Tactile Systems Technology, Inc. (TCMD) Earnings Call Transcript & Summary

Before we start get to the good stuff, I need to read the disclosure. For important disclosures, please see the Morgan Stanley research disclosure website at www.morganstanley.com/research disclosures. If you have any questions, please reach out to your Morgan Stanley sales representatives. And with that out of the way, let's get started. Today from Tactile Medical is Dan Reuvers, CEO; and Brent Moen, Chief Financial Officer. Welcome, and appreciate you all joining the conference.

Look, I think before we get into kind of the detail, why don't we start off with a high-level overview of Tactile for those of the audience that may be new to the story. Dan?

Sure. Thanks, Peter. So I joined the company about 15 months ago, and just to start, the company's mission is to treat patients with underserved chronic conditions in the home. And one of the things that I found particularly appealing was what I believe to be a very large TAM. We've seen that not only the diagnosed patient level has grown from 700,000 to over 1.4 million in the last half a dozen years, but we also believe that there's as many as 20 million patients suffering from some form of lymphedema that remain underdiagnosed and underrecognized. So I really believe that we're still in the early innings. We've got a bit of a unique structure. We're vertically integrated, so we both design, make, educate, sell, reimburse, do the patient billing and train the patient all within the confines of our employee base. Our call points particularly focused on lymphedema have been lymphedema therapists, oncology and vascular, which is where we find most of our kinds of patients. And then just from a financial profile, this year, our guidance is $216 million to $224 million, gives you a bit of a framework on scale. And our profile, we've said that since COVID, we see ourselves as a consistent 20-plus percent top line grower with gross margins over 70% and expanding profitability. And we're a little bit in thin air in that a company our size and growing at our pace actually is profitable today. So that's kind of just a quick framework of what we do and what we're about.

That's great. And look, we always appreciate when clients had some significant news the night before our conference. So thanks for that. On that note, before going back to base business, maybe spend a little time on the AffloVest acquisition you announced last night. I think the consideration is about $100 million or $80 million upfront. Can you tell us about the technology, how it fits in what you're doing? How it leverages your call points? Because it's certainly an exciting deal, and I know you guys have been looking for deals.

You bet. We tried to time this just for the Morgan Stanley conference. So it works out well. But yes, so this is the first material acquisition we've made since I've been here, and I think, on the watch at Tactile. We really believe this is the right one for a couple of reasons. First of all, if I go back to our mission, we treat under -- patients with underserved chronic conditions in the home with wearable therapies. So that's done with both the AffloVest acquisition we made as well as our core lymphedema business. I mentioned the growth profile, the gross margin targets, the expanding adjusted EBITDA and it checked all those boxes as well, so it fit the filters that we applied. We've said we didn't need a deal because we've got still great conviction for our role in developing the lymphedema space, but I happen to be really familiar with this one. I was President of one of the -- basically, the first vest company that sold to Hill-Rom in 2003. And so was there even before Hill-Rom was their novel leader. The #2 player is Philips, and they acquired a business called RespirTech a few years ago. I'd served on their board for 10 years. And our head of sales came from Philips. And over his 19-year career, he spent 2 years integrating and serving as General Manager for the vest business there. So we know this space well. It fits our mission, but we also believe that there's 2 particularly interesting and provocative opportunities in it. The first one is they have a unique attribute to their device. It's the first truly mobile device. So it's not tethered to a wall. It's not pneumatic. It doesn't have a pump and hoses. It's a garment that they wear. It's got embedded motors. It runs on a battery. And while I think all of the options in vest therapy are effective, why not choose the one that's got mobility? So we think that's a truly differentiating characteristic. The second one is maybe more significant. And that's -- the seller had started to develop this business using traditional respiratory DMEs. The intention is to continue to use the respiratory DMEs because the 3 companies that have been in this space for years, Hill-Rom, Philips and Electromed, all have direct sales forces and they're vertically integrated. They look a lot like the description I just gave of us. But collectively, they have less than 300 salespeople out there between all of them. There's over 4,000 respiratory DME representatives and they sell oxygen, nebulizers, ventilators. And what our diligence has demonstrated is patients that need airway clearance are the same patients that need oxygen and nebulizers and ventilators. So historically, a discharge planner would call Hill-Rom and say, "I want a vest on Peter when he gets home tomorrow." And then they would call Lincare and say, "I want to make sure somebody gets out there to set them up on oxygen and a nebulizer." And I think it's an opportunity for the easy button. They can call one respiratory DME and they get the entire component. And from the DME standpoint, finally, with the placement of one of these vests at an average sell price retail, and it's very regularly reimbursed, got a HCPCS code, at about $10,000 is equivalent to them having to set up more than 25 CPAP starts. So the DME community is interested in participating. They just haven't had a product to do it. And we think that there's a nice convergence of opportunity here.

