Electromed: Q3 Another Solid Quarter, Upgrading To Outperform.

May.13.11 | About: Electromed, Inc. (ELMD)

Q3 2011 Financial Results …

Electromed (NYSEMKT:ELMD) reported financial results for the fiscal third quarter ending March 31, 2011 on May 12, 2011. For the second straight quarter, the company beat our estimates on both the top and bottom lines. While the company does not provide revenue or earnings guidance, management's comments on the conference call may indicate that they have no reason to believe revenue momentum will stall anytime soon. We have made some slight upwards adjustments to our revenue estimates for Q4 2010 and beyond.

Revenue

Q3 revenue of $5.2 million was up 23% y-o-y (+11% sequentially) and consisted of $4.7 million (+26% y-o-y) from the Homecare segment, $143k (-46% y-o-y) from International and $367k (+56% y-o-y) from Government/Institutional.

Homecare sales continue to be driven by growth in the size of the sales force (3 reps added in the current quarter) and while not definitive, also potentially from share gains against competitors. Expansion of the sales force has almost certainly afforded deeper penetration of SmartVest into already well established (CF, bronchiectasis) indications. This strategy has clearly been successful for Electromed and we expect the company will continue to add additional sales reps for at least the next 12 months. As newly hired reps become more productive, operating expense leverage should widen and a greater percentage of revenue should flow to the bottom line.

Actual Y-o-Y Zacks Est Actual +/-
Q3 2010 Q3 2011 Change Q3 2011 Zacks est.
Homecare $3,727.0 $4,689.0 25.8% $4,432.0 5.8%
International $267.0 $143.0 -46.4% $205.0 -30.2%
Gov't / Instit. $235.0 $367.0 56.2% $220.0 66.8%
$4,229.0 $5,199.0 22.9% $4,857.0 7.0%
Click to enlarge

Total revenue came in 7% better than our estimate, driven by 6% better Homecare and 67% better Gov't/Institutional segment sales, partially offset by 30% lower than modeled International sales. As Homecare accounts for about 90% of total sales, this segment (31% y-o-y growth for the first 9 months of 2011) continues to be the major driver of Electromed's revenue growth.

Gov't/Institutional has also experienced recent significant revenue growth (+89% for the first nine months of 2011), although this segment's sales can be somewhat volatile on a short-term basis so it may be too early to conclude that this upward trajectory will continue for the longer-term. This will be something to keep an eye on as the company heads into the new fiscal year.

Gross Margin

GM came in at 71.2% compared to our 74% estimate. GM is also somewhat variable on a short-term basis (was 72.1% in Q1 and 75.6% in Q2), largely due to referral mix and related average reimbursement rates (not all insurance reimburses at the same rate).

Operating Expenses

Operating expenses were almost dead-on where we had them modeled. SG&A came in at $2.76 million versus our $2.74 million estimate, while R&D was $272k versus our $228k estimate. We continue to expect operating expenses as a percent of sales to be slightly higher in fiscal 2011 compared to the prior year as a result of head count additions and marketing initiatives. We think Electromed can begin to squeeze leverage from these "investments" during 2012 as newly hired sales reps become more seasoned and productive.

Net Income/EPS

Net income of $488k was 39% better than our $350k estimate. EPS came in at $0.06, $0.02 ahead of our $0.04 estimate. Net income and EPS benefitted from a lower than modeled income tax rate (24% actual versus 40%) as a result of realization of R&D tax credits in the quarter. Going forward, this is expected to return the historical norm of 35% - 40%.

Cash

Electromed exited the quarter with $3.95 million in cash and equivalents, compared to $5.16 million at 12/31/10. Cash used in operating activities was $1.04 million, but stripping out a $1.70 million increase in working capital including $1.38 million increase in A/R), operating cash flow was positive $654k. We see no concern with the increase in A/R as long collection times are very typical of the industry and can cause intermittent spikes in A/R. Cash position remains strong and along with cash from operations and piecemeal draws on the revolver should provide sufficient flexibility to weather any quarterly variability in working capital needs.

Valuation and Recommendation

We are raising our price target on ELMD due to a combination of moving our 2011 EPS estimate from $0.13 prior to Q3 results to $0.15 currently and comparable valuations moving higher since our last update. We are also moving our investment recommendation from Hold to Outperform due to the discrepancy between ELMD's current share price ($3.51) and our new target ($5.50).

We continue to value Electromed using Hill-Rom's (NYSE:HRC) long-term PE/G ratio as a comparable. Hill-Rom's long-term PE/G currently sits at 1.64 (up from 1.32 since our last update on ELMD). We model ELMD to post EPS of $0.34 in 2014, implying four-year CAGR of 22.4%. Backing this growth rate into the 1.64 PE/G results in a near-term P/E multiple of 37x. We look for ELMD to earn $0.15/share in fiscal 2011 which values the company at approximately $5.50 per share.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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