|
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 Annual Report on Form 10-K. The forward-looking statements
include statements that reflect management’s good faith beliefs, plans, objectives, goals, expectations, anticipations and
intentions with respect to our future development plans, capital resources and requirements, results of operations, and future
business performance. Our actual results could differ materially from those anticipated in the forward-looking statements included
in this discussion as a result of certain factors, including, but not limited to, those discussed in the section entitled “Information
Regarding Forward-Looking Statements” immediately preceding Part I of this Annual Report on Form 10-K.
Overview
Electromed
develops and provides innovative airway clearance products applying HFCWO technologies in pulmonary care for patients of all ages.
We
manufacture, market and sell products that provide HFCWO, including the SmartVest System and related products, to patients with
compromised pulmonary function. The SmartVest SQL is smaller, quieter and lighter than our previous product (the SV2100), 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 2014. In 2017, we launched the SmartVest SQL with SmartVest Connect™ wireless technology.
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 chronic obstructive
pulmonary disease 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
key growth strategies for the fiscal 2021 include:
|
●
|
focus
on increasing referrals in the largest, fastest growing segments: adult pulmonology/bronchiectasis;
|
|
●
|
increase
sales productivity through deeper clinic penetration and market share growth;
|
|
●
|
enhance
patient and provider support to provide best-in-class customer care;
|
|
●
|
expand
and promulgate the body of clinical evidence to increase utilization of SmartVest for
patients with bronchiectasis;
|
|
●
|
continue
to develop innovative device features that appeal to patients; and
|
|
●
|
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
Annual Report on Form 10-K.
COVID-19
Pandemic and CARES Act Funding
In
March 2020, the World Health Organization designated COVID-19 as a global pandemic. The impact of the COVID-19 pandemic on our
business remains uncertain and its effects on our operational and financial performance will depend in part on future developments,
which cannot be reasonably estimated at this time. Such future developments include, but are not limited to, the duration, scope
and severity of the COVID-19 pandemic in geographic areas in which we operate or in which our patients live, actions taken to
contain or mitigate its impact, the impact on governmental healthcare programs and budgets, the development of treatments or vaccines,
and the resumption of widespread economic activity. Due to the inherent uncertainty of the unprecedented and evolving situation,
we are unable to predict with confidence the likely impact of the COVID-19 pandemic on our future operations.
The
COVID-19 pandemic has created significant volatility, uncertainty and economic disruption and has negatively impacted business
in our industry starting in March 2020. In particular, certain healthcare facilities and clinics restricted access to their clinicians,
reducing patient consultations and treatments, or closed temporarily due to the COVID-19 pandemic, which reduced homecare referrals
and resulted in institutional orders being postponed. We believe that these and other responses by healthcare systems have had
a negative impact on our operating results and cash flows during the fourth quarter of fiscal 2020. As we exited the fourth quarter
of fiscal 2020, home care referral levels returned to near prior year levels as government restrictions began to ease and patients
began re-engaging with our clinicians. Institutional revenue has been negatively impacted as hospitals and long-term care facilities
have adjusted their operating protocols and procurement management since the onset of the COVID-19 pandemic. We expect the impact
on our business will continue to lessen during fiscal 2021 and continue to do so in subsequent periods; however, if COVID-19 rates
increase and federal, state and local restrictions on commerce, stay-at-home orders or other restrictions on businesses are reinstated,
such measures could have a material adverse effect on our business.
We
believe that the COVID-19 pandemic’s adverse impact on our operating results, cash flows and financial condition will be
primarily driven by: the severity and duration of the pandemic; its impact on the U.S. healthcare system and economy; and the
timing, scope and effectiveness of U.S. governmental responses to the COVID-19 pandemic.
While
we have not yet experienced adverse impacts on our supply chain, it is possible the COVID-19 pandemic could have an adverse impact
on our supply chain in the future, including impacts associated with preventive and precautionary measures that other businesses
and the governments are taking. A reduction or interruption in any of our manufacturing processes could have a material adverse
effect on our business.
In
response to the negative impacts of the COVID-19 pandemic on our business, in April 2020 we initiated cost-containment measures,
which included reducing discretionary and variable spend, such as travel, and the use of contractors, consultants, temporary help
and employee furloughs in our manufacturing and general and administrative functions due to lower near-term demand for our products.
Employee furloughs continued through the end of July 2020, at which time we returned to full employment in both our manufacturing
and general and administrative functions.
We
have also taken measures to ensure the safety of our employees and to comply with applicable governmental orders. We consider
our business to be essential under applicable orders due primarily to our role in manufacturing and supplying needed medical devices
to patients with respiratory related issues.
In
response to the COVID-19 pandemic and the U.S. federal government’s declaration of a public health emergency, the CMS implemented
a number of temporary rule changes and waivers to allow prescribers to best treat patients during the period of the public health
emergency. These waivers are retroactively effective to March 1, 2020. Clinical indications and documentation typically required
will not be enforced for respiratory related products including the SmartVest System (solely with respect to Medicare patients).
The minimum documentation now requires a valid order and documentation of a respiratory related diagnosis. Face-to-face and in-person
requirements for respiratory devices are being waived during such period, which is currently scheduled to expire in October 2020.
On
April 10, 2020, we received a stimulus payment in the amount of approximately $913,000 under the Provider Relief Fund established
pursuant to the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”), which is intended to offset losses
in revenue and expenses Medicare fee-for-service providers incurred due to the impacts of the COVID-19 pandemic. We are a Medicare
fee-for-service provider, and incurred revenue losses subsequent to receipt of the funds in excess of the amount of the stimulus
payment, and recognized the full amount as income during fiscal 2020.
Revenue
Recognition and Allowance for Doubtful Accounts
We
measure revenue based on consideration specified in the contract with a customer, adjusted for any applicable estimates of variable
consideration and other factors affecting the transaction price, including noncash consideration, consideration paid or payable
to customers and significant financing components. Revenue from all customers is recognized when a performance obligation is satisfied
by transferring control of a distinct good or service to a customer.
Individual
promised goods and services in a contract are considered a performance obligation and accounted for separately if the individual
good or service is distinct (i.e., the customer can benefit from the good or service on its own or with other resources that are
readily available to the customer and the good or service is separately identifiable from other promises in the arrangement).
If an arrangement includes multiple performance obligations, the consideration is allocated between the performance obligations
in proportion to their estimated standalone selling price, unless discounts or variable consideration is attributable to one or
more but not all the performance obligations. Costs related to products delivered are recognized in the period incurred, unless
criteria for capitalization of costs under Accounting Standards Codification (“ASC”) 340-40, “Other Assets and
Deferred Costs,” or other applicable guidance are met.
We
include shipping and handling fees in net revenues. Shipping and handling costs associated with the shipment of SmartVest Systems
after control has transferred to a customer are accounted for as a fulfillment cost and are included in cost of revenues.
Accounts
receivable are also net of an allowance for doubtful accounts, which are accounts from which payment is not expected to be received.
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 are certified to recondition and resell returned SmartVest units. Returned units are typically reconditioned and resold and
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.
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 on future
product performance and durability and is estimated largely based on historical experience. We estimate the average useful life
of our products is 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 issued to employees. Expense for options is estimated using the Black-Scholes pricing model
at the date of grant. 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 and adjusted upon completion of the vesting period. 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 8 to the Financial Statements included in Part
II, Item 8, of this Annual Report on Form 10-K for a description of these assumptions.
Results
of Operations
Fiscal
Year Ended June 30, 2020 Compared to Fiscal Year Ended June 30, 2019
Revenues
Revenue
for the twelve-month periods are summarized in the table below (dollar amounts in thousands).
|
|
Twelve
Months Ended June 30,
|
|
|
|
|
|
|
2020
|
|
|
2019
|
|
|
Increase
(Decrease)
|
|
Total
Revenue
|
|
$
|
32,471
|
|
|
$
|
31,300
|
|
|
$
|
1,171
|
|
|
|
3.7
|
%
|
Home
Care Revenue
|
|
|
29,323
|
|
|
|
28,949
|
|
|
|
374
|
|
|
|
1.3
|
%
|
Institutional
Revenue
|
|
|
2,000
|
|
|
|
1,604
|
|
|
|
396
|
|
|
|
24.7
|
%
|
Home
Care Distributor Revenue
|
|
|
430
|
|
|
|
—
|
|
|
|
430
|
|
|
|
—
|
|
International
Revenue
|
|
|
718
|
|
|
|
747
|
|
|
|
(29
|
)
|
|
|
(3.9
|
%)
|
Home
Care Revenue. Our home care revenue increased by 1.3%, or approximately $374,000, for fiscal 2020, compared to fiscal 2019.
Home care revenue increased year-over-year predominantly due to a greater percentage of approved referrals and a higher average
allowable based on payer mix, which was partially offset by a lower level of referrals as compared to the prior year. The decline
in fiscal 2020 referrals was due to a significant decrease in referrals that occurred during the three months ended June 30, 2020
driven by the COVID-19 pandemic. As we exited fiscal 2020, referrals began to come back to pre-COVID-19 levels. Home care referrals
benefited from a temporary rule changes and waivers to allow prescribers to best treat patients during the period of the public
health emergency. These waivers are retroactively effective to March 1, 2020. Clinical indications and documentation typically
required will not be enforced for respiratory related products including the SmartVest System (solely with respect to Medicare
patients). The minimum documentation now requires a valid order and documentation of a respiratory related diagnosis. Face-to-face
and in-person requirements for respiratory devices are being waived during such period, which is currently scheduled to expire
in October 2020.
