Revenue results for the nine-month periods are summarized in the table below (dollar amounts in thousands).
Gross profit decreased to approximately $7,777,000, or 70.2% of net revenues, for the nine months ended March 31, 2013, from approximately $10,919,000, or 73.1% of net revenues, in the same period in 2012. The decrease in gross profit percentage was primarily the result of reduced leverage of manufacturing costs on lower revenue levels over the nine-month period.
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Operating expenses
Selling, general and administrative expenses. Selling, general and administrative (SG&A) expenses were approximately $8,851,000 for the nine months ended March 31, 2013, representing a decrease of approximately $584,000, or 6.2%, compared to SG&A expenses of approximately $9,435,000 for the same period the prior year. Payroll and compensation-related expenses were approximately $4,380,000 for the nine months ended March 31, 2013, representing a decrease of approximately $173,000, or 3.8%, compared to approximately $4,553,000 in the same period the prior year. This decrease primarily resulted from lower commissions and overall management compensation as compared to the same period in the prior year. In addition, selling, general and administrative expenses increased approximately $44,000 as a result of the medical device tax that was implemented during the quarter ended March 31, 2013.
Travel, meals and entertainment and trade show expenses were approximately $1,106,000 for the nine months ended March 31, 2013, representing a decrease of approximately $286,000, or 20.5%, compared to approximately $1,392,000 for the same period in the prior year. This decrease was primarily due to the elimination of industry training that was sponsored by Electromed, eliminating costs related to tradeshows that do not fit our growth strategies and reducing travel expenses among the sales force through improved travel planning.
Advertising and marketing expenses for the nine months ended March 31, 2013 were approximately $527,000, a decrease of approximately $411,000, or 43.8%, compared to approximately $938,000 in the same period the prior year. The decrease was related to bringing marketing leadership in-house, thus reducing our external marketing fees, as well as targeting more cost-effective advertising.
Professional fees for the nine months ended March 31, 2013 were approximately $947,000, an increase of approximately $202,000 compared to approximately $745,000 in the same period in the prior year. These fees are for services related to legal costs, reporting requirements, expenses related to information technology security and backup, one time consulting expenses, and expenses for printing and other shareowner services. The increase in fees over the same period last year was primarily due to a shareholder’s proposal at our annual meeting and the resulting litigation, as well as consulting fees related to upgrading our current information technology infrastructure. We have insurance for professional fees and expenses incurred in connection with the pending litigation and are working with our insurance carrier on coverage matters. While we believe that a majority of our fees and expenses incurred as a result of the litigation will be covered by insurance, there can be no guarantee of any specific coverage amount.
Research and development expenses.Research and development expenses were approximately $312,000 for the nine months ended March 31, 2013, representing a decrease of approximately $394,000, or 55.8%, compared to approximately $706,000 in the same period the prior year. Research and development expenses for the nine months ended March 31, 2013 were 2.8% of revenue, compared to 4.7% of revenue in the same period the prior year. As a percentage of revenue, management expects to spend up to 5.0% of revenues on research and development expenses over the long term.
Interest expense
Interest expense was approximately $108,000 for the nine months ended March 31, 2013, representing a decrease of approximately $27,000, or 20.0%, compared to approximately $135,000 for the same period the prior year. The decrease resulted from a decrease in average debt outstanding.
Income tax benefit (expense)
Income tax benefit is estimated at approximately $564,000 for the nine months ended March 31, 2013 compared to income tax expense of approximately $283,000 in the same period in the prior year. The effective tax rates for the nine months ended March 31, 2013 and March 31, 2012 were 38.2% and 43.7%, 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 decrease in effective tax rate is related primarily to permanent differences including certain meals and entertainment expenses that are only 50% deductible for tax purposes.
