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Edited Transcript of TCMD earnings conference call or presentation 5-Aug-19 9:00pm GMT

Q2 2019 Tactile Systems Technology Inc Earnings Call

MINNEAPOLIS Aug 10, 2019 (Thomson StreetEvents) -- Edited Transcript of Tactile Systems Technology Inc earnings conference call or presentation Monday, August 5, 2019 at 9:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Brent A. Moen

Tactile Systems Technology, Inc. - CFO

* Gerald R. Mattys

Tactile Systems Technology, Inc. - CEO & Director

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Conference Call Participants

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* Anna Marie Nussbaum

William Blair & Company L.L.C., Research Division - Associate

* Christopher Thomas Pasquale

Guggenheim Securities, LLC, Research Division - Director and Senior Analyst

* David Kenneth Rescott

Canaccord Genuity Corp., Research Division - Associate

* Jonathan Preston McKim

Piper Jaffray Companies, Research Division - VP & Senior Research Analyst

* Kyle Royal Bauser

Dougherty & Company LLC, Research Division - Senior Research Analyst

* Suraj Kalia

Northland Capital Markets, Research Division - MD & Senior Research Analyst

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Presentation

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Operator [1]

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Good afternoon, ladies and gentlemen, and welcome to the Second Quarter of 2019 Earnings Conference Call for Tactile Medical. (Operator Instructions) Please note that this conference 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 that could cause actual results to differ materially from those indicated, including those identified in the Risk Factors section of our most recent annual report on Form 10-K as well as our most recent 10-Q filing filed today 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.

I would now like to turn the call over to Mr. Jerry Mattys, Tactile Medical's Chief Executive Officer. Please go ahead, sir.

Mr. Mattys, please go ahead, sir.

(technical difficulty)

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Gerald R. Mattys, Tactile Systems Technology, Inc. - CEO & Director [2]

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Sorry, everyone, for the little technical snafu. We'll get rolling. Thank you.

Good afternoon. Welcome, everyone, to our second quarter of 2019 earnings call. I'm joined on the call today by our Chief Financial Officer, Brent Moen.

Let me provide you with a brief outline of today's call. I'll start with a review of our financial performance highlights during the first 6 months and second quarter of 2019, followed by some commentary on the primary drivers of our revenue growth. Then I'll provide you with a brief update on our operational progress during the quarter. Brent will then discuss our financial results in detail and review our financial guidance for 2019, which we updated in our earnings press release this afternoon. I'll conclude today's prepared remarks by providing a few thoughts on our outlook for the second half of 2019 before we open the call for questions.

We achieved exceptional company performance during the first 6 months of 2019 with total revenue of $82.8 million, representing 36% growth year-over-year. Flexitouch Plus System sales and rentals were the primary driver of our revenue growth in the period, increasing 34% year-over-year to $75.1 million. We also saw strong sales of our Entré and ACTitouch Systems, which increased 52% year-over-year to $7.8 million.

During the first half of 2019, our revenue results were favorably impacted by our adoption of accounting standard ASC 842. Excluding the impact of this accounting change which contributed 7 percentage points to our revenue growth, I'm pleased to report that we achieved revenue growth of 29% year-over-year in the first half of 2019. Brent will review this accounting standard and its impact in greater detail during his prepared remarks.

Our revenue growth during the first half of 2019 benefited primarily from the following 4 growth drivers: First, the commercialization of Flexitouch Plus remains an important contributor to our performance. Our sales team has been very successful this year in driving strong sales of this latest generation of Flexitouch system. We also continue to see evidence that the improved design and enhanced capabilities of Flexitouch Plus has encouraged clinicians to prescribe the system for more patients, especially those with bilateral lymphedema.

Second, our revenue growth benefited from the investments we've made to expand our field sales team. We ended the second quarter with a team that included more than 215 sales representatives compared to over 160 at the beginning of 2018.

Third, our strategy to target and focus our sales representatives on the highest diagnosing facilities in the United States lymphedema market remains successful. Recall that according to our last analysis of claims data, Tactile Medical was doing business with at least 1 clinician at nearly 50% of the more than 4,700 high-diagnosing facilities. During the first half of 2019, we continued to enhance and expand our relationships with clinicians at these facilities.

Fourth, we experienced an important tailwind as a result of the broad in-network coverage that we've obtained with commercial payers in recent years. At the end of 2018, we were an in-network provider with payers covering over 275 million U.S. lives or roughly 90% of the U.S. insured population. Our status as an in-network provider lowers the out-of-pocket expenses for this population which helps to facilitate the sales process. Most notably, in the first half of 2019, we continued to benefit from a new direct contract with a large U.S. commercial payer which became effective in July of last year. In the past, we had indirect access to a portion of this payer's plans via a buying group, and this new contract provided us with direct, in-network access to all the patients covered by this payer, albeit at a lower contracted price.

