiscal 2018.2020. Institutional revenue includes sales to distributors, group purchasing organization (“GPO”) members,organizations, rental companies and other institutions. The increasedecrease in the current year periods was primarily due to the continued impact of COVID-19 on hospital purchasing activity. Our institutional revenue was a result of an increaseincreased each quarter throughout fiscal 2021 as hospital purchasing activity began returning to more standard operating procedures as were in the number of single patient use garments soldplace prior to COVID-19.

Home Care Distributor Revenue. Home care distributor revenue increased 30.9%, or approximately $133,000, for fiscal 2021 compared to the same period infiscal 2020. The growth versus the prior year partially offsetwas driven by lower revenue and averageadditional capital sales with our primary distributor. We began selling prices of units sold.to home medical equipment distributors during fiscal 2020, who in turn sell our SmartVest System in the U.S. home care market. 

International Revenue. International revenue wasdecreased by 8.4%, or approximately $747,000$60,000, in fiscal 20192021 compared to $500,000 in fiscal 2018.2020. International revenue growth is not currently a primary focus for us, and our corporate resources are only focused on supporting and maintaining our current distributors.

Gross Profit

Gross profit increased to approximately $23,848,000$27,305,000 during fiscal 2019,2021, or 76.2%76.4% of net revenues, from approximately $21,773,000,$25,200,000, or 76.9%77.6% of net revenues, during fiscal 2018.2020. The increase in gross profit was primarily related to increases in domestic home care revenue. The decrease in gross profit as a percentage of net revenue was driven by a lower selling price per devicehigher warranty reserve adjustment, costs associated with discontinuing shipments of the SmartVest SV2100 in our institutional market.

During the fiscal years ended June 30, 2017United States, and June 30, 2016, we loweredlimited cost increases to both raw materials and shipping costs, which was partially offset by a higher mix of home care revenue and a favorable mix of Medicare within the costhome care channel. The increase in the warranty reserve was driven by a combination of our SmartVest SQL to a cost significantly lower than our previous products. This shortenedan increase in components included in the time in which we expect to phase out sales ofwarranty calculation and higher repair costs for our SV2100 product. Because of this, we recordeddevice repairs. There has not been an additional reserve on certain SV2100 parts that may no longer be utilizedincrease in production, of $30,000 and $100,000 during fiscal 2019 and 2018, respectively. As we continue to phase out sales of the SV2100, we will continue to monitor and refineproduct warranty returns for either our reserve estimate if circumstances change.generators or vests.

We believe that as we continue to grow salesrevenue, we will be able to leverage manufacturing costs, and that gross margins, over the long-term, will be in a range slightly below 80%, although there canmay be fluctuations on a short-term basis related to average reimbursement based on the mix of referrals during any given period. Factors such as diagnoses that are not assured of reimbursement, insurance programs with lower allowable reimbursement amounts (for example, state Medicaid programs), and whether an individual patient meets prerequisite medical criteria for reimbursement, may have an effect on average reimbursement received on a short-term basis.basis We have a goal of improving our gross margin percentage over time due to lower product costs associated with our next generation product, supplier optimization, and gaining operating leverage on higher volumes.

Operating Expenses

Selling, General and Administrative Expenses. Selling, general and administrative (“SG&A”)&A expenses forincreased by approximately $2,498,000, or 12.5%, to approximately $22,443,00 in fiscal 2019 were approximately $20,446,000,2021, compared to approximately $18,809,000$19,945,000 in fiscal 2020. During fiscal 2021, we invested in strategic SG&A investments that we believe will position the company for sustainable, long-term growth. Key strategic SG&A investments in fiscal 2021 included increased direct-to-consumer marketing, implementation of a new revenue cycle management system, strategic market analytics and commercial planning and new headcount positions in product marketing and clinical field support. We believe that these investments will provide the prior year, an increase of approximately $1,637,000, or 8.7%.support to drive a successful sales force expansion plan beginning in fiscal 2022.

SG&A payroll and compensation-related expenses increased by approximately $1,369,000,$1,973,000, or 11.6%15.8%, to approximately $13,148,000. The increases$14,434,000 in fiscal 2019 were2021, compared to $12,461,000 in fiscal 2020. The increase was primarily due to additional employees ina higher average number of sales and administrative roles, additional sales incentives on highermarketing personnel, increased temporary resources to assist with systems infrastructure investments, increased compensation payments related to stronger home care revenue accruals, annual salary increases, a higher management bonus accrual and higher share-based equity compensation expense as compared to the prior year periods.performance.

