Item 1A. Risk Factors.
As
a smaller reporting company, we are not required to provide disclosure pursuant to this item.
Item 1B. Unresolved Staff Comments.
As
a smaller reporting company, we are not required to provide disclosure pursuant to this item.
Item 2. Properties.
We
own our principal headquarters and manufacturing facilities, consisting of approximately 37,000 square feet, which are located
on an approximately 2.3-acre parcel in New Prague, Minnesota. All of the Company’s revenues, profits, and assets are associated
with this facility. We believe that our facilities are satisfactory for our long-term growth plans.
Item 3. Legal Proceedings.
The
disclosure regarding legal proceedings set forth in Note 11 to our Financial Statements in Part II, Item 8 of this Annual Report
on Form 10-K is incorporated herein by reference. Occasionally, we may be party to legal actions, proceedings, or claims in the
ordinary course of business, including claims based on the 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.
Item 4. Mine Safety Disclosures.
None.
PART
II
Market
Information
Our
common stock is listed on the NYSE American under the symbol “ELMD”.
As
of August 15, 2023, there were 55 registered holders of our common stock.
Dividends
We
have never paid cash dividends on any of our shares of common stock. We currently intend to retain any earnings for use in operations
and do not anticipate paying cash dividends to our shareholders in the foreseeable future. The agreement governing our credit
facility restricts our ability to pay dividends.
Recent
Sales of Unregistered Equity Securities
None.
13
Purchases
of Equity Securities by the Company and Affiliated Purchasers
On
May 26, 2021, our Board of Directors approved a stock repurchase authorization. Under the authorization, we were originally able
to repurchase up to $3.0 million of outstanding shares of our common stock through May 26, 2022. On May 26, 2022, our Board of
Directors removed the date limitation. The shares of our common stock may be repurchased on the open market or in privately negotiated
transactions subject to applicable securities laws and regulations. As of June 30, 2023, the approximate dollar value of shares
that may yet be purchased under the aforementioned authorization was $275,000. The following table sets forth information concerning
purchases of shares of our common stock for the three months ended June 30, 2023:
Total — $ — —
Item 6. [Reserved].
The
following discussion and analysis of our financial condition and results of operations should be read in conjunction with our
financial statements and the accompanying notes included elsewhere in this Annual Report on Form 10-K. The forward-looking statements
include statements that reflect management’s good faith beliefs, plans, objectives, goals, expectations, anticipations and
intentions with respect to our future development plans, capital resources and requirements, results of operations, and future
business performance. Our actual results could differ materially from those anticipated in the forward-looking statements included
in this discussion as a result of certain factors, including, but not limited to, those discussed in the section entitled “Information
Regarding Forward-Looking Statements” immediately preceding Part I of this Annual Report on Form 10-K.
Overview
Electromed
develops and provides innovative airway clearance products applying HFCWO technologies in pulmonary care for patients of all ages.
We
manufacture, market and sell products that provide HFCWO, including the SmartVest System that includes our newest generation SmartVest
Clearway®, previous generation SmartVest SQL® and related products, to patients with compromised
pulmonary function. The SmartVest Clearway is an updated and modern approach to HFCWO focused on an enhanced patient experience
and proven patient outcomes. The product delivers effective 360o oscillatory pressure through our proprietary rapid
inflate-deflate technology which improves the patient’s ability to breathe deeply during therapy. SmartVest Clearway is
the smallest, and lightest generator on the market, and is designed with an intuitive touchscreen to simplify programing and everyday
use. Our products are sold in both the home health care market and the institutional market for use by patients in hospitals,
which we refer to as “institutional sales.” The SmartVest SQL has been sold in the domestic home care market since
2014. In 2015, we launched the SmartVest SQL into institutional and certain international markets. In June 2017, we announced
the launch of the SmartVest SQL with SmartVest ConnectTM wireless technology, which allows data connection between physicians
and patients to track therapy performance and collaborate in treatment decisions. In 2022, we launched the SmartVest Clearway
with SmartVest Connect technology to adult pulmonary, pediatric and cystic fibrosis patients for use in the home. We have marketed
the SmartVest System and its predecessor products since 2000 to patients suffering from cystic fibrosis, bronchiectasis and repeated
episodes of pneumonia. Additionally, we offer our products to a patient population that includes neuromuscular disorders such
as cerebral palsy, muscular dystrophies, ALS, and patients with post-surgical complications or who are ventilator dependent or
have other conditions involving excess secretion and impaired mucus transport.