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Net income (loss)
Net loss for the nine months ended March 31, 2013 was approximately $913,000 compared to net income of approximately $365,000 for the same period the prior year. The decrease in net income primarily resulted from a decrease in revenue partially offset by decreases in expenses. Management is focused on controlling costs more aggressively short term while implementing key strategies for growth which includes a fully staffed and a realigned domestic sales force, updated branding including a new logo, website, and marketing material, and an HFCWO product and service innovation roadmap. Specifically, by customer group, our initiatives include:
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| - | Homecare: increased lead generation with a greater tenured domestic sales force and adjustments to the Company’s selling process; |
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| - | Institutional: introducing additional pricing options while exploring distributor partnerships; and |
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| - | International: hiring an international sales manager to develop more distributors throughout Europe, Latin and South America and East Asia, while limiting exclusive distributors within a country. |
Liquidity and Capital Resources
Cash Flows and Sources of Liquidity
Cash Flows from Operating Activities
For the nine months ended March 31, 2013, net cash provided by operating activities was approximately $990,000. Cash flows provided by operations consisted of approximately $913,000 in net loss, adjusted for non-cash expenses of approximately $627,000, offset by decreases in accounts receivable, inventories, and trade payables and accrued liabilities of $1,653,000, $251,000, and $5,000, respectively. In addition, prepaid expenses and other assets decreased by approximately $632,000.
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 and other assets of $1,498,000, $556,000, and $215,000, respectively. In addition, trade payables and other accrued liabilities decreased by approximately $296,000.
Cash Flows from Investing Activities
For the nine months ended March 31, 2013, net cash used in investing activities was approximately $743,000. During this period we paid approximately $707,000 for purchases of property and equipment. We also paid approximately $36,000 for patent and trademark related costs.
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.
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Cash Flows from Financing Activities
For the nine months ended March 31, 2013, net cash used in financing activities was approximately $1,445,000, which consisted of principal payments on long-term debt of $237,000 and payments on our revolving line of credit of $1,208,000.
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.
Adequacy of Capital Resources
Our primary working capital requirements relate to adding employees in our sales force and supporting functions; 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.
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. During fiscal year 2013, we have obtained waivers of noncompliance or entered into amendments with our lender to modify certain covenants. Although the violations have been waived as of March 31, 2013, we believe we may be out of compliance with the covenants at June 30, 2013. 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 or preventing access to additional funds under the credit facility, or requiring prepayment of outstanding indebtedness under the credit facility. If the maturity of the indebtedness is accelerated, sufficient cash resources to satisfy the debt obligations may not be available and we may not be able to continue operations as planned. The indebtedness under the credit agreement is secured by a security interest in substantially all of our tangible and intangible assets of the Company. If we are unable to repay such indebtedness, the bank could foreclose on these assets.
The Company is working with the bank to modify the covenants in the current debt agreement to be in compliance as of June 30, 2013. Given the Company’s ability to service its debt and its past relationship with its lender, the Company believes that it will be able to successfully restructure its covenants as of June 30, 2013.
For the first nine months of fiscal years 2013 and 2012, we spent approximately $707,000 and $736,000 on property and equipment, respectively. In addition, we had approximately $145,000 of property and equipment purchases financed through accounts payable as of March 31, 2013. 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 was amended on December 30, 2011, May 14, 2012, September 21, 2012, November 13, 2012, February 13, 2013, and May 13, 2013 that provides for a revolving line of credit of $2,250,000, 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 bore interest at 4.28% (Term Loan B) and was paid in full during October 2012. Interest on the operating line of credit accrues at LIBOR plus 3.50% (3.75% at March 31, 2013) and is payable monthly. The amount eligible for borrowing on the line of credit is limited to 60% of eligible accounts receivable. 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. As of March 31, 2013, we had $560,000 outstanding on the operating line of credit and approximately $1,377,000 outstanding on Term Loan A for a total amount outstanding under the U.S. Bank credit facility of approximately $1,937,000. As of the most recent amendment date of May 13, 2013, we had $415,000 outstanding on the operating line of credit and net unused availability of $1,835,000. 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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Our credit facility contains certain financial and nonfinancial covenants, which, among others, requires us to maintain a certain fixed charge coverage ratio and a maximum cash flow leverage ratio, and restricts the payment of dividends. We were in violation of certain financial covenants during the period ended March 31, 2013. On May 13, 2013, we entered into a Waiver and Fifth Amendment to our Credit Agreement with U.S. Bank (the “Waiver Agreement”). See Part II, Item 5 to this quarterly report for a description of the material terms of such Waiver Agreement. The Waiver and Fifth Amendment to Credit Agreement provides for adjustments to the revolving line of credit to $2,250,000.
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, as amended (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, 2013 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
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.
