Earnings Transcript for TCMD - Q3 Fiscal Year 2023

Operator: Welcome ladies and gentlemen to the Third Quarter of Fiscal Year 2023 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. Reconciliation 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. Today's call will be hosted by Dan Reuvers, Tactile Medical's President and Chief Executive Officer along with Elaine Birkemeyer, Tactile's Chief Financial Officer. And I would now like to turn the call over to Mr. Reuvers. Please go ahead, sir.

Daniel Reuvers: Thanks, operator, and welcome everyone to our third quarter earnings call. I'll start with a quick agenda of what we intend to cover today. First, I'll review our financial results at a high level and the key drivers of our performance in the quarter, along with some recent operational highlights. Elaine will then cover our financial results in greater detail as well as our 2023 financial guidance, which we updated in our earnings press release today. And then I'll share some additional thoughts regarding our outlook and strategic priorities before we open the call for questions. So beginning with a review of our financial performance, I was really pleased with our team's performance in the third quarter with $69.6 million of total revenue. We posted our fourth quarter in a row of double digit lymphedema growth and exceeded our overall revenue and profit expectations for the quarter. Our growth was driven by strong performance in our lymphedema product line with lymphedema revenue increasing 15% year-over-year to $62.5 million and exceeding our expectations for the quarter. This performance was partially offset by softer than expected sales of our airway clearance products, which decreased 36% year-over-year to $7.1 million. In addition to our solid total revenue performance, we also achieved another quarter of profitability with year-over-year improvements in both our net income and adjusted EBITDA. As a result of our revenue growth and profitability improvements, we generated $4.1 million of cash flow from operations, ending the quarter with $66 million in cash as we continued to improve our balance sheet. With our Q3 financial highlights as a backdrop, I'll now cover the primary drivers of our revenue performance in a bit more detail, beginning with our lymphedema product line. Our strong lymphedema sales growth in the third quarter continued to reflect the increasing productivity of our field sales team, which again delivered double-digit growth, even as our sales headcount remained consistent throughout 2023, with 246 reps at quarter end, relatively unchanged compared to the beginning of the year. In recent quarters, our efforts to increase the productivity of our sales reps is focused on two major components

