Delay in Growth of Sales Force Continues To Impact Revenue
By Brian Marckx, CFA
Q1 2013 Financial Results
Electromed ( ELMD) reported financial results for the fiscal 2013 first quarter ending September 30, 2012 on November 13th. Revenue was significantly below our estimate for the fourth straight quarter, continuing to be a result of complete stagnation in growing the sales rep (Clinical Area Managers, or CAMs) headcount. Electromed also cited lower than average reimbursement as a headwind, which has similarly been an issue over the last few reporting periods. Q1 2013 also saw the number of referrals decline (likely tied to the drop in CAM count) - which has not been the case in most of the previous quarters where revenue fell.
While we've been disappointed with the lack of revenue growth over the past 12 months, based on our conversations with management we remain encouraged that this is largely tied to delays in growing the CAM count and getting them up to full efficiency and that there have been no substantial fundamental changes to the market, reimbursement, or competitive environment. As such, we think that ELMD's recent issues are relatively easily addressable, in their direct control and can be rectified with proper execution of their strategy.
The CAM count stood at 21 at the end of fiscal Q1 (Sept 2012), down from 22 at the end of fiscal Q4 2012 (June 2012). ELMD has experienced CAM turnover in the recent past and it shows up directly in the income statement with a hit to revenue. Their strategy has been to increase the CAM base by about 1 - 3 reps per quarter but that hasn't come to fruition with the average CAM count stagnating in the low 20's since early calendar 2011 (i.e. - about the last 18 months).
The company is addressing this however and in August 2012 hired a Director of Sales and recently announced that they would realign sales territories, both of which are expected to facilitate the CAM count and increase sales. Management noted that they now expect to have 27 CAM's by the end of fiscal 2013 (June 2013) - which includes the 22 currently (they added one subsequent to end of Q1) and current postings out for the remaining.
We have significantly trimmed our revenue estimates for the current year which reflects the lower CAM count (relative to what our previous expectations had been). However, we do model sequential revenue growth throughout the current fiscal year which assumes that ELMD executes on their strategy of building the sales force.
Q1 revenue of $4.03 million was down almost 25% y-o-y (down 12% sequentially) and consisted of $3.57 million (-30% y-o-y) from the Homecare segment, $109k (+195% y-o-y) from International and $348k (+66% y-o-y) from Government/Institutional.
The relative weakness in the Homecare segment continues to mostly reflect stagnation in growth of the sales force as well as the reimbursement mix. As noted in the past, our modeled revenue growth estimates continue to reflect the expectation that ELMD continues to add sales headcount.
Total revenue came in about 19% less than our estimate, despite Gov't/Institutional sales coming in better than our number. ELMD recently took steps to facilitate growth of their International business including signing distribution agreements with Linde Healthcare and Leader Healthcare FZCO for the German and parts of the Middle East region, respectively, which has helped international sales which have posted yoy gains the last three quarters straight.
GM came in at 70.0% compared to our 73.1% estimate. Electromed's GM can jump around from quarter-to-quarter based on the mix of reimbursement rates and, as noted in the past, this relatively low GM is not expected to persist over the longer-term. We have slightly trimmed our GM estimates, however, given that we've estimated this slightly too high in the recent past.
SG&A came in at about $2.8 million, or 69.9% of sales, compared to our 63.6% estimate. Similar to the past three quarters where revenue also came in meaningfully below our estimate, the higher than modeled SG&A as a percent of sales is likely mostly attributable to the fixed-cost portion of SG&A which is more exposed with revenue coming in below our estimate. It's worth noting, however, that ELMD has recently taken steps to reduce operating expenses including bringing most marketing functions in-house which contributed to the 49% yoy drop ($362k vs. $183k) in advertising/marketing expenses from Q1 2012 to Q1 2013. We think this, along with other recent changes including a new compensation structure which is now being implemented, should help soften the impact to the bottom line from near-term revenue growth variability and accelerate operating leverage over the longer-term.
R&D expense was $101k (2.5% of revenue) in Q1, well below our $229k (4.6% of revenue) estimate. Management continues to expect R&D expense to average about 5% of revenue going forward.
Net Income / EPS
Net income and EPS were ($71k) and ($0.01), compared to our $123k and $0.02 estimates.
Electromed exited fiscal Q1 with $1.5 million in cash and equivalents, compared to $1.5 million at the end of Q4. Cash from operating activities was an inflow of $114k in the most recent quarter. A/R, which had been growing in the past with accelerating revenues, came down by $435k in the quarter (which aided cash from operations). Stripping out the increase in working capital, cash from operating activities was an inflow of $126k. Investing activities used $224k in the quarter.
Along with the cash balance there's about $2.6 million in borrowing capacity under the revolver. The bank debt includes up to $6MM under a revolver, $1.5MM term loan A (monthly principal, due 12/2014) and $1MM term loan B (monthly principal, due 12/2012). Terms of the revolver allow ELMD to borrow up to 60% of eligible A/R less balance on the term loan B. ELMD's balance sheet remains healthy, the company remains well capitalized and we expect ELMD to have no issues in rolling over the bank debt/credit line.
Valuation and Recommendation
We now look for revenue of $22.4 million (implying growth of ~24%) in fiscal 2014, down from $25.0 million prior to Q1 results. Our 2014 EPS estimate has moved from $0.24 to $0.16. The downward revision to our 2014 estimates as well as our out-years mostly reflects the delay in building the sales force. Management is now guiding for 27 (down from the 28 - 30 estimate provided about 3 months ago) CAMs to be on-board by fiscal 2013 year-end - our financial model more conservatively assumes approximately 24 to 26 reps are detailing by the close of 2013. EPS in our out-years moved from $0.30 to $0.22 in 2015, and $0.38 to $0.31 in 2016.
We continue to value Electromed using Hill-Rom's (HRC) long-term PE/G ratio as a comparable. Hill-Rom's long-term PE/G currently sits at 1.3. We model ELMD to post EPS of $0.31 in 2016, implying a five-year (2011 - 2016) CAGR of 18%. Based on a 1.3 PE/G, ELMD should trade at about 23x 2014 EPS or ~ $3.75/share. The stock currently trades at about $1.50. We think the stock still trades significantly below fair value. Current market value is below book value (stock currently trades at ~0.75x book value). The combination of the company being (at least intermittently) cash flow positive and the stock trading below book value should provide further downside protection in our opinion. We are maintaining our Outperform rating and moving our price target from $4.00 to $3.75 per share.
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