|
Item
7.
|
Management’s
Discussion and Analysis of Financial Condition and Results of Operations.
|
The
following discussion and analysis of our financial condition and results of operations should be read in conjunction with our
financial statements and the accompanying notes included elsewhere in this Report. The forward-looking statements include statements
that reflect management’s beliefs, plans, objectives, goals, expectations, anticipations and intentions with respect to
our future development plans, capital resources and requirements, results of operations, and future business performance. Our
actual results could differ materially from those anticipated in the forward-looking statements included in this discussion as
a result of certain factors, including, but not limited to, those discussed in the section entitled “Information Regarding
Forward-Looking Statements” immediately preceding Part I of this Report.
Overview
Electromed,
Inc. (“we,” “our,” “us,” “Electromed” or the “Company”) develops and
provides innovative airway clearance products applying High Frequency Chest Wall Oscillation (“HFCWO”) technologies
in pulmonary care for patients of all ages.
We
manufacture, market and sell products that provide HFCWO, including the SmartVest
®
Airway Clearance System (“SmartVest
System”) that includes our newest generation SmartVest SQL
®
and previous generation SV2100, and related products,
to patients with compromised pulmonary function. The SmartVest SQL is smaller, quieter and lighter than our previous product,
with enhanced programmability and ease of 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 the fiscal quarter ended March 31, 2014. In the fourth quarter of our fiscal 2015, we launched
the SmartVest SQL into the institutional and certain international markets. In June 2017, we announced the launch of the SmartVest
SQL with SmartVest Connect™ wireless technology and entry into an agreement with Monaghan Medical Corporation to distribute
and sell the Aerobika
®
Oscillating Positive Expiratory Pressure (OPEP) Device in the U.S. home care
market. The SmartVest SQL with SmartVest Connect allows data connection between physicians and patients to track therapy performance
and collaborate in treatment decisions. Since 2000, we have marketed the SmartVest System and its predecessor products 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, amyotrophic lateral sclerosis (“ALS”),
the combination of emphysema and chronic bronchitis commonly known as chronic obstructive pulmonary disease (“COPD”),
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 is an important consideration for patients
considering an HFCWO course of therapy. For domestic sales, the SmartVest System may be reimbursed under the Medicare-assigned
billing code for HFCWO devices if the patient has cystic fibrosis, bronchiectasis (including chronic bronchitis or 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.
We
employ a direct-to-patient and provider model, through which we obtain patient referrals from clinicians, manage insurance claims
on behalf of our patients and their clinicians, deliver our solutions to patients and train them on proper use in their homes.
This model allows us to directly approach patients and clinicians, whereby we disintermediate the traditional durable medical
equipment channel and capture both the manufacturer and distributor margins.
Our
primary goals for the fiscal year ending June 30, 2018, include:
|
●
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delivering
profitable growth;
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●
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growing
quality referrals and increasing the rate of reimbursement on referrals; and
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●
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maintaining
the highest standards of integrity, respect and privacy.
|
Our
key growth strategies for the fiscal year ending June 30, 2018 include:
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●
|
continue
to develop innovative device features that appeal to patients;
|
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|
enhance
our superior leadership in reimbursement support and customer care;
|
|
●
|
focus
on increasing referrals in largest, fastest growing segments: adult pulmonology/bronchiectasis;
|
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●
|
maximize
therapy adherence with compelling clinical and health economic outcomes;
|
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●
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expand
third-party payer coverage; and
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●
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grow
institutional market share to support home care growth.
|
Critical
Accounting Policies and Estimates
During
the preparation of our financial statements, we are required to make estimates, assumptions and judgments that affect reported
amounts. Those estimates and assumptions affect our reported amounts of assets and liabilities, our disclosure of contingent assets
and liabilities, and our reported revenues and expenses. We update these estimates, assumptions and judgments as appropriate,
which in most cases is at least quarterly. We use our technical accounting knowledge, cumulative business experience, judgment
and other factors in the selection and application of our accounting policies. While we believe the estimates, assumptions and
judgments we use in preparing our financial statements are appropriate, they are subject to factors and uncertainties regarding
their outcome and therefore, actual results may materially differ from these estimates. The following is a summary of our primary
critical accounting policies and estimates. See also Note 1 to the Financial Statements, included in Part II, Item 8, of this
Report.
Revenue
Recognition and Allowance for Doubtful Accounts
Revenues
are primarily recognized upon shipment when evidence of a sales arrangement exists, delivery has occurred and the selling price
is determinable with collectability reasonably assured. Revenues from direct patient sales are recorded at the amount to be received
from patients under their arrangements with third-party payers, including private insurers, prepaid health plans, Medicare and
Medicaid. In addition, we record an estimate for selling price adjustments that often arise from changes in a patient’s
insurance coverage, changes in a patient’s state of domicile, insurance company coverage limitations or patient death. We
periodically review originally billed amounts and our collection history and make changes to the estimation process by considering
any changes in recent collection or sales allowance experience, but have not made material adjustments to previously recorded
revenues and receivables.
Other
than the installment sales as discussed below, we expect to receive payment on the vast majority of accounts receivable within
one year and therefore classify all receivables as current assets. However, in some instances, payment for direct patient sales
can be delayed or interrupted resulting in a portion of collections occurring later than one year. In the event receivables are
expected to be paid over longer intervals than one year, we recognize revenue under the installment method.
Certain
third-party reimbursement agencies pay us on a monthly installment basis, which can span from 18 to 60 months. California and
New York Medicaid constitute the majority of our installment method sales. Due to the length of time over which reimbursement
is received, we believe that the inherent uncertainty of collection due to external factors noted above precludes us from making
a reasonable estimate of revenue at the time the product is shipped. In certain circumstances, the patient must periodically attest
that the unit continues to be utilized as a prerequisite to continued reimbursement coverage. Therefore, we believe the installment
method is appropriate for these sales. If the third-party reimbursement agency discontinues payment and we determine no further
payments will be made from the patient, the carrying value of the account receivable is written off as a period adjustment against
the previously recognized sales. Under the installment method, we do not record accounts receivable or revenue at the time of
product shipment. We defer the revenue associated with the sale and, as each installment is received, that amount is recognized
as revenue. Deferred costs associated with the sale are amortized to cost of revenue ratably over the estimated period in which
collections are scheduled to occur.
Accounts
receivable are also net of an allowance for doubtful accounts, which are accounts from which payment is not expected to be received
although product was provided and revenue was earned. Management determines the allowance for doubtful accounts by regularly evaluating
individual customer receivables and considering a customer’s financial condition and credit history. Receivables are written
off when deemed uncollectible. Recoveries of receivables previously written off are recorded when received.
We
request that customers return previously-sold units that are no longer in use to us in order to limit the possibility that such
units would be resold by unauthorized parties or used by individuals without a prescription. The customer is under no obligation
to return the product; however, we do reclaim the majority of previously sold units upon the discontinuance of patient usage.
We obtained certification to recondition and resell returned units during fiscal 2015. Returned units can now be resold and will
continue to be used for demonstration equipment and warranty replacement parts.
Valuation
of Long-Lived and Intangible Assets
Long-lived
assets, primarily property and equipment and finite-life intangible assets, are evaluated for impairment whenever events or changes
in circumstances indicate the carrying value of an asset may not be recoverable. In evaluating recoverability, the following factors,
among others, are considered: a significant change in the circumstances used to determine the amortization period, an adverse
change in legal factors or in the business climate, a transition to a new product or service strategy, a significant change in
customer base, and a realization of failed marketing efforts. The recoverability of an asset or asset group is measured by a comparison
of the unamortized balance of the asset or asset group to future undiscounted cash flows. If we believe the unamortized balance
is unrecoverable, we would recognize an impairment charge necessary to reduce the unamortized balance to the estimated fair value
of the asset group. The amount of such impairment would be charged to operations at the time of determination.
Property
and equipment are stated at cost less accumulated depreciation. We use the straight-line method for depreciating property and
equipment over their estimated useful lives, which range from 3 to 39 years. Our finite-life intangibles consist of patents and
trademarks and their carrying costs include the original cost of obtaining the patents, periodic renewal fees, and other costs
associated with maintaining and defending patent and trademark rights. Patents and trademarks are amortized over their estimated
useful lives, generally 15 and 12 years, respectively, using the straight-line method.
Allowance
for Excess and Slow-Moving Inventory
An
allowance for potentially slow-moving or excess inventories is made based on our analysis of inventory levels on hand and comparing
it to expected future production requirements, sales forecasts and current estimated market values.
Income
Taxes
We
recognize deferred tax assets and liabilities based on the differences between the financial statement carrying amounts and the
tax basis of assets and liabilities. We provide a valuation allowance for deferred tax assets if we determine, based on the weight
of available evidence, that it is more likely than not that some or all of the deferred tax assets will not be realized. We would
reverse a valuation allowance if we determine, based on the weight of all available evidence, including when cumulative losses
become positive income, that it is more likely than not that some or all of the deferred tax assets will be realized.