On December 7, 2012, we instituted a lawsuit in the District Court for Scott County, Minnesota against Eileen Manning, the proponent of a shareholder proposal at the Company’s 2012 Annual Meeting of Shareholders (the “Annual Meeting”) seeking to elect two individuals to the Company’s board of directors, and Robert D. Hansen, the Company’s former Chairman and Chief Executive Officer. The Company asserts that Ms. Manning, the owner of an entity that formerly provided marketing services to the Company, violated the proxy solicitation rules in connection with the nomination and election of directors at the Annual Meeting. Ms. Manning has asserted a counterclaim alleging that the Company has violated her rights as a shareholder by failing to count and certify the results of the election. The Company also asserts that Mr. Hansen violated his Separation Agreement and Release in connection with his actions relating to Ms. Manning’s proposal prior to and at the Annual Meeting and seeks declaratory relief and damages. Mr. Hansen has asserted a counterclaim alleging that the Company breached the Separation Agreement and Release by failing to make a payment under the agreement, as well as that the Company has violated his rights as a shareholder by failing to make the payment under the agreement. Ms. Manning has moved for summary judgment on her counterclaim, the Company opposed the motion, and it is currently under advisement. The Company has moved for summary judgment on its claim against Mr. Hansen for breach of the Separation Agreement. That motion will be heard by the Court on May 15, 2013. We have insurance for professional fees and expenses incurred in connection with the pending litigation and are working with our insurance carrier on coverage matters. While we believe that a majority of our fees and expenses incurred as a result of the litigation will be covered by insurance, there can be no guarantee of any specific coverage amount.
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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
None.
Item 3. Defaults Upon Senior Securities
None.
Item 4. Mine Safety Disclosures
None.
Item 5. Other Information
On May 13, 2013, the Company entered into a Waiver and Fifth Amendment to Credit Agreement (the “Waiver Agreement”) with U.S. Bank National Association (the “Bank”), pursuant to which the Bank waived violation by the Company of its minimum EBITDA financial covenant under its Amended and Restated Credit Agreement with the Bank, dated as of November 7, 2011, as amended (the “Credit Agreement”). Among other things, the Credit Agreement, as amended prior to the Waiver Agreement, forbid the Company from permitting its EBITDA for the quarter ended March 31, 2013 to be less than negative $275,000.
Pursuant to the Waiver Agreement, the Bank agreed to waive the specific covenant violation described above as an event of default under the Credit Agreement. In addition, the Waiver Agreement, among other things: (1) reduced the Bank’s commitment on our revolving line of credit from $2,500,000 to $2,250,000; (2) removed the minimum EBITDA covenant for the fiscal quarter ended June 30, 2013; (3) revised the Fixed Charge Coverage Ratio covenant to require a ratio of at least 1.15 to 1 for the quarter ended June 30, 2013 and successive periods in the aggregate thereafter; (4) amended the Company’s financial reporting covenants to provide for weekly delivery of 13-week cash flow forecasts; and (5) required the Company to engage a financial consultant to conduct a review of its financial statements and projections and deliver a report regarding the same to the Bank. The Company also released claims against the Bank, reasserted its representations and warranties under the Credit Agreement, and reaffirmed the Credit Agreement and related loan and security documents.
The foregoing summary does not purport to be complete and is qualified in its entirety by reference to the full text of the Waiver Agreement, which is filed as Exhibit 10.3 to this quarterly report on Form 10-Q.
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.
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| ELECTROMED, INC. |
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Date: May 15, 2013 | /s/ Kathleen S. Skarvan |
| Kathleen S. Skarvan, Chief Executive Officer |
| (Principal Executive Officer) |
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| /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
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Exhibit
Number | | Description |
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3.1 | | Amendment No. 2 to Bylaws of Electromed (incorporated by reference to Exhibit 3.1 to the Company’s current report on Form 8-K filed with the SEC on April 2, 2013) |
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10.1 | | Waiver and Fourth Amendment to Credit Agreement by and between the Company and U.S. Bank, National Association, dated February 13, 2013 (incorporated by reference to Exhibit 10.3 to the Company’s quarterly report on Form 10-Q filed with the SEC on February 14, 2013) |
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10.2 | | Waiver and Fifth Amendment to Credit Agreement by and between the Company and U.S. Bank, National Association, dated May 13, 2013 |
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31.1 | | Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
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31.2 | | Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
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32.1 | | Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
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32.2 | | Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
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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. |
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