Overview
Electromed,
Inc. (“we,” “our,” “us,” “Electromed” or the “Company”) develops,
manufactures, markets and sells innovative products that provide airway clearance therapy, including the SmartVest
®
Airway Clearance System (“SmartVest System”) and related products, to patients with compromised pulmonary function
with a commitment to excellence and compassionate service. Our goal is to make High Frequency Chest Wall Oscillation (“HFCWO”)
treatments as effective, convenient, and comfortable as possible, so our patients, in their homes, will adhere to their prescribed
treatment schedule, leading to improved airway clearance, enhanced respiratory function and reduced healthcare utilization. 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 (“DME”) channel and capture both the manufacturer and distributor margins. Electromed was incorporated in
Minnesota in 1992. Our common stock is listed on the NYSE American under the ticker symbol “ELMD.”
The
SmartVest System features a programmable air pulse generator, a therapy garment worn over the upper body and a connecting hose,
which together provide safe, comfortable, and effective airway clearance therapy. The SmartVest System generates HFCWO, an airway
clearance therapy. The garment repeatedly compresses and releases the upper body at frequencies from 5 to 20 cycles per second
creating a “mini cough.” Each compression (or oscillation) produces pulsations that thin and loosen secretions from
the surfaces of the lung airways, propelling them toward the mouth where they can be removed by normal coughing or suction.
HFCWO
facilitates airway clearance by loosening and mobilizing respiratory secretions in a patient’s lungs. One factor of respiratory
health is the ability to clear secretions from airways. Impaired airway clearance, when mucus cannot be expectorated, may result
in labored breathing and/or inflammatory and immune systems boosting mucus production that invites bacteria trapped in stagnant
secretions to cause infections. Studies show that HFCWO therapy is as effective an airway clearance method for patients who have
compromised pulmonary function as traditional chest physical therapy (“CPT”) administered by a respiratory therapist.
However, HFCWO can be self-administered, relieving a caregiver of participation in the therapy, and eliminating the attendant
cost of an in-home care provider. We believe that HFCWO treatments are cost-effective primarily because they reduce a patient’s
risk of respiratory infections and other secondary complications that are associated with impaired mucus transport and often result
in costly hospital visits and repeated antibiotic use.
The
SmartVest System is designed for patient comfort and ease of use which promotes compliance with prescribed treatment schedules,
leading to improved airway clearance, enhanced respiratory function and a reduction in healthcare utilization. We offer a broad
range of garments, referred to as vests and wraps, in sizes for children and adults that allow for tailored fit and function.
User-friendly controls allow children and the elderly to administer their own daily therapy with minimal or no assistance. Our
direct product support services provide patient and clinician education, training, and follow-up to ensure the product is integrated
into each patient’s daily treatment regimen. Additionally, our reimbursement and billing departments assure we are working
on behalf of the patient by processing their physician paperwork, providing clinical support as needed and billing Medicare or
the applicable insurance provider on their behalf. We believe that the advantages of the SmartVest System and the Company’s
customer services to the patient include:
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improved
quality of life;
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reduction
in healthcare utilization;
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independence
from a dedicated caregiver;
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consistent
treatments at home;
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improved
comfort during therapy;
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eligibility
for reimbursement by private insurance, federal or state government programs or combinations
of the foregoing.
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Our
Products
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.
Our
products are primarily sold into the home health care market for patients with chronic lung issues, including bronchiectasis,
cystic fibrosis and neuromuscular disease. We also sell our products in acute care settings (e.g., hospitals and clinics) when
the patient is in a post-surgical or intensive care unit or was admitted for a lung infection brought on by compromised airway
clearance. Accordingly, our sales points of contact include adult pulmonology clinics, cystic fibrosis centers, neuromuscular
clinics, pulmonary rehabilitation centers, hospitals and home health care centers.
We
have received clearance from the U.S. Food and Drug Administration (“FDA”) to market the SmartVest System to promote
airway clearance and improve bronchial drainage. In addition, Electromed is certified to apply the Conformité Européenne
(“European Conformity” or “CE”) marking for HFCWO device sales in all European Union countries and approved
for HFCWO device sales in other, select international countries. The SmartVest System is available only with a physician’s
prescription.
As
part of our growth strategies, we periodically evaluate opportunities involving products and services, especially those that may
provide value to the respiratory homecare and institutional market.
The
SmartVest System
The
SmartVest System consists of an inflatable therapy garment, a programmable air pulse generator and a patented single-hose that
delivers air pulses from the generator to the garment. The SmartVest System is currently available in two models – SV2100
and SQL
®
– both of which are sold into home care and institutional markets for use by patients and hospitals.
