Net income for the three months ended March 31, 2012 was approximately $95,000, or 2.0% of revenues, compared to approximately $487,000, or 9.4% of revenues, for the same period in the prior year. The decrease in net income as a percentage of revenues primarily resulted from increases in expenses designed to develop, support and maintain a higher sales level as well as lower revenues due to turnover of approximately 16% of the sales force in the prior quarter ended December 31, 2011. Management continues to believe the investment in the sales force and reimbursement, coupled with focused marketing and research and development efforts, will provide the talent and opportunities to drive sales growth.
Revenue results for the nine-month periods are summarized in the table below (dollar amounts in thousands).
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Government/Institutional Revenue. Government/institutional revenue was approximately $759,000 for the nine months ended March 31, 2012, representing a decrease of approximately $52,000, or 6.4%, compared to approximately $811,000 during the same period in 2011. This resulted from a $26,000 decrease in sales to distributors, group purchasing organization (“GPO”) members, and other institutions, which decreased to approximately $598,000 for the nine months ended March 31, 2012 from approximately $624,000 during the same period the prior year. Sales to the U.S. Department of Veterans Affairs and other government entities decreased by approximately $26,000, decreasing to $161,000 for the nine months ended March 31, 2012 from $187,000 for the same period in 2011. The decrease in government/institutional revenue was partially due to one large institutional purchase of approximately $96,000 in the same period in the prior year.
Gross Profit
Gross profit increased to approximately $10,919,000, or 73.1% of net revenues, for the nine months ended March 31, 2012, from approximately $10,177,000, or 72.4% of net revenues, in the same period in 2011. The increase in gross profit dollars resulted primarily from the increase in sales volume. The increase in gross profit percentage was primarily the result of higher than average reimbursement from the mix of referrals during the nine month period. Factors such as diagnoses that are not assured of reimbursement and insurance programs with lower allowable reimbursement amounts (for example, state Medicaid programs) affect average reimbursement received on a short-term basis. These factors tend to fluctuate on a quarterly basis.
Operating expenses
Selling, general and administrative expenses. Selling, general and administrative (“SG&A”) expenses were approximately $9,435,000 for the nine months ended March 31, 2012, representing an increase of approximately $1,409,000, or 17.6%, compared to SG&A expenses of approximately $8,026,000 for the same period the prior year. Payroll and compensation-related expenses were approximately $4,553,000 for the nine months ended March 31, 2012, representing an increase of approximately $820,000, or 21.9%, compared to approximately $3,733,000 in the same period the prior year. This increase primarily resulted from a 39.6% increase in employees in our reimbursement, sales, administrative and patient services departments, from 53 SG&A FTEs for the nine months ended March 31, 2011 to 74 SG&A FTEs during the same period in the current year.
Health insurance costs were approximately $397,000 for the nine months ended March 31, 2012, representing a decrease of approximately $25,000, or 5.9%, from approximately $422,000 for the same period in 2011. This decrease resulted primarily from management adjusting the employee participation amount of the health insurance cost. Travel, meals and entertainment and trade show expenses were approximately $1,307,000 in the nine months ended March 31, 2012, representing an increase of approximately $118,000, or 9.9%, compared to approximately $1,189,000 in the same period in the prior year. This increase was primarily due to the 22.2% increase in the size of the sales force and an increase in the overall number of trade shows in which the Company participated.
Advertising and marketing expenses for the nine months ended March 31, 2012 were approximately $635,000, a decrease of approximately $70,000, or 9.9%, compared to approximately $705,000 in the same period the prior year. The decrease in advertising and marketing expenses is a result of the timing of expenditures.
Patient training expenses for the nine months ended March 31, 2012 were approximately $397,000, an increase of approximately $54,000, or 15.7%, compared to approximately $343,000 in the same period the prior year. These increases reflected the increased volume of home care patient referrals for the nine months ended March 31, 2012 compared to the same period in the prior year.
Professional fees for the nine months ended March 31, 2012 were approximately $740,000, an increase of approximately $240,000 compared to approximately $500,000 in the same period in the prior year. These fees are for services related to reporting requirements, expenses related to information technology security and backup, interim consulting expenses, and expenses for printing and other shareholder services.
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Research and development expenses.Research and development expenses were approximately $706,000 for the nine months ended March 31, 2012, representing an increase of approximately $17,000, or 2.5%, compared to approximately $689,000 in the same period the prior year. Research and development expenses for the nine months ended March 31, 2012 were 4.7% of revenue, compared to 4.9% of revenue in the same period the prior year. As a percentage of sales, management expects to spend at least 5.0% of sales on research and development expenses for the foreseeable future.