Institutional
Revenue. Institutional revenue increased by 24.7%, or approximately $396,000, in fiscal 2020 compared to fiscal 2019. Institutional
revenue includes sales to group purchasing organization (“GPO”) members, rental companies and other institutions.
The increases in institutional revenue was primarily due to a higher selling price per device and an increase in the number of
devices sold as compared to the prior year. Since the onset of the COVID-19 pandemic, institutional revenue has been negatively
impacted as hospitals and long-term care facilities have adjusted their operating protocols and procurement management.
Home
Care Distributor Revenue. Home care distributor revenue was approximately $430,000 for fiscal 2020. We began selling to home
medical equipment distributors during fiscal 2020, who in turn sell our SmartVest System in the U.S. home care market.
International
Revenue. International revenue was approximately $718,000 in fiscal 2020 compared to $747,000 in fiscal 2019. International
revenue growth is not a focus for us, and our corporate resources are only focused on supporting and maintaining our current distributors.
Gross
Profit
Gross
profit increased to approximately $25,200,000 during fiscal 2020, or 77.6% of net revenues, from approximately $23,848,000, or
76.2% of net revenues, during fiscal 2019. The increase in gross profit was primarily related to increases in domestic home care,
institutional revenue and home care distributor revenue. The increase in gross profit as a percentage of net revenue was driven
by a higher average allowable due to payer mix compared to the prior fiscal year.
We
believe as we continue to grow revenue we will be able to leverage manufacturing costs, 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 2020
were approximately $19,945,000, compared to approximately $20,435,000 for the prior year, a decrease of approximately $490,000,
or 2.4%.
SG&A
payroll and compensation-related expenses decreased by approximately $687,000, or 5.2%, to approximately $12,461,000. The decrease
was due to eliminating certain sales roles during the latter part of fiscal 2019, a lower number of administrative roles and lower
share-based compensation expense.
Professional
and legal fees increased by approximately $487,000 to approximately $2,002,000 in fiscal 2020, compared to approximately $1,524,000
in fiscal 2019. These fees are primarily for services related to legal costs, shareowner services and reporting requirements,
information technology (“IT”) technical support, and consulting fees for enhancing our market development strategy.
The increase in professional fees were primarily in legal, consulting and shareowner services.
Recruiting
fees were approximately $430,000 in fiscal 2020, representing an increase of approximately $174,000, or 68.0%, as compared to
the prior year. The increase in recruiting fees was due primarily to hiring a greater number of employees in sales and administrative
roles as compared to the prior year.
Travel,
meals and entertainment expenses were approximately $1,944,000 for fiscal 2020 compared to $2,341,000 in the prior year, a decrease
of approximately $397,000, or 17.0%. The decrease was due primarily to eliminating certain sales roles during fiscal 2019 and
a lower level of travel due to the COVID-19 pandemic during the three months ended June 30, 2020.
Depreciation
and amortization expense was approximately $397,000 for fiscal 2020 compared to $537,000 in the prior year, a decrease of approximately
$140,000, or 26.1%. The decrease was due primarily to our decision to terminate the lease of a property used for office space
on June 30, 2019, which required us to accelerate the amortization of the leasehold improvement assets associated with the property
in the amount of approximately $151,000 during the prior fiscal year.
Research
and Development Expenses. R&D expenses were approximately $1,050,000 and $583,000, or 3.2% and 1.9% of net revenues, for
fiscal 2020 and 2019, respectively. As a percentage of sales, we expect spending on R&D expenses to increase slightly during
the fiscal year ended June 30, 2021 as compared with fiscal 2020 with engineering resources focusing on next generation product
enhancements. Certain expenses related to our innovation investments are not always captured in R&D expenses. These expenses
may be included in cost of revenue 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.
Government
Stimulus Income. In fiscal 2020, we recorded $913,000 of government stimulus income related to general distribution funds
received from the Provider Relief Fund established by the CARES Act for Medicare fee-for-service providers due to lost revenues
resulting from the COVID-19 pandemic.
Interest
Income, net
Net
interest income was approximately $121,000 during fiscal 2020 compared to net interest income of $91,000 during the prior fiscal
year. Increases in net interest income was primarily driven by the payoff of our term loan of approximately $1,103,000 on December
18, 2018.
Income
Tax Expense
During
fiscal 2020, we recorded a current income tax expense of $1,078,000. Estimated income tax expense during fiscal 2020 includes
a current tax expense of $1,204,000 and a deferred benefit of $126,000. Estimated income tax expense for fiscal 2020 includes
a discrete current tax benefit of approximately $358,000 related to the excess tax benefit of non-qualified stock options exercised.
In
fiscal 2019, we recorded a current income tax expense of $940,000. Estimated income tax expense during fiscal 2019 includes a
current tax expense of $1,205,000 and a deferred benefit of $265,000. Estimated income tax expense for fiscal 2019 includes a
discrete deferred tax expense of approximately $157,000 related to unexercised fully vested stock options that expired and a discrete
current tax benefit of approximately $14,000 related to the excess tax benefit of non-qualified stock options exercised.
The
effective tax rates were 20.6% and 32.3% for fiscal 2020 and 2019, 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
Net
income for fiscal 2020 was approximately $4,161,000, compared to net income of approximately $1,980,000 in fiscal 2019. The year-over-year
increase in net income was driven primarily by an increase in gross profit on higher revenue, government stimulus income related
to the COVID-19 pandemic and lower payroll and compensation expenses, which was partially offset by an increase in investments
in R&D and higher professional fees. Fiscal 2020 net income also benefited by a discrete current tax benefit of approximately
$358,000 related to the excess tax benefit of non-qualified stock options exercised.
Liquidity
and Capital Resources
Cash
Flows and Sources of Liquidity
Cash
Flows from Operating Activities
For
fiscal 2020, our net cash provided by operating activities was approximately $4,196,000. Cash flows from operating activities
consisted of net income of approximately $4,161,000, non-cash expenses of approximately $1,517,000, a decrease in contract assets
of $93,000 and a decrease in prepaid expenses and other assets of $78,000. These cash flows from operating activities were partially
offset by an increase in inventory of $449,000, a decrease in accounts payable and other current liabilities of approximately
$472,000, a decrease in income taxes payable of $289,000, an increase in income taxes receivable of $262,000 and an increase in
accounts receivable of $181,000.
Cash
Flows from Investing Activities
For
fiscal 2020, cash used in investing activities was approximately $977,000. Cash used in investing activities primarily consisted
of approximately $844,000 in expenditures for property and equipment and $133,000 in payments for patent and trademark costs.
Cash
Flows from Financing Activities
For
fiscal 2020, cash used in financing activities was approximately $548,000, consisting of $628,000 for taxes paid on behalf of
employees for stock options that were exercised on a net basis, which was partially offset by $80,000 of proceeds received from
stock options exercised.
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 $25,036,000
and available borrowings under our existing credit facility will provide adequate liquidity for fiscal 2021.
Effective
December 18, 2019, we renewed our credit facility, which provides us with a revolving line of credit. Interest on borrowings on
the line of credit accrues at the prime rate (3.25% at June 30, 2020) less 1.00% and is payable monthly. There was no outstanding
principal balance on the line of credit as of June 30, 2020 or June 30, 2019. 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, 2020, if not renewed. At June 30, 2020, the maximum $2,500,000 was available under the line of credit. Payment obligations
under the line of credit are secured by a security interest in substantially all of our tangible and intangible assets.
The
documents governing our line of credit contain certain financial and nonfinancial covenants that include a minimum tangible net
worth of not less than $10,125,000 and restrictions on our ability to incur certain additional indebtedness or pay dividends.
Any
failure to comply with these covenants in the future may result in an event of default, which if not cured or waived, could result
in the lender accelerating the maturity of our indebtedness, preventing access to additional funds under the line of credit, requiring
prepayment of outstanding indebtedness, or refusing to renew the line of credit. If the maturity of the indebtedness is accelerated
or the line of credit is not renewed, sufficient cash resources to satisfy the debt obligations may not be available and we may
not be able to continue operations as planned. If we are unable to repay such indebtedness, the lender could foreclose on these
assets.
During
fiscal 2020 and 2019, we spent approximately $844,000 and $1,331,000, respectively, on property and equipment. We currently expect
to finance planned equipment purchases with cash flows from operations or borrowings under our credit facility. We may need to
incur additional debt if we have an unforeseen need for additional capital equipment or if our operating performance does not
generate adequate cash flows.
Off-Balance
Sheet Arrangements
We
have no off-balance sheet arrangements.
New
Accounting Pronouncements
In
February 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”)
2016-02, “Leases (Topic 842)” (“ASU 2016-02”). This standard requires the recognition of all lease transactions
on the balance sheet as a lease liability and a right-of-use asset (as defined in ASU 2016-02). ASU 2016-02 to Topic 842 –
Leases (“ASC 842”) became effective on July 1, 2019 and was applied retrospectively to all periods presented. We applied
the practical expedient to calculate the present value of the fixed payments without having to perform an allocation to lease
and non-lease components.