Despite the ASP impact of the new contract, our expanded access to patients covered by this payer allowed us to generate stronger-than-expected sales volume growth, which was an important contributor to our performance in the commercial channel.

We also experienced strong sales to patients with Medicare and VA coverage during the first half of the year.

Our performance serving the Medicare population has been particularly strong this year, representing 11% of our total revenues in the first 6 months compared to 8% in the same period last year. We believe that our decision in 2018 to transition Entré and ACTitouch order processing from our field team to our internal team of specialists has been an important contributor to this strong performance.

In the Veterans Administration channel, our sales performance continued to benefit from the new Federal Supply Schedule contract that we were awarded for our Flexitouch Plus System last September, along with the continued efforts of our dedicated VA specialists.

In addition to our impressive revenue growth in the first 6 months of 2019, we achieved 70% gross margin and improved our profitability overall with 235 basis points improvement in operating margins year-over-year and adjusted EBITDA of $8.3 million compared to $4.4 million in the first 6 months of 2018.

Turning to a quick review of our second quarter performance. We reported total revenue of $45.2 million for the second quarter, representing 32% growth year-over-year. Excluding the impact of ASC 842, which contributed 5 percentage points of growth year-over-year, our total revenue growth in the second quarter would have been 27%. The second quarter revenue growth was driven by sales and rentals of our Flexitouch systems which increased 31% year-over-year to $41 million, and contributions from sales of our Entré and ACTitouch Systems which increased 53% year-over-year to $4.2 million. Overall, our sales performance in the second quarter was largely due to the continuation of the 4 drivers responsible for our strong performance in the first half of this year, and we expect these drivers to remain essential to our sales performance as we enter the second half of 2019.

Lastly, we reported 70% gross margin and significantly improved profitability during the second quarter with adjusted EBITDA of $6.2 million compared to $4.3 million in the second quarter of last year.

Turning to our operational performance during the quarter. I'm pleased to report that our commercialization efforts with respect to our 3 latest products, Flexitouch Plus, Flexitouch Head and Neck and Airwear, continue to proceed as planned. First and foremost, our latest generation of Flexitouch system, Flexitouch Plus, continues to be an important enhancement to our product portfolio and a strong contributor to our sales growth. Since we began our full commercial launch of the system in April of last year, we've consistently seen evidence that the benefits of trading both limbs simultaneously are greatly appreciated by clinicians and their bilateral patients. Most notably, we believe the introduction of Flexitouch Plus and the new leg and trunk garments has led to an increased referrals for patients with lymphedema in the lower extremities. These referrals have come from our existing clinician prescribers as well as clinicians who have previously never referred our products.

During the second quarter, we also saw solid performance in sales of our Flexitouch Head and Neck system, and continue to expect Head and Neck sales in the low to mid-single digits as a percentage of total revenue for 2019. We continue to remain focused on building our portfolio of clinical evidence that will support our longer-term efforts to obtain broad reimbursement coverage for Flexitouch Head and Neck.

With this goal in mind, we've published 2 clinical studies on the product to date. In late 2017, we published a 44-patient study in the medical journal, Head and Neck, designed to evaluate the feasibility of using the Flexitouch system to help patients with head and neck lymphedema self-manage their condition. The study found that Flexitouch demonstrated edema reduction after a single 32-minute treatment session with statistically significant reductions in face and neck measurements. On January 29 of this year, we published a second study in the journal, Otolaryngology-Head and Neck Surgery, which used imaging to assess the impact of Flexitouch Head and Neck on lymphatic drainage in 10 cancer survivors. All the study subjects demonstrated enhanced lymphatic drainage after a single treatment. Furthermore, areas of dermal backflow were either partially or completely reduced in 6 of the 8 subjects that presented with dermal backflow at the onset of the study.

Building on these important findings, our clinical team remains on track to complete and submit 2 additional clinical manuscripts on Flexitouch Head and Neck by the end of the year, consistent with our expectations. As part of our longer-term strategy, we also continue to focus on developing our approach for commercializing Flexitouch Head and Neck outside of our traditional call points.

And finally, with respect to the most recent addition to our product portfolio, our Airwear static compression garment, we have made important progress in preparing for our commercial launch by continuing to focus on securing our supply chain. We still anticipate beginning our limited market release of the product in the second half of 2019. Looking forward to the launch of this truly innovative static compression garment which we believe will resonate with patients as they begin conservative therapy and enable us to establish ourselves as the provider of choice earlier in their treatment pathway, educating them about the benefits of our Flexitouch and Entré Systems.

