Tactile Systems Technology, Inc.

Welcome, ladies and gentlemen, to the third quarter of fiscal year 2022 earnings conference call for Tactile Medical. At this time, all participants have been placed in a listen-only mode. At the end of the company's prepared remarks, we will conduct a question and answer session. Please note that this conference call is being recorded and will be available on the company's website for replay shortly. Before we begin, I would like to remind everyone that our remarks and responses to your questions today may contain forward-looking statements that are based on the current expectations of management and involve inherent risks and uncertainties, which could cause actual results to differ materially from those indicated, including those identified in the risk factor section of our annual report on Form 10-K, as well as our most recent 10-Q filing to be filed with the Securities and Exchange Commission. Such factors may be updated from time to time in our filings with the SEC, which are available on our website. We undertake no obligation to publicly update or revise our forward-looking statements, as a result of new information, future events, or otherwise. This call will also include references to certain financial measures that are not calculated in accordance with generally accepted accounting principles or GAAP. We generally refer to these as non-GAAP financial measures. Reconciliations of those non-GAAP financial measures to the most comparable measures calculated and presented in accordance with GAAP are available in the earnings press release on the investor relations portion of our website. And I would now like to turn the call over to Mr. Dan Revers, Tactile Medical's President and Chief Executive Officer. Thank you, sir. Please go ahead.

Thank you, Operator. And welcome, everyone, to our third quarter earnings call. I'm joined on the line by Brent Moen, our Chief Financial Officer. I'll begin our remarks today with a high-level review of our third quarter financial performance, followed by a discussion of the factors that drove our third quarter results and an update on some of the recent operational progress we've made. Brent will then cover our quarterly financial results in greater detail and review our 2022 financial guidance, which we updated today in our earnings press release. And finally, I'll provide some thoughts on our updated outlook and continued areas of focus for 2022 before we begin the Q&A session. So let's get started with a review of our financial performance. We reported total revenue of $65.3 million for the third quarter, representing growth of 24% year over year. These results came in well above our expectation for third quarter growth of 13% to 17% year over year, which we discussed on our Q2 earnings call. Sales of our airway clearance products were the largest contributor to our stronger than anticipated revenue, contributing approximately 19 percentage points to our total revenue growth year over year. We were also pleased to see revenue from our lymphedema products increase 5% year over year, which modestly exceeded the 1% to 3% growth range we'd anticipated. In addition to our strong sales performance, we delivered significant year-over-year improvements in our profitability, increasing our gross, operating, and adjusted EBITDA margins compared to the prior year, while also maintaining our solid cash balance. Turning to a discussion of the primary drivers that contributed to our lymphedema and airway clearance sales performance, Our lymphedema business benefited from a combination of several factors. At a clinic level, we saw modest improvement in patient volumes compared to the second quarter, although pockets of clinics with staffing-related challenges do remain. At a company level, we saw a high level of engagement from our lymphedema sales reps following our training initiatives in the first half of the year and the launch of our two new products in July. In particular, the launch of our new Comfort Ease Garment has been a nice innovation for our reps to feature as they work to re-engage targeted clinics and referral sources. Additionally, we're pleased to see stabilization emerging in our field sales team, exiting the third quarter fully staffed, a consequence of improving retention and engagement. And lastly, at the clinician level, we were also pleased by the response we saw from both new and existing customers in the lymphedema channel following the launch of our new products. This was most notable in the vascular space, where Comfort Ease Garments added a fresh message. In addition to the strong sales of our lymphedema products, we enjoyed another very impressive quarter with our airway clearance products, namely the AfloVest, generating slightly over $11 million in revenue. As a reminder, we acquired the airway clearance business and its product, the AfloVest system, on September 8th of last year. and only booked about three weeks of sales in the third quarter of 2021. On a standalone basis, however, assuming it had remained a separate entity in both periods, our airway clearance product line achieved growth of 139% year-over-year in the third quarter of 