Impact
on Previously Reported Results:
The
following table presents a recast of selected unaudited statement of operations line items after giving effect to the adoption
of ASC 842:
|
|
For
the twelve months ended June 30, 2019
|
|
|
|
As
Previously Reported
|
|
|
Effect
of Adoption
|
|
|
As
Adjusted
|
|
Net
revenues
|
|
$
|
31,299,750
|
|
|
$
|
—
|
|
|
$
|
31,299,750
|
|
Cost
of revenues
|
|
|
7,451,806
|
|
|
|
—
|
|
|
|
7,451,806
|
|
Gross
profit
|
|
|
23,847,944
|
|
|
|
—
|
|
|
|
23,847,944
|
|
Operating
expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling,
general and administrative
|
|
|
20,446,122
|
|
|
|
(11,112
|
)
|
|
|
20,435,010
|
|
Research
and development
|
|
|
583,311
|
|
|
|
—
|
|
|
|
583,311
|
|
Total
operating expenses
|
|
|
21,029,433
|
|
|
|
(11,112
|
)
|
|
|
21,018,321
|
|
Operating
income
|
|
|
2,818,511
|
|
|
|
11,112
|
|
|
|
2,829,623
|
|
Interest
income, net
|
|
|
90,707
|
|
|
|
—
|
|
|
|
90,707
|
|
Net
income before income taxes
|
|
|
2,909,218
|
|
|
|
11,112
|
|
|
|
2,920,330
|
|
Income
tax expense
|
|
|
940,000
|
|
|
|
—
|
|
|
|
940,000
|
|
Net
income
|
|
$
|
1,969,218
|
|
|
$
|
11,112
|
|
|
$
|
1,980,330
|
|
Income
per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
0.24
|
|
|
$
|
0.00
|
|
|
$
|
0.24
|
|
Diluted
|
|
$
|
0.23
|
|
|
$
|
0.00
|
|
|
$
|
0.23
|
|
The
following table presents a recast of selected unaudited balance sheet line items after giving effect to the adoption of ASC 842:
|
|
June
30, 2019
|
|
|
|
As
Previously Reported
|
|
|
Effect
of Adoption
|
|
|
As
Adjusted
|
|
Assets
|
|
|
|
|
|
|
|
|
|
Other
assets
|
|
$
|
—
|
|
|
$
|
45,044
|
|
|
$
|
45,044
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities
and Shareholder’s Equity
|
|
|
|
|
|
|
|
|
|
|
|
|
Current
maturities of other long-term liabilities
|
|
|
—
|
|
|
|
30,320
|
|
|
|
30,320
|
|
Other
long-term liabilities
|
|
|
—
|
|
|
|
14,737
|
|
|
|
14,737
|
|
Retained
earnings
|
|
|
9,522,076
|
|
|
|
(12
|
)
|
|
|
9,522,064
|
|
The
following table presents a recast of selected unaudited statement of cash flow line items after giving effect to the adoption
of ASC 842:
|
|
For
the Twelve months ended June 30, 2019
|
|
|
|
As
Previously Reported
|
|
|
Effect
of Adoption
|
|
|
As
Adjusted
|
|
Cash
Flow from Operating Activities
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
income
|
|
$
|
1,969,218
|
|
|
$
|
11,112
|
|
|
$
|
1,980,330
|
|
Changes
in operating assets and liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Prepaid
expenses and other assets
|
|
|
404,234
|
|
|
|
187,223
|
|
|
|
591,457
|
|
Accounts
payable and accrued liabilities
|
|
|
(2,564
|
)
|
|
|
(198,335
|
)
|
|
|
(200,899
|
)
|
Item
8.
|
Financial
Statements and Supplementary Data.
|
Index
to Financial Statements
Report
of Independent Registered Public Accounting Firm
To
the Shareholders and the Board of Directors of Electromed, Inc.
Opinion
on the Financial Statements
We
have audited the accompanying balance sheets of Electromed, Inc. (the Company) as of June 30, 2020 and 2019, the related statements
of operations, shareholders’ equity and cash flows for the years then ended, and the related notes to the financial statements
(collectively, the financial statements). In our opinion, the financial statements present fairly, in all material respects, the
financial position of the Company as of June 30, 2020 and 2019, and the results of its operations and its cash flows for the years
then ended, in conformity with accounting principles generally accepted in the United States of America.
Change
in Accounting Principle
As
discussed in Note 1 to the financial statements, the Company has changed the manner in which it accounts for leases in fiscal
year 2020, due to the adoption of Accounting Standards Codification Topic 842, Leases.
Basis
for Opinion
These
financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on
the Company’s financial statements based on our audits. We are a public accounting firm registered with the Public Company
Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance
with U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We
conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error
or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial
reporting. As part of our audits, we are required to obtain an understanding of internal control over financial reporting but
not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting.
Accordingly, we express no such opinion.
Our
audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to
error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence
regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles
used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements.
We believe that our audits provide a reasonable basis for our opinion.
/s/
RSM US LLP
We
have served as the Company’s auditor since 2010.
Duluth,
Minnesota
August
25, 2020
Electromed,
Inc.
Balance
Sheets
June 30, 2020 and 2019
|
|
June
30,
|
|
|
|
2020
|
|
|
2019
|
|
Assets
|
|
|
|
|
|
|
Current Assets
|
|
|
|
|
|
|
|
|
Cash
|
|
$
|
10,479,150
|
|
|
$
|
7,807,928
|
|
Accounts receivable (net of allowances for doubtful accounts of $45,000)
|
|
|
12,940,677
|
|
|
|
12,760,042
|
|
Contract assets
|
|
|
902,619
|
|
|
|
995,847
|
|
Inventories
|
|
|
3,084,620
|
|
|
|
2,622,000
|
|
Prepaid expenses and other current assets
|
|
|
353,318
|
|
|
|
353,214
|
|
Income tax receivable
|
|
|
262,155
|
|
|
|
—
|
|
Total current assets
|
|
|
28,022,539
|
|
|
|
24,539,031
|
|
Property and equipment, net
|
|
|
3,788,469
|
|
|
|
3,604,744
|
|
Finite-life intangible assets, net
|
|
|
598,389
|
|
|
|
581,413
|
|
Other assets
|
|
|
80,166
|
|
|
|
45,044
|
|
Deferred income taxes
|
|
|
755,000
|
|
|
|
629,000
|
|
Total assets
|
|
$
|
33,244,563
|
|
|
$
|
29,399,232
|
|
|
|
|
|
|
|
|
|
|
Liabilities and Shareholders’ Equity
|
|
|
|
|
|
|
|
|
Current Liabilities
|
|
|
|
|
|
|
|
|
Current maturities of other long-term liabilities
|
|
$
|
72,328
|
|
|
$
|
30,320
|
|
Accounts payable
|
|
|
555,510
|
|
|
|
586,575
|
|
Accrued compensation
|
|
|
1,404,497
|
|
|
|
1,404,662
|
|
Income tax payable
|
|
|
—
|
|
|
|
288,511
|
|
Warranty reserve
|
|
|
740,000
|
|
|
|
810,000
|
|
Other accrued liabilities
|
|
|
214,045
|
|
|
|
530,453
|
|
Total current liabilities
|
|
|
2,986,380
|
|
|
|
3,650,521
|
|
Other long-term liabilities
|
|
|
8,868
|
|
|
|
14,737
|
|
Total liabilities
|
|
|
2,995,248
|
|
|
|
3,665,258
|
|
|
|
|
|
|
|
|
|
|
Commitments and Contingencies
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Shareholders’ Equity
|
|
|
|
|
|
|
|
|
Common stock, $0.01 par value; authorized: 13,000,000 shares; 8,567,834 and 8,408,351 issued and outstanding at June 30, 2020 and June 30, 2019, respectively
|
|
|
85,678
|
|
|
|
84,084
|
|
Additional paid-in capital
|
|
|
16,480,134
|
|
|
|
16,127,826
|
|
Retained earnings
|
|
|
13,683,503
|
|
|
|
9,522,064
|
|
Total shareholders’ equity
|
|
|
30,249,315
|
|
|
|
25,733,974
|
|
Total liabilities and shareholders’ equity
|
|
$
|
33,244,563
|
|
|
$
|
29,399,232
|
|
See
Notes to Financial Statements.
Electromed,
Inc.
Statements
of Operations
Years Ended June 30, 2020 and 2019
|
|
Years
Ended June 30,
|
|
|
|
2020
|
|
|
2019
|
|
Net revenues
|
|
$
|
32,470,688
|
|
|
$
|
31,299,750
|
|
Cost of revenues
|
|
|
7,270,642
|
|
|
|
7,451,806
|
|
Gross profit
|
|
|
25,200,046
|
|
|
|
23,847,944
|
|
|
|
|
|
|
|
|
|
|
Operating expenses (income)
|
|
|
|
|
|
|
|
|
Selling, general and administrative
|
|
|
19,944,851
|
|
|
|
20,435,010
|
|
Research and development
|
|
|
1,049,612
|
|
|
|
583,311
|
|
Government stimulus income
|
|
|
(913,108
|
)
|
|
|
—
|
|
Total operating expenses
|
|
|
20,081,355
|
|
|
|
21,018,321
|
|
Operating income
|
|
|
5,118,691
|
|
|
|
2,829,623
|
|
Interest income, net
|
|
|
120,748
|
|
|
|
90,707
|
|
Net income before income taxes
|
|
|
5,239,438
|
|
|
|
2,920,330
|
|
|
|
|
|
|
|
|
|
|
Income tax expense
|
|
|
1,078,000
|
|
|
|
940,000
|
|
Net income
|
|
$
|
4,161,439
|
|
|
$
|
1,980,330
|
|
|
|
|
|
|
|
|
|
|
Income per share:
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
0.50
|
|
|
$
|
0.24
|
|
Diluted
|
|
$
|
0.47
|
|
|
$
|
0.23
|
|
|
|
|
|
|
|
|
|
|
Weighted-average common shares outstanding:
|
|
|
|
|
|
|
|
|
Basic
|
|
|
8,403,220
|
|
|
|
8,306,338
|
|
Diluted
|
|
|
8,826,418
|
|
|
|
8,631,469
|
|
See
Notes to Financial Statements.