Interest expense
Interest expense was approximately $130,000 for the nine months ended March 31, 2012, representing a decrease of approximately $21,000, or 13.9%, compared to approximately $151,000 for the same period the prior year. The decrease resulted from a combination of a decrease in average debt outstanding due to payments on term loans and a decrease in the amount of debt issuance costs amortized during the period.
Income tax expense
Income tax expense is estimated at approximately $283,000 for the nine months ended March 31, 2012 compared to $420,000 in the same period in the prior year. The effective tax rates for the nine months ended March 31, 2012 and March 31, 2011 were 43.7% and 32.0%, respectively. On a quarterly basis, management estimates what its effective tax rate will be for the full fiscal year and records a quarterly income tax provision based on the anticipated rate. As the year progresses, the estimate is refined based on the facts and circumstances by each tax jurisdiction. The increase in the effective tax rate is related to changes in permanent differences including the estimate for the Federal Research and Development Tax Credit, which has not been extended past December 31, 2011 by the U.S. Congress.
Net income
Net income for the nine months ended March 31, 2012 was approximately $365,000, or 2.4% of revenues, compared to approximately $891,000, or 6.3% of revenues, for the same period the prior year. The decrease in net income as a percentage of revenues primarily resulted from increases in expenses designed to develop, support and maintain a higher sales level as well as turnover of approximately 16% of the sales force in the prior quarter ended December 31, 2011. Management continues to believe the investment in the sales force and reimbursement, coupled with focused marketing and research and development efforts, will provide the talent and opportunities to drive sales growth.
Liquidity and Capital Resources
Cash Flows and Sources of Liquidity
Cash Flows from Operating Activities
For the nine months ended March 31, 2012, net cash used in operating activities was approximately $1,679,000. Cash flows used by operations consisted of approximately $365,000 in net income, adjusted for non-cash expenses of approximately $521,000, offset by increases in accounts receivable, inventories, and prepaid expenses of $1,498,000, $556,000, and $215,000, respectively. In addition, trade payables and other accrued liabilities decreased by approximately $296,000.
For the nine months ended March 31, 2011, net cash used in operating activities was approximately $1,276,000. Cash flows used by operations consisted of approximately $891,000 in net income, adjusted for non-cash expenses of approximately $504,000, offset by increases in accounts receivable, inventories, and prepaid expenses of $2,656,000, $194,000, and $150,000, respectively. In addition, trade payables and other accrued liabilities increased by approximately $329,000.
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Cash Flows from Investing Activities
For the nine months ended March 31, 2012, net cash used in investing activities was approximately $761,000. During this period we paid approximately $736,000 for purchases of property and equipment, including $439,000 for converting approximately 10,000 square feet of a newly leased building to office space. We also paid approximately $25,000 for patent related costs.
For the nine months ended March 31, 2011, net cash used in investing activities was approximately $964,000. During the period we paid approximately $649,000 in costs related to defending our SmartVest trademark and approximately $315,000 for purchases of property and equipment.
Cash Flows from Financing Activities
For the nine months ended March 31, 2012, net cash used in financing activities was approximately $258,000. We received approximately $52,000 from warrant exercises and receipts on subscription notes receivable, offset by principal payments on long-term debt of approximately $299,000 and payments of deferred financing fees of approximately $11,000.
For the nine months ended March 31, 2011, net cash provided by financing activities was approximately $5,581,000, consisting of approximately $6,388,000 net proceeds during the nine month period from the issuance of common stock in our initial public offering (IPO) and $27,000 in proceeds from subscription notes receivable. This was offset by net payments on our revolving credit line of $500,000, principal payments on long-term debt of approximately $327,000 and payments of deferred financing fees of approximately $7,000.
Adequacy of Capital Resources
Based on our current operational performance, we believe our cash and cash equivalents and available borrowings under the existing credit facility will provide adequate liquidity for the next year. However, we cannot guarantee that we will be able to procure additional financing upon favorable terms, if at all.
Our primary capital requirements relate to adding employees in our Reimbursement, Patient Services and Administrative Departments; adding members to our sales force; continuing research and development efforts; and for general corporate purposes, including to finance equipment purchases and other capital expenditures in the ordinary course of business and to satisfy working capital needs.
