ELECTROMED, INC. – 10-Q – 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 unaudited Condensed Financial
Statements and related notes thereto included in Part I, Item 1 of this
Quarterly Report on Form 10-Q, and our audited financial statements and related
notes thereto included in Part II, Item 8 of our Annual Report on Form 10-K for
the fiscal year ended June 30, 2021 ("fiscal 2021").



Overview



Electromed, Inc. ("we," "our," "us," "Electromed" or the "Company") develops and
provides innovative airway clearance products applying High Frequency Chest Wall
Oscillation ("HFCWO") technologies in pulmonary care for patients of all ages.



We manufacture, market and sell products that provide HFCWO, including the
SmartVest® Airway Clearance System ("SmartVest System") that includes our newest
generation SmartVest SQL® and previous generation SV2100, and related products,
to patients with compromised pulmonary function. The SmartVest SQL is smaller,
quieter and lighter than our previous product, with enhanced programmability and
ease of use. Our products are sold in both the home health care market and the
institutional market for use by patients in hospitals, which we refer to as
"institutional sales." The SmartVest SQL has been sold in the domestic home care
market since 2014. In 2015, we launched the SmartVest SQL into institutional and
certain international markets. In June 2017, we announced the launch of the
SmartVest SQL with SmartVest Connect™ wireless technology, which allows data
connection between physicians and patients to track therapy performance and
collaborate in treatment decisions. SmartVest Connect is currently available to
pediatric and cystic fibrosis patients and was made available to certain
targeted adult pulmonary clinics starting in November 2017. Since 2000, we have
marketed the SmartVest System and its predecessor products to patients suffering
from cystic fibrosis, bronchiectasis and repeated episodes of pneumonia.
Additionally, we offer our products to a patient population that includes
neuromuscular disorders such as cerebral palsy, muscular dystrophies,
amyotrophic lateral sclerosis ("ALS"), the combination of emphysema and chronic
bronchitis commonly known as chronic obstructive pulmonary disease ("COPD"), and
patients with post-surgical complications or who are ventilator dependent or
have other conditions involving excess secretion and impaired mucus transport.



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The SmartVest System is often eligible for reimbursement from major private
insurance providers, health maintenance organizations ("HMOs"), state Medicaid
systems, and the federal Medicare system, which we believe is an important
consideration for patients considering an HFCWO course of therapy. For domestic
sales, the SmartVest System may be reimbursed under the Medicare-assigned
billing code (E0483) for HFCWO devices if the patient has cystic fibrosis,
bronchiectasis (including chronic bronchitis or COPD that has resulted in a
diagnosis of bronchiectasis), or any one of certain enumerated neuromuscular
diseases, and can demonstrate that another less expensive physical or mechanical
treatment did not adequately mobilize retained secretions. Private payers
consider a variety of sources, including Medicare, as guidelines in setting
their coverage policies and payment amounts.

Critical Accounting Policies and Estimates

For a description of our critical accounting policies, estimates and assumptions
used in the preparation of our financial statements, including the unaudited
Condensed Financial Statements in this Quarterly Report on Form 10-Q, see Note 1
to our unaudited Condensed Financial Statements included in Part I, Item 1 of
this Quarterly Report on Form 10-Q and Part II, Item 7, and Note 1 to our
audited financial statements included in Part II, Item 8, of our Annual Report
on Form 10-K for fiscal 2021.

Some of our accounting policies require us to exercise significant judgment in
selecting the appropriate assumptions for calculating financial statements. Such
judgments are subject to an inherent degree of uncertainty. Among other factors,
these judgments are based upon our historical experience, known trends in our
industry, terms of existing contracts and other information from outside
sources, as appropriate. We believe the critical accounting policies that
require the most significant assumptions and judgments in the preparation of our
financial statements, including the unaudited Condensed Financial Statements
contained in this Quarterly Report on Form 10-Q, include: revenue recognition
and the estimation of variable consideration, allowance for doubtful accounts,
inventory obsolescence, share-based compensation and warranty liability.

Impacts of COVID-19 on Our Business and Operations

In March 2020, the World Health Organization designated COVID-19 as a global
pandemic, and the U.S. Department of Health and Human Services designated
COVID-19 as a public health emergency. 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 and distribution 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.