Both models deliver the same clinically effective HFCWO therapy. Additionally, both systems are designed for maximum comfort and
lifestyle convenience, so patients can readily fit HFCWO therapy into their daily routines:
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Patented
single-hose design:
When the SmartVest System is in use, a single-hose delivers oscillations
to the SmartVest garment, which we believe provides therapy in a more comfortable and
unobtrusive manner than a two-hose system. Oscillations are delivered evenly from the
base of the SmartVest garment, extending the forces upward and inward in strong but smooth
cycles surrounding the chest.
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Open
system design with active inflate – active deflate:
The active inflate –
active deflate mechanism of the SmartVest System provides patients a more comfortable
treatment experience by working in unison with patients to allow them to take deep breaths
and breathe more easily without feeling restricted.
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Soft-fabric
garment is lightweight and comfortable:
The SmartVest garment is lightweight and
designed to resemble an article of clothing. Quick fit Velcro
®
-like closures
allow for a secure, comfortable fit without bulky straps and buckles. The simple design
creates a broad size adjustment range to ensure a properly tailored fit. The SmartVest
garment is available in a variety of colors and sizes to accommodate pediatric and adult
patients.
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Programmable
generator with user-friendly device operation:
The SmartVest System generator uses
an internal programmable memory feature to manage air pulse frequency, air pulse pressure
and treatment time to be set as prescribed by the patient’s physician. The air
pulse frequency can be adjusted from 5 to 20 cycles per second and the air pulse pressure
can be adjusted from 10 to 100% of a maximal pressure range.
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Patented
Soft Start
®
and 360° garment oscillation coverage:
Soft Start
creates an upward flow of air that gently fills the garment while initiating the squeeze/release
pulse, acclimating the patient to therapy and minimizing “vest creep.” All
SmartVest garments provide 360° oscillation coverage, which delivers simultaneous
treatment to all lobes of the lungs.
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The
SmartVest SQL System
We
designed the SmartVest SQL, our latest generation, with an array of features that make it easier to use and enable greater patient
freedom as compared to the SmartVest SV2100. In addition to incorporating the unique benefits of the SV2100, the SmartVest SQL
was designed to be significantly smaller, quieter, and lighter than its predecessor, and offers advanced generator programmability,
including an enhanced pause feature with save, lock and restore functionality:
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Smaller,
quieter and lighter:
The SmartVest SQL System is 25% smaller, 5db quieter and 30%
lighter than the SmartVest SV2100. The SmartVest SQL is the lightest and overall quietest
HFCWO generator on the market, weighing less than 16 pounds, making it easier for patients
to use and integrate HFCWO therapy into their daily lives.
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Programmable
ramp:
The SmartVest SQL integrates fully programmable and adjustable ramp, which
allows HFCWO therapy to start at a low frequency and pressure, ramp up, and then reduce
the frequency and pressure during treatment. This allows clinicians greater flexibility
to program patient-specific HFCWO therapy protocols.
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Enhanced
programmability:
The SmartVest SQL features new programmability options for saving,
locking and restoring protocols, providing an extra layer of security. Further, an enhanced
pause feature allows the physician to program dedicated time(s) for the patient to clear
secretions.
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SmartVest
Connect
In
June 2017, we launched the SmartVest SQL with SmartVest Connect™ wireless technology, a personalized HFCWO therapy management
portal for patients with compromised pulmonary function. The SmartVest SQL with wireless technology features built-in cellular
connectivity, offering healthcare teams and patients access to treatment information to better collaborate in making patient-centered
care decisions. SmartVest Connect is available to pediatric and cystic fibrosis patients using a wirelessly enabled SmartVest
SQL system. We expanded SmartVest Connect availability to targeted adult pulmonary clinics throughout fiscal 2018.
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Performance
insights:
SmartVest Connect enables patients to track progress of their therapy plan
and includes a real-time SmartVest Score and easy-to-read goal reports that provide an
in-depth look at performance.
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Treatment
collaboration:
Created to encourage patient engagement, SmartVest Connect provides
feedback for patients to take an active role in their HFCWO therapy, fostering improved
therapy adherence.
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Engineered
for simplicity:
SmartVest SQL with SmartVest Connect is simple, intuitive, and designed
to automatically update following completion of a therapy session.
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Other
Products
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We
market the Single Patient Use (“SPU”) SmartVest
®
and SmartVest
Wrap
®
to health care providers, particularly those working in intensive
care units. Hospitals issue the SPU SmartVest or SmartVest Wrap to an individual patient
for the duration of the patient’s stay. Both SPU products facilitate continuity
of care because they introduce the patient to our product line and may encourage use
of the SmartVest System for home care, which can be provided to patients with a chronic
condition upon discharge. Both SPU products also provide full coverage pulsation.
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The
Aerobika
®
Oscillating Positive Expiratory Pressure (“OPEP”)
device is sold in to the U.S. home care market through a distributor agreement with Monaghan
Medical Corp. since early calendar year 2017. The Aerobika OPEP device is a drug-free,
easy to use, hand-held device with a proprietary pressure-oscillation dynamic that provides
intermittent resistance and creates positive pressure and oscillations simultaneously.