Warranty
Reserve
We
provide a warranty on the SmartVest System that covers the cost of replacement parts and labor, or a new SmartVest System in the
event we determine a full replacement is necessary. For 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 within the U.S., and for all international sales, except Canadian home care, we provide a three-year
warranty. We estimate, based upon a review of historical warranty claim experience, the costs that may be incurred under our warranty
policies and record a liability in the amount of such estimate at the time a product is sold. The warranty cost is based upon
future product performance and durability, and is estimated largely based upon historical experience. We estimate the average
useful life of our products to be approximately five years. Factors that affect our warranty liability include the number of units
sold, historical and anticipated rates of warranty claims, the product’s useful life, and cost per claim. At our discretion,
based upon the cost to either repair or replace a product, we have occasionally replaced such products covered under warranty
with a new or refurbished model. We periodically assess the adequacy of our recorded warranty liability and make adjustments to
the accrual as claims data and historical experience warrant.
Share-Based
Compensation
Share-based
payment awards consist of options and restricted stock issued to employees and directors 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. The portion of the award that is ultimately expected to vest is recognized on a straight-line
basis over the requisite service or vesting period of the award. In determining the fair value of our share-based payment awards,
we make various assumptions using the Black-Scholes pricing model, including expected risk-free interest rate, stock price volatility,
life and forfeitures. See Note 7 to the Financial Statements included in Part II, Item 8, of this Report for a description of
these assumptions.
Results
of Operations
Fiscal
Year Ended June 30, 2017 Compared to Fiscal Year Ended June 30, 2016
Revenues
Revenue
for the twelve-month periods are summarized in the table below (dollar amounts in thousands).
|
|
Twelve
Months Ended June 30,
|
|
|
|
|
|
|
|
|
|
2017
|
|
|
2016
|
|
|
Increase
(Decrease)
|
|
Total Revenue
|
|
$
|
25,861
|
|
|
$
|
22,991
|
|
|
$
|
2,870
|
|
|
|
12.5
|
%
|
Home Care Revenue
|
|
|
23,387
|
|
|
|
20,500
|
|
|
|
2,887
|
|
|
|
14.1
|
%
|
Institutional Revenue
|
|
|
1,758
|
|
|
|
1,778
|
|
|
|
(20
|
)
|
|
|
(1.1
|
%)
|
International Revenue
|
|
|
716
|
|
|
|
713
|
|
|
|
3
|
|
|
|
0.4
|
%
|
Home
Care Revenue.
Our home care revenue increased by 14.1%, or approximately $2,877,000, for fiscal year ended June 30, 2017 (“fiscal
2017”), compared to the fiscal year ended June 30, 2016 (“fiscal 2016”). Home care revenue increased year-over-year
primarily due to an increase in approvals and referrals and an increase in the average rate of reimbursement per approval. The
increase in referrals was primarily due to growth in the number of field sales employees and a higher referral per field sales
employee as compared to the comparable prior year period.
During
fiscal 2017, we entered into a settlement agreement with the Centers for Medicare and Medicaid Services with respect to approximately
700 Medicare fee-for-service claims submitted between calendar years 2012 through 2015, resulting in approximately $703,000 of
net recognized revenue. This benefit was partially offset by the retroactive repayment of previously collected and recognized
revenue to a state Medicaid program totaling approximately $212,000. The repayment resulted from the state Medicaid program’s
reinterpretation of its reimbursement process and a reduction in its allowable payments. We believe the repayment is a one-time
event and is not reflective of other state Medicaid reimbursement processes. Our fiscal 2016 home care revenue benefited by approximately
$250,000 from processing a backlog of referrals from the prior fiscal year in a certain state. The backlog accumulated while we
reapplied for a state home medical equipment license until we met a newly imposed requirement to have an approved in-state presence.
The license was reinstated in October 2015.
Institutional
Revenue.
Institutional revenue decreased by 1.1%, or approximately $20,000, in fiscal 2017 compared to fiscal 2016. Institutional
revenue includes sales to distributors, group purchasing organization (“GPO”) members, and other institutions. The
decrease in institutional revenue was driven by a decrease in the number of units sold compared to the prior year, which was partially
offset by an increase in the sales of single patient use garments.
International
Revenue.
International revenue was approximately $716,000 in fiscal 2017 compared to $713,000 in fiscal 2016.
Gross
Profit
Gross
profit increased to $20,568,000, or 79.5% of net revenues, for fiscal 2017, from approximately $17,876,000, or 77.7% of net revenues,
for fiscal 2016. The increase in gross profit was primarily related to increases in domestic home care revenues and a decrease
in our manufacturing costs of the SmartVest SQL as compared to the prior year.
During
fiscal years 2017 and 2016, we lowered the cost of our SmartVest SQL to a cost significantly lower than our previous products.
This has shortened the time period in which we expect to phase out sales of our SV2100 product. Because of this, we recorded an
additional reserve on certain SV2100 parts that may no longer be utilized in production, of $30,000 and $10,000 during fiscal
2017 and 2016, respectively.
We
believe that as we continue to grow sales we will be able to continue to leverage manufacturing costs, and that gross margins,
over the long-term, will continue to be in a range slightly above 75%, although there can be fluctuations on a short-term basis
related to average reimbursement based on the mix of referrals during any given period. Factors such as diagnoses that are not
assured of reimbursement, insurance programs with lower allowable reimbursement amounts (for example, state Medicaid programs),
and whether an individual patient meets prerequisite medical criteria for reimbursement, may have an effect on average reimbursement
received on a short-term basis.
Operating
Expenses
Selling,
General and Administrative Expenses.
Selling, general and administrative (“SG&A”) expenses for fiscal 2017
were approximately $16,402,000, compared to approximately $14,387,000 for the prior year, an increase of approximately $1,988,000,
or 14.0%.
SG&A
payroll and compensation-related expenses increased by approximately $1,148,000, or 14.2%, to approximately $9,251,000. The increase
is due to additional employees in sales and administration, additional sales incentives on higher revenue, higher share-based
equity compensation expense, annual salary increases and the replacement of certain employees at a higher rate of compensation
in our sales department, which were partially offset by lower management bonus accruals. For fiscal 2017, we had 6.3 net additional
field sales full time equivalents (“FTEs”) and 2.9 net additional general and administrative FTEs, an increase of
22.6% and 5.1%, respectively, as compared to the prior fiscal year.
Professional
and legal fees increased by approximately $176,000 to approximately $1,455,000 in fiscal 2017, compared to approximately $1,279,000
in fiscal 2016. These fees were for services related to legal costs, shareholder services and investor relations consulting, consulting
fees, reporting requirements and information technology (“IT”) security and backup. The year-over-year increase in
professional fees was primarily due to increases in reimbursement consulting, shareholder and investor relations services and
human resources consulting, which were partially offset by a decrease in IT costs and sales consulting.
Recruiting
fees were approximately $479,000 in fiscal 2017, representing an increase of approximately $150,000, or 45.4%, as compared to
the same period in the prior year. The increase in recruiting fees was due primarily to adding more employees in sales and administrative
roles as compared to the prior year.
Travel,
meals and entertainment expenses were approximately $1,759,000 for fiscal 2017 compared to $1,513,000 in the prior year, an increase
of approximately $247,000, or 16.2%. The increase was due primarily to additional sales personnel, which was partially offset
by an overall decrease in travel expense per salesperson.
SG&A
expenses included a loss on the abandonment of certain domestic and foreign patents with net values of approximately $133,000
during fiscal 2017 as compared to $18,000 recognized in fiscal 2016. The majority of the pending patents that were abandoned related
to the initial development of our SQL SmartVest technology. During a review of our patent portfolio it was determined that certain
patents proved redundant to a subsequent SQL patent filing and were therefore abandoned. A smaller portion of expense was related
to patents that covered technology that we considered outdated and are no longer in use.
In
addition, SG&A expenses did not include medical device excise tax for all of fiscal 2017, a decrease of approximately $132,000
compared to the prior year. Beginning January 1, 2016, we realized a positive impact to operating profit with the Federal Consolidated
Appropriations Act, 2016, which included a two-year moratorium on the U.S. Federal medical device excise tax.
Research
and Development Expenses.
Research and development (“R&D”) expenses were approximately $597,000 and
$380,000, or 2.3% and 1.7% of net revenues, for fiscal 2017 and 2016, respectively. During fiscal 2016, we began developing
the SmartVest Connect wireless technology. We believe this innovation will strengthen our patient and clinician partnerships,
leading to greater therapy adherence and improved quality of life for individuals with compromised pulmonary function. We
launched this new feature during June of 2017. During fiscal 2017, we capitalized approximately $223,000 related to software development
in conjunction with this project. As a percentage of net revenues, we expect spending on R&D expenses to
remain relatively consistent over the next twelve months with engineering resources focusing on product enhancements and
other market opportunities. Certain expenses related to our innovation investments are not always captured in
R&D expenses. These expenses may be included in cost of sales as in the case of depreciation of tooling, or for SG&A,
in the case of professional fees or higher labor expense, as we improve our internal processes or enhance our
customer service.