During the first quarter of our fiscal year ending June 30, 2022 ("fiscal
2022"), we experienced a reduction in the number of clinics allowing
face-to-face access by our sales team as the number of infections relating to
the delta variant of COVID-19 increased throughout most regions of the United
States and hospitals implemented additional safety protocols. Our sales team
continued to utilize a hybrid sales process of virtual and face-to-face
clinician interaction with strict adherence to specific clinic and healthcare
system safety protocols, which we believe allowed them to drive stronger
referral growth compared to the prior-year period.



We believe that the impact of the COVID-19 pandemic on our home care and
institutional business will likely continue during the remainder of fiscal 2022.
Our home care and institutional revenue for the three months ended September 30,
2021 has increased as compared to the three months ended September 30, 2020;
however, if COVID-19 infection rates increase and federal, state and local
restrictions on commerce, stay-at-home orders or other restrictions on
businesses are reinstated, then such measures could have a material adverse

effect on our business.

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We have observed some minor changes to our supply chain timelines and increased
raw material and shipping costs during the most recent quarter, but we have not
experienced any material adverse impacts on our supply chain or product costs at
this time. It is possible the COVID-19 pandemic could have an adverse impact on
our supply chain in the future, including impacts associated with preventative
and precautionary measures that other businesses and applicable governments are
taking. A reduction or interruption in any of our manufacturing processes could
have a material adverse effect on our business. Any significant increases to our
raw material or shipping costs could reduce our gross margins.



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 governmental orders, primarily due to our role in manufacturing
and supplying needed medical devices to patients with respiratory-related issues
and have therefore continued to operate during the government restrictions put
in place in response to the pandemic.



In response to the COVID-19 pandemic and the U.S. federal government's
declaration of a public health emergency, the Centers for Medicare & Medicaid
Services ("CMS") implemented a number of temporary rule changes and waivers to
allow prescribers to best treat patients during the period of the public health
emergency. These waivers became effective on  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 while the waiver is in
place. The CMS waiver was recently extended in conjunction with the extension of
the federal public health emergency for an additional 90-day period beginning
October 15, 2021.



The Company continues to evaluate the scope and application of existing, pending
and potential COVID-19 vaccination mandates and their potential impacts on our
future financial condition and results of operations.



In September 2021, President Biden announced a proposed new regulation requiring
all employers with at least 100 employees to ensure that their employees are
fully vaccinated or require unvaccinated workers to obtain a negative COVID-19
test at least once per week. The Department of Labor's Occupational Safety and
Health Administration has been charged with drafting an emergency temporary
standard implementing this announced directive. As a company with more than 100
employees, we expect to be subject to the regulation. It remains unclear when
the regulation may take effect, if the vaccination mandate will apply to all
employees or only employees who work in office environments, how compliance will
be documented, and what standards will apply with respect to any vaccination or
testing options or exceptions.



Additionally, in September 2021 President Biden signed an executive order
directing executive departments and agencies to include a clause in all covered
federal contracts to comply with guidance issued by the Safer Federal Workforce
Task Force, which requires, among other things, covered federal contractor
employees, including employees working remotely related to federal contracts, to
be fully vaccinated by December 8, 2021, unless the employee is entitled to an
accommodation. As a federal contractor to the Department of Veterans Affairs
Federal Supply Schedule ("Veterans Administration"), we are subject to this
regulation.  Approximately $557,000, or 1.6%, of our fiscal 2021 total revenues,
were attributable to the Veterans Administration, and we intend to leverage that
business as a future growth opportunity; approximately 19 million U.S. veterans
were served by the Veterans Administration healthcare system in calendar year
2020.



It is currently not possible to predict with certainty the specific quantitative
or operational impacts existing or future vaccination requirements may have on
our operations, including potential employee attrition. We anticipate achieving
compliance with any applicable requirements, but we cannot be certain that all
personnel will agree to required vaccinations or otherwise qualify for
permissible accommodations. We are working to identify potential at-risk roles
to minimize potential business disruption. If we were to lose employees, it
could impact our ability to meet customer demand and have an adverse effect on
future revenues and costs, which could be material. Accordingly, the pending and
proposed new regulations could have a material adverse effect on our business
and results of operations.



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Results of Operations



Net Revenues

Net revenues for the three months ended September 30, 2021 and 2020 are
summarized in the table below (dollar amounts in thousands).