Electromed,
Inc.
Statements of Shareholders’ Equity
Years Ended June 30, 2020 and 2019
|
|
Common
Stock
|
|
|
|
Additional
Paid-
in
Capital
|
|
|
|
Retained
Earnings
|
|
|
|
Total
Shareholders’
Equity
|
|
|
|
Shares
|
|
|
Amount
|
|
|
|
|
|
|
|
|
|
|
Balance at June 30, 2018
|
|
|
8,288,659
|
|
|
$
|
82,887
|
|
|
$
|
14,953,103
|
|
|
$
|
7,541,734
|
|
|
$
|
22,577,724
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
1,980,330
|
|
|
|
1,980,330
|
|
Issuance of restricted stock
|
|
|
40,000
|
|
|
|
400
|
|
|
|
(400
|
)
|
|
|
—
|
|
|
|
—
|
|
Issuance of common stock upon exercise of options
|
|
|
79,692
|
|
|
|
797
|
|
|
|
251,052
|
|
|
|
—
|
|
|
|
251,849
|
|
Share-based compensation expense
|
|
|
—
|
|
|
|
—
|
|
|
|
924,071
|
|
|
|
—
|
|
|
|
924,071
|
|
Balance at June 30, 2019
|
|
|
8,408,351
|
|
|
|
84,084
|
|
|
|
16,127,826
|
|
|
|
9,522,064
|
|
|
|
25,733,974
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
|
—
|
|
|
|
—
|
|
|
|
—
|
|
|
|
4,161,439
|
|
|
|
4,161,439
|
|
Issuance of restricted stock
|
|
|
50,000
|
|
|
|
500
|
|
|
|
(500
|
)
|
|
|
—
|
|
|
|
—
|
|
Issuance of common stock upon exercise of options
|
|
|
109,483
|
|
|
|
1,094
|
|
|
|
79,275
|
|
|
|
—
|
|
|
|
80,369
|
|
Taxes paid on stock option exercised on a net basis
|
|
|
—
|
|
|
|
—
|
|
|
|
(628,399
|
)
|
|
|
—
|
|
|
|
(628,399
|
)
|
Share-based compensation expense
|
|
|
—
|
|
|
|
—
|
|
|
|
901,932
|
|
|
|
—
|
|
|
|
901,932
|
|
Balance at June 30, 2020
|
|
|
8,567,834
|
|
|
$
|
85,678
|
|
|
$
|
16,480,134
|
|
|
$
|
13,683,503
|
|
|
$
|
30,249,315
|
|
See
Notes to Financial Statements.
Electromed, Inc.
Statements of Cash Flows
Years Ended June 30, 2020 and 2019
|
|
Years
Ended June 30,
|
|
|
|
2020
|
|
|
2019
|
|
Cash Flows From Operating Activities
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
4,161,439
|
|
|
$
|
1,980,330
|
|
Adjustments to reconcile net income to net cash provided by operating activities:
|
|
|
|
|
|
|
|
|
Depreciation
|
|
|
616,468
|
|
|
|
804,587
|
|
Amortization of finite-life intangible assets
|
|
|
121,762
|
|
|
|
120,640
|
|
Amortization of debt issuance costs
|
|
|
—
|
|
|
|
1,958
|
|
Share-based compensation expense
|
|
|
901,932
|
|
|
|
924,071
|
|
Deferred income taxes
|
|
|
(126,000
|
)
|
|
|
(265,000
|
)
|
Loss on disposal of property and equipment
|
|
|
2,622
|
|
|
|
11,186
|
|
Loss on disposal of intangible assets
|
|
|
—
|
|
|
|
4,840
|
|
Changes in operating assets and liabilities:
|
|
|
|
|
|
|
|
|
Accounts receivable
|
|
|
(180,635
|
)
|
|
|
(948,734
|
)
|
Contract assets
|
|
|
93,228
|
|
|
|
(219,509
|
)
|
Inventories
|
|
|
(449,335
|
)
|
|
|
(106,174
|
)
|
Prepaid expenses and other assets
|
|
|
78,222
|
|
|
|
591,457
|
|
Income tax receivable
|
|
|
(262,155
|
)
|
|
|
—
|
|
Income tax payable
|
|
|
(288,511
|
)
|
|
|
(108,879
|
)
|
Accounts payable and accrued liabilities
|
|
|
(472,589
|
)
|
|
|
(200,899
|
)
|
Net cash provided by operating activities
|
|
|
4,196,448
|
|
|
|
2,589,874
|
|
|
|
|
|
|
|
|
|
|
Cash Flows From Investing Activities
|
|
|
|
|
|
|
|
|
Expenditures for property and equipment
|
|
|
(844,226
|
)
|
|
|
(1,330,598
|
)
|
Proceeds of sales of equipment
|
|
|
—
|
|
|
|
1,750
|
|
Expenditures for finite-life intangible assets
|
|
|
(132,970
|
)
|
|
|
(57,790
|
)
|
Net cash used in investing activities
|
|
|
(977,196
|
)
|
|
|
(1,386,638
|
)
|
|
|
|
|
|
|
|
|
|
Cash Flows From Financing Activities
|
|
|
|
|
|
|
|
|
Principal payments on long-term debt including capital lease obligations
|
|
|
—
|
|
|
|
(1,103,001
|
)
|
Issuance of common stock upon exercise of options
|
|
|
80,369
|
|
|
|
251,849
|
|
Taxes paid on stock options exercised on a net basis
|
|
|
(628,399
|
)
|
|
|
—
|
|
Net cash used in financing activities
|
|
|
(548,030
|
)
|
|
|
(851,152
|
)
|
Net increase in cash
|
|
|
2,671,222
|
|
|
|
352,084
|
|
Cash
|
|
|
|
|
|
|
|
|
Beginning of period
|
|
|
7,807,928
|
|
|
|
7,455,844
|
|
End of period
|
|
$
|
10,479,150
|
|
|
$
|
7,807,928
|
|
|
|
|
|
|
|
|
|
|
Supplemental Disclosures of Cash Flow Information
|
|
|
|
|
|
|
|
|
Cash paid for interest
|
|
$
|
3,133
|
|
|
$
|
22,991
|
|
Cash paid for income taxes
|
|
|
1,754,666
|
|
|
|
1,313,878
|
|
|
|
|
|
|
|
|
|
|
Supplemental Disclosures of Noncash Investing and Financing Activities
|
|
|
|
|
|
|
|
|
Property and equipment acquisitions in accounts payable
|
|
$
|
1,278
|
|
|
$
|
29,405
|
|
Intangible asset acquisitions in accounts payable
|
|
$
|
5,768
|
|
|
$
|
—
|
|
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 $718,000 and $747,000 for the fiscal years ended June 30, 2020 (“fiscal 2020”) and 2019 (“fiscal
2019”), 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 variable consideration, allowance for doubtful accounts, the potential impairment of intangible and long-lived assets, inventory
obsolescence, share-based compensation and the warranty reserve.
COVID-19
Pandemic and CARES Act Funding
In
March 2020, the World Health Organization designated COVID-19 as a global pandemic. The impact of the COVID-19 pandemic on the
Company’s business remains uncertain and its effects on operational and financial performance will depend in part on future
developments, which cannot be reasonably estimated at this time. Such future developments include, but are not limited to, the
duration, scope and severity of the COVID-19 pandemic in geographic areas in which the Company operates or in which its patients
live, actions taken to contain or mitigate its impact, the impact on governmental healthcare programs and budgets, the development
of treatments or vaccines, and the resumption of widespread economic activity. Due to the inherent uncertainty of the unprecedented
and evolving situation, the Company is unable to predict with confidence the likely impact of the COVID-19 pandemic on its future
operations.
The
COVID-19 pandemic has created significant volatility, uncertainty and economic disruption and has negatively impacted business
in the Company’s industry starting in March 2020. In particular, certain healthcare facilities and clinics restricted access
to their clinicians, reducing patient consultations and treatments, or closed temporarily due to the COVID-19 pandemic, which
reduced homecare referrals and resulted in institutional orders being postponed. The Company believes that these and other responses
by healthcare systems had a negative impact on the Company’s operating results and cash flows during the fourth quarter
of fiscal 2020.
In
response to the negative impacts of the COVID-19 pandemic on the Company’s business, in April 2020 the Company initiated
cost-containment measures, which included reducing discretionary and variable spend, such as travel, and the use of contractors,
consultants, temporary help and employee furloughs in its manufacturing and general and administrative functions due to lower
near-term demand for its products.
The
Company has also taken measures to ensure the safety of its employees and to comply with applicable governmental orders. The Company
considers its business to be essential under applicable orders due primarily to its role in manufacturing and supplying needed
medical devices to patients with respiratory related issues.
In
response to the COVID-19 pandemic and the U.S. federal government’s declaration of a public health emergency, the CMS implemented
a number of temporary rule changes and waivers to allow prescribers to best treat patients during the period of the public health
emergency. These waivers are retroactively effective to March 1, 2020. Clinical indications and documentation typically required
will not be enforced for respiratory related products including the SmartVest System (solely with respect to Medicare patients).
The minimum documentation now requires a valid order and documentation of a respiratory related diagnosis. Face-to-face and in-person
requirements for respiratory devices are being waived during such period, which is currently scheduled to expire in October 2020.
On
April 10, 2020, the Company received a stimulus payment in the amount of approximately $913,000 under the Provider Relief Fund
established pursuant to the Coronavirus Aid Relief, and Economic Security Act (“CARES Act”), which is intended to
offset losses in revenue and expenses Medicare fee-for-service providers incurred due to the impacts of the COVID-19 pandemic.