The device opens weak or collapsed airways to mobilize and assist mucociliary clearance
to the upper airways where it can be coughed out. After over a year of offering Aerobika
®
OPEP, we have determined that continuing to offer the product direct to patients
is unlikely to serve a broader patient population as originally planned. We plan to discontinue
distribution of the Aerobika OPEP device prior to December 1, 2018.
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Our
Market
We
estimate the total served U.S. market for HFCWO in 2017 was approximately $150 million to $170 million. We believe our business
model is supported by many market trends related to an aging population and growing awareness by physicians of diseases and conditions
for which patients can benefit from using HFCWO therapy. Indications for when HFCWO should be prescribed are not specific to any
one disease. A physician may elect to prescribe HFCWO when he or she believes the patient will benefit from improved airway clearance
and external chest manipulation is the treatment of choice to enhance mucus transport and improve bronchial drainage.
The
SmartVest System is prescribed for patients with bronchiectasis, ALS, cerebral palsy, cystic fibrosis, muscular dystrophy, quadriplegia
and the combination of emphysema and chronic bronchitis commonly known as chronic obstructive pulmonary disease (“COPD”).
The estimated patient populations in 2017 for diseases and conditions routinely prescribed HFCWO therapy are listed below.
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Bronchiectasis:
We believe that bronchiectasis, an irreversible lung condition where the airways
become damaged and abnormally widened from recurring inflammation or infection, represents
the fastest growing diagnostic category and greatest potential for HFCWO growth in the
United States. Bronchiectasis is currently under recognized and underdiagnosed. Several
recent studies have estimated prevalence of bronchiectasis, which we believe are helpful
for estimating a range of the market size.
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Seitz
(2012) estimated that 190,000 unique cases of bronchiectasis were diagnosed in Medicare
patients in 2007 and bronchiectasis prevalence increased 8.7% annually between 2000 and
2007
1
. Based on historic growth in prevalence and assuming a constant growth
rate, the estimated number of bronchiectasis diagnoses in 2017 exceeded 440,000.
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Martinez-Garcia
(2013) indicated that prevalence of bronchiectasis is high in patients with moderate-to-severe
COPD and has been associated with exacerbations and bacterial colonization. Ninety-nine
patients in Global Initiative for Chronic Obstructive Lung Disease (GOLD) II, 85 in GOLD
III, and 17 in GOLD IV stages were included in the study. Bronchiectasis was present
in 115 patients (57.2%). Bronchiectasis was associated with an independent increased
risk of all-cause mortality in patients with moderate-to-severe COPD.
2
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Chalmers
(2017) found that prevalence of bronchiectasis in patients with COPD ranged from a low
of 4% to as high as 69% with mean prevalence of 54% in a recent systematic literature
review. In many studies in patients with COPD, the presence of bronchiectasis was associated
with reduced lung function, greater sputum production, more frequent exacerbations and
increased mortality versus those with COPD alone.
3
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Weycker
(2017) projected approximately 4.2 million adults in the United States over 40 years
may have bronchiectasis, suggesting there is a large pool of patients with undiagnosed
disease.
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These
clinical studies indicate a wide range of potential prevalence of bronchiectasis patients from a low of 440,000 to as high as
4.2 million patients in the United States. We also believe that it is difficult to estimate from these clinical studies which
patients will need or benefit from HFCWO. A clinical study published in 2017 using data from the US bronchiectasis research registry
indicated approximately 15% of the registered patients were prescribed HFCWO as part of their treatment plan.
5
Using
that study data, we estimate that, within the diagnosed Medicare population of 440,000, approximately 15% or 66,000 have been
prescribed HFCWO. We believe that bronchiectasis is underdiagnosed in the U.S. based on clinical study evidence. We also believe
that HFCWO is under prescribed for bronchiectasis patients. By applying approximately 15% HFCWO penetration of diagnosed Medicare
patients to the Weycker clinical study to the estimated 4.2 million prevalence of bronchiectasis in the U.S., we derived that
the HFCWO opportunity may be 630,000 forecasted units. (See Figure 1)
Bronchiectasis
is experiencing a surge in clinical interest and awareness, including the relationship to COPD, commonly referred to as bronchiectasis
COPD overlap syndrome (“BCOS”). A recent paper that evaluated the U.S. Bronchiectasis Research Registry (“BRR”)
found that out of 1,826 patients with bronchiectasis enrolled between 2008 and 2014, 20% (n=350) also had COPD and 29% (n=515)
also had asthma.
5
Other studies have found that the overlap between bronchiectasis and COPD is currently observed in
27% to 57% of patients with COPD.
6–8
Estimated
HFCWO Market Opportunity - Bronchiectasis Patients (U.S.) – Figure 1
1
Seitz,
A.E., et al. Trends in Bronchiectasis Among Medicare Beneficiaries in the United States, 2000 to 2007.
Chest.