                                            Three Months Ended September 30,
                                              2021                    2020               Increase (Decrease)
Home care                               $       9,284,000       $      7,464,000     $  1,820,000           24.4 %
Institutional                                     449,000                278,000          171,000           61.5 %
Home care distributor                             156,000                178,000          (22,000 )        (12.4 % )
International                                     112,000                 84,000           28,000           33.3 %
Total                                   $      10,001,000       $      8,004,000     $  1,997,000           25.0 %




Home care revenue. Home care revenue for the three months ended September 30,
2021 was approximately $9,284,000, representing an increase of approximately
$1,820,000, or 24.4%, compared to the same period in fiscal 2021.  The increase
was primarily due to an increase in referrals and approvals. The increase in
referrals was due to increased productivity from existing sales representatives,
an increase in direct sales representatives, the sales team adapting to a hybrid
virtual and face-to-face selling model implemented to combat clinic access
limitations due to the COVID-19 pandemic, and continued benefits of the CMS
waiver on the non-commercial Medicare portion of our home care revenue.



The CMS waiver continues to benefit the non-commercial Medicare portion of our
home care revenue by increasing the number of referrals and the approval
percentage for non-covered diagnoses. We believe that our ongoing sales team
execution, along with the expected return to pre-COVID-19 levels of patient
face-to-face engagement with physicians and clinic access for our sales team,
has the potential to mitigate the impact of a CMS waiver expiration, which is
currently effective until January 2022.



Institutional revenue. Institutional revenue for the three months ended
September 30, 2021 was approximately $449,000, representing an increase of
approximately $171,000, or 61.5%, compared to the same period in fiscal 2021.
The increase in the current year period was due to increased capital purchases
and stronger disposable volumes compared to the prior year period, as hospitals
resumed utilization of HFCWO protocols, after reducing utilization early in

the
COVID-19 pandemic.

Home care distributor revenue. Home care distributor revenue for the three
months ended September 30, 2021 was approximately $156,000, representing a
decrease of approximately $22,000, or 12.4%, compared to the same period in
fiscal 2021. We began selling to a limited number of 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 for the three months ended
September 30, 2021 was approximately $112,000, representing an increase of
approximately $28,000, or 33.3%, compared to the same period in fiscal 2021.
International sales are affected by the timing of international distributor
purchases which can cause significant fluctuations in reported revenue on a
quarterly basis.

Gross profit



Gross profit increased to approximately $7,701,000, or 77.0% of net revenues,
for the three months ended September 30, 2021, from approximately $6,148,000, or
76.8% of net revenues, in the same period in fiscal 2021. The increase in gross
profit dollars for the three months ended September 30, 2021 was primarily due
to stronger home care revenue. The increase in gross profit percentage was
primarily due to favorable revenue mix, partially offset by increased raw
material and shipping costs.



Operating expenses

Selling, general and administrative expenses. Selling, general and
administrative ("SG&A") expenses were approximately $6,787,000 for the three
months ended September 30, 2021, representing an increase of approximately
$1,783,000, or 35.6%, compared to the same period in the prior year.

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Payroll and compensation-related expenses were approximately $4,015,000 for the
three months ended September 30, 2021, representing an increase of approximately
$716,000, or 21.7%, compared to the same period in the prior year. The increase
in the current year period was due to a higher average number of employees in
sales and marketing roles, increased commissions on higher home care revenue,
two separate merit increases, including a December 2020 merit increase that was
originally delayed from the normal July 2020 timing, and increased health
insurance costs. Field sales employees totaled 51 at the end of Q1 FY 2022, 41
of which were direct sales representatives, compared to 42 field sales employees
and 35 direct sales representatives at the end of Q1 FY 2021.



Travel, meals and entertainment expenses were approximately $641,000 for the
three months ended September 30, 2021, representing an increase of approximately
$277,000 or 76.1%, compared to the same period in the prior year. The increase
in the current year period was primarily due to our sales representatives
resuming closer-to-normal levels of travel compared to the COVID-19 driven
travel restrictions in the prior year, and a national sales meeting that was
held in the current fiscal quarter but was not held in the prior year due to
COVID-19.