Before I discuss the outlook for the remainder of 2019, let me turn the call over to Brent to walk you through our Q2 financial results in greater detail and review our 2019 guidance, which we updated in our press release this afternoon. Brent?

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Brent A. Moen, Tactile Systems Technology, Inc. - CFO [3]

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Thanks, Jerry. Total revenue for the second quarter increased 32% to $45.2 million compared to $34.1 million for the quarter ended June 30, 2018. Our total revenue performance in the quarter was driven by sales and rentals of our Flexitouch systems, which increased $9.6 million or 31% year-over-year to $41 million. The increase in our Flexitouch revenue was largely driven by the expansion of our sales force, increasing physician and patient awareness of the treatment options for lymphedema, expanded contractual coverage with insurance payers, and growth in the Medicare channel.

Similar to the first quarter of 2019, we also saw stronger-than-expected sales volume to a large commercial payer. We negotiated a new direct contract with this payer which went into effect on July 1, 2018. The second quarter volume-related benefit of this contract more than offset the expected impact of our selling price reduction. Flexitouch accounted for 91% of our total revenue in the second quarter of 2019 compared to 92% of sales in the prior-year period.

Entré and ACTitouch sales increased $1.5 million or 53% year-over-year to $4.2 million in the quarter. The performance of our Entré, ACTitouch product category was driven primarily by our strategic shift in 2018 to managing these orders in-house, along with higher-than-expected sales volume due to our new direct contract with a large commercial payer.

Second quarter revenue by payer was 71% commercial, 18% VA and 11% Medicare, compared to 74%, 20% and 6%, respectively, last year. Our total revenue growth during the second quarter benefited from the adoption of the new lease accounting standard, ASC 842, that became effective on January 1, 2019. As a reminder, we adopted this standard on a modified retrospective basis, which did not require us to restate any of our prior periods.

For the second quarter and the first 6 months of 2019, our total rental revenue is reported in accordance with ASC 842, which requires rental agreements that began this year to be recorded as sales-type leases. For these lease rental agreements, we recognized all of the revenue upon commencement of the agreement as opposed to our prior practice of spreading net revenue over the life of the agreement. For rental agreements that were in place prior to this year, we continue to recognize revenue on a month-to-month basis as an operating lease until they are completed, which we anticipate to be in the fourth quarter of this year.

In the second quarter and the first 6 months of 2019, the adoption of ASC 842 benefited our total revenue growth by 5 percentage points and 7 percentage points, respectively. Beginning in 2019, we also now classify revenue from garments sold to our rental customers as rental revenue. This garment revenue was previously classified as sales revenue. For consistency and comparability purposes, garment revenue associated with rental agreements was reclassified to rental revenue in the prior year periods. As a reminder, to assist in comparing our 2019 revenue and gross profit reporting to prior periods, we provided an unaudited supplemental schedule as an appendix to our 8-K filed on May 6, 2019.

Turning to the rest of the P&L. Second quarter gross profit increased $7 million or 28% to $31.5 million compared to $24.5 million last year. Gross margin was 70% of sales in the second quarter of 2019 compared to 72% of sales in the second quarter of 2018. The decrease in gross margin was primarily attributable to incremental pricing headwinds related to our new contract with a large commercial payer.

Also impacting gross margin is revenue mix by product and payer compared to last year, and to a lesser extent, by noncash amortization expense related to the intangible assets we licensed from Sun Scientific.

Second quarter operating expenses increased $5.2 million or 23% to $28.5 million compared to $23.2 million last year. The increase in operating expenses in the second quarter was primarily driven by a year-over-year increase of $4 million or 27% in sales and marketing expenses due to the continued investments in the field sales team and increased spending on marketing initiatives. Operating income for the second quarter of 2019 increased $1.7 million or 132% to $3 million compared to operating income of $1.3 million last year.

We recorded an income tax expense of $422,000 for the second quarter of 2019 compared to an income tax benefit of $1.1 million last year. The tax expense recognized in the second quarter of 2019 was primarily related to decreased tax benefits from share-based compensation compared to the prior year.

Net income for the second quarter of 2019 increased to $2.8 million or $0.14 per diluted share compared to net income of $2.6 million or $0.13 per diluted share for the second quarter of 2018. Weighted average shares used to compute diluted net income per share were 19.6 million and 19.3 million for the second quarters of 2019 and 2018, respectively.

Second quarter adjusted EBITDA was $6.2 million compared to adjusted EBITDA of $4.3 million in the second quarter of 2018. Our adjusted EBITDA margin was 13.8% in the second quarter of 2019 compared to 12.6% in the second quarter of last year. As a reminder, we have provided a reconciliation of certain GAAP measures to non-GAAP measures in our earnings press release.