The
SmartVest System is often eligible for reimbursement from major private insurance providers, health maintenance organizations
(“HMOs”), state Medicaid systems, and the federal Medicare system, which we believe is an important consideration
for patients considering an HFCWO course of therapy. For domestic sales, the SmartVest System may be reimbursed under the Medicare-assigned
billing code (E0483) for HFCWO devices if the patient has cystic fibrosis, bronchiectasis (including chronic bronchitis or COPD
that has resulted in a diagnosis of bronchiectasis), or any one of certain enumerated neuromuscular diseases, and can demonstrate
that another less expensive physical or mechanical treatment did not adequately mobilize retained secretions. Private payers consider
a variety of sources, including Medicare, as guidelines in setting their coverage policies and payment amounts.
14
We
employ a direct-to-patient and provider model, through which we obtain patient referrals from clinicians, manage insurance claims
on behalf of our patients and their clinicians, deliver our solutions to patients and train them on proper use in their homes.
This model allows us to directly approach patients and clinicians, whereby we disintermediate the traditional durable medical
equipment channel and capture both the manufacturer and distributor margins. We have engaged a limited number of regional durable
medical equipment distributors focused on respiratory therapies as an alternate sales channel. Revenue through this channel was
3% of our total revenues in fiscal 2023.
Our
key growth strategies for fiscal 2024 are to accelerate our revenue growth by taking market share and expanding the addressable
population for the largest and fastest growing segments of the market: adult pulmonology/bronchiectasis. Actions to support accelerating
our growth include the following:
● Provide best-in-class customer care and support; and
Impacts
of COVID-19 on Our Business and Operations
In
March 2020, the World Health Organization designated COVID-19 as a global pandemic, and the U.S. Department of Health and Human
Services designated COVID-19 as a public health emergency (“PHE”). In response to the COVID-19 pandemic and the U.S.
federal government’s declaration of a PHE, the Centers for Medicare & Medicaid Services (“CMS”) implemented
several temporary rule changes and waivers to allow prescribers to best treat patients during the period of the PHE. These waivers
became effective on March 1, 2020. Clinical indications and documentation typically required were not enforced for respiratory-related
products, including the SmartVest System (solely with respect to Medicare patients).
On
January 30, 2023, the Biden administration announced that the COVID-19 national and PHE declarations will end on May 11, 2023.
The CMS waiver was not extended and expired on May 11, 2023. We believe that we were able to mitigate the potential effects on
our net revenue resulting from the expiration of the CMS waiver by hiring additional employees to increase capacity and minimize
the average timeframe to convert a Medicare patient referral to approval and re-educating clinicians on Medicare requirements
for reimbursement of HFCWO.
We
did not receive any direct financial assistance from any government program during fiscal 2022 or fiscal 2023 in connection with
COVID-19 relief measures.
Impacts
of Certain Macro-Economic Conditions and the Supply Chain on Our Business and Operations
We
observed increased lead times for certain components in our supply chain and increased material costs and shipping rates during
the second half of fiscal 2022 and all of fiscal 2023. The changes to our supply chain lead times resulted in a temporary interruption
that impacted product availability for certain customers beginning in September 2022 and continuing through June 2023. We anticipate
that these increased lead times and temporary interruption of supply have the potential to continue through the first half of
fiscal 2024. If we are unable to procure components to meet our demand or if we extend delivery lead-times to our customers, there
may be an adverse impact to our revenue and, longer term, the potential of market share losses. We are taking actions to expedite
components and to identify and qualify alternate suppliers for certain components to minimize any impact to our revenue and customer
deliveries. We expect that material costs and shipping rates will remain elevated during the first half of fiscal 2024 relating
to supply chain availability and inflationary trends in electronic components and may extend to other components. In certain instances,
we have purchased key electronic materials in advance to ensure adequate future supply and mitigate the risk of potential supply
chain disruptions. It is possible that these macro-economic conditions could have a greater adverse impact on our supply chain
in the future, including impacts associated with preventative and precautionary measures taken by other businesses and applicable
governments. A reduction or further interruption in any of our manufacturing processes could have a material adverse effect on
our business. Any significant increases to our raw material or shipping costs could reduce our gross margins.
15
Critical
Accounting Estimates
During
the preparation of our financial statements, we are required to make estimates, assumptions and judgment that affect reported
amounts. Those estimates and assumptions affect our reported amounts of assets and liabilities, our disclosure of contingent assets
and liabilities, and our reported revenues and expenses. We update these estimates, assumptions, and judgment as appropriate.