Total discretionary marketing expenses were approximately $153,000 for the three
months ended September 30, 2021, representing a decrease of approximately
$36,000, or 19.0%, compared to the same period in the prior year. The decrease
in the current year period was primarily due to a shift to more cost-effective
direct-to-consumer marketing investments.



Professional fees for the three months ended September 30, 2021 were
approximately $1,111,000, an increase of approximately $657,000, or 144.7%,
compared to the same period in the prior year. Professional fees are primarily
for services related to legal costs, shareowner services and reporting
requirements, information technology technical support and consulting fees. The
increase in the current year period was primarily due to increased costs related
to shareholder activism, which concluded with a cooperation agreement that
became effective in September 2021. Shareholder activism related costs primarily
consisted of communication firm consulting fees, legal cost, settlement costs
and proxy solicitation fees. We also continued to make key investments in our
systems infrastructure, including investments in our ERP system, enhancements to
our customer relationship management system, and further optimization of the
revenue cycle management system that was implemented in June 2021. We expect to
make continued investments in our systems infrastructure over the next year,
which we expect will result in more efficient and scalable operational processes
and provide enhanced analytics to drive business performance.



Research and development expenses. Research and development ("R&D") expenses
were approximately $376,000 for the three months ended September 30, 2021,
representing a decrease of approximately $105,000 compared to the same period in
the prior year. The decrease in the current year period was primarily due to
reduced professional services costs associated with our next generation platform
development. R&D expenses for the three months ended September 30, 2021 were
3.8% of revenue compared to 6.0% of revenue for the same period in the prior
year.



Interest income, net

Net interest income for the three months ended September 30, 2021 was
approximately $9,000, which was essentially flat compared to the prior year
period. Interest earned on our cash balance remains at a historically low rate.

Income tax expense



Income tax expense was estimated at $108,000 and $137,000 and the effective tax
rate was 19.7% and  20.4% for the three months ended September 30, 2021 and
2020, respectively. Estimated income tax expense for the three months  ended
September 30, 2021 included a $20,000 discrete tax benefit related to the
exercise of stock options. The net impact of this discrete event decreased the
estimated effective tax rates by 3.7% during the three months ended September
30, 2021. The income tax expense for the three months ended September 30, 2020
includes a discrete tax benefit of $39,000 related to the exercise of stock

options.



Net income

Net income for the three months ended September 30, 2021 was approximately
$439,000 compared to approximately $535,000 for the same period in the prior
year. The decrease in the current year period was primarily due to costs related
to the shareholder activism matter and increased investment in SG&A, partially
offset by stronger revenue performance.



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Liquidity and Capital Resources

Cash Flows and Sources of Liquidity

Cash Flows from Operating Activities

For the three months ended September 30, 2021, net cash used by operating
activities was approximately $576,000. Cash flows provided by operating
activities consisted of net income of approximately $439,000, an increase in
accounts payable and accrued liabilities of $396,000, non-cash expenses of
$439,000, a decrease in contract assets of $74,000, and a decrease in inventory
of $91,000. These cash flows from operating activities were offset by an
increase in accounts receivable of $1,331,000, an increase in prepaid expenses
and other assets of $186,000, and an increase in income tax receivable of
$498,000. The increase in accounts receivable was primarily due to an increase
in the Medicare portion of our home care business, which has a 13-month payment
cycle.

Cash Flows from Investing Activities

For the three months ended September 30, 2021, cash used in investing activities
was approximately $270,000. Cash used in  investing activities consisted of
approximately $225,000 in investments in property and equipment primarily for
our next generation platform, and approximately $45,000 in expenditures for
intangible asset costs.

Cash Flows from Financing Activities

For the three months ended September 30, 2021, cash used in financing activities
was approximately $63,000, which consisted of taxes paid on net share
settlements of stock option exercises.

Adequacy of Capital Resources

Our primary working capital requirements relate to adding employees to our sales
force and support functions, continuing R&D efforts, IT infrastructure projects,
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 $27,617,000 and available borrowings under our existing credit
facility will provide adequate liquidity during fiscal 2022.



Effective December 18, 2020, 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 September 30, 2021) less 1.00% and is
payable monthly. There was no outstanding principal balance on the line of
credit as of September 30, 2021 or June 30, 2021. 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,
2021, if not renewed. At September 30, 2021, 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.



