10-K
1
elmd201269_10k.htm
FORM 10-K FOR THE FISCAL YEAR ENDED JUNE 30, 2020
UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
Washington,
D.C. 20549
FORM 10-K
(Mark
One)
For
the Fiscal Year Ended June 30, 2020
For
the Transition Period From ________ to ________.
Commission
File number 001-34839
Electromed, Inc.
(Exact Name of Registrant as Specified in its Charter)
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
500 Sixth
Avenue NW, New Prague, MN 56071
(Address of principal executive offices,
including zip code)
(Registrant’s telephone number, including area code)
Securities
registered pursuant to Section 12(b) of the Act:
Title of each class Trading Symbol(s) Name of each exchange on which registered
Common Stock, par value $0.01 per share ELMD NYSE American
Securities registered pursuant
to Section 12(g) of the Act: None
Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☐ No ☑
Indicate
by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ☐
No ☑
Indicate
by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such
reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☑ No ☐
Indicate
by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant
to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that
the registrant was required to submit such files). Yes ☑ No ☐
Indicate
by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting
company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer”,
“smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer ☐ Accelerated filer ☐
Non-accelerated filer ☐ Smaller reporting company ☑ Emerging growth company ☐
If
an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for
complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate
by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness
of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Ac t (15 U.S.C. 7262(b)) by the registered
public accounting firm that prepared or issued its audit report. ☐
Indicate
by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ☐ No ☑
The
aggregate market value of the common stock held by non-affiliates of the registrant as of December 31, 2019 was approximately
$61,222,000 based upon the closing price of the registrant’s common stock, as reported on the NYSE American, on such date.
There
were 8,588,590 shares of the registrant’s common stock outstanding as of August 21, 2020.
DOCUMENTS
INCORPORATED BY REFERENCE
Portions of the Definitive Proxy
Statement for the registrant’s Fiscal 2021 Annual Meeting of Shareholders, to be filed within 120 days of June 30, 2020,
are incorporated by reference into Part III of this Annual Report on Form 10-K.
Electromed,
Inc.
Index
to Annual Report on Form 10-K
PART I 1
Item 1. Business 1
Item 1A. Risk Factors 11
Item 1B. Unresolved Staff Comments 11
Item 2. Properties 12
Item 3. Legal Proceedings 12
Item 4. Mine Safety Disclosures 12
Item 6. Selected Financial Data 12
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 21
Item 8. Financial Statements and Supplementary Data F-1
Item 9A. Controls and Procedures 22
Item 9B. Other Information 22
PART III 23
Item 10. Directors, Executive Officers and Corporate Governance 23
Item 11. Executive Compensation 23
Item 14. Principal Accountant Fees and Services 24
Item 15. Exhibits and Financial Statement Schedules 24
i
INFORMATION
REGARDING FORWARD-LOOKING STATEMENTS
Statements
contained in this Annual Report on Form 10-K that are not statements of historical fact should be considered forward-looking statements
within the meaning of the safe harbor provisions of Section 27A of the Securities Act of 1933, as amended (the “Securities
Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Forward-looking
statements include, but are not limited to, statements regarding: the expected impact of the COVID-19 pandemic on our business;
our business strategy, including our intended level of investment in research and development (“R&D”) and marketing
activities; our expectations with respect to earnings, gross margins and sales growth, industry relationships, marketing strategies
and international sales; estimated sizes of markets into which our products are or may be sold; our business strengths and competitive
advantages; our ability to grow additional sales distribution channels; our intent to retain any earnings for use in operations
rather than paying dividends; our expectation that our products will continue to qualify for reimbursement and payment under government
and private insurance programs; our intellectual property plans and practices; the expected impact of applicable regulations on
our business; our beliefs about our manufacturing processes; our expectations and beliefs with respect to our employees and our
relationships with them; our belief that our current facilities are adequate to support our growth plans; our expectations with
respect to ongoing compliance with the terms of our credit facility; our expectations regarding the ongoing availability of credit
and our ability to renew our line of credit; enhancements to our products and services; expected excise tax exemption for the
SmartVest System; and our anticipated revenues, expenses, capital requirements and liquidity. Words such as “anticipate,”
“believe,” “continue,” “could,” “estimate,” “expect,” “goal,”
“intend,” “may,” “ongoing,” “plan,” “potential,” “project,”
“should,” “target,” “will,” “would,” and similar expressions, including the negative
of these terms, are intended to identify forward-looking statements but are not the exclusive means of identifying such statements.