The Company, a Medicare fee-for-service provider, incurred revenue losses subsequent to receipt of the funds in excess of the
amount of the stimulus payment, and recognized the full amount as income during fiscal 2020.
Revenue
recognition: Revenue is measured based on consideration specified in the contract with a customer, adjusted for any applicable
estimates of variable consideration and other factors affecting the transaction price, including noncash consideration, consideration
paid or payable to customers and significant financing components. Revenue from all customers is recognized when a performance
obligation is satisfied by transferring control of a distinct good or service to a customer. See Note 2 for information on revenue.
Shipping
and handling expense: Shipping and handling charges incurred by the Company are included in cost of revenues and were $515,000
and $454,000 for fiscal 2020 and 2019, 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, 2020 and 2019.
Contract
assets: Contract assets include amounts recognized as revenue that are estimates of variable consideration for Medicare appeals
where the final determination of the insurance coverage amount is dependent on future approval of an appeal, or when the consideration
due to the Company is dependent on a future event such as the patient meeting a deductible prior to the Company’s claim
being processed by the payer. Contract assets are classified as current as amounts will turn into accounts receivable and be collected
during the Company’s normal business operating cycle. Contract assets are reclassified to accounts receivable when the right
to receive payment is unconditional.
Inventories:
Inventories are stated at the lower of cost (first-in, first-out method) or net realizable value. Work in process and finished
goods are carried at standard cost, which approximates actual cost, and includes materials, labor and allocated overhead. Standard
costs are reviewed at least quarterly by management, or more often in the event circumstances indicate a change in cost has occurred.
The reserve for obsolescence is determined by analyzing the inventory on hand and comparing it to expected future sales. Estimated
inventory to be returned is based on how many devices that have shipped that are expected to be returned prior to completion of
the insurance reimbursement process.
Property
and equipment: Property and equipment are stated at cost less accumulated depreciation. Depreciation is computed using the
straight-line method over the estimated useful lives of the assets. Leasehold improvements are depreciated over the shorter of
their estimated useful lives or the remaining lease term. The Company retains ownership of demonstration equipment in the possession
of both inside and outside sales representatives, who use the equipment in the sales process.
Finite-life
intangible assets: Finite-life intangible assets include patents and trademarks. These intangible assets are amortized on
a straight-line basis over their estimated useful lives, as described in Note 5.
Long-lived
assets: Long-lived assets, primarily property and equipment and finite-life intangible assets, are evaluated for impairment
whenever events or changes in circumstances indicate the carrying value of an asset or asset group may not be recoverable. In
evaluating recoverability, the following factors, among others, are considered: a significant change in the circumstances used
to determine the amortization period, an adverse change in legal factors or in the business climate, a transition to a new product
or service strategy, a significant change in customer base, and a realization of failed marketing efforts. The recoverability
of an asset or asset group is measured by a comparison of the carrying value of the asset to future undiscounted cash flows.
If
the Company believes the carrying value is unrecoverable, then it recognizes an impairment charge necessary to reduce the unamortized
balance to the estimated fair value of the asset or asset group. The amount of such impairment is charged to operations in the
current period.
Warranty
liability: The Company provides a lifetime warranty on its products to the prescribed patient for sales within the U.S. and
Canada, and a three-year warranty for all institutional sales and sales to individuals outside the U.S. (except for Canadian home
care). The Company estimates the costs that may be incurred under its warranty and records a liability in the amount of such costs
at the time the product is shipped. Factors that affect the Company’s warranty liability include the number of units shipped,
historical and anticipated rates of warranty claims, the product’s useful life, and cost per claim. The Company periodically
assesses the adequacy of its recorded warranty liability and adjusts the amounts as necessary.
Changes
in the Company’s warranty liability were approximately as follows:
|
|
Years Ended June 30,
|
|
|
|
2020
|
|
|
2019
|
|
Beginning warranty reserve
|
|
$
|
810,000
|
|
|
$
|
760,000
|
|
Accrual for products sold
|
|
|
79,000
|
|
|
|
201,000
|
|
Expenditures and costs incurred for warranty claims
|
|
|
(149,000
|
)
|
|
|
(151,000
|
)
|
Ending warranty reserve
|
|
$
|
740,000
|
|
|
$
|
810,000
|
|
Income
taxes: Deferred taxes are provided on a liability method whereby deferred tax assets are recognized for deductible temporary
differences and operating loss and tax credit carryforwards and deferred tax liabilities are recognized for taxable temporary
differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax bases.
Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some
portion or all of the deferred tax assets will not be realized. The Company reverses a valuation allowance if it determines, based
on the weight of all available evidence, including when cumulative losses become positive income, that it is more likely than
not that some or all of the deferred tax assets will be realized. Deferred tax assets and liabilities are adjusted for the effects
of changes in tax laws and rates on the date of enactment.
The
Company recognizes tax liabilities when the Company believes that certain positions may not be fully sustained upon review by
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 2020 and 2019, were approximately $781,000 and $576,000, 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.
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 zero shares and 318,000 shares were excluded from the calculation
of diluted earnings per share for fiscal 2020 and 2019, respectively, as their impact was antidilutive. See Note 8 for information
on stock options.
New
accounting pronouncements: In February 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting
Standards Update (“ASU”) 2016-02, “Leases (Topic 842)” (“ASU 2016-02”). This standard requires
the recognition of all lease transactions on the balance sheet as a lease liability and a right-of-use asset (as defined in ASU
2016-02). ASU 2016-02 to Topic 842 – Leases (“ASC 842”) became effective on July 1, 2019 and was applied retrospectively
to all periods presented. The Company applied the practical expedient to calculate the present value of the fixed payments without
having to perform an allocation to lease and non-lease components. Additional information and required disclosures are included
in Note 10.
Impact
on Previously Reported Results:
The
following table presents a recast of selected unaudited statement of operations line items after giving effect to the adoption
of ASC 842:
|
|
For the twelve months ended June 30, 2019
|
|
|
|
As Previously Reported
|
|
|
Effect
of Adoption
|
|
|
As Adjusted
|
|
Net revenues
|
|
$
|
31,299,750
|
|
|
$
|
—
|
|
|
$
|
31,299,750
|
|
Cost of revenues
|
|
|
7,451,806
|
|
|
|
—
|
|
|
|
7,451,806
|
|
Gross profit
|
|
|
23,847,944
|
|
|
|
—
|
|
|
|
23,847,944
|
|
Operating expenses
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling, general and administrative
|
|
|
20,446,122
|
|
|
|
(11,112
|
)
|
|
|
20,435,010
|
|
Research and development
|
|
|
583,311
|
|
|
|
—
|
|
|
|
583,311
|
|
Total operating expenses
|
|
|
21,029,433
|
|
|
|
(11,112
|
)
|
|
|
21,018,321
|
|
Operating income
|
|
|
2,818,511
|
|
|
|
11,112
|
|
|
|
2,829,623
|
|
Interest income, net
|
|
|
90,707
|
|
|
|
—
|
|
|
|
90,707
|
|
Net income before income taxes
|
|
|
2,909,218
|
|
|
|
11,112
|
|
|
|
2,920,330
|
|
Income tax expense
|
|
|
940,000
|
|
|
|
—
|
|
|
|
940,000
|
|
Net income
|
|
$
|
1,969,218
|
|
|
$
|
11,112
|
|
|
$
|
1,980,330
|
|
Income per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
0.24
|
|
|
$
|
0.00
|
|
|
$
|
0.24
|
|
Diluted
|
|
$
|
0.23
|
|
|
$
|
0.00
|
|
|
$
|
0.23
|
|
The
following table presents a recast of selected unaudited balance sheet line items after giving effect to the adoption of ASC 842:
|
|
June 30, 2019
|
|
|
|
As Previously
Reported
|
|
|
Effect
of Adoption
|
|
|
As Adjusted
|
|
Assets
|
|
|
|
|
|
|
|
|
|
Other assets
|
|
$
|
—
|
|
|
$
|
45,044
|
|
|
$
|
45,044
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities and Shareholder’s Equity
|
|
|
|
|
|
|
|
|
|
|
|
|
Current maturities of other long-term liabilities
|
|
|
—
|
|
|
|
30,320
|
|
|
|
30,320
|
|
Other long-term liabilities
|
|
|
—
|
|
|
|
14,737
|
|
|
|
14,737
|
|
Retained earnings
|
|
|
9,522,076
|
|
|
|
(12
|
)
|
|
|
9,522,064
|
|
The
following table presents a recast of selected unaudited statement of cash flow line items after giving effect to the adoption
of ASC 842:
|
|
For the Twelve months ended June 30, 2019
|
|
|
|
As Previously
Reported
|
|
|
Effect
of Adoption
|
|
|
As
Adjusted
|
|
Cash Flow from Operating Activities
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
1,969,218
|
|
|
$
|
11,112
|
|
|
$
|
1,980,330
|
|
Changes in operating assets and liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
Prepaid expenses and other assets
|
|
|
404,234
|
|
|
|
187,223
|
|
|
|
591,457
|
|
Accounts payable and accrued liabilities
|
|
|
(2,564
|
)
|
|
|
(198,335
|
)
|
|
|
(200,899
|
)
|
Note 2.
Revenues
Revenue
is measured based on consideration specified in the contract with a customer, adjusted for any applicable estimates of variable
consideration and other factors affecting the transaction price, including non-cash consideration, consideration paid or payable
to customers and significant financing components. Revenue from all customers is recognized when a performance obligation is satisfied
by transferring control of a distinct good or service to a customer, as further described below under Performance obligations
and transaction price.