For the first nine months of fiscal years 2012 and 2011, we spent approximately $736,000 and $315,000 on property and equipment, respectively. We currently expect to finance equipment purchases with borrowings under our credit facility and cash flows from operations. We may need to incur additional debt or equity financing if we have an unforeseen need for additional capital equipment or if our operating performance does not generate adequate cash flows.
On November 8, 2011 we entered into an amended and restated credit facility with U.S. Bank, National Association (“U.S. Bank”), which facility was amended on December 30, 2011, that provides for an increase in the revolving line of credit to $6,000,000, an increase of $2,500,000 over the prior credit agreement, and $2,520,000 in term debt. A $1,520,000 Term Loan bears interest at 5.79% (“Term Loan A”). The remaining $1,000,000 term loan bears interest at 4.28% (“Term Loan B”). Interest on the operating line of credit accrues at LIBOR plus 3.08% (3.33% at March 31, 2012) and is payable monthly. The amount eligible for borrowing on the line of credit is limited to 60% of eligible accounts receivable less the outstanding balance on our Term Loan B. The line of credit will expire on December 31, 2013, if not earlier renewed. Term Loan A requires monthly payments of principal and interest of approximately $10,700 and has a maturity date of December 9, 2014. Term Loan B requires monthly payments of principal and interest of approximately $29,600 and has a maturity date of December 9, 2012. As of March 31, 2012, we had approximately $1,768,000 outstanding on the operating line of credit and approximately $1,685,000 outstanding on the term loan debt for a total amount outstanding under the U.S. Bank credit facility of $3,453,000. As of March 31, 2012, we had net unused availability of $3,435,000 under the line of credit. We are required to pay a fee of 0.125% per annum on unused portions of the revolving line of credit.
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The agreement governing the credit facility contains certain covenants that restrict our ability to, among other things, pay cash dividends, make certain investments, incur indebtedness or liens, change our Chief Executive Officer, merge or consolidate with any person, or sell, lease, assign, transfer or otherwise dispose of any assets other than in the ordinary course of business. The agreement also contains financial covenants that require maintenance of certain fixed charge and total cash flow leverage ratios. We were in compliance with all requirements under the credit facility as of March 31, 2012. As provided in Note 10 to the Notes to the Condensed Consolidated Financial Statements, on May 11, 2012, the Company’s former Chairman and Chief Executive Officer retired from his positions as Chairman, Chief Executive Officer and director effective immediately. Under the amended and restated credit facility, a change in the Company’s Chief Executive Officer position is a covenant violation and, by extension, an event of default. The Company notified U.S. Bank of its violation of the covenant, and, on May 14, 2012, the Company and U.S. Bank entered into a Consent and Waiver and Second Amendment to Credit Agreement, pursuant to which U.S. Bank has waived the event of default.
On May 14, 2012, we entered into a separation agreement and release with our former Chairman and Chief Executive Officer which calls for a payment equal to one year’s base salary of $209,000 payable in a lump sum on December 1, 2012, provided he complies with the terms of the separation agreement. He will also receive any earned and unpaid bonus for the period through May 11, 2012, estimated at $98,000, payable in July 2012, and Company payments of all COBRA health insurance premiums for a period of 18 months following the effective date of retirement, estimated at $16,500, subject to the limitations contained in the separation agreement. In exchange, he executed a general release of claims and will continue to be bound by the terms of his Non-Competition, Non-Solicitation and Confidentiality Agreement dated January 1, 2010.
On August 13, 2010, we completed the sale of 1,700,000 shares of common stock, par value $0.01 per share, in an IPO, at an offering price of $4.00 per share. On September 28, 2010, Feltl and Company, Inc., the underwriter of the IPO, acquired 200,000 shares of our common stock at a price of $4.00 per share, pursuant to exercise of its over-allotment option. Gross proceeds from the issuance of common stock in connection with the IPO, including the overallotment option, were approximately $7,600,000. After deducting the payment of underwriters’ discounts and commissions and offering expenses, our net proceeds from the sale of shares in the IPO, including the overallotment option, were approximately $5,946,000.
In connection with the employment agreement we entered into with our Chief Financial Officer on October 18, 2011, we may be required to make cash payments to this officer if he resigns following a change in control or is terminated at any time without cause. With respect to a resignation upon a change in control or a termination without cause, the amount of the severance payment would be an amount equal to his ending base salary from the date of termination through the expiration of the then-current term. The first term of the agreement ended the last day of the calendar year 2011 and automatically renewed for a one-year period. The agreement will automatically renew for successive one calendar year periods unless terminated pursuant to the terms of the agreement. The severance amount would be payable in a lump sum within 60 days of the separation event, and the executive would, in order to receive the severance and continued benefits, be required to sign a release of claims against us, return all property owned by Electromed and agree not to disparage us.