That's great. So super exciting. I know investors like to see the deployment of capital as -- looks like good use of proceeds capital. So let's put it back to the main business. And obviously, TAM continues to be a very big focus of investors and investor sentiment these days. Obviously, you're out there with a $5 billion TAM. I don't think people appreciate that is actually the size of lymphedema. So maybe talk a little bit about how you get that TAM, how penetrated you are in the TAM and how you kind of get patients to recognize your offering out there?

Yes. So we talk about the TAM. There's a lot of literature to the points, as I said, as many as 20 million patients, but let's get started with the known numbers. In 2014, we acquired LexisNexis data, third-party source, that reflected 700,000 patients have been diagnosed that year with lymphedema. Fast forward 6 years to 2020. It was 1.4 million. if you take the 1.4 million times our average sell price, that's how we get to a $5 billion space, and that's the known lymphedema universe. So many of these patients continue to be under-recognized, and I really believe that in the spirit of obstructive sleep apnea, I think it's a great predicate for us to compare to. Forty years ago, my dad snored. Nobody knew what obstructive sleep apnea was. It was a joke when somebody snored. They don't know how to diagnose it, didn't know about the comorbidities or how to treat it effectively. And we fast-forward today and company like Philips and ResMed leaned into it and developed that market. We all know it's a big ecosystem that helps a lot of patients. We think that lymphedema looks a lot like that. Really big market, misunderstood, didn't get much education on the medical side, and we're trying to play that role. And having seen the market double in the known universe in the last handful of years with an increasingly large sales force and an increasing amount of energy going into educating physicians and caregivers, we think we can continue to reveal even more of those patients that are still underserved.

And I think historically, when people thought about lymphedema, they think about legs. And I know you guys, a big focus of your all is the head and the neck, which is, I think, untapped potential right now. How do you plan to target that? Is it consistent with where you're calling today? Do you have to make some change in your sales force? And what's the kind of level of overlap with your current customers? And what's really the opportunity moving from what I think historically of a leg opportunity for you all to the upper part of the body?

Yes. So let me just touch a little bit on the segments, and I think I can cover that one. There's a few different call points for us. This really started in oncology. Women that had breast cancer tended to get disruption of their lymph nodes. They were either removed or damaged with radiation and started to find themselves with lymphedema in the upper extremity. That's where the company started, and that was the segment that was originally focused on. Over time, we recognize that phlebolymphedema or the convergence of lymphedema and chronic venous insufficiency was an even bigger market. So we've not pivoted, but added, not just oncology, radiation oncologies. Two, we started to recognize the vascular community as a very large source of referrals for us. And then the third one, which is lymphedema therapists, and I'll come back to that in a moment. But those are -- think about physical therapists kind of people that are taught to do manual massage on patients with lymphedema to mobilize and move it back into the central passage ways. Head and neck is one that we're still very interested in. But just to size it, it's about 5% of the total lymphedema market. So it's not huge, but we're interested because they have so few options. There are a [ few ] compression of the neck. We did a pilot study that showed statistical significance of improvement in reduction of swelling, and improvement in swallowing, less pain. So some people, I think, get confused that lymphedema is a vanity disease, and it's not, not when you're talking about swallowing and pain. So we're continuing to develop more evidence on the head and neck because we want to continue to develop the reimbursement climate for that segment, but it's the lymphedema therapist that's the largest source of referrals followed by a close second of vascular and then it becomes oncology. One of the things that happens today, Peter, is that we have -- we've just accumulated a big data pool that's reflected that an awful lot of docs will refer the patient to a lymphedema clinic and assume that they'll take care of everything. And the reality is while reimbursement might support 8 or 10 visits, the average patient goes less than twice, not dissimilar to me going to physical therapy. After I go once, I decide I can probably do this at home, and I'm too busy to go 10x. So they're not necessarily getting the treatment that they need. And it's not us or them, but we think that this complement is an important opportunity.