Individual
promised goods and services in a contract are considered a performance obligation and accounted for separately if the individual
good or service is distinct (i.e., the customer can benefit from the good or service on its own or with other resources that are
readily available to the customer and the good or service is separately identifiable from other promises in the arrangement).
If an arrangement includes multiple performance obligations, the consideration is allocated between the performance obligations
in proportion to their estimated standalone selling price, unless discounts or variable consideration is attributable to one or
more but not all the performance obligations. Costs related to products delivered are recognized in the period incurred, unless
criteria for capitalization of costs under FASB Accounting Standards Codification (“ASC”) 340-40, “Other Assets
and Deferred Costs” (“ASC 340”), or other applicable guidance are met.
The
Company includes shipping and handling fees in net revenues. Shipping and handling costs associated with the shipment of the Company’s
SmartVest® Airway Clearance System (“SmartVest System”) after control has transferred to a customer are accounted
for as a fulfillment cost and are included in cost of revenues.
The
timing of revenue recognition, billings and cash collections results in accounts receivable on the balance sheets as further described
below under Accounts receivable and Contract assets.
Disaggregation
of revenues. In the following table, revenue is disaggregated by market:
|
|
For
the twelve months ended June 30,
|
|
|
|
2020
|
|
|
2019
|
|
Home Care
|
|
$
|
29,322,649
|
|
|
$
|
28,948,861
|
|
Institutional
|
|
|
1,999,784
|
|
|
|
1,603,522
|
|
Home Care Distributor
|
|
|
430,363
|
|
|
|
—
|
|
International
|
|
|
717,892
|
|
|
|
747,367
|
|
Total
|
|
$
|
32,470,688
|
|
|
$
|
31,299,750
|
|
In
the following table, home care revenue is disaggregated by payer type:
|
|
For
the twelve months ended June 30,
|
|
|
|
2020
|
|
|
2019
|
|
Commercial
|
|
$
|
11,728,179
|
|
|
$
|
13,106,919
|
|
Medicare
|
|
|
14,863,032
|
|
|
|
13,787,059
|
|
Medicaid
|
|
|
1,696,380
|
|
|
|
1,230,766
|
|
Other
|
|
|
1,035,058
|
|
|
|
824,117
|
|
Total
|
|
$
|
29,322,649
|
|
|
$
|
28,948,861
|
|
Revenues
in the Company’s home care, home care distributor and international markets are recognized at a point in time when control
passes to the customer upon product shipment or delivery. Revenues in the Company’s institutional market include sales recognized
at a point in time upon shipment or delivery as well as revenues recognized over time under operating leases.
Performance
obligations and transaction price. A performance obligation is a promise in a contract to transfer a distinct good or service
to the customer and is the unit of account under ASC 606, “Revenue From Contracts With Customers” (“ASC 606”).
A contract’s transaction price is allocated to each distinct performance obligation in proportion to the standalone selling
price for each and recognized as revenue when, or as, the performance obligation is satisfied. The Company’s performance
obligations and the timing or method of revenue recognition in each of the Company’s markets are discussed below:
Home
care market. In the Company’s home care market, its customers are patients who use the SmartVest System. The various
models of the SmartVest System are comprised of three main components - a generator, a vest and a connecting hose - that are sold
together as an integrated unit. Accordingly, in contracts within the home care market, the Company regards the SmartVest System
to be a single performance obligation.
The
Company makes available to its home care patients limited post-sale services that are not material in the context of the contracts,
either individually or taken together, and therefore does not consider them to be performance obligations. The costs associated
with the services are accrued and expensed when the related revenues are recognized. As such, transactions in the home care market
consist of a single performance obligation: the SmartVest System.
Home
care patients generally will rely on third-party payers, including commercial payers and governmental payers such as Medicare,
Medicaid and the U.S. Department of Veterans Affairs to cover and reimburse all or part of the cost of the SmartVest System. The
third-party payers’ reimbursement programs fall into three types, distinguished by the differences in the timing of payments
from the payer, consisting of either (i) outright sale, in which payment is received from the payer based on standard terms, (ii)
capped installment sale, under which the SmartVest System is sold for a series of payments that are capped not to exceed a prescribed
or negotiated amount over a period of time or (iii) installment sale, under which the SmartVest System is paid for over a period
of several months as long as the patient continues to use the SmartVest System.
Regardless
of the type of transaction, provided criteria for an enforceable contract are met, it is the Company’s long-standing business
practice to regard all home care agreements as transferring control to the patient upon shipment or delivery, in spite of possible
payment cancellation under government or commercial programs where the payer is controlling the payment over specified time periods.
For home care sales that feature installment payments, the ultimate amount of consideration received from Medicare, Medicaid or
commercial payers can be significantly less than expected if the contract is terminated due to changes in the patient’s
status, including insurance coverage, hospitalization, death or otherwise becoming unable to use the SmartVest System. However,
once delivered to a patient who needs the SmartVest System, the patient is under no obligation to return the SmartVest System
should payments be terminated as a result of the described contingencies. As a result, the Company’s product sales qualify
for point in time revenue recognition. Control transfers to the patient, and revenue is recognized, upon shipment of the SmartVest
System. At this point, physical possession and the significant risks and rewards of ownership are transferred to the patient and
either a current or future right to payment is triggered, as further discussed under Accounts receivable and Contract
assets below.
The
Company’s contractually stated transaction prices in the home care market are generally set by the terms of the contracts
negotiated with insurance companies or by government programs. The transaction price for the Company’s products may be further
impacted by variable consideration. ASC 606 requires the Company to adjust the transaction price at contract inception and throughout
the contract duration for the estimated value of payments to be received from insurance payers based on historical experience
and other available information, subject to the constraint on estimates of variable consideration. Transactions requiring estimates
of variable consideration primarily include (i) capped installment payments, which are subject to the third-party payer’s
termination due to changes in insurance coverage, death or the patient’s discontinued use of the SmartVest System, (ii)
contracts under appeal and (iii) patient responsibility amounts for deductibles, coinsurance, copays and other similar payments.
Although
estimates may be made on a contract-by-contract basis, whenever possible, the Company uses all available information including
historical collection patterns to estimate variable consideration for portfolios of contracts. The Company’s estimates of
variable consideration consist of amounts it may receive from insurance providers in excess of its initial revenue estimate due
to patients meeting deductibles or coinsurance during the payment duration, changes to a patient’s insurance status, changes
in an insurance allowable, claims in appeals with Medicare and amounts received directly from patients for their allowable or
coinsurance. The Company believes it has representative historical information to estimate the amount of variable consideration
in relevant portfolios considering the significant experience it has with each portfolio and the similarity of patient accounts
within a portfolio. The analysis includes steps to ensure that revenue recognized on a portfolio basis does not result in a material
difference when compared with an individual contract approach. The Company also leverages its historical experience and all available
relevant information for each portfolio of contracts to minimize the risk its estimates used to arrive at the transaction price
will result in a significant reversal in the amount of cumulative revenue recognized when the uncertainty associated with the
variable consideration is subsequently resolved. Variable consideration is included in the transaction price if, in the Company’s
judgment, it is probable that a significant future reversal of cumulative revenue under the contract will not occur.
For
example, for contracts in which the Company believes the criteria for reimbursement under government or commercial payer contracts
have been met but for which coverage is unconfirmed or payments are under appeal, the Company has significant observable evidence
of relatively consistent claims recovery experience over the prior three to five years. The Company believes the low volatility
in historical claims approval rates for populations of patients whose demographics are similar to those of current patients provides
reliable predictive value in arriving at estimates of variable consideration in such contracts. Similarly, historical payment
trends for recovery of claims subject to payer installments and payments from patients have remained relatively consistent over
the past five years. No significant changes in patient demographics or other relevant factors have occurred that would limit the
predictive value of such payment trends in estimating variable consideration for current contracts. As a result, the Company believes
its estimates of variable consideration are generally not subject to the risk of significant revenue reversal.
For
each type of variable consideration discussed above, there are a large number of contracts with similar characteristics with a
wide range of possible transaction prices. For that reason, the Company uses the probability-weighted expected value method provided
under ASC 606 to estimate variable consideration.
The
Company often receives payment from third-party payers for the SmartVest System sales over a period of time that may exceed one
year. Despite these extended payment terms, no significant financing component is deemed to exist because the purpose of such
terms is not to provide financing to the patient, the payer or the Company. Rather, the extended payment terms are mandated by
the government or commercial insurance programs; the fundamental purpose of which is to avoid paying the full purchase price of
equipment that may potentially be used by the patient for only a short period of time.
Home
Care Distributors. Sales to distributors, who sell direct to patients, are made at fixed contract prices and may include
tiered pricing structures or volume-based rebates which offer more favorable pricing once certain volumes are achieved per the
negotiated contract. The distributor’s purchases accumulate to give the distributor a right to a higher discount on purchases
in excess of the specified level within the contract period. As a result, to the extent the Company expects the distributor to
exceed the specified volume of purchases in the annual period, it recognizes revenue at a blended rate based on estimated total
annual volume and sales revenue. This effectively defers a portion of the transaction price on initial purchases below the specified
volumes for recognition when the higher discount is earned on purchases in excess of specified volumes. Transfer of control of
the products occurs upon shipment or delivery to the distributor as applicable.
Institutional
market. The Company’s institutional sales are made to hospitals and home health care centers, pulmonary rehabilitation
centers and other clinics. Sales to these institutions are negotiated with the individual institution or with group purchasing
organizations, with payments received directly from the institution. No insurance reimbursement is involved. Generators are either
sold or leased to the institutions and associated hoses and wraps (used in institutional settings rather than vests) are sold
separately. Accordingly, each product is distinct and considered a separate performance obligation in sales to institutional customers.