Let me now turn to a review of our 2019 revenue guidance which we updated in our earnings release this afternoon.

We are raising the full year revenue guidance range to account for our stronger-than-expected performance in the second quarter. For 2019, we now expect total revenue in the range of $182 million to $184 million, which represents growth of 26.5% to 28% year-over-year, compared to revenue of $143.8 million in 2018. This revised outlook compares our prior year revenue guidance range of $180 million to $182.5 million or 25% to 27% year-over-year growth.

As a reminder, our 2019 total revenue guidance continues to assume that the adoption of ASC 842 will benefit our full year total revenue by approximately $6 million or approximately 4 percentage points of growth year-over-year.

The line item components of our updated 2019 total revenue guidance, which calls for growth of 26.5% to 28% year-over-year, includes the following assumptions:

Sales revenue will be in the range of $157 million to $158.5 million compared to sales revenue of $130.2 million in 2018. The sales revenue guidance range includes the impact of the re-class of garments revenue to rental revenue. Rental revenue guidance remains unchanged and will be in the range of $25 million to $25.5 million compared to rental revenue of $13.6 million in 2018. The year-over-year increase in rental revenue for 2019 is expected to be driven by: The impact of the adoption of ASC 842, representing approximately half of the increase in rental revenue for 2019; the reclassification of garment revenue to rental revenue that was previously reported in sales revenue, representing approximately 1/4 of the increase in rental revenue for 2019; and operational growth of 20% to 22% over the 2018 rental revenue, representing approximately 1/4 of the increase in rental revenue for 2019.

By product, our 2019 total revenue guidance range assumes sales of our Flexitouch products increase approximately 26% to 28% year-over-year in 2019 compared to 25% to 27% growth in our prior guidance range. And sales of our Entré ACTitouch products increased approximately 30% year-over-year in 2019 compared to 24% growth in our prior guidance range.

In terms of the anticipated contribution of our new products, we continue to expect Head and Neck sales in the low to mid single digits as a percentage of total revenue, and we continue to expect sales of Airwear to be immaterial in 2019.

Lastly, for full year 2019, we expect our gross margin to remain in the low 70% range and our adjusted EBITDA margin to be in the range of 13% to 14%. This adjusted EBITDA range assumes stock-based compensation expense of approximately $10 million, approximately $1 million of expenses related to the planned move to our new corporate headquarters in the third quarter of 2019. As a reminder, the $1 million of expenses is comprised of approximately $400,000 of moving expenses which will only impact our full year 2019 P&L. The remaining expense comes from accelerated depreciation on our current facility and higher rent expense related to occupancy at both the current and new facility this year. For purposes of calculating earnings per share, we expect our fully diluted weighted average share count in 2019 to be 20 million shares.

With that, I'll now turn the call back to Jerry for some closing remarks. Jerry?

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Gerald R. Mattys, Tactile Systems Technology, Inc. - CEO & Director [4]

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Thank you, Brent. We're raising our guidance again this quarter to account for our exceptional second quarter sales results, driven by strong execution across our 4 strategic growth drivers, including the stronger-than-anticipated sales volume we saw as a result of last year's new direct contract with a large commercial payer. I'm incredibly pleased by the performance our team has achieved across the board this year and would like to congratulate everyone at Tactile Medical for contributing their energy and time to helping more patients suffering from chronic diseases live better and care for themselves at home.

We continue to see a bright future in store for our company as we look at a number of important macro dynamics, including: the growing awareness of lymphedema in the market at both the clinician and patient level; the more than $4 billion addressable U.S. market opportunity that remains in front of us; and our unique position in the market, with an established direct-to-patient-and-provider model, proven reimbursement and payer relations expertise and innovative products, supported by extensive clinical and economic evidence.

As we enter the second half of 2019, we'll continue to drive growth in our markets by leveraging the features and benefits of our Flexitouch System in our sales process: by expanding our field sales team to over 230 sales representatives by year-end and improving the productivity of our recent hires; by developing our relationships with the more than 4,700 high-diagnosing lymphedema accounts in the United States; and by continuing to capitalize on our broad in-network coverage with insurers. We believe these important growth drivers, along with our focus on executing against our near- and longer-term initiatives, will enable us to continue to deliver impressive top line growth, improved profitability and strong returns for our shareholders as we leverage our leadership in the market for at-home therapies.

Thank you, everyone, for your interest in our company and for your participation on tonight's call. Operator, we will now open the call for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question will come from the line of JP McKim from Piper Jaffray.