Some of our accounting policies and estimates require us to exercise significant judgment in selecting the appropriate assumptions
for calculating financial statements. Such judgments are subject to an inherent degree of uncertainty. Among other factors, these
judgments are based upon our historical experience, known trends in our industry, terms of existing contracts and other information
from outside sources, as appropriate. The following is a summary of our primary critical accounting policies and estimates. See
also Note 1 to the Financial Statements, included in Part II, Item 8, of this Annual Report on Form 10-K.
Revenue
Recognition
Revenue
is measured based on consideration specified in the contract with a customer, adjusted for any applicable estimates of variable
consideration and other factors affecting the transaction price, including consideration paid or payable to customers and significant
financing components. Revenue from all customers is recognized when a performance obligation is satisfied by transferring control
of a distinct good or service to a customer.
Individual
promised goods and services in a contract are considered a performance obligation and accounted for separately if the individual
good or service is distinct (i.e., the customer can benefit from the good or service on its own or with other resources that are
readily available to the customer and the good or service is separately identifiable from other promises in the arrangement).
If an arrangement includes multiple performance obligations, the consideration is allocated between the performance obligations
in proportion to their estimated standalone selling price, unless discounts or variable consideration is attributable to one or
more but not all the performance obligations. Costs related to products delivered are recognized in the period incurred, unless
criteria for capitalization of costs under Accounting Standards Codification (“ASC”) 340-40, “Other Assets and
Deferred Costs,” or the requirements under other applicable accounting guidance are met.
The
Company includes shipping and handling fees in net revenues. Shipping and handling costs associated with the shipment of the Company’s
SmartVest System after control has transferred to a customer are accounted for as a fulfillment cost and are included in cost
of revenues.
We
request that customers return previously sold units that are no longer in use to us to limit the possibility that such units would
be resold by unauthorized parties or used by individuals without a prescription. The customer is under no obligation to return
the product; however, we do reclaim the majority of previously sold units upon the discontinuance of patient usage. We are certified
to recondition and resell returned SmartVest System units. Returned units are typically reconditioned and resold and continue
to be used for demonstration equipment and warranty replacement parts.
Inventory
Valuation
Inventories
are stated at the lower of cost (first-in, first-out method) or net realizable value. Work in process and finished goods are carried
at standard cost, which approximates actual cost, and includes materials, labor and allocated overhead. The reserve for obsolescence
is determined by analyzing the inventory on hand and comparing it to expected future sales. Estimated inventory to be returned
is based on how many devices that have shipped that are expected to be returned prior to completion of the insurance reimbursement
process.
16
Warranty
Reserve
The
Company provides a lifetime warranty on its products to the prescribed patient for sales within the U.S. and a three-year warranty
for all institutional sales and sales to individuals outside the U.S. The Company estimates the costs that may be incurred under
its warranty and records a liability in the amount of such costs at the time the product is shipped. Factors that affect the Company’s
warranty reserve include the number of units shipped, historical and anticipated rates of warranty claims, the product’s
useful life and cost per claim. The Company periodically assesses the adequacy of its recorded warranty reserve and adjusts the
amounts as necessary.
Share-Based
Compensation
Share-based
payment awards consist of options to purchase shares of our common stock issued to employees. Expense for share-based payment
awards consist of options to purchase shares of our common stock issued to employees for services. Expense for options is estimated
using the Black-Scholes pricing model at the date of grant and expense for restricted stock is determined by the closing price
on the day the grant is made. Expense is recognized on a straight-line basis over the requisite service or vesting period of the
award, or at the time services are provided for non-employee awards. In determining the fair value of options, we make various
assumptions using the Black-Scholes pricing model, including expected risk-free interest rate, stock price volatility, and life.
See Note 8 to the Financial Statements included in Part II, Item 8, of this Annual Report on Form 10-K for a description of these
assumptions.
17
Results
of Operations
Fiscal
Year Ended June 30, 2023 Compared to Fiscal Year Ended June 30, 2022
Revenues
Revenue
for the fiscal years ended June 30, 2023 and 2022 are summarized in the table below.
Fiscal Years Ended June 30,
Home
Care Revenue. Home care revenue increased by $5,941,000, or 15.6%, in fiscal 2023 compared to fiscal 2022. The revenue increase
compared to fiscal 2022 was primarily due to increases in referrals and approvals. The increase in referrals was primarily due
to an increase in direct sales representatives, increased sales representative productivity driven by increased clinic access
and patient flow, our sales team refining their selling process and clinic targeting methodology, and benefits of the CMS waiver
on the non-commercial Medicare portion of our home care revenue. Additionally, we benefitted from a Medicare allowable rate increase
that took effect on January 1, 2023. Annual Medicare rate increases for our device are linked closely to changes in the Urban
Consumer Price Index.