2012;142(2),
432–439.
2
Martínez-García,
M.A., et al. Prognostic Value of Bronchiectasis in Patients with Moderate-to-Severe Chronic Obstructive Pulmonary Disease.
Am
J Respir Crit Care Med.
2013;187(8):823–31.
3
Chalmers
J.D. and Sethi S. Raising awareness of bronchiectasis in primary care: overview of diagnosis and management strategies in adults.
NPJ Prim Care Respir Med
. 2017;27:18.
4
Weycker
D, Hansen G, Seifer F. Prevalence and incidence of noncystic fibrosis bronchiectasis among US adults in 2013.
Chronic Respiratory
Disease.
2017; 14(4):377-384.
5
Aksamit
T.R., et al. Bronchiectasis Research Registry C. Adult Patients With Bronchiectasis: A First Look at the US Bronchiectasis Research
Registry.
Chest
. 2017;151:982-92
6
Patel
I.S., et al. Bronchiectasis, exacerbation indices, and inflammation in chronic obstructive pulmonary disease.
Am J Respir Crit
Care Med
. 2004;170:400-7.
7
O’Brien
C, et al. Physiological and radiological characterisation of patients diagnosed with chronic obstructive pulmonary disease in
primary care.
Thorax
. 2000;55:635-42.
8
Bafadhel
M, et al. The role of CT scanning in multidimensional phenotyping of COPD.
Chest
. 2011;140:634-42.
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Neuromuscular
and neuromotor disorders:
A range of neuromuscular and neuromotor disorders — including ALS, cerebral palsy, Duchenne
muscular dystrophy, and quadriplegia — can cause respiratory muscle weakness and compromised airway clearance. Effective
airway clearance therapy is a critical aspect of respiratory care for people with neuromuscular or neuromotor disorders who lack
respiratory muscle strength. Not all people with neuromuscular or neuromotor disorders will require airway clearance therapy.
We estimate the total number of people in the U.S. with a neuromuscular or neuromotor disorder that may benefit from airway clearance
therapy is approximately 250,000.
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Cystic
Fibrosis:
In the U.S., approximately 30,000 people are living with cystic fibrosis,
and an estimated 1,000 new cases of cystic fibrosis are diagnosed each year.
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Marketing,
Sales and Distribution
Our
sales and marketing efforts are focused on building market awareness and acceptance of our products and services with physicians,
clinicians, patients, and third-party payers. Because the sale of the SmartVest System requires a physician’s prescription,
we market to physicians and health care providers as well as directly to patients. The vast majority of our revenue comes from
domestic home care sales through a physician referral model. We have established our own domestic sales force, which we believe
is able to provide superior education, support and training to our customers. Our direct U.S. sales force works with physicians
and clinicians, primarily pulmonologists, in defined territories to help them understand our products and services and the value
they provide to their respective patients. As of June 30, 2018, we had 50 field sales employees, including five regional sales
managers, 42 clinical area managers (“CAMs”) and three clinical educators. We also have developed a network of approximately
300 respiratory therapists and health care professionals across the U.S. to assist with in-home SmartVest patient training on
a non-exclusive independent contractor basis. These independent contractors are credentialed by the National Board for Respiratory
Care as either Certified Respiratory Therapists or Registered Respiratory Therapists.
Of
the $28.2 million of our revenue derived from the U.S. in fiscal 2018, approximately 94% represented home care and 6% represented
institutional sales. Due to readmission penalties associated with the Patient Protection and Affordable Care Act, as reconciled
by the Health Care and Education Reconciliation Act of 2010 (collectively the “PPACA”), for certain diseases and conditions
including COPD and pneumonia, we believe opportunities for further growth exist for HFCWO therapy because the device used by a
patient in an institution may influence the choice of device prescribed at discharge. We expect to achieve future sales, earnings,
and overall market share growth with increasing home care referrals by educating and building awareness of diseases and conditions
that may benefit from HFCWO, like bronchiectasis, with physicians and patients and the value of SmartVest Airway Clearance System’s
differentiated features and benefits.
We
generate sales leads through multiple channels that include visits to pulmonology clinics and medical centers, participation in
medical conferences, maintenance of industry contacts in order to increase the visibility and acceptance of our products by physicians
and health care professionals, participation with patient organizations such as the Cystic Fibrosis Foundation, as well as through
patients by word of mouth and traffic to our website. We are currently evaluating opportunities to offer the SmartVest System
through selected Home Medical Equipment (“HME”) distributors. The addition of a HME distribution network would expand
our access to physicians and institutions in certain areas of the United States and would be expected to support our other growth
strategies. In addition, we place advertisements in leading medical magazines and journals.
Additionally,
because the availability of reimbursement is an important consideration for health care professionals and patients, we must also
demonstrate the effectiveness of our products to public and private insurance providers. The availability of reimbursement exists
primarily due to an established Healthcare Common Procedure Coding System (“HCPCS”) code for HFCWO. A HCPCS code is
assigned to services and products by the Centers for Medicare and Medicaid Services (“CMS”). Because our product has
an assigned HCPCS code, a claim can be billed for reimbursement using that code.