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Jonathan Preston McKim, Piper Jaffray Companies, Research Division - VP & Senior Research Analyst [2]

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I wanted to start just on the breakdown between Medicare, VA and commercial. I guess, I've been more surprised by that kind of the difference in the growth drivers this year than in prior years. It used to be very VA-heavier just given the growth rate there. But this year, it seems to be Medicare, less VA and more commercial. So maybe comment on that. And I know you don't give guidance on these 3 segments, but maybe just kind of brushstroke what you think the key drivers are going to be for the remainder of this year.

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Gerald R. Mattys, Tactile Systems Technology, Inc. - CEO & Director [3]

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Thanks, JP, and thanks for the question. You're right. We don't necessarily break out by channel the different performance of the company. That's actually not how we forecast internally. We don't forecast by Medicare, commercial and VA business. But try to get some color around your question. In the first half of the year, Medicare made up 11% of sales versus 8% last year. We think the single biggest reason for that shift has been the move inside to lift the burden of paperwork and order processing from our field team so that they may focus on Flexitouch sales. So most of those sales came from our simpler products, the Entré and ACTitouch, and that was the primary driver for the Medicare mix shift that you saw in the first half of this year.

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Jonathan Preston McKim, Piper Jaffray Companies, Research Division - VP & Senior Research Analyst [4]

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Okay. And any comments on the VA and where you are in terms of the number of clinics or adding specialized VA reps?

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Gerald R. Mattys, Tactile Systems Technology, Inc. - CEO & Director [5]

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We've made our biggest addition in VA reps last year, in 2018. So for the first half of the year, the VA made up 19% of total revenue versus 20% over the same period last year. We're very happy with the VA performance. Overall, it was up 22% year-over-year in that particular segment. Keep in mind that when we signed the Federal Supply Schedule or got on the new Federal Supply Schedule last September, the VA is entitled to most favored nation pricing, so our volume is actually higher than the revenue that we showed here, and we're feeling very comfortable about being able to continue that into the second half of 2019.

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Jonathan Preston McKim, Piper Jaffray Companies, Research Division - VP & Senior Research Analyst [6]

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Okay. That's helpful. And then just 1 more for me just around gross margins. How we should think about -- I mean you're like -- you're hovering around 70. You're sticking on 70. But how should we think about that for the remainder of this year and into next year? And then I didn't hear anything on -- I thought you had a new product coming in, in the back half, the lower cost Entré, if I'm correct, and maybe how that could benefit you guys in the margin line.

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Brent A. Moen, Tactile Systems Technology, Inc. - CFO [7]

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JP, it's Brent. So yes, we finished the year-to-date, 6-month period at gross margins of 69.7%, down from the prior year by roughly about 215 basis points. The largest driver of that, say, 2/3 of that difference, really is the impact of the new direct contract that we have with the large commercial payer. The other piece that's impacting gross margin is certainly the mix, and that's the mix by product and by payer. So if you think about Entré growing at 53%, relative to Flexitouch, there's a slight margin differential between those 2. As we look forward to the remainder of the year, we anniversary against those ASPs that we've been talking about for the last 3 quarters. So I -- our expectation is that we'll start to see a gradual lift in gross margin in the second half of the year, but still hovering right around that low 70% range for the full year.

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Gerald R. Mattys, Tactile Systems Technology, Inc. - CEO & Director [8]

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And then to your last question, JP, on the Entré, keep in mind that Flexitouch is our most profitable of the 3 products in terms of gross margin, but we are having good progress made on the -- bringing in a new Entré product to lower our costs. So that's still plugging away as we expected. Those will be incremental improvements and are contemplated in our guidance for the second half.

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Operator [9]

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Your next question comes from the line of Chris Pasquale from Guggenheim.

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Christopher Thomas Pasquale, Guggenheim Securities, LLC, Research Division - Director and Senior Analyst [10]

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Congrats on the quarter, guys. Jerry, the potential for Plus to increase your traction among patients with bilateral disease was something you called out ahead of that launch. It sounds like that's playing out. I'm curious if maybe you can quantify the progress you've made there in any way, either in terms of the percentage of systems that you're shipping with double leg wraps or the percentage of your customer base that is now prescribing for those patients.

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Gerald R. Mattys, Tactile Systems Technology, Inc. - CEO & Director [11]

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Thanks, Chris, and appreciate the question and the congratulations on the quarter.