Interest
Expense
Interest
expense, net, decreased to approximately $50,000 in fiscal 2017, compared to $67,000 in fiscal 2016, a decrease of approximately
$17,000. The decrease in interest expense during fiscal 2017 as compared to the prior year was driven by a lower effective interest
rate on outstanding borrowings, a lower level of debt as compared to the prior year, and an increase in interest income.
Income
Tax Expense
For
fiscal 2017, the Company recorded a current income tax expense of $1,290,000. Estimated income tax expense during fiscal 2017
includes a current tax expense of $1,439,000, a deferred benefit of $117,000 and a discrete tax benefit of $32,000 as a result
of the lapse of the statute of limitations on uncertain tax positions. For fiscal 2016, the Company recorded a current income
tax expense of $830,000. Income tax expense during fiscal 2016 includes a current tax expense of $1,173,000 and a deferred tax
benefit of $343,000, primarily from a discrete tax benefit caused by the Company’s release of the full valuation allowance
against all of its net U.S. federal and state deferred tax assets.
The
effective tax rates were 36.7% and 27.3% for fiscal 2017 and 2016, respectively. The effective tax rates differ from the statutory
federal rate due to the effect of state income taxes, R&D tax credits, the domestic production activities deduction and other
permanent items that are non-deductible for tax purposes relative to the amount of taxable income.
Net
Income/Loss
Net
income for fiscal 2017 was approximately $2,229,000, compared to net income of approximately $2,213,000 in fiscal 2016. The year-over-year
increase in net income was driven primarily by an increase in gross profit, which was partially offset by increased payroll and
compensation expenses in sales and administrative departments, increased travel, meals and entertainment driven by additional
sales personnel, increased R&D costs, increased professional fees and a higher level of recruiting costs. Additionally, the
prior year benefited by a discrete tax benefit of $294,000.
Liquidity
and Capital Resources
Cash
Flows and Sources of Liquidity
Cash
Flows from Operating Activities
For
fiscal 2017, our net cash provided by operating activities was approximately $1,191,000. Our net income of approximately $2,229,000
was adjusted for non-cash expenses of approximately $1,267,000, a decrease in income tax receivable of $192,000, an increase in
income tax payable of $157,000, and a decrease in prepaid expenses and other assets of $50,000. It also was offset by increases
in accounts receivable, accounts payable and accrued liabilities, and inventories of approximately $2,338,000, $338,000 and $28,000,
respectively.
For
fiscal 2016, our net cash provided by operating activities was approximately $2,167,000. Our net income of approximately $2,213,000
was adjusted for non-cash expenses of approximately $695,000, an increase in other accrued liabilities of $996,000 and a decrease
in prepaid expenses and other assets of $19,000. It also was offset by increases in accounts receivable, inventories and income
tax receivable of approximately $1,093,000, $348,000 and $192,000, respectively, and a decrease in income taxes payable of $123,000.
Cash
Flows from Investing Activities
For
fiscal 2017, cash used in investing activities was approximately $687,000. Cash used in investing activities primarily consisted
of approximately $619,000 in expenditures for property and equipment and $68,000 in payments for patent and trademark costs.
For
fiscal 2016, cash used in investing activities was approximately $580,000. Cash used in investing activities primarily consisted
of approximately $535,000 in expenditures for property and equipment and $45,000 in payments for patent and trademark costs.
Cash
Flows from Financing Activities
For
fiscal 2017, cash used in financing activities was approximately $54,000, consisting of $49,000 in principal payments on long-term
debt and $5,000 in payments for deferred financing fees.
For
fiscal 2016, cash used in financing activities was approximately $62,000, consisting of $49,000 in principal payments on long-term
debt and $13,000 in payments for deferred financing fees.
Adequacy
of Capital Resources
Our
primary working capital requirements relate to adding employees to our sales force and support functions, continuing R&D efforts,
and supporting general corporate needs, including financing equipment purchases and other capital expenditures incurred in the
ordinary course of business. Based on our current operational performance, we believe our working capital of approximately $15,580,000
and available borrowings under our existing credit facility will provide adequate liquidity for our fiscal year ending June 30,
2018.
Effective
December 18, 2016, we renewed our credit facility, which provides us with a revolving line of credit and a term loan. Interest
on borrowings on the line of credit accrues at the prime rate and is payable monthly. The amount eligible for borrowing on the
line of credit is limited to the lesser of $2,500,000 or 57.00% of eligible accounts receivable, and the line of credit expires
on December 18, 2017, if not renewed. At June 30, 2017, the maximum $2,500,000 was available under the line of credit and the
applicable interest rate (the prime rate) was 4.25%. Payment obligations under the line of credit are secured by a security interest
in substantially all of our tangible and intangible assets.
In
connection with the credit facility, we also have a term loan, which had an outstanding principal balance of approximately $1,154,000
at June 30, 2017 and $1,200,000 as of June 30, 2016. The term loan was refinanced effective December 18, 2016, reducing the interest
rate from 5.00% to 3.88%. The unamortized debt issuance cost associated with this debt was approximately $6,000 and $10,000 as
of June 30, 2017 and June 30, 2016, respectively. The term loan bears interest at 3.88%, with monthly payments of principal and
interest of approximately $7,900 and a final payment of principal and interest of approximately $1,085,000 due on the maturity
date of December 18, 2018. Payment obligations under the term loan are secured by a mortgage on the Company’s real property.
The
documents governing our line of credit and term loan 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. We were in compliance with these covenants as of June 30, 2017.
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 and/or
term loan, requiring prepayment of outstanding indebtedness under either arrangement, 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. The indebtedness under the
line of credit and term loan are secured by a security interest in substantially all of our tangible and intangible assets and
a mortgage on our real property, respectively. If we are unable to repay such indebtedness, the lender could foreclose on these
assets.
We
spent approximately $619,000 and $535,000 on property and equipment during fiscal 2017 and 2016, respectively. 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.
Off-Balance
Sheet Arrangements
We
have no off-balance sheet arrangements.
New
Accounting Pronouncements
In
May 2014, the Financial Accounting Standards Board (“FASB”) issued guidance creating Accounting Standards Codification
(“ASC”) Section 606, “Revenue from Contracts with Customers.” The new section will replace ASC Section
605, “Revenue Recognition,” and creates modifications to various other revenue accounting standards for specialized
transactions and industries. The section is intended to conform revenue accounting principles with a concurrently issued International
Financial Reporting Standards with previously differing treatment between U.S. practice and that of much of the rest of the world,
as well as to enhance disclosures related to disaggregated revenue information. Entities will have the option to apply the standard
retrospectively to all prior periods presented (“full retrospective”), or to apply it retrospectively only to contracts
existing at the effective date (“modified retrospective”), with the cumulative effect of the standard recorded as
an adjustment to beginning retained earnings. In August 2015, the FASB issued Accounting Standards Update (“ASU”)
2015-14, which delayed the effective date of the new revenue recognition guidance by one year. The Company is currently evaluating
which of the alternative approaches it will apply and the potential impact of adoption of the revised revenue standards on its
financial statements. The Company intends to complete its evaluation during its fiscal year ending June 30, 2018.
In
April 2015, FASB issued ASU 2015-03, “Simplifying the Presentation of Debt Issuance Costs.” This standard became effective
on July 1, 2016 for the Company and requires that debt issuance costs be presented as a direct deduction from the carrying amount
of long-term debt on the balance sheet. The new guidance aligns the presentation of debt issuance costs with debt discounts and
premiums. The Company adopted this guidance retrospectively effective as of July 1, 2016. As a result, the Company presented $10,000
of unamortized debt issuance costs that had been included in “Other assets” on its condensed balance sheet as of June
30, 2016 as a direct deduction from the carrying amounts of the related long-term debt liability.
In
July 2015, FASB issued ASU 2015-11, “Inventory (Topic 330) Related to Simplifying the Measurement of Inventory,” which
applies to all inventory except that which is measured using last-in, first-out (“LIFO”) or the retail inventory method.
Inventory measured using first-in, first-out (“FIFO”) or average cost is within the scope of the new guidance and
should be measured at the lower of cost and net realizable value. Net realizable value is the estimated selling price in the ordinary
course of business, less reasonably predictable cost of completion, disposal, and transportation. Subsequent measurement is unchanged
for inventory measured using LIFO or the retail inventory method. The amendments will be effective for public business entities
for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years. The new guidance should
be applied prospectively, and earlier application is permitted as of the beginning of an interim or annual reporting period. The
Company has evaluated that ASU 2015-11 will have no material impact on its consolidated financial statements or financial statement
disclosures upon adoption.
In
February 2016, FASB issued ASU 2016-02, “Leases.” This standard requires the recognition of all lease transactions
with terms in excess of 12 months on the balance sheet as a lease liability and a right-of-use asset (as defined in the standard).