Professional and legal fees decreasedincreased by approximately $206,000$431,000, or 21.5%, to approximately $1,524,000$2,433,000 in fiscal 2019,2021, compared to approximately $1,730,000$2,002,000 in fiscal 2018.2020. These fees are primarily for services related to legal costs, shareowner services and reporting requirements, information technology (“IT”) technical support, and consulting fees for enhancing our market development strategy. The decreases in professional fees were primarily in shareowner services, legal and IT costs, which were partially offset by an increase in marketing consulting fees.the current year periods was primarily due to higher legal fees, annual fees associated with   a new human resources platform, increased investment in leadership development training, and fees associated with the implementation of our new revenue cycle management software.  We expect to make continued investments in our systems infrastructure over the next year, including an enterprise resource planning software implementation.

Recruiting fees were approximately $256,000Total discretionary marketing expenses increased by $281,000, or 36.0% to $1,062,,000 in fiscal 2019, representing a decrease of approximately $376,000, or 59.5%, as2021, compared to $781,000 in fiscal 2020. The increase in the prior year. The decreasecurrent year period was primarily due to a direct-to-consumer marketing campaign that began in recruiting fees was due primarily to adding fewer employeesMay 2020 and investment in sales as compared to the prior year.strategic market analytics and commercial planning activities.

Travel, meals and entertainment expenses were approximately $2,341,000decreased $164,000, or 8.4%, to $1,780,000 for fiscal 20192021 compared to $2,181,000$1,944,000 in fiscal 2020. The decrease in the priorcurrent year an increase of approximately $160,000, or 7.3%. The increaseperiod was primarily due primarily to an increasetravel reductions in connection with COVID-19, primarily in the average travel,first half of the fiscal year. Travel, meals and entertainment expense per salesperson.

Depreciation and amortization expense was approximately $537,000 for fiscal 2019 comparedexpenses returned to $396,000 innear pre-COVID-19 levels by the prior year, an increase of approximately $141,000, or 35.4%. The increase was due primarily to our decision to terminate a lease of a property used for office space on June 30, 2019, which required us to accelerate the amortization of the leasehold improvement assets associated with the property in the amount of approximately $151,000. We are currently expanding owned real estate to replace the leased office space which should be completed in the firstfourth quarter of fiscal 2020.2021.

Also, during fiscal 2018, we concluded an examination with the Internal Revenue Service (“IRS”) related to federal medical device excise taxes paid on revenue associated with the sales of the SmartVest System during the tax periods ended June 30, 2014 through December 31, 2015. As a result, it was determined the SmartVest System was eligible for the retail exemption from the medical device excise tax, resulting in the IRS agreeing to a refund of approximately $406,000, which was included as a reduction of SG&A expense during fiscal 2018. The refund was received from the IRS in July 2018. We expect the SmartVest System we will be exempt from the medical device tax after the conclusion of the current two-year medical device tax moratorium, which is scheduled to end on December 31, 2019.

Research and Development Expenses.R&D expenses increased by $672,000, or 64.0%, to $1,722,000 in fiscal 2021 compared to $1,050,000 in fiscal 2020. R&D expenses were approximately $583,000 and $251,000, or 1.9% and 0.9%4.8% of net revenues, forrevenue in fiscal 2019 and 2018, respectively.2021 compared to 3.2% of revenue in fiscal 2020. The increase in the current year period was primarily due to professional consulting fees associated with our next generation platform development activities. We expect R&D spending on research and development to remain consistentbetween 3.0% and 5.0% of revenue during fiscal 2020 as compared to fiscal 20192022, as we look to finalize our development and product testing work on enhancements to our SmartVest Connect wireless patient monitoring feature, initiate early stage design work onin preparation for an anticipated fiscal year 2023 next generation product enhancements and evaluate other market opportunities, including the anticipated launchlaunch.

Government Stimulus Income. We did not record any government stimulus income in fiscal 2021. In fiscal 2020, we recorded $913,000 of SmartVest Connect with Bluetooth™ technology and supporting mobile applications. Certain expensesgovernment stimulus income related to our innovation investments are not always captured in R&D expenses. These expenses may be included in cost of revenue as ingeneral distribution funds received from the case of depreciation of tooling, orProvider Relief Fund established by the CARES Act for SG&A, inMedicare fee-for-service providers due to lost revenues resulting from the case of professional fees or higher labor expense, as we improve our internal processes or enhance our customer service.COVID-19 pandemic. 