We don't really break out upper versus lower extremity sales, but as you suggested, our thesis that having the ability to treat both limbs of a bilateral patient simultaneously rather than having them treat 1 limb at a time, thus reducing the amount of time needed for treatment by half, has played out quite well in our marketing efforts. I would say that not only did we get more patients from our existing customer base, which we certainly anticipated, but we also were able to find new customers that weren't really prescribing our product because of that limitation, that product limitation on the Flexitouch classic. So don't have any specific numbers to highlight that for you, other than to say it's been one of the primary drivers of our growth in the first half, and we expect that Flexitouch Plus appeal to continue as we carry into the second half of 2019.

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Christopher Thomas Pasquale, Guggenheim Securities, LLC, Research Division - Director and Senior Analyst [12]

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Okay. And then can you just remind us how you're planning to sell Airwear once it launches? There's some synergy between that product and Flexitouch. It helps to identify the patients earlier, and then it's something you can be selling to your existing installed base. But I would think that keeping the reps focused on Plus is going to be priority #1. So how do you maximize the potential of the Airwear product without having your sales force kind of take their eye off the ball?

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Gerald R. Mattys, Tactile Systems Technology, Inc. - CEO & Director [13]

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A really good question and certainly one we've been grappling with. We've been focused with our Airwear efforts on securing the supply chain. So it's taken us longer than we anticipated, frankly, to get the vendors in line to be able to supply that product at the quantity we think we're going to be able to sell, and we're still in the process of doing that. So to your point about distracting the sales force, we've changed our plans a little bit in that we'll still be able to execute our limited market release here in the second half of 2019, but we'll postpone coming out with the full launch of that product until our National Sales Meeting which is in early 2020. So to avoid that distraction in what inevitably is going to be our strongest quarter for this year, we're just going to push that out a quarter because we don't see that as something that we want to take on with the risk of disrupting the field team during that fourth quarter.

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Christopher Thomas Pasquale, Guggenheim Securities, LLC, Research Division - Director and Senior Analyst [14]

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But the plan is still to have your core reps selling that product rather than carving it out like you've done with Entré and ACTitouch?

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Gerald R. Mattys, Tactile Systems Technology, Inc. - CEO & Director [15]

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I think for at least the first part of next year, and we'll certainly get into this more -- in more detail when we talk about our 2020 guidance, we will have our reps introducing that product to their customer base, but it's our intent to be able to move quickly from that introduction to the follow up being the responsibility of the inside -- the internal team. So you've hit on the key concern that we have about that product. We don't want our reps spending too much time on selling Airwear when they could be selling Flexitouch. But we certainly want to leverage their relationships that they've built with our customer base.

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Operator [16]

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Your next question comes from the line of Kyle Bauser from Dougherty & Company.

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Kyle Royal Bauser, Dougherty & Company LLC, Research Division - Senior Research Analyst [17]

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Great quarter here. Just a couple of market-related questions for me. It sounds like you're making some nice progress within the high-diagnosing facilities. I'm just curious, how do you define high- diagnosing facilities? And what is the minimum amount of patient volume a facility needs to see to be in that bucket of 4,700 clinics?

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Gerald R. Mattys, Tactile Systems Technology, Inc. - CEO & Director [18]

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Thanks, Kyle. Appreciate the question, and thanks for the kudos on the quarter. We actually access the list of high-diagnosing clinicians when we do our 18- to 24-month refresh trying to identify how many patients were diagnosed with lymphedema in the United States. So those data come from LexisNexis. We've been doing that survey, if you will, of the marketplace for 5 years now. And that the number of patients diagnosed each year over the past 5, it's been an average compounded growth rate of about 11% of that 5-year period. So the market's continuing to grow. When we get those data, we also get a list of the high -- of who diagnosed those patients, and we can stratify those into the highest deciles of prescribers. So the 4,700 number comes from the top 3 deciles or the top 30% of high-diagnosing clinicians. And we've been focusing our field team to call on those top 3 deciles as a way to uncover new customers. We came in to 2019 with a relationship with at least 1 clinician in about half of those high-diagnosing facilities. So we'll report on our progress once we get into guiding around the 2020 timeframe, but that is an area of keen focus for our field organization and one where we're making great headway.

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Kyle Royal Bauser, Dougherty & Company LLC, Research Division - Senior Research Analyst [19]

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Got it. And it sounds like you do -- I think you said an 18- to 24-month refresh. Do you have an updated year-to-date number, or perhaps for the first 6 months, for diagnosing volumes in lymphedema? I mean, any clarity kind of on how volumes this year have been trending would be helpful.

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Gerald R. Mattys, Tactile Systems Technology, Inc. - CEO & Director [20]

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Yes. So our last data pool was with data through December of 2018. So no, we don't have anything fresher than December of 2018. But the list is still quite current and has been a very fruitful call point for our sales organization.