The agreements with institutions fall into two main types, distinguished by differences in the timing of transfer of control and
timing of payments:
|
●
|
Outright
sale – Under these transactions, the Company sells its products for a prescribed
or negotiated price. Transfer of control of the product, and associated revenue recognition,
occurs at the time of shipment and payment is made within normal credit terms, usually
within 30 days.
|
|
●
|
Rentals
– Under these transactions, the customer obtains a right to use the product for
a period of time in exchange for consideration as usage occurs. These transactions are
treated as operating leases and revenue is recognized ratably over the applicable rental
period. Lease revenue recognized during fiscal 2020 and 2019 was approximately $6,000
and $38,000, respectively.
|
International
market. Sales to international markets are made directly to a number of independent distributors at fixed contract prices
that are not subject to further adjustments for variable consideration. Transfer of control of the products occurs upon shipment
or delivery to the distributor as applicable.
Product
Warranty. The Company offers warranties on its products. These warranties are assurance type warranties not sold on a standalone
basis or are otherwise considered immaterial in the context of the contract, and therefore are not considered distinct performance
obligations under ASC 606. The Company estimates the costs that may be incurred under its warranties and records a liability in
the amount of such costs at the time the product is sold.
Accounts
receivable. Accounts receivable include amounts billed to customers and third-party payers, for which only the passage of
time is required before payment of consideration is due. Amounts due are stated at their net estimated realizable value.
Contract
assets. Contract assets include amounts recognized as revenue that are estimates of variable consideration for Medicare appeals
where the final determination of the insurance coverage amount is dependent on future approval of an appeal, or when the consideration
due to the Company is dependent on a future event such as the patient meeting a deductible prior to the Company’s claim
being processed by the payer. Contract assets are classified as current as amounts will turn into accounts receivable and be collected
during the Company’s normal business operating cycle. Contract assets are reclassified to accounts receivable when the right
to receive payment is unconditional.
Incremental
costs to obtain a contract. Sales incentives paid to sales representatives are eligible for capitalization as they are incremental
costs that would not have been incurred without entering into a specific sales arrangement and are recoverable through the expected
margin on the transaction. However, the recovery period is less than one year as the performance obligation is satisfied
upon shipment or delivery. Consequently, the Company applies the practical expedient provided by ASC 340 and expense sales incentives
as incurred. These costs are included in selling, general and administrative expenses in the Company’s statements of operations.
Contract
balances. The following table provides information about accounts receivable and contracts assets from contracts with customers:
|
|
June
30, 2020
|
|
|
June
30, 2019
|
|
Receivables, included in “Accounts receivable, net of allowance for doubtful accounts”
|
|
$
|
12,940,677
|
|
|
$
|
12,760,042
|
|
Contract assets
|
|
$
|
902,619
|
|
|
$
|
995,847
|
|
Significant
changes in contract assets during the period are as follows:
|
|
Twelve
Months Ended
|
|
|
Fiscal
Year Ended
|
|
|
|
June
30, 2020
|
|
|
June
30, 2019
|
|
|
|
Increase
(decrease)
|
|
|
Increase
(decrease)
|
|
Contract assets, beginning
|
|
$
|
995,847
|
|
|
$
|
776,338
|
|
Reclassification of contract assets to accounts receivable
|
|
|
(1,857,818
|
)
|
|
|
(2,012,619
|
)
|
Contract assets recognized
|
|
|
1,733,835
|
|
|
|
2,169,835
|
|
Increase as a result of changes in the estimate of amounts to be realized from payers, excluding amounts transferred to receivables during the period
|
|
|
30,755
|
|
|
|
62,293
|
|
Contract assets, ending
|
|
$
|
902,619
|
|
|
$
|
995,847
|
|
The
components of inventories at June 30, 2020 and 2019 were approximately as follows:
|
|
June
30,
|
|
|
|
2020
|
|
|
2019
|
|
Parts inventory
|
|
$
|
2,271,000
|
|
|
$
|
1,783,000
|
|
Work in process
|
|
|
127,000
|
|
|
|
444,000
|
|
Finished goods
|
|
|
827,000
|
|
|
|
521,000
|
|
Estimated inventory to be returned
|
|
|
150,000
|
|
|
|
184,000
|
|
Less: Reserve for obsolescence
|
|
|
(290,000
|
)
|
|
|
(310,000
|
)
|
Total
|
|
$
|
3,085,000
|
|
|
$
|
2,622,000
|
|
|
Note
4.
|
Property
and Equipment
|
Property
and equipment were approximately as follows:
|
|
Estimated
Useful Lives (Years)
|
|
|
June
30,
|
|
|
|
|
|
2020
|
|
|
2019
|
|
Building and building improvements
|
|
|
15-39
|
|
|
$
|
3,437,000
|
|
|
$
|
1,977,000
|
|
Land
|
|
|
N/A
|
|
|
|
200,000
|
|
|
|
200,000
|
|
Land improvements
|
|
|
15
|
|
|
|
166,000
|
|
|
|
166,000
|
|
Equipment
|
|
|
3-7
|
|
|
|
3,311,000
|
|
|
|
3,082,000
|
|
Demonstration and rental equipment
|
|
|
3
|
|
|
|
1,075,000
|
|
|
|
1,018,000
|
|
Construction in progress
|
|
|
15-39
|
|
|
|
16,000
|
|
|
|
1,090,000
|
|
|
|
|
|
|
|
|
8,205,000
|
|
|
|
7,533,000
|
|
Less: Accumulated depreciation
|
|
|
|
|
|
|
(4,417,000
|
)
|
|
|
(3,928,000
|
)
|
Net property and equipment
|
|
|
|
|
|
$
|
3,788,000
|
|
|
$
|
3,605,000
|
|
During
fiscal 2020 and 2019, the Company impaired or disposed of certain property and equipment, no longer in use, with a net value of
approximately $3,000 and $11,000, respectively, which was included as an expense in cost of revenues or selling, general and administrative
expense on the statements of operations.
|
Note
5.
|
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 fiscal 2019, the Company abandoned certain domestic and foreign
patents with a net value of approximately $5,000 which was included as an expense in selling, general and administrative expense
on the statements of operations. Accumulated amortization was approximately $1,119,000 and $1,010,000 at June 30, 2020 and 2019,
respectively.
The
activity and net balances of finite-life intangible assets were approximately as follows:
|
|
Years
Ended June 30,
|
|
|
|
2020
|
|
|
2019
|
|
Balance, beginning
|
|
$
|
581,000
|
|
|
$
|
649,000
|
|
Additions
|
|
|
139,000
|
|
|
|
58,000
|
|
Abandonments
|
|
|
—
|
|
|
|
(5,000
|
)
|
Amortization expense
|
|
|
(122,000
|
)
|
|
|
(121,000
|
)
|
Balance, ending
|
|
$
|
598,000
|
|
|
$
|
581,000
|
|
Based
on the carrying value as of June 30, 2020, future amortization is expected to be approximately as follows:
Fiscal years ending June 30:
|
|
|
|
|
2021
|
|
|
$
|
125,000
|
|
2022
|
|
|
|
91,000
|
|
2023
|
|
|
|
29,000
|
|
2024
|
|
|
|
25,000
|
|
2025
|
|
|
|
23,000
|
|
Thereafter
|
|
|
|
305,000
|
|
Total
|
|
|
$
|
598,000
|
|
|
Note
6.
|
Financing Arrangements
|
The
Company has a credit facility that provides for a revolving line of credit and a term loan. Effective December 18,
2019, 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, 2020 or June 30, 2019. Interest on borrowings under the line of credit, if any, accrues at the prime rate (3.25%
at June 30, 2020) less 1.00% 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, 2020, if not renewed.
At June 30, 2020, the maximum $2,500,000 was eligible for borrowing. The line of credit is secured by a security interest in substantially
all the tangible and intangible assets of the Company.
The
documents governing the line of credit 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.
Authorized
shares: The Company’s Articles of Incorporation, as amended, 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 8.
|
Share-Based
Payments
|
Share-based
compensation expense for fiscal 2020 and 2019 was approximately $902,000 and $924,000, respectively, related to employee options
and restricted stock awards. At June 30, 2020, the Company had approximately $409,000 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 expire
ten years from the grant date and vest over a period of up to five years. In November 2017, the Company’s shareholders approved
the 2017 Omnibus Incentive Plan (the “2017 Plan”) which supersedes the 2014 Equity Incentive Plan (the “2014
Plan”). The 2017 Plan allows the Company’s Board of Directors to grant stock options, stock appreciation rights, restricted
stock, restricted stock units and other stock-based awards, as well as cash incentive awards to all employees, non-employee directors,
and advisors or consultants of the Company. The vesting schedule and term for each award are determined by the Board upon each
grant. The maximum number of shares of common stock available for issuance under the 2017 Plan is 900,000. There were 316,249
options granted under the 2014 Plan and prior plans outstanding as of June 30, 2020. There were 274,531 options issued under the