International
Marketing
Approximately
1.7% and 2.8% of our net revenues were from sales outside the U.S. in our fiscal years ended June 30, 2018 and 2017 (“fiscal
2018” and “fiscal 2017”), respectively. We sell our products outside the U.S. primarily through independent
distributors specializing in respiratory products. Through June 30, 2018, the majority of our distributors operated in exclusive
territories. Our principal distributors are located in Europe, Southeast Asia, South and Central America and the Arab states of
the Persian Gulf. Units are sold at a fixed contract price with payments made directly from the distributor, rather than being
tied to reimbursement rates of a patient’s insurance provider as is the case for domestic sales. Our sales strategy outside
the U.S. is to focus our corporate resources on maintaining our current distributors with less emphasis on contracting with new
distributors.
Third-Party
Reimbursement
In
the U.S., individuals who use the SmartVest System generally will rely on third-party payers, including private payers and governmental
payers such as Medicare and Medicaid, to cover and reimburse all or part of the cost of using the SmartVest System. Approximately
half of our home care revenue is from commercial payers and one quarter is from each of the Medicare and Medicaid programs. Reimbursement
for HFCWO therapy and the SmartVest System varies among public and private insurance providers.
A
key strategy to grow sales is achieving world class customer service and support for our patients and clinicians. We do this with
an established and effective reimbursement department working on behalf of the patient by processing physician paperwork, seeking
insurance authorization and processing claims. The skill and knowledge gained and offered by our reimbursement department is an
important factor in building our revenue and serving patients’ financial interests. Our payment terms generally allow patients
to acquire the SmartVest System over a period of 1 to 15 months, which is consistent with reimbursement procedures followed by
Medicare and other third parties. The payment amount we receive for any single referral may vary based on a number of factors,
including Medicare and third-party reimbursement processes and policies. The patient retains the risk of reimbursement to the
Company in the event of non-payment by third-party payers.
Our
SmartVest System is reimbursed under HCPCS code E0483. Currently, the Medicare total allowable amount of reimbursement for this
billing code is approximately $12,000. The allowed amount for state Medicaid programs range from approximately $8,000 to $12,000,
which is similar to commercial payers. Actual reimbursement from third-party payers can vary and can be significantly less than
the full allowable amount. Deductions from the allowable amount include co-payments, deductibles and/or maximums on durable medical
equipment, decrease the reimbursement received from the third-party payer. Collecting a full allowable amount depends on our ability
to obtain reimbursement from the patient’s secondary and/or supplemental insurance if the patient has additional coverage,
or our ability to collect amounts from individual patients.
Most
patients are able to qualify for reimbursement and payment from Medicare, Medicaid, private insurance or combinations of the foregoing.
We expect that subsequent generations of HFCWO products also will qualify for reimbursement under Medicare Plan B and most major
health plans. However, some third-party payers must also approve coverage for new or innovative devices or therapies before they
will reimburse health care providers who use the medical devices or therapies. In addition, we face the risk that new or modified
products could have a lower reimbursement rate, or that the levels of reimbursement currently available for our existing products
could decrease, which would hamper our ability to market and sell that product. Consequently, our sales will continue to depend
in part on the availability of coverage and reimbursement from third-party payers, even though our devices may have been cleared
for marketing by the FDA. The manner in which reimbursement is sought and obtained varies based upon the type of payer involved
and the setting in which the procedure is furnished.
Research
and Development
Our
research and development capabilities consist of full-time engineering staff and several consultants. We periodically engage consultants
and contract engineering employees to supplement our development initiatives. Our team has a demonstrated record of developing
new products that receive the appropriate product approvals and regulatory clearances around the world.
During
fiscal 2018 and 2017, we incurred research and development expenses of approximately $251,000 and $597,000, or 0.9% and 2.3% of
net revenues, respectively. As a percentage of sales, we expect spending on research and development expenses to increase during
the fiscal year ended June 30, 2019 to a level more similar to fiscal 2017 as we work on enhancements to our SmartVest Connect
wireless patient monitoring feature, and with engineering resources focusing on next generation product enhancements and other
market opportunities.
Intellectual
Property
As
of June 30, 2018, we held 17 U.S. and 23 foreign issued patents covering the SmartVest System and its underlying technology and
had 14 pending U.S. and foreign patent applications. These patents and patent applications offer coverage in the field of air
pressure pulse delivery to a human in support of airway clearance. One of our U.S. patents will expire during our upcoming fiscal
year ending June 30, 2019.
We
generally pursue patent protection for patentable subject matter in our proprietary devices in foreign countries that we have
identified as key markets for our products. These markets include the European Union, Canada, Japan, and other countries.