The
CMS waiver benefited the non-commercial Medicare portion of our home care revenue by increasing the number of referrals and the
approval percentage for previously non-covered diagnoses. We believe that our ongoing sales team execution, along with the return
to pre-COVID-19 levels of patient face-to-face engagement with physicians and clinic access for our sales team mitigated the fourth
quarter homecare revenue impact of the CMS waiver expiration on May 11, 2023.
Institutional
Revenue. Institutional revenue increased by $420,000, or 25.3%, in fiscal 2023 compared to fiscal 2022. Institutional revenue
includes sales to group purchasing organizations, rental companies and other institutions. The revenue increase was due to increased
capital purchases and stronger consumable volumes compared to fiscal 2022, as hospitals resumed utilization of HFCWO protocols
after reducing utilization early in the COVID-19 pandemic.
Home
Care Distributor Revenue. Home care distributor revenue increased by $144,000, or 9.8%, in fiscal 2023 compared to fiscal
2022. The revenue increase in fiscal 2023 was due to increased demand from one of our primary home care distribution partners.
We began selling to a limited number of home medical equipment distributors during our fiscal year ended June 30, 2020, who in
turn sell our SmartVest System in the U.S. home care market.
International
Revenue. International revenue decreased by $97,000, or 18.6%, in fiscal 2023 compared to fiscal 2022. International revenue
growth is not currently a primary focus for us, and our corporate resources are focused on supporting and maintaining our current
international distributors.
Gross
Profit
Gross
profit increased to $36,519,000 in fiscal 2023, or 76.0% of net revenues, from $31,442,000 or 75.5% of net revenues, in fiscal
2022. The increase in gross profit was primarily related to increases in domestic home care revenue including the Medicare allowable
rate increase that took effect in January 2023.
18
We
have a goal of improving our gross margin percentage over time due to cost savings initiatives associated with Clearway, supplier
optimization, and gaining operating leverage on higher volumes.
Operating
Expenses
Selling,
General and Administrative Expenses. Selling, general and administrative (“SG&A”) expenses were $31,595,000
in fiscal 2023, representing an increase of $4,481,000 or 16.5% from $27,114,000 in fiscal 2022.
SG&A
payroll and compensation-related expenses including health insurance benefits and other compensation increased by $2,629,000,
or 14.7%, to $20,552,000 in fiscal 2023, compared to $17,923,000 in fiscal 2022. The increase in the current year was primarily
due to a higher average number of sales, sales support and marketing personnel, increased reimbursement personnel to process higher
patient referrals, increased temporary resources to assist with systems infrastructure investments and increased incentive payments
on higher home care revenue. We have also continued to provide regular merit-based increases for our employees and are regularly
benchmarking our compensation ranges for new and existing employees to ensure we can hire and retain the talent needed to drive
growth in our business. Field sales employees totaled 55, of which 46 were direct sales, as of June 30, 2023, compared to 52 as
of June 30, 2022, of which 43 were direct sales. We expect to continue to expand our salesforce to align with our revenue growth
projections.
Professional
and legal fees, including recruiting and insurance expenses, increased by $859,000, or 19.4%, to $5,284,000 in fiscal 2023, compared
to $4,425,000 in fiscal 2022. Professional fees include services related to legal costs, shareowner services and reporting requirements,
information technology technical support and consulting fees. The increase in the current year was primarily due to an increased
investment in our system infrastructure and increased clinical study costs. We continue to make key investments in systems infrastructure
including implementing a new enterprise resource planning system, enhancing our customer relationship management system and further
optimizing of the revenue cycle management system that was implemented in June 2021. We expect these system infrastructure investments
will result in more efficient and scalable operational processes and provide enhanced analytics to drive business performance.
Total
discretionary marketing expenses increased by $211,000, or 25.6% to $1,035,000 in fiscal 2023, compared to $824,000 in fiscal
2022. The increase in the current year was primarily due to discretionary investment in market research, physician marketing,
and peer to peer education engagement strategies.
Travel,
meals and entertainment expenses increased $422,000, or 16.4%, to $2,990,000 for fiscal 2023 compared to $2,568,000 in fiscal
2022. The increase in the current year period was primarily due to an increase in headcount and our annual sales meeting expenses.
Research
and Development Expenses
R&D
expenses decreased by $440,000, or 32.4%, to $916,000 in fiscal 2023 compared to $1,356,000 in fiscal 2022. The decrease in the
current year was primarily due to reduced professional consulting costs associated with our next generation platform development
activities. R&D expenses were 1.9% of revenue in fiscal 2023 compared to 3.3% of revenue in fiscal 2022. We expect R&D
spending to be between 1.0% and 2.0% of revenue during fiscal 2024.