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Kyle Royal Bauser, Dougherty & Company LLC, Research Division - Senior Research Analyst [21]

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Got it. That's helpful. And just lastly, if we're just talking about your accounts in the high-diagnosing facilities bucket, to the extent you can share what percent of lymphedema-related sales come from this bucket? I'm just sort of wondering if the 80-20 rule sort of applies here.

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Gerald R. Mattys, Tactile Systems Technology, Inc. - CEO & Director [22]

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We don't really break that out in terms of our reporting. What we have said in the past is that once we can get one of those clinicians to start prescribing our product or start using the Tactile sales organization, those customers tend to order twice the amount of product from us that our typical accounts order. So it's, again, a very lucrative call point for us and one that we're quite focused on and will continue to focus on for the second half of 2019.

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Operator [23]

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Your next question comes from the line of Jason Mills from Canaccord Genuity.

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David Kenneth Rescott, Canaccord Genuity Corp., Research Division - Associate [24]

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This is David Rescott on for Jason. Can you hear me all right?

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Brent A. Moen, Tactile Systems Technology, Inc. - CFO [25]

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David, yes we can.

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David Kenneth Rescott, Canaccord Genuity Corp., Research Division - Associate [26]

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It looks like in the -- slightly easier comps in the second half of the year, comparable adjusted basis. So it would imply slower growth in the second half of the year. So could you walk us through kind of some of the puts and takes in the assumptions in here and how we should think about these headwinds and tailwinds driving growth in the second half of the year based on what's implied in the current comparable guidance?

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Gerald R. Mattys, Tactile Systems Technology, Inc. - CEO & Director [27]

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Sure. Thanks, David. Appreciate the question. First and foremost, we're feeling very confident about our second half 2019 growth. We're continuing to enjoy the tailwinds of expansion of the field organization since the -- up 45 reps from this time a year ago. The Flexitouch Plus adoption and the expanded access and covered lives are all nice tailwinds to the second half. We also get some comparison headwinds on ASP that go away with the anniversary of our large payer contract which went effect of July of last year, and our VA FSS schedule, which we executed in September. So feeling good about the second half growth.

In terms of the overall growth of the business in the second half, we have to achieve about 55% of the company's annual revenue yet in the second half. And each and every year, we see the second half growing a bit slower than the first half. So we've guided to Flexitouch growing in the 20% to 23% range. Others, the Entré and other products in the 13% range. Feeling really good about what that contribution can be for the second half of the year.

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David Kenneth Rescott, Canaccord Genuity Corp., Research Division - Associate [28]

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Okay. And maybe second, around sales rep hires. I know you mentioned a little bit of commentary around the hires so far this year over the first half of last year. Could you provide any color around kind of how that trend's been going so far as well as what you're seeing on the lines of rep productivity when your products head to the bag, and how we should think about the much higher trends going forward.

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Gerald R. Mattys, Tactile Systems Technology, Inc. - CEO & Director [29]

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Absolutely, David. So let me just spend a minute on field hiring. We did end the second quarter with over 215 reps. That's up from 200 at the beginning of the year. And we had committed to trying to add 30 more reps in 2019. So we're about halfway there at the halfway mark. Having said that, this is a little -- we are behind a bit on our hiring. It's harder to find good people out there these days with the unemployment where it is, and we would've liked to have had more reps in place by this time of the year. We're very confident in our updated guidance that the hiring to date will be able to deliver on the second half results, but we're behind on the hiring at this point in time. Feeling good about getting to that 230 number, but again, we would've liked to have had it a little earlier in the year.

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David Kenneth Rescott, Canaccord Genuity Corp., Research Division - Associate [30]

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And I guess a follow up to that one. Would any -- would upside in the second half of the year come with any hiring trends coming in faster than that, as well as in productivity trends ticking higher than they are now?

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Gerald R. Mattys, Tactile Systems Technology, Inc. - CEO & Director [31]

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I think from a productivity perspective, we've really enhanced the training programs that we have in place and are seeing reps become productive in many situations faster than anticipated. But again, being a little behind in our hiring at this point in time, we're not really forecasting any additional upside from hiring for the remainder of the year because these reps take some time to be productive. So we're still confident in the updated guidance, though the hiring to date's been a little below our internal expectations.

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Operator [32]

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Your next question comes from the line of Margaret Kaczor from William Blair.

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Anna Marie Nussbaum, William Blair & Company L.L.C., Research Division - Associate [33]

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This is Anna on for Margaret. I'll follow up on the question about guidance and the implied deceleration there, though appreciate the color that you did provide. Specifically, if you could talk about the -- or the tailwinds from the large commercial payer and traction there in the Medicare channel. What percent of that channel is coming from Entré versus Flexitouch and your expectations going forward? And then in regards to the sales force, how much benefit is that -- are you getting from the internal sales reps, and as part of the expected hires, include increases in the internal sales force?