ASU 2016-02 will be effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal
years, with earlier application permitted. Upon adoption, the lessee will apply the new standard retrospectively to all periods
presented or retrospectively using a cumulative effect adjustment in the year of adoption. The Company has evaluated that ASU
2016-02 will have no material impact on its financial statements or financial statement disclosures upon adoption based on current
facts and circumstances.
In
March 2016, FASB issued ASU 2016-09, “Compensation—Stock Compensation (Topic 718): Improvements to Employee Share-Based
Payment Accounting,” which reduces complexity in accounting standards related to share-based payment transactions, including,
among others, (1) accounting for income taxes, (2) classification of excess tax benefits on the statement of cash flow, (3) forfeitures,
and (4) statutory tax withholding requirements. ASU 2016-09 will be effective for annual reporting periods beginning on or after
December 15, 2016, and interim periods within those annual periods. The Company has evaluated
that ASU 2016-09 will have no material impact on its financial statements or financial statement disclosures upon adoption.
|
Item
8.
|
Financial
Statements and Supplementary Data.
|
Index
to Financial Statements
Report
of Independent Registered Public Accounting Firm
To
the Board of Directors and Shareholders
Electromed, Inc.
We
have audited the accompanying balance sheets of Electromed, Inc. as of June 30, 2017 and 2016, and the related statements of operations,
shareholders’ equity, and cash flows for the years then ended. These financial statements are the responsibility of the
Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We
conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those
standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are
free of material misstatement. The Company is not required to have, nor were we engaged to perform an audit of its internal control
over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing
audit procedures that are appropriate in the circumstances, 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. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting
principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In
our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of
Electromed, Inc. as of June 30, 2017 and 2016, and the results of its operations and its cash flows for the years then
ended, in conformity with U.S. generally accepted accounting principles.
/s/
RSM US LLP
Duluth,
Minnesota
September
5, 2017
Electromed,
Inc.
Balance
Sheets
June 30, 2017 and 2016
|
|
June
30,
|
|
|
|
2017
|
|
|
2016
|
|
Assets
|
|
|
|
|
|
|
Current Assets
|
|
|
|
|
|
|
|
|
Cash
|
|
$
|
5,573,709
|
|
|
$
|
5,123,355
|
|
Accounts receivable (net of allowances for doubtful accounts of $45,000)
|
|
|
9,949,759
|
|
|
|
7,611,437
|
|
Inventories
|
|
|
2,559,485
|
|
|
|
2,480,443
|
|
Prepaid expenses and other current assets
|
|
|
393,319
|
|
|
|
419,616
|
|
Income tax receivable
|
|
|
—
|
|
|
|
192,685
|
|
Total current assets
|
|
|
18,476,272
|
|
|
|
15,827,536
|
|
Property and equipment, net
|
|
|
3,303,233
|
|
|
|
3,375,189
|
|
Finite-life intangible assets, net
|
|
|
721,276
|
|
|
|
904,033
|
|
Other assets
|
|
|
99,868
|
|
|
|
127,759
|
|
Deferred income taxes
|
|
|
460,000
|
|
|
|
343,000
|
|
Total assets
|
|
$
|
23,060,649
|
|
|
$
|
20,577,517
|
|
|
|
|
|
|
|
|
|
|
Liabilities and Shareholders’ Equity
|
|
|
|
|
|
|
|
|
Current Liabilities
|
|
|
|
|
|
|
|
|
Current maturities of long-term debt
|
|
$
|
50,703
|
|
|
$
|
46,309
|
|
Accounts payable
|
|
|
663,376
|
|
|
|
589,225
|
|
Accrued compensation
|
|
|
946,623
|
|
|
|
1,489,798
|
|
Income tax payable
|
|
|
156,524
|
|
|
|
—
|
|
Warranty reserve
|
|
|
640,000
|
|
|
|
660,000
|
|
Other accrued liabilities
|
|
|
438,748
|
|
|
|
287,194
|
|
Total current liabilities
|
|
|
2,895,974
|
|
|
|
3,072,526
|
|
Long-term debt, less current maturities and net of debt issuance costs
|
|
|
1,097,125
|
|
|
|
1,146,395
|
|
Total liabilities
|
|
|
3,993,099
|
|
|
|
4,218,921
|
|
|
|
|
|
|
|
|
|
|
Commitments and Contingencies
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shareholders’ Equity
|
|
|
|
|
|
|
|
|
Common stock, $0.01 par value; authorized: 13,000,000 shares; 8,230,167 and 8,187,112 issued and outstanding at June 30, 2017 and June 30, 2016, respectively
|
|
|
82,302
|
|
|
|
81,871
|
|
Additional paid-in capital
|
|
|
14,028,602
|
|
|
|
13,549,551
|
|
Retained earnings
|
|
|
4,956,646
|
|
|
|
2,727,174
|
|
Total shareholders’ equity
|
|
|
19,067,550
|
|
|
|
16,358,596
|
|
Total liabilities and shareholders’ equity
|
|
$
|
23,060,649
|
|
|
$
|
20,577,517
|
|
See
Notes to Financial Statements.
Electromed,
Inc.
Statements
of Operations
Years Ended June 30, 2017 and 2016
|
|
Years
Ended June 30,
|
|
|
|
2017
|
|
|
2016
|
|
Net revenues
|
|
$
|
25,861,144
|
|
|
$
|
22,991,999
|
|
Cost of revenues
|
|
|
5,292,715
|
|
|
|
5,115,736
|
|
Gross profit
|
|
|
20,568,429
|
|
|
|
17,876,263
|
|
|
|
|
|
|
|
|
|
|
Operating expenses
|
|
|
|
|
|
|
|
|
Selling, general and administrative
|
|
|
16,402,214
|
|
|
|
14,386,563
|
|
Research and development
|
|
|
596,876
|
|
|
|
380,392
|
|
Total operating expenses
|
|
|
16,999,090
|
|
|
|
14,766,955
|
|
Operating income
|
|
|
3,569,339
|
|
|
|
3,109,308
|
|
Interest expense, net of interest income of $17,044 and $12,658, respectively
|
|
|
49,867
|
|
|
|
66,806
|
|
Net income before income taxes
|
|
|
3,519,472
|
|
|
|
3,042,502
|
|
|
|
|
|
|
|
|
|
|
Income tax expense
|
|
|
(1,290,000
|
)
|
|
|
(830,000
|
)
|
Net income
|
|
$
|
2,229,472
|
|
|
$
|
2,212,502
|
|
|
|
|
|
|
|
|
|
|
Income per share:
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
0.27
|
|
|
$
|
0.27
|
|
Diluted
|
|
$
|
0.26
|
|
|
$
|
0.27
|
|
|
|
|
|
|
|
|
|
|
Weighted-average common shares outstanding:
|
|
|
|
|
|
|
|
|
Basic
|
|
|
8,168,152
|
|
|
|
8,135,514
|
|
Diluted
|
|
|
8,461,120
|
|
|
|
8,248,391
|
|
See
Notes to Financial Statements.
Electromed,
Inc.
Statements of Shareholders’ Equity
Years Ended June 30, 2017 and 2016
|
|
Common
Stock
|
|
|
|
Additional
Paid-
|
|
|
|
Retained
|
|
|
|
Total
Shareholders’
|
|
|
|
|
Shares
|
|
|
|
Amount
|
|
|
|
in
Capital
|
|
|
|
Earnings
|
|
|
|
Equity
|
|
Balance at June 30, 2015
|
|
|
8,133,857
|
|
|
$
|
81,339
|
|
|
$
|
13,327,320
|
|
|
$
|
514,672
|
|
|
$
|
13,923,331
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
2,212,502
|
|
|
|
2,212,502
|
|
Issuance of restricted stock
|
|
|
53,255
|
|
|
|
532
|
|
|
|
(532
|
)
|
|
|
—
|
|
|
|
—
|
|
Share-based compensation expense
|
|
|
—
|
|
|
|
—
|
|
|
|
222,763
|
|
|
|
—
|
|
|
|
222,763
|
|
Balance at June 30, 2016
|
|
|
8,187,112
|
|
|
|
81,871
|
|
|
|
13,549,551
|
|
|
|
2,727,174
|
|
|
|
16,358,596
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
2,229,472
|
|
|
|
2,229,472
|
|
Issuance of restricted stock
|
|
|
43,055
|
|
|
|
431
|
|
|
|
(431
|
)
|
|
|
—
|
|
|
|
—
|
|
Share-based compensation expense
|
|
|
—
|
|
|
|
—
|
|
|
|
479,482
|
|
|
|
—
|
|
|
|
479,482
|
|
Balance at June 30, 2017
|
|
|
8,230,167
|
|
|
$
|
82,302
|
|
|
$
|
14,028,602
|
|
|
$
|
4,956,646
|
|
|
$
|
19,067,550
|
|
See
Notes to Financial Statements.
Electromed, Inc.