Interest
Income, net
Net
interest income was approximately $78,000 in fiscal 2023 compared to net interest income of $25,000 in fiscal 2022. The increase
in the current year was primarily due to higher interest rates earned on our cash deposits despite lower overall cash balances
in the current year.
Income
Tax Expense
Income
tax expense in fiscal 2023 was $920,000, which includes a current tax expense of $963,000 and a deferred benefit of $43,000. Estimated
income tax expense includes a current federal and state tax benefit of approximately $250,000 related to the excess tax benefit
for fully vested stock options and non-qualified stock options that were exercised during the period.
19
Income
tax expense in fiscal 2022 was $692,000, which included a current tax expense of $1,181,000 and a deferred benefit of $489,000.
Estimated income tax expense included a current federal and state tax benefit of approximately $12,000 related to excess tax benefit
for fully vested stock options and non-qualified stock options that were exercised during the period.
The
effective tax rates were 22.5% and 23.1% for fiscal 2023 and 2022, respectively. The effective tax rates differ from the statutory
federal rate because of state income taxes, R&D tax credits, and other permanent items that are non-deductible for tax purposes
relative to the amount of taxable income.
Net
Income
Net
income for fiscal 2023 was $3,166,000, compared to net income of $2,305,000 in fiscal 2022. The increase in current year net income
was primarily due to stronger home care and distributor revenue growth.
Liquidity
and Capital Resources
Cash
Flows and Sources of Liquidity
Cash
Flows from Operating Activities
Net cash provided by operating activities in fiscal 2023 was $1,315,000. Cash flows from operating activities consisted of net income of $3,166,000, non-cash expenses of approximately $1,278,000, a decrease in prepaid expenses of $202,000 an increase in tax payable of approximately $285,000 and a $696,000 increase in accounts payable and accrued liabilities, and accrued compensation. These cash flows from operating activities were offset by a $3,078,000 increase in accounts receivable, an increase in inventory of $1,033,000, and a $201,000 increase in contract assets. The increase in accounts receivable was primarily due to an increase in the Medicare portion of our home care business, which has a 13-month payment cycle. The increase in inventory was primarily due to an increase in raw materials associated with the launch of Clearway. Our cash receipt collection remains strong, with the three months ended June 30, 2023, period having the highest cash receipt collections in our company's history, building upon the prior record that was set in the previous quarter.
Cash
Flows from Investing Activities
Net
cash used in investing activities in fiscal 2023 was approximately $1,716,000. Cash used in investing activities consisted of
approximately $1,648,000 in expenditures for property and equipment, approximately $1,083,000 for software and $565,000 for equipment,
and $68,000 in payments for patent and trademark costs.
Cash
Flows from Financing Activities
Net
cash used in financing activities in fiscal 2023 was approximately $380,000, consisting of $153,000 used for our share repurchase
program and $310,000 for taxes paid on net share settlements of stock option exercises offset by $83,000 of cash provided by the
issuance of common stock upon exercise of options.
Adequacy
of Capital Resources
Our
primary working capital requirements relate to adding employees to our sales force and support functions, continuing infrastructure
investments, and supporting general corporate needs, including financing equipment purchases and other capital expenditures incurred
in the ordinary course of business. Based on our current operational performance, we believe our working capital of approximately
$29,734,000 and available borrowings under our existing credit facility will provide adequate liquidity for fiscal 2024.
Effective
December 17, 2021, we renewed our credit facility, which provides us with a revolving line of credit. Interest on borrowings on
the line of credit accrues at the prime rate (8.25% as of June 30, 2023) less 1.0% and is payable monthly. There was no outstanding
principal balance on the line of credit as of June 30, 2023 or June 30, 2022. The amount eligible for borrowing on the line of
credit is limited to the lesser of $2,500,000 or 57.0% of eligible accounts receivable, and the line of credit expires on December
18, 2023, if not renewed. As of June 30, 2023, the maximum $2,500,000 was available under the line of credit. Payment obligations
under the line of credit are secured by a security interest in substantially all of our tangible and intangible assets.
20
The
documents governing our line of credit contain certain financial and nonfinancial covenants that include a minimum tangible net
worth of not less than $10,125,000 and restrictions on our ability to incur certain additional indebtedness or pay dividends.