We
also have received ten U.S. trademark and service mark registrations, one registration in each of Canada, Peru and Japan, one
pending international registration and one through the Madrid Protocol for India.
Manufacturing
Our
headquarters in New Prague, Minnesota includes a dedicated manufacturing and engineering facility of more than 10,000 square feet
and we are certified on an annual basis to be compliant with ISO 13485 and ISO 9001 quality system standards. Our site has been
audited regularly by the FDA and ISO, in accordance with their practices, and we maintain our operations in a manner consistent
with their requirements for a medical device manufacturer. While components are outsourced to meet our detailed specifications,
each SmartVest System is assembled, tested, and approved for final shipment at our manufacturing site in New Prague, consistent
with FDA, Underwriters Laboratory (“UL”), and ISO standards. Many of our vendors are located within 100 miles of our
headquarters, which enables us to closely monitor our component supply chain. We maintain established inventory levels for critical
components and finished goods to assure continuity of supply.
Product
Warranties
We
provide a warranty on the SmartVest System that covers the cost of replacement parts and labor, or a new SmartVest System in the
event we determine a full replacement is necessary. For home care SmartVest Systems initially purchased and currently located
in the U.S. and Canada, we provide a lifetime warranty to the individual patient for whom the SmartVest System is prescribed.
For sales to institutions within the U.S., and for all international sales, except Canadian home care, we provide a three-year
warranty.
Competition
The
original HFCWO technology was licensed to American Biosystems, Inc. (now Advanced Respiratory, Inc. (“ARI”), part
of Hill-Rom Holdings, Inc.), which, until the introduction of our original MedPulse Respiratory Vest System
®
in
2000, was the only manufacturer of a product with HFCWO technology cleared for market by the FDA (ARI’s The Vest
®
Airway Clearance System). ARI has also received FDA 510(k) clearance for the Monarch™ Airway Clearance System, a mobile
device that uses pulmonary oscillating discs. Respiratory Technologies, Inc., doing business as RespirTech, received FDA clearance
to market their HFCWO product, the inCourage
®
Airway Clearance Therapy (the “inCourage System”). In
August 2017, Royal Phillips acquired RespirTech. Both ARI and RespirTech employ a direct-to-patient model, and recently Royal
Phillips announced plans to offer its HFCWO device through selected HME distributors.
The
AffloVest
®
(the “AffloVest”) from International Biophysics Corporation (“IBC”) also participates
in the same market as our SmartVest System. IBC received FDA 510(k) clearance for its device in 2013. IBC primarily sells its
device through durable medical equipment (“DME”) companies who distribute home care medical devices and supplies.
Clinical and cost-effective evidence, technology innovations, including wireless connectivity, and HFCWO product features and
benefits, such as size, weight of the generator, reputation for patient and reimbursement services, and sales effectiveness of
field personnel, have become the key drivers of HFCWO product sales.
Alternative
products for administering pulmonary therapy include: Positive Expiratory Pressure (“PEP”); OPEP; Intrapulmonary Percussive
Ventilation (“IPV”); CPT and breathing techniques. Physicians may prescribe some or all of these devices and techniques,
depending upon each patient’s health status, severity of disease, compliance, or personal preference. We believe our primary
competitive advantages over alternative treatments are patient comfort, ease of use, and the effectiveness of HFCWO treatment.
Because HFCWO is not “technique dependent,” as compared to most other pulmonary therapy products, therapy begins automatically
once power is provided and remains consistent and controlled for the duration of treatment.
Governmental
Regulation
Medicare
and Medicaid
Recent
government and private sector initiatives in the U.S. and foreign countries aim at limiting the growth of health care costs, including
price regulation, competitive pricing, coverage and payment policies, comparative effectiveness of therapies, technology assessments,
and managed-care arrangements, and are causing the marketplace to put increased emphasis on the delivery of more cost-effective
medical devices that result in better clinical outcomes. Government programs, including Medicare and Medicaid, have attempted
to control costs by limiting the amount of reimbursement the program will pay for particular procedures or treatments, restricting
coverage for certain products or services, and implementing other mechanisms designed to constrain utilization and contain costs.
Many private insurance programs look to Medicare as a guide in setting coverage policies and payment amounts. These initiatives
have created an increasing level of price sensitivity among our customers.
Home
Medical Equipment Licensing
Although
we do not fall under competitive bidding for Medicare, we often must satisfy the same licensing requirements as other DME providers
that qualify for competitive bidding. In response to out-of-state businesses winning the competitive bidding process, which had
a significant impact on small local DME businesses, many states have enacted regulations that require a DME provider to have an
in-state business presence, specifically through state Home Medical Equipment (“HME”) licensing boards or through
state Medicaid programs. In order to do business with any patients in the state or to be a provider for the state Medicaid program,
a DME provider must have an in-state presence. In addition to Minnesota, our corporate headquarters, we have a licensed in-state
presence in four other states. In-state presence requirements are different from state to state, but generally require a physical
location that is staffed and open during regular business hours. We are licensed to do business in all states except for Hawaii.