Although we believe these forward-looking statements are reasonable, they involve risks and uncertainties that may cause actual
results to differ materially from those projected by such statements. Such statements involve known and unknown risks, uncertainties
and other factors that may cause our actual results or our industry’s actual results, levels of activity, performance or
achievements to be materially different from the information expressed or implied by the forward-looking statements.
Factors
that could cause actual results to differ from those discussed in the forward-looking statements include, but are not limited
to:
● the competitive nature of our market;
● changes to Medicare, Medicaid, or private insurance reimbursement policies;
● changes to state and federal health care laws;
● changes affecting the medical device industry;
● new drug or pharmaceutical discoveries;
● general economic and business conditions;
● our ability to protect and expand our intellectual property portfolio; and
● the risks associated with expansion into international markets.
This
list of factors is not exhaustive, however, and these or other factors, many of which are outside of our control, could have a
material adverse effect on us and our results of operations. Therefore, you should consider these risk factors with caution and
form your own critical and independent conclusions about the likely effects of these risk factors on our future performance. Forward-looking
statements speak only as of the date on which the statements are made, and we undertake no obligation to update any forward-looking
statement for any reason, even if new information becomes available or other events occur in the future. You should carefully
review the disclosures in this and other documents we file from time to time with the Securities and Exchange Commission (the
“SEC”), including our Quarterly Reports on Form 10-Q and Current Reports on Form 8-K. All forward-looking statements
attributable to us or persons acting on our behalf are expressly qualified in their entirety by the cautionary statements set
forth herein.
ii
PART
I
Item
1. Business.
Overview
Electromed,
Inc. (“we,” “our,” “us,” “Electromed” or the “Company”) develops,
manufactures, markets and sells innovative products that provide airway clearance therapy, including the SmartVest®
Airway Clearance System (“SmartVest System”) and related products, to patients with compromised pulmonary function
with a commitment to excellence and compassionate service. Our goal is to make High Frequency Chest Wall Oscillation (“HFCWO”)
treatments as effective, convenient, and comfortable as possible, so our patients can breathe easier and live better with improved
respiratory function and fewer exacerbations.
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 deliver the SmartVest System to patients, training 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 (“DME”)
channel and capture both the manufacturer and distributor margins. We also sell our products in the acute care setting for patients
in a post-surgical or intensive care unit, or who were admitted for a lung infection brought on by compromised airway clearance.
Electromed was incorporated in Minnesota in 1992. Our common stock is listed on the NYSE American under the ticker symbol “ELMD.”
The
SmartVest System features a programmable air pulse generator, a therapy garment worn over the upper body and a connecting hose,
which together provide safe, comfortable, and effective airway clearance therapy. The SmartVest System generates HFCWO, an airway
clearance therapy. One factor of respiratory health is the ability to clear secretions from airways. Impaired airway clearance,
when mucus cannot be expectorated, may result in labored breathing and/or inflammatory and immune systems boosting mucus production
that invites bacteria trapped in stagnant secretions to cause infections. Studies show that HFCWO therapy is as effective an airway
clearance method for patients who have compromised pulmonary function as traditional chest physical therapy (“CPT”)
administered by a respiratory therapist.1 However, HFCWO can be self-administered, relieving a caregiver of participation
in the therapy, and eliminating the attendant cost of an in-home care provider. We believe that HFCWO treatments are cost-effective
primarily because they reduce a patient’s risk of respiratory infections and other secondary complications that are associated
with impaired mucus transport and often result in costly hospital visits and repeated antibiotic use.