Any
failure to comply with these covenants in the future may result in an event of default, which if not cured or waived, could result
in the lender accelerating the maturity of our indebtedness, preventing access to additional funds under the line of credit, requiring
prepayment of outstanding indebtedness, or refusing to renew the line of credit. If the maturity of the indebtedness is accelerated
or the line of credit is not renewed, sufficient cash resources to satisfy the debt obligations may not be available and we may
not be able to continue operations as planned. If we are unable to repay such indebtedness, the lender could foreclose on these
assets.
During
fiscal 2023 and 2022, we spent approximately $1,648,000 and $1,425,000, respectively, on property and equipment. We currently
expect to finance planned equipment purchases with cash flows from operations or borrowings under our credit facility. We may
need to incur additional debt if we have an unforeseen need for additional capital equipment or if our operating performance does
not generate adequate cash flows.
While
the impact of macroeconomic conditions and other factors such as inflation are difficult to predict, we believe our cash, cash
equivalents and cash flows from operations will be sufficient to meet our working capital, capital expenditure, operational cash
requirements for fiscal 2024.
Accounting
Standards Recently Issued But Not Yet Adopted by the Company
See
Note 1 of the Notes to our Financial Statements in this Annual Report on Form 10-K for information on new accounting standards
adopted in fiscal 2023 or pending adoption.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
As
a smaller reporting company, we are not required to provide disclosure pursuant to this item.
21
Item 8. Financial Statements and Supplementary Data.
Index
to Financial Statements
Report of Independent Registered Public Accounting Firm F-2
Balance Sheets F-4
Statements of Operations F-5
Statements of Shareholders’ Equity F-6
Statements of Cash Flows F-7
Notes to Financial Statements F-8
F-1
Report
of Independent Registered Public Accounting Firm
Shareholders
and Board of Directors
Electromed,
Inc.
Opinion
on the Financial Statements
We have audited the accompanying balance sheets of Electromed, Inc. (the Company) as of June 30, 2023 and 2022, the related statements of operations, shareholders' equity and cash flows for the years then ended, and the related notes to the financial statements. In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of June 30, 2023 and 2022, and the results of its operations and its cash flows for the years then ended in conformity with accounting principles generally accepted in the United States of America.
Basis
for Opinion
These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company's financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits, we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion.
Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
Critical
Audit Matter
The critical audit matter communicated below is a matter arising from the current period audit of the financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective or complex judgments. The communication of the critical audit matter does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing separate opinions on the critical audit matter or on the accounts or disclosures to which it relates.
Measurement
of Customer Revenue Net of Adjustments
As discussed in Note 2 to the financial statements, revenues are recognized at a point in time when control passes to the customer upon product shipment or delivery. Net patient revenues (patient revenue less estimated adjustments) are recognized at the estimated net realizable amounts from third-party payers and customers in exchange for the product. The Company has agreements with third-party payers that provide for payments at amounts different from its established rates. Each quarter, the Company estimates its adjustments for each sale based on the terms of third-party payer contracts and historical collections experience, then applies an estimate for an adjustment reserve percentage to the gross accounts receivable balances.
We identified the measurement of the adjustment reserve related to customer revenue as a critical audit matter due to the audit effort, degree of auditor judgment, and subjectivity involved in evaluating the audit evidence related to management’s estimate.
F-2
Our audit procedures related to the Company’s measurement of the adjustment reserve included the following, among others.
/s/
RSM US LLP
We
have served as the Company’s auditor since 2010.
Rochester,
Minnesota
August 22,
2023
F-3
Electromed,
Inc.
Balance
Sheets
June 30, 2023 and 2022
Assets
Current Assets
Liabilities and Shareholders’ Equity
Current Liabilities
Commitments and Contingencies (Note 11)
Shareholders’ Equity
See
Notes to Financial Statements.
F-4
Electromed,
Inc.
Statements
of Operations
Years Ended June 30, 2023 and 2022
Years Ended June 30,
Operating expenses
Income per share:
Weighted-average common shares outstanding:
See
Notes to Financial Statements.
F-5
Electromed,
Inc.
Statements of Shareholders’ Equity
Years Ended June 30, 2023 and 2022
Additional Total
Common Stock Paid-in Retained Shareholders’
Shares Amount Capital Earnings Equity
Issuance of common stock upon exercise of options 13,245 — — — —
Taxes paid on stock option exercised on a net basis — — (77,000 ) — (77,000 )
Issuance of restricted stock, net 28,701 — — — —
Taxes paid on stock option exercised on a net basis — — (310,000 ) — (310,000 )
See
Notes to Financial Statements.
F-6
Electromed, Inc.