2022. This performance reflects the ongoing adoption among the respiratory DME reps we've partnered with. As I've described previously, these respiratory DMEs portfolios of complementary products coupled with the existing clinicians that they serve, are leading them to both new and existing patients that are well qualified to benefit from airway clearance therapy via the AfloVest. The case for at-home treatment with AfloVest is a compelling one, as these eligible patients are likely to require hospitalization if left untreated due to recurring pulmonary infections and pneumonias. And from an economic standpoint, AfloVest receives favorable reimbursement making it a compelling product for our DME partners. With this as a backdrop, we believe the strong demand we're seeing is largely driven by identifying eligible patients that need at-home airway clearance therapy within our channel partners' existing customer base and referral networks. Importantly, we also believe our growth is benefiting from identifying patients that would have otherwise been left unidentified or untreated if not for the efforts of these reps. we couldn't be more pleased to be bringing AfloVest therapy to countless underserved patients, which is in keeping with Tactile's mission to both reveal and treat those suffering from underserved chronic diseases in their homes. During the third quarter, we also continued to see our existing DME partners expand the availability of AfloVest to additional branches within their networks, aided in part by our team of respiratory specialists. This represents another important driver of demand and one with significant runway as we continue to expand the number of reps, branches, and DMEs bringing in AfloVest's relief to more patients. Lastly, from a supply side, we continue to make progress in expanding our AfloVest production capacity. We continue to work closely with our existing supplier, and we're also able to secure some initial inventory from our new second supplier to support demand. although their initial progress remained dependent on spot buys. While we expect some lumpiness through the rest of the year, we remain on track to be fully up and running with our second supplier by year end, which should position us to keep pace with the strong demand we expect going forward. Stepping back, when we acquired our airway clearance business a year ago, it represented the largest acquisition within Tactile to date. It had generated just under $17 million in revenue over the prior 12-month period and remained in the initial phases of validating its strategy to leverage the DME channel. Given the progress we've achieved over the last year, and as indicated by our updated guidance, the fact that we now expect to generate upwards of $36 million in airway clearance revenue this year, we're convinced we're pursuing the right strategy with the right assets to support our focus on delivering sustainable growth and improving profitability. Shifting to a review of our third quarter operational highlights, most notably in July, we began the full market release of our two latest solutions for our lymphedema patients, our Comfort Ease garments and our Kiley mobile application. It's important to note that these represent the first new product introductions from Tactile Medical in over three years. and reflect our multi-year effort to enhance our focus on R&D and new product development. Let me update you on our recent progress with respect to each of these solutions. As a reminder, our ComfortEase garments are designed to be used with our FlexiTouch system on the lower extremities. Our primary goal in designing this latest generation of FlexiTouch garments was to enhance the overall user experience for our patients by improving ease of use, comfort, and fit while insisting on preserving and delivering our clinically proven results. With this goal in mind, our Comfort Ease garments were developed to be more intuitive to put on and take off, much like any other article of clothing, and were created out of lighter, cooler, and more malleable materials to improve patient comfort. Many patients with lymphedema in the lower extremities have limited mobility, so our Comfort Ease garments are designed to help them overcome these issues within their daily management of their lymphedema at home. These improvements were also intended to make it easier to train patients, promote strong patient adherence, and ultimately facilitate optimal treatment outcomes. Following the full market release, we've received excellent feedback from our sales reps, trainers, clinicians, and most importantly, our patients. Our reps are excited to have a new product to facilitate conversations with existing and potential new clinician prescribers. And as I mentioned earlier, we're pleased with the level of customer engagement they're seeing. And our patient trainers have broadly shared that patients are finding our ComfortEase garments more intuitive and easier to use. Importantly, they're seeing that patients with limited mobility are able to put on and take off ComfortEase garments more easily. We've also been pleased with the feedback received following the launch of our