Elaine Birkemeyer: Thanks, Dan. Turning to review of our financial results. Unless noted otherwise, all references to third quarter financial results are on a GAAP and year-over-year basis. Total revenue in the third quarter increased $4.3 million or 6.6% to $69.6 million. By product line, sales and rentals of lymphedema products, which includes our FlexiTouch and Entre systems, increased $8.3 million, or 15.3% to $62.5 million. And sales of our airway clearance products, which includes our AffloVest system, decreased $4 million, or 35.9% to $7.1 million. Continuing down the P&L, gross margin was 70.9% of revenue compared to 71.7%. Non-GAAP growth margin, which excludes non-cash and tangible amortization in both periods was 71.4% compared to 72.2%. GAAP and non-GAAP gross margins in the third quarter of 2023 were impacted by changes in our mix related to strong growth and sales of our Entre Plus system and lower AffloVest sales along with higher labor rates and material costs. Third quarter operating expenses decreased $7 million or 14.5% to $41.4 million. The decrease in GAAP operating expenses was driven by a $7.1 million decrease in non-cash and tangible asset amortization and earn-out expense, and a $0.6 million decrease in sales and marketing expenses. These items were offset partially by research and development and reimbursement general and administrative expenses, which increased by $0.4 million and $0.2 million, respectively. Operating income was $8 million compared to an operating loss of $1.6 million. The $9.6 million improvement in our operating income was driven by a $2.6 million or 5.5% increase in our growth profit, as well as the aforementioned $7.7 million or 14.5% decrease in our operating expenses. Non-GAAP operating income was $5.2 million compared to $3.9 million in the third quarter of 2022, a 34% increase year-over-year. As a reminder, our non-GAAP operating income excludes non-cash intangible amortization and earnout expense, as well as certain non-reoccurring operating expenses in the prior year period. We have provided a detailed GAAP to non-GAAP reconciliation in the earnings press release. Other expense net was $0.4 million compared to $0.7 million last year. The decrease is primarily due to an increase in interest income. Income tax benefit was $14.7 million, compared to $77,000 in the third quarter of 2022. The year-over-year change in income tax was driven by a one-time adjustment for releasing our evaluation allowance. This non-cash impact reflects our projected return to more consistent profitability. Net income increased $24.6 million to $22.3 million or $0.94 per diluted share. Non-GAAP net Income increased $18.4 million to $20.2 million compared to $1.9 million in the third quarter of 2022. Adjusted EBITDA increased $0.5 million to $7.7 million or 11.1% of sales compared to $7.2 million or 11% of sales last year. Turning to the balance sheet, we're pleased with our continued improvements here. As of quarter end, we had $66 million in cash and cash equivalents and $46.8 million of outstanding borrowings. This compares to $21.9 million in cash and $49 million of outstanding borrowings as of December 31, 2022. Shifting to a review of our 2023 outlook which we updated in today's press release. We now expect full year 2023 total revenue of approximately $273 million to $277 million representing year-over-year growth of 11% to 12% compared to our prior guidance of 11% to 13%. Our 2023 total revenue guidance range now assumes sales and rentals of our lymphedema products increase approximately 14% to 15% compared to our prior expectation of 13% to 14% increase. And sales of our airway clearance products decreased approximately 9% to 8% versus our prior expectation of a 0% to 5% increase. These updated growth assumptions reflect better than expected sales of our lymphedema products in the third quarter. They also reflect softer sales of our airway clearance products in the third quarter and reduce expectations for the fourth quarter as well, as we continue to face the headwind related to the large [indiscernible] customer that Dan discussed through May of next year. For modeling purposes for the full year 2023 we expect our GAAP gross margins to be approximately 71%, our GAAP operating expenses to be down approximately 4% year-over-year compared to our prior expectation of a flat to down 1% year-over-year. Interest expense of approximately $2.6 million compared to our prior expectation of $3.8 million. We now expect a benefit on the GAAP tax line at a rate of 112% to 139% compared to a tax expense rate of 57% previously. The change in expectation is primarily the result of evaluation allowance removal in the third quarter and a fully diluted weighted average share count of approximately 23.5 million shares. We continue to expect to generate adjusted EBITDA of approximately $25 million to $27 million in 2023. Our adjusted EBITDA expectation assumes certain non-cash items, including stock compensation expense of approximately $7.7 million compared to $9.8 million previously, Intangible amortization and changes in fair value of contingent consideration of approximately $100,000 to $150,000 compared to our prior expectation of approximately $5.8 million. The depreciation expense of approximately $2.8 million compared to approximately $2.5 million previously. With that, I'll turn the call back to Dan for closing remarks.

Daniel Reuvers: Thanks, Elaine. Stepping back, we're pleased to have delivered solid financial performance in the third quarter, with revenue growth in our lymphedema business of 15% year-over-year, record operating profit and expanded cash flow from operations. Our financial results demonstrate the improved productivity of our sales team, as well as our enhanced operational efficiencies overall. In Q4, our teams focused on bringing 2023 to a strong conclusion and by continuing to execute on the following four strategic initiatives for this year

Operator: Thank you. [Operator Instructions] And our first question will come from the line of Adam Maeder with Piper Sandler. Please proceed with your question.

Simran Kaur: Hi, Dan. Hi, Elaine. This is Simran on for Adam. Thank you for taking the question. So I just kind of wanted to start off with AffloVest. It sounds like the headwind with the one DME is expected to linger into Q4 and at least part of the first half of 2024. Can you -- this is a two-parter, can you quantify what percentage of the AffloVest business that this particular DME comprises, or are you able to give a growth rate for AffloVest in the quarter ex the one DME? And then two, how do we think about AffloVest longer term in terms of the potential growth trajectory? Is it still accretive tier 2025 financial target?