Statements of Cash Flows
Years Ended June 30, 2023 and 2022
Years Ended June 30,
Cash Flows from Operating Activities
Amortization of finite-life intangible assets 63,000 125,000
Changes in operating assets and liabilities:
Net cash provided by (used in) operating activities 1,315,000 (686,000 )
Cash Flows from Investing Activities
Expenditures for finite-life intangible assets (68,000 ) (100,000 )
Cash Flows from Financing Activities
Issuance of common stock upon exercise of options 83,000 —
Taxes paid on stock options exercised on a net basis (310,000 ) (77,000 )
Cash and cash equivalents
Supplemental Disclosures of Cash Flow Information
Supplemental Disclosures of Noncash Investing and Financing Activities
Property and equipment acquisitions in accounts payable $ 60,000 $ 44,000
Intangible asset acquisitions in accounts payable $ 4,000 $ 3,000
Demonstration equipment returned to inventory $ 10,000 $ 8,000
See
Notes to Financial Statements.
F-7
Electromed,
Inc.
Notes to Financial Statements
Note 1. Nature of Business and Summary of Significant Accounting Policies
Nature
of business: Electromed, Inc. (the “Company”) develops, manufactures and markets innovative airway clearance products
that apply High Frequency Chest Wall Oscillation (“HFCWO”) therapy in pulmonary care for patients of all ages. The
Company markets its products in the U.S. to the home health care and institutional markets for use by patients in personal residences,
hospitals and clinics. The Company also sells internationally both directly and through distributors. International sales were
$424,000 and $521,000 for the fiscal years ended June 30, 2023 (“fiscal 2023”) and June 30, 2022 (“fiscal 2022”),
respectively. Since its inception, the Company has operated in a single industry segment: developing, manufacturing, and marketing
medical equipment.
Impacts
of COVID-19 on the Company’s business
The
Company did not receive any direct financial assistance from any government program during fiscal 2022 or fiscal 2023 in connection
with COVID-19 relief measures.
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 (“CMS”) implemented a number of temporary rule changes and waivers to allow prescribers
to best treat patients during the period of the public health emergency. These waivers were made retroactively effective to March
1, 2020 and were in place for the duration of fiscal 2021 and fiscal 2022 and through May 11, 2023. Clinical indications and documentation
typically required were not enforced for respiratory related products including the Company’s SmartVest® Airway Clearance
System (“SmartVest System”) (solely with respect to direct Medicare covered patients) applicable for the Company’s
home care prescriptions.
The
potential impact of the COVID-19 pandemic and its effects on our operational and financial performance will depend in large part
on future developments, which cannot be reasonably estimated at this time.
A
summary of the Company’s significant accounting policies follows:
Use
of estimates: Management uses estimates and assumptions in preparing the financial statements in accordance with U.S. generally
accepted accounting principles (“U.S. GAAP”). Those estimates and assumptions affect the reported amounts of assets
and liabilities, the disclosure of contingent assets and liabilities, and the reported revenues and expenses. Actual results could
vary from the estimates that were used. The Company believes the critical accounting policies that require the most significant
assumptions and judgments in the preparation of its financial statements include revenue recognition and the related estimation
of variable consideration, inventory valuation, share-based compensation and warranty reserve.
Revenue
recognition: Revenue is measured based on consideration specified in the contract with a customer, adjusted for any applicable
estimates of variable consideration and other factors affecting the transaction price, including noncash consideration, consideration
paid or payable to customers and significant financing components. Revenue from all customers is recognized when a performance
obligation is satisfied by transferring control of a distinct good or service to a customer. See Note 2 for information on revenue.
Shipping
and handling expense: Shipping and handling charges incurred by the Company are included in cost of revenues and were $896,000
and $982,000 for fiscal 2023 and 2022, respectively.
Cash
and cash equivalents: Cash and cash equivalents consist of cash in bank deposits and money market funds with original maturities
of three months or less at the time of purchase. The Company has not experienced any losses in these accounts.
Accounts
receivable: The Company’s accounts receivable balance is comprised of amounts due from individuals, institutions and
distributors. Balances due from individuals are typically remitted to the Company by third-party reimbursement agencies such as
Medicare, Medicaid and private insurance companies. Accounts receivable are carried at amounts estimated to be received from patients
under reimbursement arrangements with third-party payers. Accounts receivable are also net of an allowance for doubtful accounts.
Management determines the allowance for doubtful accounts by regularly evaluating individual customer receivables and considering
a customer’s financial condition and credit history. Receivables are written off when deemed uncollectible. Recoveries of
receivables previously written off are recorded when received. The allowance for doubtful accounts was $45,000 as of June 30,
2023 and 2022.