Statements of Cash Flows
Years Ended June 30, 2017 and 2016
|
|
Years
Ended June 30,
|
|
|
|
2017
|
|
|
2016
|
|
Cash Flows From Operating Activities
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
2,229,472
|
|
|
$
|
2,212,502
|
|
Adjustments to reconcile net income to net cash provided by operating activities:
|
|
|
|
|
|
|
|
|
Depreciation
|
|
|
636,709
|
|
|
|
616,021
|
|
Amortization of finite-life intangible assets
|
|
|
118,418
|
|
|
|
122,681
|
|
Amortization of debt issuance costs
|
|
|
13,067
|
|
|
|
18,016
|
|
Share-based compensation expense
|
|
|
479,482
|
|
|
|
222,763
|
|
Deferred income taxes
|
|
|
(117,000
|
)
|
|
|
(343,000
|
)
|
Loss on disposal of property and equipment
|
|
|
3,302
|
|
|
|
40,456
|
|
Loss on disposal of intangible assets
|
|
|
132,724
|
|
|
|
17,706
|
|
Changes in operating assets and liabilities:
|
|
|
|
|
|
|
|
|
Accounts receivable
|
|
|
(2,338,322
|
)
|
|
|
(1,092,621
|
)
|
Inventories
|
|
|
(28,334
|
)
|
|
|
(347,623
|
)
|
Prepaid expenses and other assets
|
|
|
49,864
|
|
|
|
18,917
|
|
Income tax receivable
|
|
|
192,685
|
|
|
|
(192,685
|
)
|
Income tax payable
|
|
|
156,524
|
|
|
|
(122,657
|
)
|
Accounts payable and accrued liabilities
|
|
|
(337,470
|
)
|
|
|
996,427
|
|
Net cash provided by operating activities
|
|
|
1,191,121
|
|
|
|
2,166,903
|
|
|
|
|
|
|
|
|
|
|
Cash Flows From Investing Activities
|
|
|
|
|
|
|
|
|
Expenditures for property and equipment
|
|
|
(618,763
|
)
|
|
|
(534,944
|
)
|
Expenditures for finite-life intangible assets
|
|
|
(68,385
|
)
|
|
|
(44,577
|
)
|
Net cash used in investing activities
|
|
|
(687,148
|
)
|
|
|
(579,521
|
)
|
|
|
|
|
|
|
|
|
|
Cash Flows From Financing Activities
|
|
|
|
|
|
|
|
|
Principal payments on long-term debt including capital lease obligations
|
|
|
(48,747
|
)
|
|
|
(48,747
|
)
|
Payments of deferred financing fees
|
|
|
(4,872
|
)
|
|
|
(13,520
|
)
|
Net cash used in financing activities
|
|
|
(53,619
|
)
|
|
|
(62,267
|
)
|
Net increase in cash
|
|
|
450,354
|
|
|
|
1,525,115
|
|
Cash
|
|
|
|
|
|
|
|
|
Beginning of period
|
|
|
5,123,355
|
|
|
|
3,598,240
|
|
End of period
|
|
$
|
5,573,709
|
|
|
$
|
5,123,355
|
|
|
|
|
|
|
|
|
|
|
Supplemental
Disclosures of Cash Flow Information
|
|
|
|
|
|
|
|
|
Cash
paid for interest
|
|
$
|
59,233
|
|
|
$
|
61,560
|
|
Cash
paid for income taxes
|
|
|
1,089,791
|
|
|
|
1,494,512
|
|
See
Notes to Financial Statements.
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
approximately $716,000 and $713,000 for the fiscal years ended June 30, 2017 and 2016, respectively. Since its inception, the
Company has operated in a single industry segment: developing, manufacturing and marketing medical equipment.
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 selling price adjustments, allowance for doubtful accounts, inventory obsolescence, share-based compensation, income taxes
and the warranty reserve.
Revenue
recognition:
The Company recognizes revenue when persuasive evidence of a sales arrangement exists, delivery of goods occurs
through the transfer of title and risks and rewards of ownership, the selling price is fixed or determinable, and collectability
is reasonably assured. Revenues are primarily recognized upon shipment.
Direct
patient sales are recorded at amounts to be received from patients under reimbursement arrangements with third-party payers, including
private insurers, prepaid health plans, Medicare and Medicaid. In addition, the Company records an estimate for selling price
adjustments that often arise from changes in a patient’s insurance coverage, changes in a patient’s domicile, insurance
company coverage limitations or patient death. Other than the installment sales as discussed below, the Company expects to receive
payment on the vast majority of accounts receivable within one year and therefore has classified all accounts receivable as current.
However, in some instances, payment for direct patient sales can be delayed or interrupted, resulting in a portion of collections
occurring later than one year.
During
fiscal 2017, the Company entered into a settlement agreement with the Centers for Medicare and Medicaid Services with respect
to approximately 700 Medicare fee-for-service claims submitted between calendar years 2012 through 2015, resulting in approximately
$703,000 of net recognized revenue.
Certain
third-party reimbursement agencies pay the Company on a monthly installment basis, which can span over several years. Due to the
length of time over which cash is collected and the inherent uncertainty of collectability with these installment sales, the Company
cannot make a reasonable estimate of revenue at the time of sale and does not record accounts receivable or revenue at the time
of product shipment. Under the installment method, the Company defers the revenue associated with the sale and, as each installment
is received, that amount is recognized as revenue. Deferred costs associated with the sale are amortized to cost of revenue ratably
over the estimated period in which collections are scheduled to occur.
Sales
made under the installment method were approximately as follows:
|
|
Years
Ended June 30,
|
|
|
|
2017
|
|
|
2016
|
|
Revenue recognized under installment sales
|
|
$
|
1,246,000
|
|
|
$
|
1,555,000
|
|
Amortized cost of revenues recognized
|
|
|
161,000
|
|
|
|
188,000
|
|
Unrecognized
installment method sales were approximately as follows:
|
|
June
30,
|
|
|
|
2017
|
|
|
2016
|
|
Estimated unrecognized sales, net of discounts
|
|
$
|
1,814,000
|
|
|
$
|
1,977,000
|
|
Unamortized costs of revenues included in prepaid and other current assets and other assets
|
|
|
209,000
|
|
|
|
263,000
|
|
Shipping
and handling expense:
Shipping and handling charges incurred by the Company are included in cost of goods sold and were $363,000
and $333,000 for the fiscal years ended June 30, 2017 and 2016, respectively.
Cash:
The Company maintains its cash in bank deposit accounts that, at times, may exceed federally insured limits. 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 approximately $45,000 as
of June 30, 2017 and 2016.
Inventories:
Inventories are stated at the lower of cost (first-in, first-out method) or market. 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.
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 and assets acquired under capital leases
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.
Finite-life
intangible assets:
Finite-life intangible assets include patents and trademarks. These intangible assets are being amortized
on a straight-line basis over their estimated useful lives, as described in Note 4.
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, it would recognize 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 would be charged to operations
in the current period.
Warranty
liability:
The Company provides a lifetime warranty on products sold to patients in the U.S. and Canada and a three-year warranty
for institutional sales within the U.S., as well as for all international sales. 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 sold. Factors that affect the
Company’s warranty liability include the number of units sold, 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.
Changes
in the Company’s warranty liability were approximately as follows:
|
|
Years
Ended June 30,
|
|
|
|
2017
|
|
|
2016
|
|
Beginning warranty reserve
|
|
$
|
660,000
|
|
|
$
|
660,000
|
|
Accrual for products sold
|
|
|
129,000
|
|
|
|
152,000
|
|
Expenditures and costs incurred for warranty claims
|
|
|
(149,000
|
)
|
|
|
(152,000
|
)
|
Ending warranty reserve
|
|
$
|
640,000
|
|
|
$
|
660,000
|
|
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. We would reverse a valuation allowance if we determine, based
on the weight of all available evidence, including when cumulative losses become positive income, that it is more likely than
not that some or all of the deferred tax assets will be realized. 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
tax authorities. Benefits from tax positions are measured at the largest amount of benefit that is greater than 50 percent likely
of being realized upon settlement. To the extent that the final tax outcome of these matters is different than the amounts recorded,
such differences impact income tax expense in the period in which such determination is made. Interest and penalties, if any,
related to accrued liabilities for potential tax assessments are included in income tax expense.
Research
and development:
Research and development costs include costs of research activities as well as engineering and technical
efforts required to develop new products or make improvements to existing products. Research and development costs are expensed
as incurred.
Advertising
costs:
Advertising costs are charged to expense when incurred. Advertising, marketing and trade show costs for the fiscal
years ended June 30, 2017 and 2016, were approximately $380,000 and $331,000, respectively.
Share-based
payments:
Share-based payment awards consist of options and restricted stock issued to employees for services, and to non-employees
in lieu of payment 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.
Fair
value of financial instruments:
The carrying values of cash, accounts receivable, accounts payable and accrued expenses approximate
their fair value due to the short-term nature of these instruments. The carrying value of long-term debt is the remaining amount
due to debtors under borrowing arrangements. To estimate the fair value of debt, the Company estimates the interest rate necessary
to secure financing to replace its debt. At June 30, 2017, the fair value of long-term debt was not significantly different than
its carrying value.