Kiley mobile application for both the iOS and Android platforms. This app is intended to expand our support for lymphedema patients that are earlier in their journey towards obtaining a definitive diagnosis and effective treatment. Our analysis has shown that it takes an average of three years for the average lymphedema patient to obtain a definitive diagnosis following the onset of symptoms. and engagement with three or more healthcare providers along their journey. This underscores the lack of awareness and understanding that exists among healthcare practitioners when it comes to lymphedema, which is unsurprising given the little attention the lymphatic system receives in medical training, even among most specialty programs. With Kiley, patients can easily learn more about lymphedema and their treatment options, and then use the app to document their disease progression. In doing so, We believe they'll be able to arrive at the doctor's office better informed, ultimately shortening the eligibility time it takes to obtain one of our Entrez or FlexiTouch Plus systems. Once a patient receives an Entrez or FlexiTouch, they can also use the product tutorial videos and FAQs available on our Kiley app to complete their training easily and effectively or use it as a source of support. Following its launch, we focused on introducing the Kiley app to our clinician prescribers and making it available to patients in their doctor's offices, through our in-clinic patient demos, and via social media platforms. While still early, we've seen some patients initiating therapy immediately upon receipt of their device, finding the video vignettes easy to understand and responding with satisfaction scores equally high to those with an in-home training experience. In time, Kiley is expected to grow in its utility, including as a path to exchange documents and process orders more efficiently, but also in ways for us to continue our ongoing patient engagement, keys to delivering high patient satisfaction scores while reducing our overall cost to serve. In addition to promoting the use of our Kiley mobile app, we're continuing to raise awareness for lymphedema and its effective treatment within the medical community through virtual and in-person clinician education events. In the third quarter, we hosted a total of 45 educational programs that were attended by approximately 1,500 U.S. clinician participants. Year-to-date, we've hosted over 160 educational programs and trained nearly 4,900 participants, both in person and virtually. We plan to continue hosting educational events focused on cancer-related lymphedema, including survivorship and proper management of cancer-related lymphedema. All in all, we were excited to complement our stronger than expected financial performance with continued operational progress during the third quarter. Brent will now review our third quarter financial results in more detail, along with our updated financial guidance. Brent?

Thanks, Dan. Total revenue in the third quarter increased 24% year-over-year to $65.3 million compared to $52.5 million in the third quarter of 2021. Looking at our total revenue by product line, sales of our airway clearance products, which includes the AfloVest product line we acquired on September 8th of 2021, increased $10.2 million year-over-year to $11 million. And sales and rentals of our Lymphedema products, which includes our FlexiTouch Plus and Entrez systems, increased $2.6 million, or 5% year-over-year, to $54.2 million. Total revenue by channel was comprised of $36.2 million from sales to commercial payers, $11.3 million from Medicare, $11 million from durable medical equipment distributors, and $6.8 million from the VA. As a reminder, durable medical equipment distributors is comprised of revenue from our acquisition of the airway clearance therapy business. These figures compare to our total revenue by channel in the third quarter of 2021, in which commercial, Medicare, DME distributors, and the VA represented approximately $36 million, $8.9 million, $861,000, and $6.7 million, respectively. Continuing down the P&L, unless noted, all references to third quarter results are on a year-over-year basis. Gross margin was 71.7 percent of revenue compared to 70.4 percent last year. Non-GAAP gross margin increased nearly 40 basis points year-over-year to 72.2 percent compared to 71.8 percent in the prior year. The increase in non-GAAP gross margin was attributable to both product and payer mix. Non-GAAP gross margin excludes non-cash intangible amortization in both periods. Non-GAAP gross margin in the third quarter of 2021 also excludes inventory write-offs and non-cash purchase price adjustments related to the acquisition of the AFLO vest in this period. As a reminder, we have provided reconciliations of certain GAAP to non-GAAP measures in our earnings press release. Third quarter operating expenses were $48.4 million, an increase of $10.1 million, or 26%. The increase in operating expenses year over year was primarily driven by a $4.4 million increase in sales and marketing expenses, largely due to the addition of our AfloVest sales team and new hires added to our Lymphedema sales team, along