Product
Regulations
Our
medical devices are subject to regulation by numerous government agencies, including the FDA and comparable foreign regulatory
agencies. To varying degrees, each of these agencies requires us to comply with laws and regulations governing the development,
testing, manufacturing, labeling, marketing, and distribution of our medical devices, and compliance with these laws and regulations
entails significant costs for us. Our regulatory and quality assurance departments provide detailed oversight in their areas of
responsibility to support required clearances and approvals to market our products.
In
addition to the clearances and approvals discussed below, we obtained ISO 9001 and ISO 13485 certification in January 2005 and
receive annual certification of our compliance with ISO quality standards.
FDA
Requirements
We
have received clearance from the FDA to market our products, including the SmartVest System. We may be required to obtain additional
FDA clearance before marketing a new or modified product in the U.S., either through the 510(k) clearance process or the more
complex premarket approval process. The process may be time consuming and expensive, particularly if human clinical trials are
required. Failure to obtain such clearances or approvals could adversely affect our ability to grow our business.
Continuing
Product Regulation
In
addition to its approval processes for new products, the FDA may require testing and post-market surveillance programs to monitor
the safety and effectiveness of previously cleared products that have been commercialized and may prevent or limit further marketing
of products based on the results of post-mark surveillance results. At any time after marketing clearance of a product, the FDA
may conduct periodic inspections to determine compliance with both the FDA’s Quality System Regulation (“QSR”)
requirements and/or current medical device reporting regulations. Product approvals by the FDA can be withdrawn due to failure
to comply with regulatory standards or the occurrence of unforeseen problems following initial market clearance. The failure to
comply with regulatory standards or the discovery of previously unknown problems with a product or manufacturer could result in
fines, delays or suspensions of regulatory clearances, seizures or recalls of products (with the attendant expenses), the banning
of a particular device, an order to replace or refund the cost of any device previously manufactured or distributed, operating
restrictions and criminal prosecution, as well as decreased sales as a result of negative publicity and product liability claims.
We
must register annually with the FDA as a device manufacturer and, as a result, are subject to periodic FDA inspection for compliance
with the FDA’s QSR requirements that require us to adhere to certain extensive regulations. In addition, the federal Medical
Device Reporting regulations require us to provide information to the FDA whenever there is evidence that reasonably suggests
that a device may have caused or contributed to a death or serious injury or, if a malfunction were to occur, could cause or contribute
to a death or serious injury. We also must maintain certain certifications to sell products internationally, and we undergo periodic
inspections by notified bodies to obtain and maintain these certifications.
Advertising
and marketing of medical devices, in addition to being regulated by the FDA, are also regulated by the Federal Trade Commission
and by state regulatory and enforcement authorities. Recently, promotional activities for FDA-regulated products of other companies
have been the subject of enforcement action brought under health care reimbursement laws and consumer protection statutes. Competitors
and others also can initiate litigation relating to advertising and /or marketing claims. If the FDA determines that our promotional
or training materials constitute promotion of an unapproved or uncleared claim of use, we may need to modify our training or promotional
materials or be subject to regulatory or enforcement actions that may result in civil fines or criminal penalties. Other federal,
state or foreign enforcement authorities might take action if they determine that our promotional or training materials constitute
promotion of an unapproved use, which could result in significant fines or penalties.
European
Union and Other Regions
European
Union rules require that medical products receive the right to affix the CE marking, demonstrating adherence to quality standards
and compliance with relevant European Union Medical Device Directives (MDD). Products that bear CE marking can be imported to,
sold or distributed within the European Union. We obtained clearance to use CE marking on our products in April 2005. Renewal
of CE marking is required every five years, and our notified body performs an annual audit to ensure that we are in compliance
with all applicable regulations. We have maintained our CE marking in good standing since originally receiving it and most recently
renewed it in January 2015. We also require all of our distributors in the European Union and other regions to comply with their
home country regulations in our distributor agreements.
The
2010 Healthcare Reform Legislation, medical device excise tax and Federal Physician Payments Sunshine Act
U.S.
healthcare reform legislation, the PPACA, was enacted into law in March 2010. The PPACA imposes a 2.3% excise tax on certain domestic
sales of medical devices by manufacturers. To the extent that third-party payers and institutions will not absorb increased costs
represented by the tax because of reimbursement or contract limitations, we are not able to offset the tax with increased revenue.
Beginning
with the third quarter of fiscal 2016, we realized a positive impact to operating profit with the adoption of the recent Consolidated
Appropriations Act, 2016, which includes a two-year moratorium on the medical device excise tax effective as of January 1, 2016.