Interest Income, net

Net interest income was approximately $91,000$39,000 during fiscal 20192021 compared to net interest income of $20,000 during the prior$121,000 in fiscal year. Increases2020. The decrease in net interest income was primarily driven by higherlower interest rates earned onin fiscal 2021 as compared to fiscal 2020.

Other Expense, net

Net other expense was approximately $12,000 during fiscal 2021 compared to net other expense of zero in fiscal 2020.  Net other expenses represent costs related to our cash deposits and the payoffJune 2021 data security incident of our term loan$187,000, net of approximately $1,103,000 on December 18, 2018.related insurance reimbursement of $175,000.  

Income Tax Expense

Income Tax Expense

During fiscal 2019, we recorded a current income tax expense of $940,000. Estimated income tax expense during fiscal 20192021 was $805,000, which includes a current tax expense of $1,205,000$1,099,000 and a deferred benefit of $265,000.$294,000. Estimated income tax expense for fiscal 2019 includes a discrete deferred tax expense of approximately $157,000$81,000 related to unexercised fully-vestedfully vested stock options that expired and a discrete current tax benefit of approximately $14,000$33,000 related to the excess tax benefit of non-qualified stock options exercised.that were exercised during the period. 

EstimatedIn fiscal 2020, we recorded a current income tax expense during fiscal 2018of $1,078,000, which includes a current tax expense of $1,260,000$1,204,000 and a deferred benefit of $359,000.$126,000. Estimated income tax expense duringfor fiscal 2018 includes2021 included a discrete deferred tax expense of approximately $48,000 as a result of re-measuring certain deferred tax assets and liabilities based on the rates at which they are expected to reverse in future periods under the Tax Cuts and Jobs Act of 2017. Additionally, a discretecurrent tax benefit of approximately $27,000 was recognized$358,000 related to the excess tax benefit of non-qualified stock options that were exercised during fiscal 2018 as a result of greater federal and state research and development tax credits than what was originally estimated in our tax provision for the fiscal year ended June 30, 2017.period.

The effective tax rates were 32.3%25.4% and 33.0%20.6% for fiscal 20192021 and 2018,2020, respectively. The effective tax rates differ from the statutory federal rate due to the effect of state income taxes, R&D tax credits, the domestic production activities deduction and other permanent items that are non-deductible for tax purposes relative to the amount of taxable income.

Net Income/LossIncome

Net income for fiscal 20192021 was approximately $1,969,000,$2,362,000, compared to net income of approximately $1,831,000$4,161,000 in fiscal 2018.2020. The year-over-year increasedecrease in net incomethe current year period was driven primarily by an increaseincreased strategic investments in SG&A and R&D and a lower gross profit on higher revenue, lower recruiting costs and lower professional and legal fees. These increases in net income wasmargin percentage, partially offset by higher compensation, higher R&D expenses, a discrete tax expensestronger home care revenue performance. Fiscal year 2021 does not include any government stimulus income, compared to $913,000 of $157,000 related to unexercised fully-vested stock options and higher depreciation and amortization expense related togovernment income received under the termination of leased office space of approximately $151,000. Additionally, net income duringCARES Act in fiscal 2018 included a medical device excise tax refund of approximately $406,000.2020.  

Liquidity and Capital Resources

Cash Flows and Sources of Liquidity

Cash Flows from Operating Activities

For fiscal 2019, our netNet cash provided by operating activities in fiscal 2021 was approximately $2,590,000.$3,077,000. Cash flows from operating activities consisted of net income of approximately $1,969,000,$2,362,000, non-cash expenses of approximately $1,602,000$1,340,000, a $1,284,000 increase in accounts payable and accrued liabilities, a decrease in prepaid expenses and otherinventory of $971,000, a decrease in contract assets of $404,000.$510,000 and a $151,000 decrease in prepaid expenses. These cash flows from operating activities were partially offset by increasesa $4,091,000 increase in accounts receivable. The increase in accounts receivable of approximately $949,000,was primarily due to an increase in contract assetsthe Medicare portion of $219,000,our home care business, which has a decrease in income taxes payable of $109,000, an increase in inventory of $106,000 and a decrease in accounts payable and other current liabilities of $2,000.13-month payment cycle.