Daniel Reuvers: Yeah, so we haven't broken out what the distributor was responsible for, but quite clearly, it's a meaningful portion. The entire reduction for the full year is associated with that distributor. So, some of their base number came down, and then obviously the growth didn't materialize. And that's what really represented the reduction. As far as the future implications, yes, we do think that we're probably going to have to lap May to get back into kind of the more predictable growth trajectory with them. In the meantime, we're really pleased that the balance of the field, the rest of our DME customers have continued to grow. And we really don't think it has any impact on our longer-term targets. We're still very committed to those, and we don't see any change in the underlying segment. I mean, this is one I think that I've shared I've had an interest in for years in this segment of treating pulmonary patients. And we continue to believe that the TAM is every bit as large as it was. And I think, we've talked about 500,000 patients with bronchiectasis and more than 4 million that have gone undiagnosed and we continue to stay very focused on that and see it as a long-term growth contributor to the business.

Simran Kaur: Okay, very helpful. And then just for my follow-up here, I know you're not providing formal guidance for 2024 today, but the businesses showed pretty impressive P&L leverage over the past couple of quarters. So just help us think about

Elaine Birkemeyer: Hi, [Celine] (ph). Yes, we're not providing 2024, but we are continuing to focus on the 2025 targets that we put out at the beginning of the year. Again, that was $350 million in revenue, $50 million of adjusted EBITDA, which would be a little bit over a 14% adjusted EBITDA margin. We still feel good about our path in achieving that. And I think the profitability we're demonstrating this year is, I think, showing good progress in that direction.

Daniel Reuvers: Yes, and I would just add, too, I think, to Elaine's point is, as it relates to the durability, particularly some of the growth that we've seen on the lymphedema side. I think this is reflective of a more stable environment that we've probably not been in since 2023 over the course of the last few years. We think the sales productivity gains that are contributing to some of this has some additional runway as we haven't completed all of the demos that have not all shifted over to our trainers. So, we still see an opportunity to continue to expand that capacity with our sales team. And I think the strong reception we're seeing to some of our new products, namely Entre Plus and hopefully more of the same with our ComfortEase garments, certainly point to some good continued sustainable growth as we look forward.

Simran Kaur: Great. Thank you.

Operator: And the next question comes from the line of Ryan Zimmerman with BTIG. Please proceed with your question.

Ryan Zimmerman: Good evening. Thanks for taking the question. I want to ask too, first, I appreciate you guys giving some context on the GLP-1 debate and the patient population, but I just want to understand it. So assuming, I think it's about 24% of your patients have BMIs over 40, just based on the slides that you showed. What happens if their BMIs drop, assuming they are taking a GLP-1, for example, are you assuming that those patients go away completely? Because it sounds like obesity is maybe one factor in what can be driving lymphedema here. Are you assuming that if the people who are over 50, they go away or there's just maybe less severe lymphedema going forward if they are taking those drugs?

Daniel Reuvers: Yeah, it's a really good question Ryan and it's -- there's a lot of variables that we're all trying to anticipate. I think that a few things that we've learned, one is if a patient has done enough damage to their venous and lymphatics, meaning they're well above a BMI of 50, it's unlikely that their lymphedema will recover even if they lose the weight. I think the other is, we have also -- our understanding is that current users of these drugs might lose 15% to 25% of their body weight, but if you've got a BMI over 50, you're still going to be north of 30 and probably potentially north of 40, depending on how high you start, which still doesn't take you out of the universe of likely developing or having lymphedema. I think it's going to be a long time before these patients start to show any potential impact in large part because even if these drugs help patients avoid becoming these over 50 BMIs, the existing universe of those patients are unlikely to recover and see their lymphedema get resolved without ongoing treatment. So it's going to take a long time, we think, for this to wash itself out. Some will step down. But I don't know if Elaine has a little bit -- anything else you want to add?

Elaine Birkemeyer: No, I think -- I think if you look at the very last slide, that's what we were trying to demonstrate there is, this will take some time as the existing people who have BMI greater than 40, unfortunately, will likely not see a reduction of their lymphedema, and it's really preventing people to take that place in the time to come in the future.