On August 19, 2011, we entered into a Transition Agreement with our former Chief Financial Officer, Mr. Terry Belford, pursuant to which he retired effective on October 18, 2011, the date on which our new Chief Financial Officer commenced employment. We entered into a Separation Agreement and Release on the effective date of Mr. Belford’s retirement, which supersedes Mr. Belford’s January 1, 2010 employment agreement. The Separation Agreement and Release provides that Mr. Belford will receive approximately $27,600 as payment for accrued but unused vacation time and a payment in the amount of approximately $147,000 representing six months of separation pay and a pro rata portion of the calendar year 2011 bonus payment, which will be paid in a lump sum on the first day of the seventh month following the effective date of Mr. Belford’s retirement. In exchange, Mr. Belford executed a general release of claims, will continue to be bound by the terms of his Non-Competition, Non-Solicitation and Confidentiality Agreement dated January 1, 2010, and was required to provide consulting and transition services as reasonably requested by the Company through December 31, 2011.
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In connection with the employment agreement we entered into with our Chief Operating Officer, Dr. James J. Cassidy, on February 15, 2012, we may be required to make cash payments to this officer if he resigns following a change in control or is terminated at any time without cause. Effective May 11, 2012, the Board appointed Dr. Cassidy to the position of interim Chief Executive Officer. The agreement was not materially amended in connection with Dr. Cassidy’s appointment as interim Chief Executive Officer. If the agreement is terminated by the Company without cause, the Company may be required to pay severance to Dr. Cassidy in a lump sum equal to his ending base salary from the date of termination through the expiration of his then current term of employment. The severance will be paid in exchange for Dr. Cassidy’s release of any and all claims against the Company and his compliance with the separate Non-Competition Agreement. If the agreement is terminated by Dr. Cassidy following a change in control, the Company may be required to pay severance to Dr. Cassidy in a lump sum equal to his earned and unpaid bonus or incentive compensation and two years of his base salary. The severance will be paid in exchange for Dr. Cassidy’s release of any and all claims against the Company.
Certain Information Concerning Off-Balance Sheet Arrangements
We have no off-balance sheet arrangements.
Item 3. Quantitative and Qualitative Disclosure About Market Risk
As a smaller reporting company, we are not required to provide disclosure pursuant to this item.
Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures
Our principal executive officer and principal financial officer evaluated the effectiveness of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) promulgated under the Securities Exchange Act of 1934 (the “Exchange Act”), as of the end of the period subject to this Report. Based on this evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures were effective.
Changes to Internal Control Over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the three months ended March 31, 2012 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
As previously disclosed in Part II, Item I of our Quarterly Report on Form 10-Q for the fiscal quarter ended September 30, 2010, we reached a definitive settlement agreement on September 30, 2010 with respect to our litigation with Hill-Rom Services, Inc., ARI, Hill-Rom Company, Inc., and Hill-Rom Services Pte. Ltd. (collectively, “Hill-Rom”). The terms of the settlement are confidential. We have no plans to change our use of the SmartVest® marks.
Occasionally, we may be party to legal actions, proceedings, or claims in the ordinary course of business, including claims based on assertions of patent and trademark infringement. Corresponding costs are accrued when it is probable that loss will be incurred and the amount can be precisely or reasonably estimated. We are not aware of any undisclosed actual or threatened litigation that would have a material adverse effect on our financial condition or results of operations.
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Item 1A. Risk Factors
As a smaller reporting company, we are not required to provide disclosure pursuant to this item.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Unregistered Sales of Equity Securities
On January 1, 2012, we issued 12,000 shares of common stock to an employee pursuant to a warrant exercise involving cash consideration of $24,000. The transaction did not involve an underwriter. We believe the transaction was exempt from the registration requirements of the Securities Act of 1933, as amended, by virtue of Section 4(2) thereof, because the issuance did not involve a public offering, the recipient acquired the shares for investment and not resale, and we have taken appropriate measures to restrict transfer.
