Electromed Inc

Condensed Balance Sheets

Condensed Statements of Operations (Unaudited)

Condensed Statements of Cash Flows (Unaudited)

Condensed Statements of Shareholders’ Equity (Unaudited)

Notes to Condensed Financial Statements (Unaudited)

Note 1. Interim Financial Reporting

**Nature of business:**Electromed, Inc. (the “Company”) develops, manufactures, and markets innovative airway clearance products that apply High Frequency Chest Wall Oscillation (“HFCWO”) therapy for pulmonary care patients. The Company markets its products in the U.S. to the homecare and hospital markets. The Company also sells internationally through distributors.

Since its inception, the Company has operated in a single industry segment: developing, manufacturing, and marketing medical equipment.

**Basis of presentation:**The accompanying unaudited Condensed Financial Statements of the Company have been prepared in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”) for interim financial statements and pursuant to the rules and regulations of the U.S. Securities and Exchange Commission. In the opinion of management, the accompanying unaudited Condensed Financial Statements reflect all adjustments consisting of normal recurring adjustments necessary for a fair presentation of the Company’s financial position and results of operations as required by Regulation S-X. Interim results of operations are not necessarily indicative of the results that may be achieved for the full year. The financial statements and related notes do not include all information and footnotes required by U.S. GAAP for annual reports. This interim report should be read in conjunction with the financial statements included in the Company’s Annual Report on Form 10-K for the fiscal year ended June 30, 2023 (“fiscal 2023”).

A summary of the Company’s significant accounting policies follows:

**Use of estimates.**Management uses estimates and assumptions in preparing the unaudited Condensed Financial Statements in accordance with 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 unaudited Condensed Financial Statements include revenue recognition and the related estimation of variable consideration, inventory valuation, share-based compensation and warranty reserve.

**Net income per common 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 would be anti-dilutive. Common stock equivalents excluded from the calculation of diluted earnings per share because their impact was anti-dilutive were 289,362 and 179,992 for the three months ended March 31, 2024, and 2023, respectively, and were 400,639 and 200,140 for the nine months ended March 31, 2024, and 2023, respectively.

Recently Issued Accounting Standards

In June 2016, the Financial Accounting Board issued Accounting Standards Update (“ASU”) 2016-13, Financial Instruments -- Credit Losses: Measurement of Credit Losses on Financial Instruments, which was subsequently amended by ASU 2018-19, ASU 2019-04, 2019-05, 2019-10, 2019-11, and 2020-02. The standard introduces new accounting guidance for credit losses on financial instruments within its scope, including trade receivables. This new guidance adds an impairment model that is based on expected losses rather than incurred losses. The company adopted the standard effective July 1, 2023. The Company’s adoption of the standard did not have a material impact on the financial statements.

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 consideration paid or payable from 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 underPerformance 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 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 in the Condensed Statements of Operations.

The timing of revenue recognition, billings and cash collections results in accounts receivable on the Condensed Balance Sheets as further described below underAccounts receivable andContract assets.

Disaggregation of revenues. In the following table, net revenues are disaggregated by market:

In the following table, net homecare revenue is disaggregated by payer type:

Revenues are recognized at a point in time when control passes to the customer upon product shipment or delivery.

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:

Homecare market. In the Company’s homecare 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 homecare market, the Company regards the SmartVest System to be a single performance obligation.

The Company makes available to its homecare 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 homecare market consist of a single performance obligation: the SmartVest System.

Homecare 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 homecare agreements as transferring control to the patient upon shipment or delivery, despite possible payment cancellation under government or commercial programs where the payer is controlling the payment over specified time periods. For homecare 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 because 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 underAccounts receivable andContract assets below.

The Company’s contractually stated transaction prices in the homecare 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 many 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 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.

Homecare 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 the right to a higher discount on purchases more than 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.

Hospital market. The Company’s hospital sales are made to hospitals and other clinics. Sales to these hospitals are negotiated with the individual hospital or with group purchasing organizations, with payments received directly from the hospital. No insurance reimbursement is involved. Generators are either sold or leased to the hospitals and associated hoses and wraps (used in hospital settings rather than vests) are sold separately. Accordingly, each product is distinct and considered a separate performance obligation in sales to hospital customers. The agreements with hospitals fall into two main types, distinguished by differences in the timing of transfer of control and timing of payments:

Other. Other revenue consists of international sales which are made directly to several independent distributors at fixed contract prices that are not subject to further adjustments for variable consideration or sales to other customers that do not fall into the markets described above. Transfer of control of the products occurs upon shipment or delivery to the distributor or customer, 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.**The Company’s accounts receivable balance is comprised of amounts due from individuals, -hospitals, 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 receivables are carried at amounts estimated to be received from patients under reimbursement arrangements with third-party payers. Accounts receivable is also net of an allowance for credit losses. Management determines the allowance for credit losses by regularly evaluating individual customer accounts and determining expected losses.

**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.

Contract balances. The following table provides information about contract assets from contracts with customers:

**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 expenses sales incentives as incurred. These costs are included in selling, general and administrative expenses in the Condensed Statements of Operations.