with increased travel and related expenses as we return to normalized business activities. The year-over-year increase in operating expenses was also driven by a $3.8 million increase in non-cash intangible asset amortization and a non-cash earn-out expense related to the acquisition of the airway clearance therapy business. An increase of $1.8 million in reimbursement general and administrative expenses and $172,000 increase in research and development expenses. Excluding the aforementioned non-cash expenses, along with litigation, defense, and executive transition costs in both periods, our non-GAAP operating expenses increased 18% year over year in the third quarter. Operating loss was $1.6 million compared to $1.4 million last year. Non-GAAP operating income was $3.9 million, or 6% of sales, compared to $1 million, or 1.8% of sales last year. Interest expense was $700,000 compared to $100,000 last year, driven by incremental borrowings related to our acquisition of the airway clearance business in the third quarter of 2021. Income tax benefit was $77,000 compared to an expense of $1.9 million last year. The difference relates to a full valuation allowance being recorded against all net deferred tax assets in the current period, whereas no valuation allowance was recorded for 2021. Net loss was $2.3 million or 11 cents per diluted share compared to a net loss of $3.4 million or 17 cents per diluted share last year. Non-GAAP net income was $1.9 million compared to a non-GAAP net loss of $1.6 million last year. Weightage average shares used to compute GAAP diluted net loss per share were $20.1 million and $19.8 million in the third quarters of 2022 and 2021 respectively. Adjusted EBITDA increased 74% year-over-year to $7.2 million or 11% of sales compared to 4.1 million or 7.8% of sales last year. As of September 30, 2022, we had $23.4 million in cash and $49.8 million of outstanding borrowings. This compares to $23.4 million in cash and $50.5 million of outstanding borrowings as of June 30, 2022, and $28.2 million of cash and $55 million of outstanding borrowings at December 31st, 2021. Turning to a review of our 2022 outlook, which we updated in our earnings press release today, we are raising our full year guidance range to account for our stronger than expected performance during the third quarter of 2022. We now expect total revenue in the range of 242 to $245 million, which represents growth of approximately 16% to 18% year over year. This revised outlook compares to our prior revenue guidance range of $238 to $242 million, representing growth of approximately 14% to 16% year over year. Our updated 2022 total revenue guidance range assumes sales of our lymphedema products in the range of $207 to $209 million, representing growth of 2.5% at the midpoint of the range, consistent with the growth expectations in our prior guidance range, which also points to growth in the second half of 2022 in the mid-single digits. And sales of our airway clearance products in the range of approximately $35 million to $36 million. This compares to our prior guidance range of $30 to $32 million. For modeling purposes, for the full year 2022, we expect gross margins in the 71% to 72% range, our gap operating expenses to increase 26% to 28% year over year, compared to 23% to 24% previously. The higher expected growth in our gap operating expense for this year is driven primarily by non-cash intangible amortization and earn-out expense of $3.3 million in Q3 and approximately $500,000 of executive transition and legal expenses, neither of which were contemplated in our prior guidance ranges. Note, our updated full-year guidance now assumes legal expenses of approximately $3.5 million compared to $3 million previously, executive transition costs of approximately $300,000 recognized in the third quarter and not contemplated in our prior guidance, interest expense of approximately $2.8 million compared to $2 million previously, and fully diluted weighted average share count of approximately 20 million shares. In 2022, we now expect to generate adjusted EBITDA of approximately $15 million to $16 million compared to our prior guidance of $14 to $16 million. In addition, our adjusted EBITDA guidance range excludes certain non-cash items, including intangible amortization and estimated changes in contingent consideration of approximately $14.8 million compared to $11.5 million previously, stock compensation expense of $11 million compared to $12 million previously, and depreciation expense of approximately $2.4 million. We continue to expect to deliver improving cash flow from operations and profitability in the fourth quarter. Specifically, we expect cash flow from operations in the fourth quarter to exceed the expected cash outflows, including operating capital needs, debt service, and the earn-out payment related to the acquisition of AfloVest due in Q4. that we recently updated the terms of this earn-out payment to $5 million due in Q4, with the remaining $5 million balance deferred until May of 2023. In summary, we remain confident in our balance sheet and financial condition. With that, I'll turn the call back to Dan for some closing remarks. Dan?