Basic
and diluted earnings per share:
Net income is presented on a per share basis for both basic and diluted common shares. Basic
net income per common share is computed using the weighted-average number of common shares outstanding during the period, excluding
any restricted stock awards which have not vested. The diluted net income per common share calculation includes outstanding restricted
stock grants and assumes that all stock options were exercised and converted into common stock at the beginning of the period,
unless their effect is anti-dilutive. Common stock equivalents of 177,500 shares and 307,800 shares were excluded from the calculation
of diluted earnings per share for the fiscal years ended June 30, 2017 and 2016, respectively, as their impact was antidilutive.
See Note 7 for information on stock options and warrants.
New
Accounting Pronouncements:
In May 2014, the Financial Accounting Standards Board (“FASB”) issued guidance creating
Accounting Standards Codification (“ASC”) Section 606, “Revenue from Contracts with Customers.” The new
section will replace ASC Section 605, “Revenue Recognition,” and creates modifications to various other revenue accounting
standards for specialized transactions and industries. The section is intended to conform revenue accounting principles with a
concurrently issued International Financial Reporting Standards with previously differing treatment between U.S. practice and
that of much of the rest of the world, as well as to enhance disclosures related to disaggregated revenue information. Entities
will have the option to apply the standard retrospectively to all prior periods presented (“full retrospective”),
or to apply it retrospectively only to contracts existing at the effective date (“modified retrospective”), with the
cumulative effect of the standard recorded as an adjustment to beginning retained earnings. In August 2015, the FASB issued Accounting
Standards Update (“ASU”) 2015-14, which delayed the effective date of the new revenue recognition guidance by one
year. The updated guidance will be effective for public business entities for fiscal years beginning after December 15, 2017,
and interim periods within that year. The Company is currently evaluating which of the alternative approaches it will apply and
the potential impact of adoption of the revised revenue standards on its financial statements. The Company intends to complete
its evaluation during its fiscal year ending June 30, 2018.
In
April 2015, FASB issued ASU 2015-03, “Simplifying the Presentation of Debt Issuance Costs.” This standard became effective
on July 1, 2016 for the Company and requires that debt issuance costs be presented as a direct deduction from the carrying amount
of long-term debt on the balance sheet. The new guidance aligns the presentation of debt issuance costs with debt discounts and
premiums. The Company adopted this guidance retrospectively effective as of July 1, 2016. As a result, the Company presented $10,000
of unamortized debt issuance costs that had been included in “Other assets” on its condensed balance sheet as of June
30, 2016 as a direct deduction from the carrying amounts of the related long-term debt liability.
In
July 2015, FASB issued ASU 2015-11, “Inventory (Topic 330) Related to Simplifying the Measurement of Inventory,” which
applies to all inventory except that which is measured using last-in, first-out (“LIFO”) or the retail inventory method.
Inventory measured using first-in, first-out (“FIFO”) or average cost is within the scope of the new guidance and
should be measured at the lower of cost and net realizable value. Net realizable value is the estimated selling price in the ordinary
course of business, less reasonably predictable cost of completion, disposal, and transportation. Subsequent measurement is unchanged
for inventory measured using LIFO or the retail inventory method. The amendments will be effective for public business entities
for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years. The new guidance should
be applied prospectively, and earlier application is permitted as of the beginning of an interim or annual reporting period. The
Company has evaluated that ASU 105-11 will have no material impact on its financial statements or financial statement disclosures
upon adoption.
In
February 2016, FASB issued ASU 2016-02, “Leases.” This standard requires the recognition of all lease transactions
with terms in excess of 12 months on the balance sheet as a lease liability and a right-of-use asset (as defined in the standard).
ASU 2016-02 will be effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal
years, with earlier application permitted. Upon adoption, the lessee will apply the new standard retrospectively to all periods
presented or retrospectively using a cumulative effect adjustment in the year of adoption. The Company has evaluated that ASU
2016-02 will have no material impact on its financial statements or financial statement disclosures upon adoption based on current
facts and circumstances.
In
March 2016, FASB issued ASU 2016-09, “Compensation—Stock Compensation (Topic 718): Improvements to Employee Share-Based
Payment Accounting,” which reduces complexity in accounting standards related to share-based payment transactions, including,
among others, (1) accounting for income taxes, (2) classification of excess tax benefits on the statement of cash flow, (3) forfeitures,
and (4) statutory tax withholding requirements. ASU 2016-09 will be effective for annual reporting periods beginning on or after
December 15, 2016, and interim periods within those annual periods. The Company has evaluated
that ASU 2016-09 will have no material impact on its financial statements or financial statement disclosures upon adoption.
Reclassifications:
Certain items in the Company’s financial statements for the year ended June 30, 2016 have been reclassified to be consistent
with the classifications adopted for the Company’s year ended June 30, 2017. The reclassifications are specific to the adoption
of ASU 2015-03, “Simplifying the Presentation of Debt Issuance Costs” and had no impact on previously reported net
income or equity.
Note
2. Inventories
The
components of inventories at June 30, 2017 and 2016 were approximately as follows:
|
|
June
30,
|
|
|
|
2017
|
|
|
2016
|
|
Parts inventory
|
|
$
|
1,789,000
|
|
|
$
|
1,615,000
|
|
Work in process
|
|
|
205,000
|
|
|
|
165,000
|
|
Finished goods
|
|
|
745,000
|
|
|
|
850,000
|
|
Less: Reserve for obsolescence
|
|
|
(180,000
|
)
|
|
|
(150,000
|
)
|
Total
|
|
$
|
2,559,000
|
|
|
$
|
2,480,000
|
|
Note
3. Property and Equipment
Property
and equipment, including assets under capital leases, were approximately as follows:
|
|
Estimated
Useful Lives (Years)
|
|
June
30,
|
|
|
|
|
2017
|
|
|
|
2016
|
|
Building and building improvements
|
|
15-39
|
|
$
|
2,236,000
|
|
|
$
|
2,236,000
|
|
Land
|
|
N/A
|
|
|
200,000
|
|
|
|
200,000
|
|
Land improvements
|
|
15
|
|
|
166,000
|
|
|
|
166,000
|
|
Equipment
|
|
3-7
|
|
|
2,982,000
|
|
|
|
2,755,000
|
|
Demonstration and
rental equipment
|
|
3
|
|
|
959,000
|
|
|
|
1,040,000
|
|
|
|
|
|
|
6,543,000
|
|
|
|
6,397,000
|
|
Less: Accumulated
depreciation
|
|
|
|
|
(3,240,000
|
)
|
|
|
(3,022,000
|
)
|
Net property and
equipment
|
|
|
|
$
|
3,303,000
|
|
|
$
|
3,375,000
|
|
During
the fiscal years ended June 30, 2017 and 2016, the Company impaired or disposed of certain property and equipment, no longer in
use, with a net value of approximately $3,000 and $40,000, respectively, which was included as an expense in cost of goods sold
or selling, general and administrative expense on the statements of operations. During the year ended June 30, 2016, there was
approximately $17,000 of impairment charges associated with tooling that will no longer be used to produce SmartVest SQL parts
as new, more cost-effective manufacturing processes were implemented.
Note
4. Finite-life Intangible Assets
The
carrying value of patents and trademarks includes the original cost of obtaining the patents, periodic renewal fees, and other
costs associated with maintaining and defending patent and trademark rights. Patents and trademarks are amortized over their estimated
useful lives, generally 15 and 12 years, respectively. During the years ended June 30, 2017 and 2016, the Company abandoned certain
domestic and foreign patents with a net value of approximately $133,000 and $18,000, respectively, which was included as an expense
in selling, general and administrative expense on the statements of operations. The majority of the pending patents that were
abandoned related to the initial development of the Company’s SQL SmartVest technology. During a review of the Company’s
patent portfolio it was determined that certain patents proved redundant to a subsequent SQL patent filing and were therefore
abandoned. A smaller portion of expense was related to patents that covered technology that management considered outdated, and
was no longer in use. Accumulated amortization was approximately $790,000 and $820,000 at June 30, 2017 and 2016, respectively.
The
activity and balances of finite-life intangible assets were approximately as follows:
|
|
Years
Ended June 30,
|
|
|
|
2017
|
|
|
2016
|
|
Balance, beginning
|
|
$
|
904,000
|
|
|
$
|
1,000,000
|
|
Additions
|
|
|
68,000
|
|
|
|
45,000
|
|
Abandonments
|
|
|
(133,000
|
)
|
|
|
(18,000
|
)
|
Amortization expense
|
|
|
(118,000
|
)
|
|
|
(123,000
|
)
|
Balance, ending
|
|
$
|
721,000
|
|
|
$
|
904,000
|
|
Based
on the carrying value at June 30, 2017, future amortization expense is expected to be approximately $112,000 annually.