For the three months ended September 30, 2021 and 2020, we spent approximately
$225,000 and $16,000, respectively, on property and equipment. We currently
expect to finance planned equipment purchases with available working capital,
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.



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Off-Balance Sheet Arrangements

As of September 30, 2021, we had no off-balance sheet arrangements.

Cautionary Note Regarding Forward-Looking Statements

Statements contained in this Quarterly Report on Form 10-Q that are not
statements of historical fact should be considered forward-looking statements
within the meaning of the safe harbor provisions of Section 27A of the
Securities Act of 1933, as amended, and Section 21E of the Securities Exchange
Act of 1934, as amended (the "Exchange Act"). Forward-looking statements
include, but are not limited to, statements regarding: the expected impact of
the COVID-19 pandemic on our business; our business strategy, including our
intended level of investment in R&D and marketing activities; our expectations
with respect to earnings, gross margins and sales growth, industry
relationships, marketing strategies and international sales; estimated sizes of
markets into which our products are or may be sold; our business strengths and
competitive advantages; our ability to grow additional sales distribution
channels; our intent to retain any earnings for use in operations rather than
paying dividends; our expectation that our products will continue to qualify for
reimbursement and payment under government and private insurance programs; our
intellectual property plans and practices; the expected impact of applicable
regulations on our business; our beliefs about our manufacturing processes; our
expectations and beliefs with respect to our employees and our relationships
with them; our belief that our current facilities are adequate to support our
growth plans; our expectations with respect to ongoing compliance with the terms
of our credit facility; our expectations regarding the ongoing availability of
credit and our ability to renew our line of credit; enhancements to our products
and services; expected excise tax exemption for the SmartVest System; and our
anticipated revenues, expenses, capital requirements and liquidity. Words such
as "anticipate," "believe," "continue," "could," "estimate," "expect," "goal,"
"intend," "may," "ongoing," "plan," "potential," "project," "should," "target,"
"will," "would," and similar expressions, including the negative of these terms,
are intended to identify forward-looking statements but are not the exclusive
means of identifying such statements. Although we believe these forward-looking
statements are reasonable, they involve risks and uncertainties that may cause
actual results to differ materially from those projected by such statements.
Such statements involve known and unknown risks, uncertainties and other factors
that may cause our actual results or our industry's actual results, levels of
activity, performance or achievements to be materially different from the
information expressed or implied by the forward-looking statements.

Factors that could cause actual results to differ from those discussed in the
forward-looking statements include, but are not limited to, the following:

? the duration, extent and severity of the COVID-19 pandemic, including its

effects on our business, operations and employees as well as its impact on our

    customers and distribution channels and on economies and markets more
    generally;


  ? the competitive nature of our market;

? changes to Medicare, Medicaid, or private insurance reimbursement policies;

? supply chain disruptions that limit our ability to produce and deliver our

    products to patients;


  ? changes to state and federal health care laws;


  ? changes affecting the medical device industry;

? our ability to develop new sales channels for our products such as the home

care distributor channel;

? our need to maintain regulatory compliance and to gain future regulatory

    approvals and clearances;


  ? new drug or pharmaceutical discoveries;


  ? general economic and business conditions;


  ? our ability to renew our line of credit or obtain additional credit as
    necessary;


  ? our ability to protect and expand our intellectual property portfolio;


  ? the risks associated with expansion into international markets;

? the risks associated with cyberattacks, data breaches, computer viruses and

    other similar security threats; and


  ? the risks associated with our planned sales force expansion.


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This list of factors is not exhaustive, however, and these or other factors,
many of which are outside of our control, could have a material adverse effect
on us and our results of operations. Therefore, you should consider these risk
factors with caution and form your own critical and independent conclusions
about the likely effect of these risk factors on our future performance.
Forward-looking statements speak only as of the date on which the statements are
made, and we undertake no obligation, and expressly disclaim any such
obligation, to update any forward-looking statement for any reason other than as
required by law, even if new information becomes available or other events occur
in the future. You should carefully review the disclosures and the risk factors
described in this and other documents we file from time to time with the
Securities and Exchange Commission (the "SEC"), including our Annual Report on
Form 10-K for fiscal 2021. All forward-looking statements attributable to us or
persons acting on our behalf are expressly qualified in their entirety by the
cautionary statements set forth herein.