F-8
Contract
assets: Contract assets include amounts recognized as revenue that are estimates of variable consideration for Medicare appeals
where the final determination of the insurance coverage amount is dependent on future approval of an appeal, or when the consideration
due to the Company is dependent on a future event such as the patient meeting a deductible prior to the Company’s claim
being processed by the payer. Contract assets are classified as current as amounts will turn into accounts receivable and be collected
during the Company’s normal business operating cycle. Contract assets are reclassified to accounts receivable when the right
to receive payment is unconditional.
Inventories:
Inventories are stated at the lower of cost (first-in, first-out method) or net realizable value. Work in process and finished
goods are carried at standard cost, which approximates actual cost, and includes materials, labor and allocated overhead. Standard
costs are reviewed at least quarterly by management, or more often in the event circumstances indicate a change in cost has occurred.
The reserve for obsolescence is determined by analyzing the inventory on hand and comparing it to expected future sales. Estimated
inventory to be returned is based on how many devices that have shipped that are expected to be returned prior to completion of
the insurance reimbursement process.
Property
and equipment: Property and equipment are stated at cost less accumulated depreciation. Depreciation is computed using the
straight-line method over the estimated useful lives of the assets. Leasehold improvements are depreciated over the shorter of
their estimated useful lives or the remaining lease term. The Company retains ownership of demonstration equipment in the possession
of both inside and outside sales representatives, who use the equipment in the sales process.
Leases:
The Company determines if an arrangement is a lease at inception. Where an arrangement is a lease, the Company determines
if it is an operating lease or a finance lease. At lease commencement, the Company records a lease liability and corresponding
right of use ROU asset. Lease liabilities represent the present value of our future lease payments over the expected lease term,
which includes options to extend or terminate the lease when it is reasonably certain those options will be exercised. The present
value of the Company’s lease liability is determined using its incremental collateralized borrowing rate at lease inception.
ROU assets represent the Company’s right to control the use of the leased assets during the lease and are recognized in
an amount equal to the lease liability for leases with an initial term greater than 12 months. Over the lease term (operating
leases only), the Company uses the effective interest rate method to account for the lease liability as lease payments are made
and the ROU asset is amortized to consolidated statement of operations in a manner that results in straight line expense recognition.
Finite-life
intangible assets: Finite-life intangible assets include patents and trademarks. These intangible assets are amortized on
a straight-line basis over their estimated useful lives, as described in Note 5.
Long-lived
assets: Long-lived assets, primarily property and equipment and finite-life intangible assets, are evaluated for impairment
whenever events or changes in circumstances indicate the carrying value of an asset or asset group may not be recoverable. In
evaluating recoverability, the following factors, among others, are considered: a significant change in the circumstances used
to determine the amortization period, an adverse change in legal factors or in the business climate, a transition to a new product
or service strategy, a significant change in customer base, and a realization of failed marketing efforts. The recoverability
of an asset or asset group is measured by a comparison of the carrying value of the asset to future undiscounted cash flows.
If
the Company believes the carrying value is unrecoverable, then it recognizes an impairment charge necessary to reduce the unamortized
balance to the estimated fair value of the asset or asset group. The amount of such impairment is charged to operations in the
current period.
Warranty
liability: The Company provides a lifetime warranty on its products to the prescribed patient for sales within the U.S. and
a three-year warranty for all institutional sales and sales to individuals outside the U.S. The Company estimates the costs that
may be incurred under its warranty and records a liability in the amount of such costs at the time the product is shipped or delivered.
Factors that affect the Company’s warranty liability include the number of units shipped, historical and anticipated rates
of warranty claims, the product’s useful life, and cost per claim. The Company periodically assesses the adequacy of its
recorded warranty liability and adjusts the amounts as necessary.
F-9
Changes
in the Company’s warranty liability were as follows:
Schedule of changes in warranty liability
Years Ended June 30,
Expenditures and costs incurred for warranty claims (294,000 ) (178,000 )
Income
taxes: Deferred taxes are provided on a liability method whereby deferred tax assets are recognized for deductible temporary
differences and operating loss and tax credit carryforwards and deferred tax liabilities are recognized for taxable temporary
differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax bases.
Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some
portion or all of the deferred tax assets will not be realized. The Company reverses a valuation allowance if it determines, based
on the weight of all available evidence, including when cumulative losses become positive income, that it is more likely than
not that some or all of the deferred tax assets will be realized. Deferred tax assets and liabilities are adjusted for the effects
of changes in tax laws and rates on the date of enactment.
The
Company recognizes tax liabilities when the Company believes that certain positions may not be fully sustained upon review by