Note
5. Financing Arrangements
The
Company has a credit facility that provides for a revolving line of credit and a term loan. Effective December 18, 2016, the Company
renewed its $2,500,000 revolving line of credit. There was no outstanding principal balance on the line of credit as of June 30,
2017 or June 30, 2016. Interest on borrowings under the line of credit, if any, would accrue at the prime rate (4.25% at June
30, 2017) and is payable monthly. The amount eligible for borrowing on the line of credit is limited to the lesser of $2,500,000
or 57.00% of eligible accounts receivable and the line of credit expires on December 18, 2017, if not renewed. At June 30, 2017,
the maximum $2,500,000 was eligible for borrowing. The line of credit is secured by a security interest in substantially all of
the tangible and intangible assets of the Company.
In
connection with the credit facility, the Company also has a term loan, which had an outstanding principal balance of approximately
$1,154,000 at June 30, 2017 and $1,200,000 as of June 30, 2016. The term loan was refinanced effective December 18, 2016, reducing
the interest rate from 5.00% to 3.88%. The unamortized debt issuance cost associated with this debt was approximately $6,000 and
$10,000 as of June 30, 2017 and June 30, 2016, respectively. The term loan bears interest at 3.88%, with monthly payments of principal
and interest of approximately $7,900 and a final payment of principal and interest of approximately $1,085,000 due on the maturity
date of December 18, 2018. Payment obligations under the term loan are secured by a mortgage on the Company’s real property.
The
documents governing the line of credit and term loan contain certain financial and nonfinancial covenants that include a minimum
tangible net worth covenant of not less than $10,125,000 and restrictions on the Company’s ability to incur certain additional
indebtedness or pay dividends.
Long-term
debt consisted of approximately the following as of June 30, 2017 and 2016:
|
|
June
30,
|
|
|
|
2017
|
|
|
2016
|
|
Mortgage note payable with bank, due in monthly installments of $7,932, including interest at 3.88%, remaining due December 2018, secured by land and building
|
|
$
|
1,154,000
|
|
|
$
|
1,200,000
|
|
Capital lease obligation, due in monthly installments of $648, including interest at 6.99%, to November 2016, secured by equipment
|
|
|
—
|
|
|
|
2,000
|
|
Total
|
|
|
1,154,000
|
|
|
|
1,202,000
|
|
Less: Current portion
|
|
|
51,000
|
|
|
|
46,000
|
|
Less: Debt issuance costs, net
|
|
|
6,000
|
|
|
|
10,000
|
|
Long-term debt
|
|
$
|
1,097,000
|
|
|
$
|
1,146,000
|
|
Approximate
future maturities of long-term debt, net of debt issuance costs, as of June 30, 2017 were as follows:
Fiscal year ending June 30:
|
|
|
|
2018
|
|
$
|
51,000
|
|
2019
|
|
|
1,097,000
|
|
Total
|
|
$
|
1,148,000
|
|
Capital
leases:
The Company has financed certain office equipment through capital leases.
At
June 30, 2017 and 2016, the carrying value of assets under these capital leases was approximately as follows:
|
|
June 30,
|
|
|
|
2017
|
|
|
2016
|
|
Fixtures and office equipment
|
|
$
|
33,000
|
|
|
$
|
33,000
|
|
Less: Accumulated depreciation
|
|
|
(19,000
|
)
|
|
|
(16,000
|
)
|
Total
|
|
$
|
14,000
|
|
|
$
|
17,000
|
|
Depreciation
expense for these assets was approximately $3,000 for each of the years ended June 30, 2017 and 2016.
Note
6. Common Stock
Authorized
shares:
The Company’s Articles of Incorporation have established 15,000,000 authorized shares of capital stock consisting
of 13,000,000 shares of common stock, par value $0.01 per share, and 2,000,000 shares of undesignated stock.
Note
7. Share-Based Payments
Share-based
compensation expense for the years ended June 30, 2017 and 2016 was approximately $479,000 and $223,000, respectively, related
to employee options and restricted stock awards. At June 30, 2017, the Company had approximately $252,000 of unrecognized compensation
expense related to non-vested equity awards, which is expected to be recognized over a weighted-average period of 0.8 years.
Employee
options:
The Company has historically granted stock options to employees as long-term incentive compensation. Options generally
expire four to ten years from the grant date and vest over a period of up to five years. In November 2014, the Company’s
shareholders approved the 2014 Equity Incentive Plan (the “2014 Plan”) which supersedes the Company’s 2012 Stock
Incentive Plan. The Plan allows the Board of Directors (the “Board”) to grant non-qualified stock options or restricted
stock to employees, directors, or consultants. The vesting schedule for options or restricted stock units and the term of the
options are determined by the Board upon each grant. The maximum number of shares of common stock available for issuance under
the Plan is 650,000. There were 450,800 options granted under the 2012 and prior plans outstanding as of June 30, 2017 and 2016.
There were 340,000 options issued under the 2014 Plan and 296,834 outstanding as of June 30, 2017. There were 237,251 available
for grant under the 2014 Plan as of June 30, 2017.
The
Company recognizes compensation expense related to share-based payment transactions in the financial statements based on the estimated
fair value of the award issued. The fair value of each option is estimated using the Black-Scholes pricing model at the time of
award grant. The Company estimates the expected life of options based on the expected holding period by the option holder. The
risk-free interest rate is based upon observed U.S. Treasury interest rates for the expected term of the options. The Company
makes assumptions with respect to expected stock price volatility based upon the volatility of its stock price. Forfeitures are
estimated at the time of grant and revised in subsequent periods if actual forfeitures differ from initial estimates. Forfeitures
are estimated based on the percentage of awards expected to vest, taking into consideration the seniority level of the award recipient.
The
following assumptions were used to estimate the fair value of options granted:
|
|
Years
Ended June 30,
|
|
|
|
2017
|
|
|
2016
|
|
Risk-free interest rate
|
|
|
1.14-1.27
|
%
|
|
|
1.40-1.92
|
%
|
Expected term (years)
|
|
|
6
|
|
|
|
6
|
|
Expected volatility
|
|
|
100.5-105.8
|
%
|
|
|
89.3-93.1
|
%
|
The
following table presents employee option activity for the years ended June 30, 2017 and 2016:
|
|
Number
of
Shares
|
|
|
Weighted-
Average
Grant Date
Fair Value
|
|
|
Weighted-
Average
Exercise Price
|
|
|
Weighted-
Average
Remaining
Contractual Life
(in Years)
|
|
Options outstanding at June 30, 2015
|
|
|
450,800
|
|
|
$
|
1.74
|
|
|
$
|
2.80
|
|
|
|
5.15
|
|
Granted
|
|
|
163,500
|
|
|
|
1.55
|
|
|
|
2.05
|
|
|
|
—
|
|
Canceled or Forfeited
|
|
|
(14,500
|
)
|
|
|
1.37
|
|
|
|
1.80
|
|
|
|
—
|
|
Options outstanding at June 30, 2016
|
|
|
599,800
|
|
|
|
1.70
|
|
|
|
2.62
|
|
|
|
5.38
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Granted
|
|
|
176,500
|
|
|
|
3.09
|
|
|
|
3.91
|
|
|
|
—
|
|
Canceled or Forfeited
|
|
|
(28,666
|
)
|
|
|
2.46
|
|
|
|
3.14
|
|
|
|
—
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options outstanding at June 30, 2017
|
|
|
747,634
|
|
|
|
2.00
|
|
|
|
2.91
|
|
|
|
5.31
|
|
Options exercisable at June 30, 2017
|
|
|
584,469
|
|
|
|
1.80
|
|
|
|
2.76
|
|
|
|
4.35
|
|
The
aggregate intrinsic value of options outstanding was $1,961,000 and options exercisable were $1,621,000 at June 30, 2017. There
were no options exercised during the years ended June 30, 2017 and 2016.
Options
issued in conjunction with the initial public offering:
In connection with the Company’s 2010 initial public offering
and the exercise of the underwriter’s over-allotment option, the Company issued to the underwriter options to purchase up
to 190,000 additional shares of the Company’s common stock at a price of $4.80 per share. These options became exercisable
in August 2011 and expired in August 2015.
Warrants
issued with convertible debt:
In years prior to fiscal 2010, the Company issued convertible notes payable to certain individual
creditors. In conjunction with the issuance of these convertible notes, creditors also received warrants to purchase common stock
at an exercise price of $3.00 per share. The Company had approximately 44,000 warrants that were outstanding and exercisable at
an exercise price of $3.00 per share which expired in September 2015. At June 30, 2017, there were no warrants outstanding and
there were none exercised during the years ended June 30, 2017 and 2016.
Restricted
stock:
The 2014 Plan permits the Personnel and Compensation Committee of the Board of Directors to grant other stock-based
awards. The Company makes restricted stock grants to key employees and non-employee directors that vest over six months to three
years.