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Gerald R. Mattys, Tactile Systems Technology, Inc. - CEO & Director [34]

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Anna, thank you. Thank you for the questions. First, on the guidance. We're forecasting sales and rental revenues for the Flexitouch to be -- that's with 1 up in our guidance this quarter. So up to 157 to 158.5, so 20.5% to 22% increase on the sales revenue side. On the rental side, that remain unchanged at $25 million to $25.5 million for the rest of the year. So Flexitouch overall, we're looking at 26% to 28% growth year-over-year. That implies 20% to 23% in the second half. So we feel really good about being able to achieve those numbers as we think about that.

On the question around the inside sales team, that's primarily a driver for Entré and ACTitouch growth, not necessarily Flexitouch volume. And I think the second half of the year, we're still tracking beautifully. We expect overall the growth in that product line to be 30% in this year -- for the full year. So that's where we're seeing the big benefit from our internal organization. They're able to lift that burden of paperwork and order processing from our field team, allowing them to go get the Flexitouch revenue we just talked about.

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Anna Marie Nussbaum, William Blair & Company L.L.C., Research Division - Associate [35]

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Okay. That makes sense. And then in regard to adjusted EBITDA and some of the drivers there, how do you view the sustainability of some of the operating leverage seen this quarter, particularly in the sales and marketing and then G&A line?

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Brent A. Moen, Tactile Systems Technology, Inc. - CFO [36]

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Anna, it's Brent. I'll take a shot at that question. So certainly, we were pleased with where our adjusted EBITDA percentage came in for the second quarter and then for the first half of the year. For the remainder of the year, we also expect improvement and improved leverage on the adjusted EBITDA line. So if you look at our first half of the year, we came in at 10% adjusted EBITDA margin. Our expectation is to get between 13% and 14% for the full year, so we do expect a step up in leverage and adjusted EBITDA margin in the second half of the year. The majority of that margin is going to come from G&A and reimbursement. We continue to invest in our sales and marketing line. So the majority of that's going to come out of those other cost categories.

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Operator [37]

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(Operator Instructions) Your next question comes from the line of Suraj Kalia from Northland Security.

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Suraj Kalia, Northland Capital Markets, Research Division - MD & Senior Research Analyst [38]

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Jerry, my apologies. I joined the call a little bit late, so you might have mentioned this. What were the respective growth rates within Medicare, VA and commercially in the quarter? And a corollary to that question, Jerry, maybe others have it figured out. I'm a little confused. So any color you can give would greatly be appreciated. Your new commercial payer kicked in really in Q4. If I strip out this new contracted payer and the ASC 842 changes, can you give me the -- what would growth rates look like? So on an apples-to-apples basis, we could have -- get our arms around some of the core growth rates in these 3 buckets. Any color would be great.

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Gerald R. Mattys, Tactile Systems Technology, Inc. - CEO & Director [39]

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Yes. You bet, Suraj. Appreciate the question. Let me start with the channel description or the Medicare, commercial, VA that you asked about. So for the first half of the year, Medicare -- our Medicare business equaled about 11% of sales versus 8% last year. That's a big step-up, almost -- over 90% step-up in Medicare volume. Commercial was 70% of our business versus 71% last year. And the VA was 19% of our business versus 20% last year. That's the first half. The second quarter specifically, 11% of sales for Medicare versus 6% last year, so a little step up there. Commercial at 71% versus 74% prior year. And VA, 18% versus 20% last year.

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Brent A. Moen, Tactile Systems Technology, Inc. - CFO [40]

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And Suraj, it's Brent. I will give you a little bit of color on growth drivers excluding ASC 842, and I'll try to give you a little bit of context on the large payer as well. So for the first half of 2019, our reported growth rate was 36%. We've identified the impact of ASC 842 to be 7 percentage points on that number. So taking out the effect of ASC 842, our year-over-year growth rate would have been 29%. And then as it relates to the step-up and full year guidance, we expected and got to see some improvement relative to volumes from that large payer contract. We increased our midpoint on the guidance range by $1.7 million. We attribute about roughly $1 million of that to the large payer contract that's out there. So that will just give you a little bit of perspective on kind of what the drivers are. The other piece that is a contributor to our overall step up in guidance for Q2 is just the stronger execution by our sales teams overall, and that new guidance range implies normalized growth rates of 22.5% to 24% year-over-year.

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Operator [41]

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There are no further questions at this time. This concludes tonight's call. Thank you for your participation. You may now disconnect.