The
SmartVest System is designed for patient comfort and ease of use which promotes adherence to prescribed treatment schedules, leading
to improved airway clearance, patient outcomes and quality of life and a reduction in healthcare utilization. We offer a broad
range of garments, referred to as vests and wraps, in sizes for children and adults that allow for tailored fit. User-friendly
controls allow patients to administer their daily therapy with minimal or no assistance. Our direct product support services provide
patient and clinician education, training, and follow-up to ensure the product is integrated into each patient’s daily treatment
regimen. Additionally, our reimbursement department assures we are working on behalf of the patient by processing their physician
paperwork, providing clinical support and billing the applicable insurance provider. We believe that the advantages of the SmartVest
System and the Company’s customer services to the patient include:
● improved quality of life;
● reduction in healthcare utilization;
● independence from a dedicated caregiver;
● consistent treatments at home;
● improved comfort during therapy; and
1Nicolini A, et al.
Effectiveness of treatment with high-frequency chest wall oscillation in patients with bronchiectasis. BMC Pulmonary Medicine.
2013;13(21).
1
Our
Products
Since
2000, we have marketed the SmartVest System and its predecessor products to patients suffering from bronchiectasis, cystic fibrosis,
and neuromuscular conditions such as cerebral palsy and amyotrophic lateral sclerosis (“ALS”). Our products are sold
into the home health care market and the acute care setting for patients in a post-surgical or intensive care unit, or who were
admitted for a lung infection brought on by compromised airway clearance. Accordingly, our sales points of contact include adult
pulmonology clinics, cystic fibrosis centers, neuromuscular clinics and hospitals.
We
have received clearance from the U.S. Food and Drug Administration (“FDA”) to market the SmartVest System to promote
airway clearance and improve bronchial drainage. In addition, Electromed is certified to apply the Conformité Européenne
(“European Conformity” or “CE”) marking for HFCWO device sales in all European Union countries and approved
for HFCWO device sales in other, select international countries. The SmartVest System is available only with a physician’s
prescription.
The
SmartVest System is currently available in two models – SV2100 and SQL® – both of which are sold into
home care and hospital markets. We are in the process of phasing out the SmartVest SV2100 product but will support and service
SV2100 pursuant to the product warranty.
As
part of our growth strategies, we periodically evaluate opportunities involving products and services, especially those that may
provide value to the respiratory homecare and institutional market.
The
SmartVest SQL System
The
SmartVest SQL System consists of an inflatable therapy garment, a programmable air pulse generator and a patented single-hose
that delivers air pulses from the generator to the garment. The SmartVest SQL is designed for maximum comfort and lifestyle convenience,
so patients can readily fit therapy into their daily routines. The SmartVest SQL was designed significantly smaller, quieter,
and lighter than its predecessor, and offers features that make it easier to use and enable greater patient freedom.
2
SmartVest
Connect
In
June 2017, we launched the SmartVest SQL with SmartVest Connect® wireless technology, a personalized HFCWO therapy
management portal for patients with compromised pulmonary function. The SmartVest SQL with wireless technology features built-in
cellular and BluetoothTM connectivity (BluetoothTM launched March 2020), offering healthcare teams and patients access
to treatment information to better collaborate in making patient-centered care decisions. SmartVest Connect is available to pediatric
and cystic fibrosis patients, and targeted adult pulmonary clinics using a wirelessly enabled SmartVest SQL System.
Other
Products
We
market the Single Patient Use (“SPU”) SmartVest and SmartVest Wrap® to health care providers in the
acute care setting. Hospitals issue the SPU SmartVest or SmartVest Wrap to an individual patient for managing airway clearance.
Both SPU products provide full coverage oscillation and facilitate continuity of care because they introduce the patient to our
product and may encourage use of the SmartVest System for home care, which can be provided to patients with a chronic condition
upon discharge.