On
May 22, 2018, we concluded an examination with the Internal Revenue Service (“IRS”) related to federal medical device
excise taxes paid on revenue associated with our sales of the SmartVest during our tax periods ended June 30, 2014 through December
31, 2015. As a result, it was determined the SmartVest was eligible for the retail exemption from the medical device excise tax,
resulting in the IRS agreeing to a refund of approximately $406,000. This refund has been recognized in fiscal 2018 results and
payment was received in July 2018. Furthermore, we expect we will be exempt from the medical device tax after the conclusion of
the current two-year medical device tax moratorium, which is scheduled to end on December 31, 2019.
Federal
Physician Payments Sunshine Act
The
Federal Physician Payments Sunshine Act (Section 6002 of the PPACA, the “Sunshine Act”) was adopted on February 1,
2013, to create transparency for the financial relationship between medical device companies and physicians and/or teaching hospitals.
The Sunshine Act requires all manufacturers of drugs and medical devices to annually report to the CMS any payments or any other
“transfers of value” made to physicians and teaching hospitals, including but not limited to consulting fees, grants,
clinical research support, royalties, honoraria, and meals. This information is then posted on a public website so that consumers
can learn how much was paid to their physician by drug and medical device companies. The Sunshine Act requires ongoing data collection
and annual management and reporting by us.
Fraud
and Abuse Laws
Federal
health care laws apply to the marketing of our products and when we or our customers submit claims for items or services that
are reimbursed under Medicare, Medicaid or other federally-funded health care programs. The principal applicable federal laws
include:
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the
False Claims Act, which prohibits the submission of false or otherwise improper claims
for payment to a federally-funded health care program;
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the
Anti-Kickback Statute, which prohibits offers to pay or receive remuneration of any kind
for the purpose of inducing or rewarding referrals of items or services reimbursable
by a federal health care program; and
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the
Stark Law, which prohibits physicians from profiting (actually or potentially) from their
own referrals.
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There
are often similar state false claims, anti-kickback, and anti-self referral and insurance laws that apply to state-funded Medicaid
and other health care programs and private third-party payers. In addition, the U.S. Foreign Corrupt Practices Act can be used
to prosecute companies in the U.S. for arrangements with physicians, or other parties outside the U.S. if the physician or party
is a government official of another country and the arrangement violates the law of that country. Enforcement of all of these
regulations has become increasingly stringent, particularly due to more prevalent use of the whistleblower provisions under the
False Claims Act, which allow a private individual to bring actions on behalf of the federal government alleging that the defendant
has submitted a false claim to the federal government and to share in any monetary recovery. If a governmental authority were
to conclude that we are not in compliance with applicable laws and regulations, we and our officers and employees could be subject
to severe criminal and civil penalties and disbarment from participation as a supplier of product to beneficiaries covered by
Medicare or Medicaid.
HIPAA/HITECH
and Other Privacy Regulations
Federal
and state laws protect the confidentiality of certain patient health information, including patient records, and restrict the
use and disclosure of such information. The Health Insurance Portability and Accountability Act of 1996 and its implementing regulations
(“HIPAA”) and the Health Information Technology for Economic and Clinical Health Act (“HITECH”) set forth
privacy and security standards that govern the use and disclosure of protected electronic health information by “covered
entities”, which include healthcare providers, health plans and healthcare clearinghouses. Because we provide our products
directly to patients and bill third-party payers such as Medicare, Medicaid, and insurance companies, we are a “covered
entity” and must comply with these standards. Failure to comply with HIPAA/HITECH or any state or foreign laws regarding
personal data protection may result in significant fines or penalties and/or negative publicity. In addition to federal regulations
issued under HIPAA/HITECH, some states have enacted privacy and security statutes or regulations that, in some cases, are more
stringent than those issued under HIPAA/HITECH. In those cases, it may be necessary to modify our planned operations and procedures
to comply with the more stringent state laws. If we fail to comply with applicable state laws and regulations, we could be subject
to additional sanctions.
The
HIPAA/HITECH health care fraud and false statement statutes also prohibit, among other things, knowingly and willfully executing,
or attempting to execute, a scheme to defraud any health care benefit program, including private payers, and knowingly and willfully
falsifying, concealing or covering up a material fact or making any materially false, fictitious or fraudulent statement or representation
in connection with the delivery of or payment for health care benefits, items or services.
Environmental
Laws
We
are subject to various environmental laws and regulations both within and outside the U.S. Like other medical device companies,
our operations involve the use of substances regulated under environmental laws, primarily manufacturing, sterilization, and disposal
processes. We do not expect that compliance with environmental protection laws will have a material impact on our results of operations,
financial position, or cash flows.
Employees
As
of June 30, 2018, we had 132 employees. Thirteen of our employees are respiratory therapists licensed by appropriate state professional
organizations, including all of the employees in our Patient Services Department. We also retain approximately 300 respiratory
therapists and health care professionals on a non-exclusive independent contractor basis to provide training to our customers
in the U.S. None of our employees are covered by a collective bargaining agreement. We believe our relations with our employees
are good.