Note 3. Inventories

The components of inventory were as follows:

Note 4. Warranty Reserve

The Company provides a lifetime warranty on its products to the prescribed patient for sales within the U.S. and a three-year warranty for all hospital sales and sales to individuals outside the U.S. 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 reserve 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 reserve and adjusts the amounts as necessary.

Changes in the Company’s warranty reserve were as follows:

Note 5. Income Taxes

Income tax expense was estimated at $468,000 and $1,217,000, and the effective tax rate was 23.9% and 26.8% for the three and nine months ended March 31, 2024, respectively. Estimated income tax expense for the three and nine months ended March 31, 2024, includes a discrete current tax benefit of $99,000 and $95,000, respectively, primarily related to the exercise of stock options.

Income tax expense was estimated at $147,000 and $418,000, and the effective tax rate was 12.0% and 16.4% for the three and nine months ended March 31, 2023, respectively. Estimated income tax expense for the three and nine months ended March 31, 2023, includes a discrete current tax benefit of $176,000 and $219,000, respectively, related to the exercise of stock options.

The Company is subject to U.S. federal and state income tax in multiple jurisdictions. With limited exceptions, years prior to the Company’s fiscal year ended June 30, 2020, are no longer open to U.S. federal, state or local examinations by taxing authorities. The Company is not under any current income tax examinations by any federal, state or local taxing authority. If any issues addressed in the Company’s tax audits are resolved in a manner not consistent with management’s expectations, the Company could be required to adjust its provision for income taxes in the period such resolution occurs.

Note 6. Financing Arrangements

The Company has a credit facility that provides for a $2,500,000 revolving line of credit through December 18, 2025, if not renewed before such date. There wasno outstanding principal balance on the line of credit as of March 31, 2024, or June 30, 2023. Interest on borrowings under the line of credit, if any, accrues at the prime rate (8.50% on March 31, 2024) 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. On March 31, 2024, the maximum $2,500,000 was eligible for borrowing. Payment obligations under the line of credit, if any, are 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 non-financial 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.

Note 7. Common Stock

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.

On May 26, 2021, the Company’s Board of Directors (the “Board”) approved a stock repurchase authorization. Under the authorization, the Company was originally able to repurchase up to $3.0 million of shares of common stock through May 26, 2022. On May 26, 2022, the Board removed the date limitation. As of March 31, 2024, a total of 239,995 shares have been repurchased and retired under this authorization for a total cost of $2,725,000, or $11.36 per share. Repurchased shares have been retired and constitute authorized but unissued shares. There were no share repurchases for the three and nine months ended March 31, 2024.

Note 8. Share-Based Compensation

The Company’s share-based compensation plans are described in Note 8 to the financial statements included in the Company’s Annual Report on Form 10-K for fiscal 2023. Share-based compensation expense was $1,250,000 and $506,000 for the nine months ended March 31, 2024, and 2023, respectively. This expense is included in selling, general and administrative expense in the Condensed Statements of Operations.

Stock Options

Stock option transactions during the nine months ended March 31, 2024, are summarized as follows:

The following assumptions were used to estimate the fair value of stock options granted:

The intrinsic value of an option is the amount by which the fair value of the underlying stock exceeds its exercise price. On March 31, 2024, the weighted average remaining contractual term for all outstanding stock options was 6.7 years and the aggregate intrinsic value of the options was $4,878,000. Outstanding on March 31, 2024, were 637,590 stock options issued to employees, of which 319,088 were vested and exercisable and had an aggregate intrinsic value of $3,118,000. As of March 31, 2024, $925,000 of total unrecognized compensation expense related to stock options is expected to be recognized over a weighted-average period of approximately 2.8 years.

Restricted Stock

During the nine months ended March 31, 2024, the Company issued restricted stock awards to employees totaling 23,428 shares of common stock, with a weighted average vesting term of 3.0 years and a weighted average fair value of $10.74 per share, and to directors totaling 21,000 shares of common stock, with a vesting term of six months and a weighted average fair value of $10.44 per share. There were 57,661 shares of unvested restricted stock with a weighted average fair value of $10.53 per share outstanding as of March 31, 2024. As of March 31, 2024, $253,000 of total unrecognized compensation expense related to restricted stock awards is expected to be recognized over a weighted-average period of approximately 1.6 years.

Performance-Based Restricted Stock Units

The Company granted 175,000 performance-based restricted stock units (“PSUs”) to our CEO in connection with his appointment as CEO on July 1, 2023. The PSUs are to be earned based on the extent to which performance goals tied to Total Shareholder Return (“TSR”) are achieved. The performance-based restricted stock units will be eligible to vest and settle into shares of common stock on a 1-for-1 basis with respect to one-half of the shares upon achieving a total shareholder return of 50% and the remaining shares upon a total shareholder return of 100%, in each case within four years of the date of grant. The grant date fair value of the awards was determined using a Monte Carlo valuation model with an expected term of four years.

Stock based compensation expense recognized for PSUs was $217,000 and $0 for the nine months ended March 31, 2024, and 2023, respectively. The weighted average grant date fair value per unit was $6.58 and as of March 31, 2024, there are 175,000 PSUs outstanding. On March 31, 2024, there was approximately $935,000 of total unrecognized compensation expense related to outstanding PSUs that is expected to be recognized over a period of 3.25 years.

Note 9. Commitments and Contingencies

The Company is occasionally involved in claims and 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.