Our
Market
We
estimate the total served U.S. market for HFCWO in 2018 was approximately $220 million to $240 million. We believe our business
model is supported by many market trends related to an aging population and growing awareness by physicians of diseases and conditions
for which patients can benefit from using HFCWO therapy. Indications for when HFCWO may be prescribed are not specific to any
one disease. A physician may elect to prescribe HFCWO when he or she believes the patient will benefit from improved airway clearance
and external chest manipulation is the treatment of choice to enhance mucus transport and improve bronchial drainage.
The
SmartVest System is prescribed for patients with bronchiectasis, cystic fibrosis, and neuromuscular conditions such as cerebral
palsy and ALS. We believe that bronchiectasis represents the fastest growing diagnostic category and greatest potential for HFCWO
growth in the United States. Bronchiectasis is an irreversible, chronic lung condition characterized by enlarged and permanently
damaged bronchi. The condition is associated with recurrent lower respiratory infections, inflammation, reduction in pulmonary
function, impaired respiratory secretion clearance, increased hospitalizations and medication use, and increased morbidity and
mortality.
We
are driven to make life’s important moments possible – one breath at a time by leading the HFCWO therapy market in
clinical evidence that supports the therapeutic imperative of clearing excess mucus from the lungs. Electromed is the only HFCWO
therapy company with multiple published clinical outcome studies demonstrating a significant improvement in quality of life and
reduction in exacerbation rates, hospitalizations, emergency department visits, and antibiotic prescriptions in bronchiectasis
patients using the SmartVest System.2-5 Leading in clinical evidence to support the SmartVest System as a treatment
for bronchiectasis patients will remain a focus in fiscal 2021.
We
believe that bronchiectasis is under recognized and underdiagnosed but is experiencing a surge in clinical interest and awareness,
including the relationship to chronic obstructive pulmonary disease (“COPD”), commonly referred to as bronchiectasis
COPD overlap syndrome (“BCOS”). The overlap of bronchiectasis and COPD increases exacerbations and hospitalizations,
reduces pulmonary function, and increases mortality. Several recent studies have estimated prevalence of bronchiectasis, which
we believe are helpful for estimating a range of the market size.
3
These
studies indicate a wide range of potential prevalence of bronchiectasis 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 515,000, approximately 15% or 77,000 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 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. (See Figure 1).
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 in BMC Pulmonary
Medicine evaluated 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.5 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
FEV1 remained stable post enrollment, suggesting early initiation of HFCWO therapy may slow the otherwise normal progression
of the disease.
2Sievert 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.
3Sievert 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.
4
4Sievert 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.
5Powner 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).
6Aksamit
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.
7Patel
I.S., et al. Bronchiectasis, exacerbation indices, and inflammation in chronic obstructive pulmonary disease. Am J Respir Crit
Care Med. 2004;170:400-7.
8O’Brien
C, et al. Physiological and radiological characterisation of patients diagnosed with chronic obstructive pulmonary disease in
primary care. Thorax. 2000;55:635-42.
9Bafadhel
M, et al. The role of CT scanning in multidimensional phenotyping of COPD. Chest. 2011;140:634-42.
10Chalmers
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.
11Seitz
A, et al. Trends in Bronchiectasis Among Medicare Beneficiaries in the United States, 2000 to 2007. Chest. 2012;142(2),
432–439.
12Weycker
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 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, 2020, we had 44 field sales employees, including five regional sales managers, 37
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. These independent contractors are credentialed by the National Board for Respiratory
Care as either Certified Respiratory Therapists or Registered Respiratory Therapists.
Of
the $31.8 million of our revenue derived from the U.S. in our fiscal year ended June 30, 2020 (“fiscal 2020”), approximately
94% represented home care and 6% 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. Service to our providers and patients is additionally a
key component of achieving future sales. Providers seek companies that are easy to work with, 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
four HME distributors, one national and three regional, to distribute and sell the SmartVest System in the United States home
care market. The Company expects to continue its direct sales channel as its primary homecare revenue source. Sale of the SmartVest
System through HME distributors began in targeted geographies in the first quarter of fiscal 2020 with approximately $430,000
of revenue generated during fiscal 2020.