The
Company issued restricted stock awards to employees totaling 30,000 during each of the years ended June 30, 2017 and 2016, with
a vesting term of one to three years and a fair value of $3.82 and $1.80 per share, respectively. During the years ended June
30, 2017 and 2016, the Company issued restricted stock awards to directors totaling 13,055 and 23,255 shares of common stock,
respectively, with a vesting term of six months and a fair value of $3.83 and $2.15 per share, respectively. Restricted stock
transactions during the years ended June 30, 2017 and 2016 are summarized as follows:
|
|
Restricted
Stock
Units
|
|
|
Weighted-
Average
Grant
Date Fair
Value
per Share
|
|
Outstanding at June 30, 2015
|
|
|
—
|
|
|
|
—
|
|
Granted
|
|
|
53,255
|
|
|
$
|
1.95
|
|
Vested
|
|
|
(33,256
|
)
|
|
$
|
2.04
|
|
Outstanding at June 30, 2016
|
|
|
19,999
|
|
|
$
|
1.80
|
|
Granted
|
|
|
43,055
|
|
|
$
|
3.82
|
|
Vested
|
|
|
(33,056
|
)
|
|
$
|
3.21
|
|
Outstanding at June 30, 2017
|
|
|
29,998
|
|
|
$
|
3.15
|
|
Note
8. Income Taxes
Components
of the provision for income taxes for the years ended June 30, 2017 and 2016 were as follows:
|
|
Years
Ended June 30,
|
|
|
|
2017
|
|
|
2016
|
|
Current
|
|
$
|
1,407,000
|
|
|
$
|
1,173,000
|
|
Deferred
|
|
|
(117,000
|
)
|
|
|
(343,000
|
)
|
Total
|
|
$
|
1,290,000
|
|
|
$
|
830,000
|
|
The
total income tax expense differed from the expected tax expense, computed by applying the federal statutory rate to the Company’s
pretax income, as follows:
|
|
Years
Ended June 30,
|
|
|
|
2017
|
|
|
2016
|
|
Tax expense at statutory federal rate
|
|
$
|
1,197,000
|
|
|
$
|
1,034,000
|
|
State income tax expense, net of federal tax effect
|
|
|
131,000
|
|
|
|
114,000
|
|
Change in valuation allowance on deferred tax assets
|
|
|
—
|
|
|
|
(308,000
|
)
|
Change in uncertain tax positions
|
|
|
(32,000
|
)
|
|
|
(6,000
|
)
|
Other permanent items
|
|
|
(6,000
|
)
|
|
|
(4,000
|
)
|
Income tax expense
|
|
$
|
1,290,000
|
|
|
$
|
830,000
|
|
The
effective tax rates for the years ended June 30, 2017 and 2016 were 36.7% and 27.3%, respectively.
For
the year ended June 30, 2017, the Company recorded an income tax expense of $1,290,000. This amount included a current tax expense
of $1,439,000, a deferred benefit of $117,000 and a discrete tax benefit of $32,000 as a result of the lapse of the statute of
limitations on uncertain tax positions.
For
the year ended June 30, 2016, the Company recorded an income tax expense of $830,000. This amount included a current tax expense
of $1,179,000, a deferred benefit of $55,000 and a discrete tax benefit of $294,000, due primarily to the Company’s release
of the full valuation allowance against all of its net U.S. net federal and state deferred tax assets during the year.
The
significant components of deferred income taxes were as follows:
|
|
June
30,
|
|
|
|
2017
|
|
|
2016
|
|
Deferred tax assets (liabilities):
|
|
|
|
|
|
|
|
|
Revenue recognition and accounts receivable
|
|
$
|
143,000
|
|
|
$
|
154,000
|
|
Accrued liabilities
|
|
|
280,000
|
|
|
|
282,000
|
|
Property and equipment
|
|
|
(534,000
|
)
|
|
|
(518,000
|
)
|
Finite-life intangible assets
|
|
|
6,000
|
|
|
|
(17,000
|
)
|
Stock options
|
|
|
443,000
|
|
|
|
326,000
|
|
Tax credits and net operating loss carryforwards
|
|
|
46,000
|
|
|
|
43,000
|
|
Other
|
|
|
76,000
|
|
|
|
73,000
|
|
Net deferred tax assets
|
|
$
|
460,000
|
|
|
$
|
343,000
|
|
As
of June 30, 2017, the Company has state net operating loss carryforwards of $2,000 which, if unused, will expire in calendar 2034.
The Company has state tax credit carryforwards of $45,000 and which if unused, will expire in years 2027 and 2032.
The
Company assesses whether a valuation allowance should be established against its deferred tax assets based on consideration of
all available evidence, using a “more likely than not” standard. In assessing the need for a valuation allowance,
the Company considered both positive and negative evidence related to the likelihood of realization of deferred tax assets. In
making such assessments, more weight was given to evidence that could be objectively verified. Future sources of taxable income
considered in determining the amount of recorded valuation allowance included:
|
●
|
Taxable income in
prior carryback years, if carryback is permitted under the tax law;
|
|
|
|
|
●
|
Future reversals
of existing taxable temporary differences, excluding those related to indefinite-lived intangible assets;
|
|
|
|
|
●
|
Tax planning strategies;
and
|
|
|
|
|
●
|
Future taxable income
exclusive of reversing temporary differences and carryforwards.
|
Based
on the evaluation of these factors the Company
evaluated all positive and negative evidence,
as described above, in determining if the valuation allowance is fairly stated. At December 31, 2015, the Company determined that,
based on the profitability it had achieved, historical cumulative profits and estimates of future income, there was sufficient
positive evidence to conclude that the likelihood of realization of deferred tax assets outweigh the negative evidence. The full
valuation allowance was released, which resulted in the recognition of $288,000 in net deferred tax assets and a decrease in income
tax expense for the year ended June 30, 2016.
The
Company applies the accounting standard for uncertain tax positions pursuant to which a more-likely-than-not threshold is utilized
to determine the recognition and derecognition of uncertain tax positions. Once the more-likely-than-not threshold is met, the
amount of benefit to be recognized is the largest amount of tax benefit that is greater than 50 percent likely of being ultimately
realized upon settlement. It further requires that a change in judgment related to the expected ultimate resolution of uncertain
tax positions be recognized in earnings in the period of such a change. The Company does not believe there will be significant
changes to the estimates in the next 12 month period. Due to the complexity of some of these uncertainties, the ultimate settlement
may result in payments that are different from The Company’s current estimate of tax liabilities, resulting in the recognition
of additional charges or benefits to income tax expense.
Changes
in the Company’s unrecognized tax benefits were approximately as follows:
|
|
Years
Ended June 30,
|
|
|
|
2017
|
|
|
2016
|
|
Beginning balance of unrecognized tax benefits
|
|
$
|
32,000
|
|
|
$
|
38,000
|
|
Lapse of statute of limitations
|
|
|
(32,000
|
)
|
|
|
(6,000
|
)
|
Ending balance of unrecognized tax benefits
|
|
$
|
—
|
|
|
$
|
32,000
|
|
The
Company recognizes interest and penalties accrued related to unrecognized tax benefits in income tax expense. During the fiscal
years ended June 30, 2017 and 2016, the amount of recognized interest expense, net of tax benefit, and accrued interest on a gross
basis was insignificant. The Company is subject to U.S. federal income tax as well as income tax of multiple state jurisdictions.
With limited exceptions, tax years prior to fiscal 2014 are no longer open to federal, state and local examination by taxing authorities.
Note
9. Commitments and Contingencies and Subsequent Events
Operating
leases:
The Company has four leases for office and warehouse space which require monthly payments that include base rent and
the Company’s share of common expenses, including property taxes. These leases have escalating payments ranging from approximately
$3,800 to $9,900 per month and expire through July 2019. The Company has a lease for office equipment that requires payments of
approximately $1,500 per month through December 2021. Rent expense for the years ended June 30, 2017 and 2016, was approximately
$175,000 and $164,000, respectively.
Approximate
future minimum operating lease payments as of June 30, 2017, were as follows:
Fiscal years ending June 30:
|
|
|
|
2018
|
|
$
|
186,000
|
|
2019
|
|
|
191,000
|
|
2020
|
|
|
18,000
|
|
2021
|
|
|
9,000
|
|
Total
|
|
$
|
404,000
|
|
Litigation:
The Company may occasionally be party to actions, proceedings, claims or disputes arising in the ordinary course of business.
The Company insures its business risks where possible to mitigate the financial impact of individual claims, and establishes reserves
for an estimate of any probable cost of settlement or other disposition.
401(k)
Profit Sharing Plan:
The Company has an employee benefit plan under Section 401(k) of the Internal Revenue Code covering all
employees who are 21 years of age or older and have at least 1,000 hours of service with the Company. The Company matches each
employee’s salary reduction contribution, not to exceed four percent of annual compensation. Total employer contributions
to this plan for the years ended June 30, 2017 and 2016, were approximately $248,000 and $195,000, respectively.
Employment
Agreements:
The Company has entered into formal employment agreements with its President and Chief Executive Officer and its
Chief Financial Officer. These agreements provide the officers with, among other things, one year of base salary upon a termination
without cause or in the event the employee resigns for good reason or within six months of a change in control.