2017 Plan outstanding and 505,800 shares available for grant under the 2017 Plan as of June 30, 2020.
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,
|
|
|
|
2020
|
|
|
2019
|
|
Risk-free
interest rate
|
|
|
1.85
|
%
|
|
|
2.36-2.77
|
%
|
Expected
term (years)
|
|
|
6
|
|
|
|
6
|
|
Expected
volatility
|
|
|
190.1
|
%
|
|
|
182.4-192.0
|
%
|
The
following table presents employee option activity for fiscal 2020 and 2019:
|
|
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, 2018
|
|
|
902,059
|
|
|
$
|
2.63
|
|
|
$
|
3.47
|
|
|
|
5.31
|
|
Granted
|
|
|
193,750
|
|
|
|
5.28
|
|
|
|
5.41
|
|
|
|
—
|
|
Exercised
|
|
|
(79,692
|
)
|
|
|
2.15
|
|
|
|
3.16
|
|
|
|
—
|
|
Canceled or Forfeited
|
|
|
(333,117
|
)
|
|
|
2.81
|
|
|
|
3.92
|
|
|
|
—
|
|
Options outstanding at June 30, 2019
|
|
|
683,000
|
|
|
|
3.35
|
|
|
|
3.84
|
|
|
|
6.96
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Granted
|
|
|
149,300
|
|
|
|
5.19
|
|
|
|
5.29
|
|
|
|
—
|
|
Exercised
|
|
|
(194,670
|
)
|
|
|
2.47
|
|
|
|
3.08
|
|
|
|
—
|
|
Canceled or Forfeited
|
|
|
(46,850
|
)
|
|
|
5.16
|
|
|
|
5.34
|
|
|
|
—
|
|
Options outstanding at June 30, 2020
|
|
|
590,780
|
|
|
|
3.96
|
|
|
|
4.34
|
|
|
|
6.87
|
|
Options exercisable at June 30, 2020
|
|
|
445,655
|
|
|
|
3.54
|
|
|
|
3.99
|
|
|
|
6.31
|
|
The
aggregate intrinsic value of options outstanding was $6,529,000 and options exercisable were $5,079,000 at June 30, 2020. There
were 194,670 and 79,692 options exercised during the fiscal years ended June 30, 2020 and June 30, 2019, respectively.
Restricted
stock: The 2014 Plan permitted, and the 2017 Plan permits the Personnel and Compensation Committee of the Board to grant other
stock-based awards, including restricted stock. The Company makes restricted stock grants to key employees and non-employee directors
that vest over six months to three years following the applicable grant date.
The
Company issued restricted stock awards to employees totaling 35,000 and 30,000 during fiscal 2020 and 2019, respectively, with
a vesting term of one to three years and a fair value of $5.84 and $5.42 per share, respectively. During fiscal 2020 and 2019,
the Company issued restricted stock awards to directors totaling 18,000 and 10,000, respectively, with a vesting term of six months
and a fair value of $9.74 and $5.70 per share, respectively. Restricted stock transactions during the years ended June 30, 2020
and 2019 are summarized as follows:
|
|
Shares
of
Restricted
Stock
|
|
|
Weighted-Average
Grant
Date Fair
Value
per Share
|
|
Outstanding at June 30, 2018
|
|
|
29,998
|
|
|
$
|
4.96
|
|
Granted
|
|
|
40,000
|
|
|
$
|
5.49
|
|
Vested
|
|
|
(40,000
|
)
|
|
$
|
5.12
|
|
Outstanding at June 30, 2019
|
|
|
29,998
|
|
|
$
|
5.46
|
|
Granted
|
|
|
53,000
|
|
|
$
|
7.17
|
|
Vested
|
|
|
(45,833
|
)
|
|
$
|
6.83
|
|
Forfeited
|
|
|
(14,666
|
)
|
|
$
|
6.23
|
|
Outstanding at June 30, 2020
|
|
|
22,499
|
|
|
$
|
6.19
|
|
Components
of the provision for income taxes for fiscal 2020 and 2019 were as follows:
|
|
Years
Ended June 30,
|
|
|
|
2020
|
|
|
2019
|
|
Current:
|
|
|
|
|
|
|
|
|
Current Federal
|
|
$
|
922,000
|
|
|
$
|
945,000
|
|
Current State
|
|
|
282,000
|
|
|
|
260,000
|
|
Total Current
|
|
|
1,204,000
|
|
|
|
1,205,000
|
|
Deferred:
|
|
|
|
|
|
|
|
|
Deferred Federal
|
|
|
(70,000
|
)
|
|
|
(190,000
|
)
|
Deferred State
|
|
|
(56,000
|
)
|
|
|
(75,000
|
)
|
Total Deferred
|
|
|
(126,000
|
)
|
|
|
(265,000
|
)
|
|
|
|
|
|
|
|
|
|
Total Income Tax Expense
|
|
$
|
1,078,000
|
|
|
$
|
940,000
|
|
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,
|
|
|
|
2020
|
|
|
2019
|
|
Tax expense at statutory federal rate
|
|
$
|
1,100,000
|
|
|
$
|
611,000
|
|
State income tax expense, net of federal tax effect
|
|
|
151,000
|
|
|
|
155,000
|
|
Change in valuation allowance on deferred tax assets
|
|
|
91,000
|
|
|
|
—
|
|
Change in uncertain tax positions
|
|
|
—
|
|
|
|
8,000
|
|
Other permanent items
|
|
|
(264,000
|
)
|
|
|
166,000
|
|
Income tax expense
|
|
$
|
1,078,000
|
|
|
$
|
940,000
|
|
The
effective tax rates for fiscal 2020 and 2019 were 20.6% and 32.3%, respectively.
The
significant components of deferred income taxes were as follows:
|
|
June 30,
|
|
|
|
2020
|
|
|
2019
|
|
Deferred tax assets (liabilities):
|
|
|
|
|
|
|
|
|
Revenue recognition and accounts receivable reserves
|
|
$
|
468,000
|
|
|
$
|
468,000
|
|
Accrued liabilities
|
|
|
253,000
|
|
|
|
246,000
|
|
Property and equipment
|
|
|
(202,000
|
)
|
|
|
(201,000
|
)
|
Finite-life intangible assets
|
|
|
(6,000
|
)
|
|
|
(6,000
|
)
|
Stock options
|
|
|
458,000
|
|
|
|
421,000
|
|
Tax credits and net operating loss carryforwards
|
|
|
92,000
|
|
|
|
82,000
|
|
Accounting method change
|
|
|
(282,000
|
)
|
|
|
(420,000
|
)
|
Valuation allowance on deferred taxes
|
|
|
(91,000
|
)
|
|
|
—
|
|
Other
|
|
|
65,000
|
|
|
|
39,000
|
|
Net deferred tax assets
|
|
$
|
755,000
|
|
|
$
|
629,000
|
|
The
Company has state tax credit carryforwards of $91,000, net of federal taxes, which if unused, will begin to expire in years 2026
and 2034. The Company has taken a full valuation allowance against these credits which relate to R&D tax credits in Minnesota,
a state in which the Company has a low state apportionment factor.
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 expense were approximately as follows:
|
|
Years
Ended June 30,
|
|
|
|
2020
|
|
|
2019
|
|
Beginning balance of unrecognized tax benefits
|
|
$
|
11,000
|
|
|
$
|
—
|
|
Increase (decrease) in unrecognized tax expense
|
|
|
(11,000
|
)
|
|
|
11,000
|
|
Lapse of statute of limitations
|
|
|
—
|
|
|
|
—
|
|
Ending balance of unrecognized tax benefits
|
|
$
|
—
|
|
|
$
|
11,000
|
|
The
Company recognizes interest and penalties accrued related to unrecognized tax benefits in income tax expense. During fiscal 2020
and 2019 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 the Company’s fiscal year ended June 30, 2017 are no longer open to federal, state and local examination
by taxing authorities.
The
Company has four leases for office and warehouse space that require monthly payments. These leases have escalating payments ranging
from approximately $400 to $4,400 per month which expire through July 2022 and are recognized on a straight-line basis over the
life of the lease. The Company has a lease for office equipment that requires payments of approximately $1,600 per month through
August 2022. All leases are classified as operating leases which do not include renewal options. The Company currently does not
have any short-term or variable lease costs. The Company applied the practical expedient to calculate the present value of the
fixed payments without having to perform an allocation to lease and non-lease components.
The
Company has recognized right of use assets associated with its operating leases of approximately $80,000 and $45,000 as of June
30, 2020 and June 30, 2019, respectively, which is included in other assets on the Company’s balance sheet. Operating lease
liabilities were $81,000 and $45,000 as of June 30, 2020 and June 30, 2019, respectively, which are included in current maturities
of long-term liabilities and other long-term liabilities on the Company’s balance sheet.
As
of June 30, 2020, the Company has a weighted-average lease term of 0.5 years for its operating leases, which have a weighted-average
discount rate of 4.0%. Operating lease payments of $73,000 are included in operating cash flows in Fiscal 2020.
Maturities
of lease liabilities, which are included in current maturities of long-term liabilities and other long-term liabilities on the
Company’s balance sheet, are as follows:
Fiscal years ending June 30:
|
|
|
|
2021
|
|
$
|
73,000
|
|
2022
|
|
|
9,000
|
|
2023
|
|
|
1,000
|
|
Total lease payments
|
|
|
83,000
|
|
Less:
Interest
|
|
|
(2,000
|
)
|
Present value of lease liabilities
|
|
$
|
81,000
|
|
|
Note 11.
|
Commitments
and Contingencies
|
Litigation:
The Company may occasionally be party to actions, proceedings, claims or disputes arising in the ordinary course of business.
The Company insures certain 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 fiscal 2020 and 2019, were approximately $329,000 and $336,000, respectively.
Employment
Agreements: The Company has entered into formal employment agreements with its President and Chief Executive Officer and its
Chief Financial Officer, as amended from time to time. These agreements provide these officers with, among other things, twelve
to eighteen months of base salary upon a termination without “Cause” or in the event the employee resigns for “Good
Reason” or within twelve months of a “Change in Control,” as such terms are defined in the respective employment
agreements.