The
addition of an HME distribution network would expand our access to physicians and hospitals in certain areas of the United States
and would be expected to support our other growth strategies. In addition, we place advertisements in leading medical magazines
and journals.
5
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
2.2% and 2.4% of our net revenues were from sales outside the U.S. in our fiscal 2020 and our fiscal year ended June 30, 2019
(“fiscal 2019”), respectively. We sell our products outside the U.S. primarily through independent distributors specializing
in respiratory products. Through June 30, 2020, the majority of our distributors operated in exclusive territories. Our principal
distributors are located in the Europe, Arab states of the Persian Gulf, Southeast Asia, and South 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 the U.S. is to focus our
corporate resources on maintaining 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 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 homecare
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. 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 1 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.
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. The allowed amount for state Medicaid programs ranges from approximately $8,000 to $12,000,
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, such 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.
6
In
response to the COVID-19 pandemic and the U.S. federal government’s declaration of a public health emergency, the Centers
for Medicare and Medicaid Services 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 2020.
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 2020 and 2019, we incurred R&D expenses of approximately $1,050,000 and $583,000, or 3.2% and 1.9% of net revenues,
respectively. As a percentage of sales, we expect spending on R&D expenses to increase slightly during the fiscal year ending
June 30, 2021 (“fiscal 2021”) as compared with fiscal 2020 with engineering resources focusing on next generation
product enhancements.
Intellectual
Property
As
of June 30, 2020, we held 16 U.S. and 30 foreign issued patents covering the SmartVest System and its underlying technology and
had 31 pending U.S. 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 U.S. patents will expire during fiscal 2021.
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, Japan, and other countries.
We
also have received ten U.S. trademark and service mark registrations, one 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 14,000 square feet
and we are certified on an annual basis to be compliant with ISO 13485 quality system standards. Our site has been audited regularly
by the FDA and the International Organization for Standardization (“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 vendors
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.
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 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.
7
Competition
The
original HFCWO technology was licensed to American Biosystems, Inc. (now part of Hill-Rom Holdings, Inc.), 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 (HillRom’s The Vest® Airway Clearance System). HillRom has also received FDA
510(k) clearance for the Monarch®TM Airway Clearance System, a mobile device that uses pulmonary oscillating
discs. Respiratory Technologies, Inc. (now RespirTech, part of Koninklijke Phillips N.V.) received FDA clearance to market their
HFCWO product, the inCourage® Airway Clearance Therapy in 2005. Both HillRom 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.
Alternative
products for administering pulmonary therapy include: Positive Expiratory Pressure; (PEP); 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 four other
states. In-state presence requirements vary 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.
8
In
addition to the clearances and approvals discussed below, we obtained ISO 13485 certification in January 2005 and receive annual
certification of our compliance to 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 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 /or marketing claims. If the FDA were to determine our promotional
or training materials constitute promotion of an unapproved or uncleared claim of use, it is possible we would need to modify
our training or promotional materials or be subject to regulatory or enforcement actions that could result in civil fines or criminal
penalties. Other federal, state or foreign enforcement authorities could 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. 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 February 2020. We are currently working on updates to our quality system to comply with the European Union Medical
Device Regulation by 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.
9
The 2010 Healthcare Reform
Legislation, medical device excise tax and Federal Physician Payments Sunshine Act
The
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.
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 System during our 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.
On
December 20, 2019, the medical device excise tax described above was permanently repealed.
Federal
Physician Payments Sunshine Act
The
Federal Physician Payments Sunshine Act (Section 6002 of the PPACA) (the “Sunshine Act”) was adopted on February 1,
2013, to create transparency for the financial relationship between medical device companies and physicians and teaching hospitals.
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.
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.
10
HIPAA/HITECH
and Other Privacy Regulations