Cash Flows from Investing Activities

For fiscal 2019,Net cash used in investing activities in fiscal 2021 was approximately $1,387,000.$448,000. Cash used in investing activities primarily consisted of approximately $1,331,000$287,000 in expenditures for property and equipment and $58,000$161,000 in payments for patent and trademark costs. These cash flows were partially offset by $2,000 in proceeds received from the sales of fixed assets.

Cash Flows from Financing Activities

For fiscal 2019,Net cash used in financing activities in fiscal 2021 was approximately $851,000,$1,219,000, consisting of $1,103,000$1,124,000 used for our share repurchase program and $141,000 for taxes paid on behalf of principal paymentsemployees stock options that were exercised on long-term debt and $252,000 ina net basis during the period, partially offset by $46,000 of proceeds received from stock options that were exercised.exercised during the period.

Adequacy of Capital Resources

Our primary working capital requirements relate to adding employees to our sales force and support functions, continuing R&D efforts, and supporting general corporate needs, including financing equipment purchases and other capital expenditures incurred in the ordinary course of business. Based on our current operational performance, we believe our working capital of approximately $20,919,000$27,065,000 and available borrowings under our existing credit facility will provide adequate liquidity for fiscal 2020.2022.

Effective December 18, 2018,16, 2020, we renewed our credit facility, which provides us with a revolving line of credit. Interest on borrowings on the line of credit accrues at the prime rate (5.50% at(3.25% as of June 30, 2019)2021) less 1.00% and is payable monthly. There was no outstanding principal balance on the line of credit as of June 30, 20192021 or June 30, 2018.2020. The amount eligible for borrowing on the line of credit is limited to the lesser of $2,500,000 or 57.00% of eligible accounts receivable, and the line of credit expires on December 18, 2019,2021, if not renewed. AtAs of June 30, 2019,2021, the maximum $2,500,000 was available under the line of credit. Payment obligations under the line of credit are secured by a security interest in substantially all of our tangible and intangible assets.

In connection with the credit facility, we also had a term loan, which had an outstanding principal balance of approximately $1,103,000 as of June 30, 2018 and an interest rate of 3.88%. The unamortized debt issuance cost associated with this debt was approximately $2,000 as of June 30, 2018. The term loan matured on December 18, 2018, and we utilized cash to repay the required balloon payment of approximately $1,085,000. Payment obligations under the term loan were secured by a mortgage on our real property, which security interest was released upon payoff. We no longer have any obligation under the term loan.

The documents governing our line of credit contain certain financial and nonfinancial covenants that include a minimum tangible net worth of not less than $10,125,000 and restrictions on our ability to incur certain additional indebtedness or pay dividends.

Any failure to comply with these covenants in the future may result in an event of default, which if not cured or waived, could result in the lender accelerating the maturity of our indebtedness, preventing access to additional funds under the line of credit, requiring prepayment of outstanding indebtedness, or refusing to renew the line of credit. If the maturity of the indebtedness is accelerated or the line of credit is not renewed, sufficient cash resources to satisfy the debt obligations may not be available and we may not be able to continue operations as planned. If we are unable to repay such indebtedness, the lender could foreclose on these assets.

During fiscal 20192021 and 2018,2020, we spent approximately $1,331,000$299,000 and $526,000,$844,000, respectively, on property and equipment. In April 2019, we entered into an agreement for a building expansion project at our New Prague, Minnesota facility. This building expansion commenced in April 2019, and we anticipate it will be complete in the first quarter of fiscal 2020. We estimate the total cost of the project to range between $1,500,000 and $1,700,000, will save us over $130,000 in annual lease expense and provide us with sufficient infrastructure to support our long-term growth.

We currently expect to finance planned equipment purchases and the completion of our building expansion with cash flows from operations or borrowings under our credit facility. We may need to incur additional debt if we have an unforeseen need for additional capital equipment or if our operating performance does not generate adequate cash flows.

Off-Balance Sheet Arrangements

We have no off-balance sheet arrangements.

New Accounting PronouncementsStandards Recently Issued But Not Yet Adopted by the Company

New accounting pronouncements:In May 2014,December 2019, the Financial Accounting Standards Board (“FASB”) issued guidance creating ASC 606, “Revenue from Contracts with Customers.” The new section replaces ASC 605, “Revenue Recognition,” and replaces all revenue guidance for specialized transactions and industries. The new section is intended to conform revenue accounting principles to concurrently issued International Financial Reporting Standards with previously differing treatment between U.S. practice and that of much of the rest of the world, as well as to enhance disclosures related to disaggregated revenue information.