Ryan Zimmerman: Okay. Very helpful. And then the second question just on the airway clearance, can you just elaborate on what the impact of profitability is for airway clearance? If this is a headwind for the next six months or so into May, what impact or what drag does that have on the adjusted dividend margin line? What impact and drag does it have on the gross margin line? Any caller there would be helpful. Thanks.

Elaine Birkemeyer: So I think we've talked about AffloVest with a little accretive to growth margin, accretive to our operating income. I think this year we've definitely seen that impact, but we're really excited that we're able to maintain our $25 million to $27 million guidance in adjusted EBITDA despite that. Again, really strong focus on our OpEx, and I think we'll be able to continue to do that as we go forward. And again, reiterating our 2025 target of growing to a 14% adjusted EBITDA margin.

Daniel Reuvers: Yeah, I would just add, Ryan, I think I agree with Elaine's comments and I think that If we would have done better on that segment, no doubt would have done even better, I think, on the adjusted EBITDA line. That said, I think the ongoing progress we've been able to demonstrate now for a series of quarters in a row about Salesforce productivity expansions, operational efficiencies, all of those have led us to really solid profitability contributions from the lymphedema business. So it allowed us to maintain our full year adjusted EBITDA target, even knowing that, we saw a step down in Q3 and predictably in Q4 on that segment. So I think as we get back on the train again next year, once we lap this May thing, certainly it should be a good guide for us.

Ryan Zimmerman: Thank you.

Operator: And the next question comes from the line of Margaret Kaczor with William Blair. Please proceed with your question.

Margaret Kaczor: Hey, good afternoon. Thanks for taking the question. I wanted to start on the increased sales rep productivity which obviously was quite impressive. You had referenced that there's still going to be some improvement from here, I don’t know, I watch baseball. So is this like the third inning of that process? Is it the eighth inning, close to the end of the game or not? And then as we think about that and other efforts, not only over the next six months or 12 months, but as we look out towards that 2025 EBITDA margin target, what other efforts can you guys put in to kind of drive that margin expansion?

Daniel Reuvers: Yeah, I think we could probably use a good middle reliever if you know one. That might be a reasonable interval probably for us. As we said that, there's lots, I mean, tens of thousands of in-home patient demos we hosted in the last 12 months. So being able to start liberating more of those from the reps so they can optimize their time in clinic, I think it's clearly having an impact. We are not doing the majority of them with our trainers yet, but clearly they're making a big impact. I think the opportunity for us to continue with that progression will take us through 2024. We're trying to be careful about it, but I think it'll continue to play itself out over 2024. And then I think by the time we get to 2025, we should certainly be in a position where we've kind of shifted some of those tasks to the extent that they still have to exist. That all depends on payer policy, of course. And I think that the other piece, Margaret, that we still think there's opportunities for us, certainly as we get to 2025, is the impact of some ongoing investment in tech. We have a handful of things that we're working on to examine how we can deploy technology to make the processing of orders more efficient. And that includes trying to introduce and find ways to bring easier ways for us to work with our prescribers, as well as an easier process for our internal team, and maybe just as importantly, those folks caught in the middle, which is the sales team. So if we can make some of those advances in 2024, I think they should be able to demonstrate some contribution. And I think those are the kinds of things that give us good enthusiasm, I think, for the next couple of years.

Margaret Kaczor: Okay. That's helpful. And then, I've got to hit on AffloVest a little bit. And I think part of the question is, what's your comfort level at this point? Because we've maybe been surprised a couple of quarters in a row now to the downside. Are you trying to take another even more conservative stab at Q4 or should we just kind of continue to assume some sequential weakness I guess until we get into May and then hopefully things start to pick up on a sequential or year-over-year basis, however you want to look at it. Thanks.

Margaret Kaczor: Yes, now, Margaret, we did reduce the guidance for AffloVest, and it really was taking into consideration what we saw in Q3 and what we're anticipating for Q4. Q3 was our first full quarter really being able to fully see the impact with the large EME partner. We've got more line of sight to what we think for the remainder of the year. And really our expectation is that Q4 is going to look quite similar to Q3, maybe a little bit better, but in that same range. And that's what we reflected in the latest guidance.