Upon the execution of his employment agreement with the Company on February 15, 2012, Dr. Cassidy received a stock option to acquire 20,000 shares of the Company’s common stock, which was issued pursuant to the terms of the Company’s 2012 Stock Incentive Plan . The option vests as follows: 10,000 shares on December 31, 2012 and 10,000 shares on December 31, 2013, provided on each date Dr. Cassidy is still employed by the Company and has continued to provide exemplary services to the Company as determined by the Company’s Chairman and Chief Executive Officer. The exercise price for the option is $3.24 per share, the closing price of our common stock on the date of grant. The option is governed by the plan and option award agreement. We believe the transaction was exempt from the registration requirements of the Securities Act of 1933, as amended, by virtue of Section 4(2) thereof, because the issuance did not involve a public offering.
Use of Proceeds
We completed our IPO during the first quarter of our 2011 fiscal year. The effective date of our registration statement relating to the IPO, filed on Form S-1 under the Securities Act of 1933 (File No. 333-166470), was August 12, 2010. Net proceeds from the IPO totaled approximately $5,946,000. We have used and intend to use the remainder of the net proceeds from the IPO to make payments on our existing indebtedness; add employees to our Reimbursement, Patient Services and Administrative Departments; add members to our sales force and further develop our focus on institutional sales; continue our research and development efforts; and for general corporate purposes, including to finance equipment purchases and other capital expenditures in the ordinary course of business and to satisfy working capital needs.
As of March 31, 2012, we have used approximately $5,045,000 in net proceeds, an increase of approximately $1,948,000 for the nine months ended March 31, 2012, compared to $3,097,000 used as of June 30, 2011. During the nine months ended March 31, 2012 , we have made net payments of approximately $255,000 on our term debt with U.S. Bank. In addition, we used approximately $393,000 to fund the addition of employees to our Reimbursement, Patient Service, and Administrative Departments; approximately $223,000 to add members to our sales force; and approximately $378,000 for expenses associated with being a public company, such as legal, accounting, and other professional fees. We used approximately $439,000 to purchase property and equipment for converting approximately 10,000 square feet of a newly leased building to office space to support the increase in the number of employees at our corporate facility.
Finally, we used approximately $260,000 of the net proceeds from the IPO to fund an increase in our research and development efforts. A portion of this amount was paid to Hansen Engine Corporation, a research and development company that provides us with engineering services pursuant to a Letter Agreement dated February 16, 2010. Robert D. Hansen, Craig N. Hansen, and Thomas M. Hagedorn are shareholders and directors of Hansen Engine Corporation, and Robert D. Hansen serves as President and Chief Executive Officer of that entity. See Part III, Item 13, “Certain Relationships and Related Transactions, and Director Independence” in our Annual Report on Form 10-K for the fiscal year ended June 30, 2011.
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Item 3. Defaults Upon Senior Securities
None.
Item 4. Mine Safety Disclosures
None.
Item 5. Other Information
None.
Item 6. Exhibits
See attached exhibit index.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| | |
| | ELECTROMED, INC. |
| | |
| | |
Date: May 15, 2012 | | /s/ Dr. James J. Cassidy |
| | Dr. James J. Cassidy, Interim Chief Executive Officer |
| | (Principal Executive Officer) |
| | |
| | /s/ Jeremy T. Brock |
| | Jeremy T. Brock, Chief Financial Officer |
| | (Principal Financial Officer and Principal Accounting Officer) |
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EXHIBIT INDEX
ELECTROMED, INC.
FORM 10-Q
| | |
Exhibit
Number | | Description |
| | |
10.1 | | Employment Agreement by and between the Company and Dr. James Cassidy, dated effective as of February 15, 2012 (incorporated by reference to Exhibit 10.1 to the Company’s current report on Form 8-K filed with the SEC on February 21, 2012)* |
| | |
10.2 | | Non-Competition, Non-Solicitation, and Confidentiality Agreement by and between the Company and Dr. James Cassidy, dated effective as of February 15, 2012 (incorporated by reference to Exhibit 10.2 to the Company’s current report on Form 8-K filed with the SEC on February 21, 2012)* |
| | |
31.1 | | Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
| | |
31.2 | | Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
| | |
32.1 | | Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
| | |
32.2 | | Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
| | |
101 | | Financial statements from the quarterly report on Form 10-Q of the Company for the quarter ended March 31, 2012, formatted in XBRL: (i) the Condensed Consolidated Balance Sheets, (ii) the Condensed Consolidated Statements of Income, (iii) the Condensed Consolidated Statements of Cash Flows, and (iv) the Notes to Condensed Consolidated Financial Statements tagged as blocks of text. |
* Management compensatory plan or agreement.