We adopted the new standard effective July 1, 2018, utilizing the full retrospective method, which required us to recast each prior reporting period presented and included adjustments with the cumulative impact of increasing retained earnings by $0.8 million as of July 1, 2017. We updated our control framework for new internal controls and made changes to existing controls related to the new revenue recognition standard.

Primary changes resulting from the adoption of ASC 606:

The adoption of ASC 606 resulted in a change to the timing of revenue recognition, primarily driven by the following:

Impact on previously reported results:

The following tables present a recast of selected statement of operations line items after giving effect to the adoption of ASC 606:

The following table presents a recast of selected balance sheet line items after giving effect to the adoption of ASC 606: 

The following table presents a recast of selected statement of cash flow line items after giving effect to the adoption of ASC 606:

Lease Accounting:

In February 2016, FASB issued Accounting Standards Update (“ASU”) 2016-02, “LeasesNo. 2019-12, Income Taxes (Topic 842).” This standard requires740): Simplifying the recognitionAccounting for Income Taxes. The new guidance simplifies the accounting for income taxes by removing certain exceptions to the general principles in Topic 740. The new guidance also improves consistent application of all lease transactions with terms in excessand simplifies U.S. generally accepted accounting principles for other areas of 12 months onTopic 740 by clarifying and amending the balance sheet as a lease liability and a right-of-use asset (as defined in the standard). ASU 2016-02 will beexisting guidance. The guidance is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years,2020, with earlier applicationearly adoption permitted. Upon adoption,The Company is currently evaluating the lessee will applyeffect of the new standard retrospectively to all periods presented or retrospectively using a cumulative effect adjustment in the year of adoption. We have evaluated ASU 2016-02 and expect it will have no material impact on our financial statements or financial statement disclosures upon adoption based on current facts and circumstances.guidance.

Item 7A.   Quantitative and Qualitative Disclosures About Market Risk.

As a smaller reporting company, we are not required to provide disclosure pursuant to this item.

Item 8.      Financial Statements and Supplementary Data.

Index to Financial Statements

Report of Independent Registered Public Accounting Firm

To the Shareholders and the Board of Directors of

Electromed, Inc.

Opinion on the Financial Statements

We have audited the accompanying balance sheets of Electromed, Inc. (the Company) as of June 30, 20192021 and 2018,2020, the related statements of operations, shareholders’ equity and cash flows for the years then ended, and the related notes to the financial statements (collectively, the financial statements).statements. In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of June 30, 20192021 and 2018,2020, and the results of its operations and its cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America.

Change in Accounting Principle

As discussed in Note 1 to the financial statements, the Company has changed the manner in which it accounts for revenues from contracts with customers in fiscal year 2019.

Basis for Opinion

These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits, we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.

Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.

Critical Audit Matter 

The critical audit matter communicated below is a matter arising from the current period audit of the financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective or complex judgments. The communication of the critical audit matter does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing separate opinions on the critical audit matter or on the accounts or disclosures to which it relates.

Measurement of Customer Revenue Net of Adjustments

As discussed in Note 2 to the financial statements, revenues are recognized at a point in time when control passes to the customer upon product shipment or delivery. Net patient revenues (patient revenue less estimated adjustments) are recognized at the estimated net realizable amounts from third-party payors and customers in exchange for the product. The Company has agreements with third-party payors that provide for payments at amounts different from its established rates. Each quarter, the Company estimates its adjustments for each sale based on the terms of third-party payor contracts and the historical collection and write-off experience and applies an estimate for an adjustment reserve percentage to the gross accounts receivable balances.

We identified the measurement of customer revenue net of adjustments as a critical audit matter due to the audit effort, degree of auditor judgment, and subjectivity involved in evaluating the audit evidence related to the adjustment reserves.

Our audit procedures related to the Company’s measurement of customer revenue net of adjustments included the following, among others.

/s/ RSM US LLP

We have served as the Company’s auditor since 2010.

Duluth, Minnesota 

August 27, 2019 

24, 2021

Electromed, Inc. 

Balance Sheets
June 30, 20192021 and 20182020