Margaret Kaczor: Okay, thank you.

Operator: [Operator Instructions] And the next question comes from the line of Suraj Kalia with Oppenheimer & Company. Please proceed with your question.

Suraj Kalia: Good afternoon, Dan, Elaine. Can you hear me all right?

Elaine Birkemeyer: We can. Perfect.

Suraj Kalia: So Dan, I want to ask a very high-level question. Since the time you have come on board, Dan, how would you characterize the time to patient acquisition within these three buckets? And as we stand today, what are the main structural factors you think are changing somewhat positively or somewhat negatively?

Daniel Reuvers: I'm not sure I understand the question, Siraj. When you say time to acquisition, can you be more specific?

Suraj Kalia: So, Dan, I guess what I'm trying to understand is, you have a certain list of docs, you have a certain amount of patients out there. From the point that you identify a patient, you've identified Siraj having lymphoedema, blah, blah, blah. It takes you, let's say, three months to basically book a sale, right? Just trying to understand how is that shaping up based on all the changes that you all are implementing?

Daniel Reuvers: Yeah, I don't know that the time to serve, I guess, is kind of what you're asking from the time we get a referral at the top of the funnel until the time we ship the product. I don't know that there's been a dramatic change over the time I've been here. And it can ebb and flow a little bit also based on payer requirements. So some payers from time to time will add some requirements that are more rigorous, some will be more relaxed, and I think all those have variables. I think what we're really focused on at this point is especially as we continue to scale. I mean, certainly we're a bigger business than we were a few years ago. And as we continue to scale, making sure that we've got scalable infrastructure and tech that I think can more efficiently help us process orders. We brought in a new CIO back in earlier part of the year, good rich experience, I think, in enriching the platforms that we're going to need. And I think we still see some good runway there. Ultimately, I would be optimistic about the impact it's going to have on how long it's going to take us to process an order and how much of it can be electronic versus manual. And the more we can reduce those handoffs and automate some of those things, I think it'll be good for patients because our goal is certainly to make sure that we can serve them as efficiently as possible.

Suraj Kalia: Got it. Elaine, was price -- can you help us quantify if price was a factor in nominal growth within the three buckets, commercial, VA, Medicare? And also, Dan, if I could, following up on your -- the tech part of the equation, forgive me, I jumped a little late on the call. Are we seeing any shift in patient compliance with the [indiscernible] app? Thank you for taking my questions.

Elaine Birkemeyer: Yeah, so I think we had talked about at the beginning of the year that there were some price increases that hasn't changed throughout the year and so it's been fairly consistent. Really, the majority of the growth that we have seen throughout the year in this quarter too has been largely driven by shipment increases.

Daniel Reuvers: Yeah, and I think as far as your other question, I think it was what impact do we think Kylee is having or have we seen on patient compliance? I think this is a really interesting one, because compliance has kind of been a bit of a black box for all of us. We've followed up with patients with phone calls and more what I call manual efforts over the years. But it's certainly less pure as we continue to deploy Kylee. We are collecting a lot of information. And I don't know that it's so much about compliance improvements because we think that certainly the outcomes that we've been able to demonstrate imply that our patients have regularly used the therapies that that we've delivered, but Kylee I think is one of the really important opportunities for us among all the other benefits for the patient for us to continue to collect a lot of really rich data. Even responding to questions about the GLP-1 impact, I think we've got a database just based on our leadership and our girth in number of patients served over the years that allows us to know more about this constituent. So I think Kylee will continue to enrich that. We're getting a lot more information than we had before about the progression of their measurements as they record those. We can even capture photos. We're being able to collect information about their usage patterns. And I think to your point, over time, that database becomes really helpful and important as we continue to choose how we deploy new products, what opportunities we have to better serve these patients.

Suraj Kalia: Thank you.

Operator: We are currently seeing no remaining questions at this time. That does conclude our conference for today. Thank you for your participation.

Daniel Reuvers: Thanks, operator.