Helpful. Look, you joined a little over a year ago. I guess the obvious question now is what has been the biggest both positive and negative surprise for you as you annualize your tenure here. And then secondly, what do you think is the most misunderstood or overlooked or underappreciated about the Tactile story by the investment community?

Yes. I think there's a couple. Fortunately, I did a good amount of due diligence, not too many shockers. I think the biggest surprise perhaps is -- I was surprised it seriously how overlooked these patients can be. And I knew that, that was the case, but having spoken to patients since I joined, they've suffered for months or years with lymphedema and struggled to get an accurate diagnosis, let alone, relief. It's one of the things that energizes group, I think, an awfully lot. The role of payer policy I have learned is going to continue to be, I think, one of the important catalysts for unlocking our total potential. We have 275 million lives under coverage, but they're not all covered the same. And some of the payer policies are antiquated based on old data and old evidence. And as more evidence has come to light, I think part of our responsibility is to make sure that we revisit that with payers and the policies reflect the right [indiscernible] expenses. I think from a misunderstood standpoint on the investor side, I scratch my head on our valuation a lot. But I think that we probably have been recognized right or wrong as a pump company. And I see us as a company that's treating chronic conditions and focusing on those that are underserved. So we're not going to jump into a CPAP system, and we're not necessarily going after the diabetic community because those are big companies, and they're getting a lot of attention. But whether it's lymphedema or bronchiectasis, I think there's disease states that we get some leverage from in our digital road map, in our product development path. But it's I think being recognized as a chronic disease company is the identity that we to continue to demonstrate.

And then on that note, right now, you're out there with targeting 20% plus growth for a number of years now. As you look at the future, is that kind of the appropriate target growth for the next 3 to 5 years? Or how do you think about the long-term trajectory given the underserved lymphedema patient population you serve and now expanding into other areas?

Well, I think there's more than enough runway for us to continue to grow at 20-plus percent. Right or wrong, we've also been a bit attentive to being a profitable company and kind of controlling our destiny. So we think that we can continue to grow at over 20% and also return -- increase expansion in our adjusted EBITDA and -- there's just not a lot of companies, I think, that are able to have both of those and frame to the market. So I think that, that balance is one that we think we can do. And if we're successful at continuing to expand into some other what we think are rich market opportunities and/or influencing payer policy, we certainly have an appetite and capacity to keep investing and expanding the sales organization and investing in more clinical evidence. So yes, I think that, that's kind of our minimum threshold expectation of ourselves for the foreseeable future.

On the sales organization front, you made some significant changes to that organization since you joined. Do you think that -- is the job done? Are you seeing the impact of that? Is the pull-through there? Or is still -- some of it still on the calm as you've made those changes?

Yes. So just to share the changes, I think, that you're referring to. We have had a large direct sales force. The company's continue to expand headcount each year. The things that we recognized was -- and I keep coming back to payer policy, it's become an increasing responsibility of ours to do demos for some payers that require a demonstration for the patient before they become eligible for a prescription to be filled that would be covered. So doing patient demos and sometimes that's going to the home, one-to-one versus one-to-many. And what we've recognized is that it's not the most efficient place for our well-paid sales professionals and market development folks to be going to one house at a time to do a patient demo. It's an important part [indiscernible] of the process. So it's not one that we can underestimate or neglect, but we don't need to have a market development sales professional doing it. So we've decided to add more field support specialists. Those are folks in the field that can either help collect medical records, which would be necessary to successfully submit for the patient or do patient demos and it's liberating our sales reps to spend more time with referral sources and in clinic where they can see more patients in a day and spend more time with the referral sources themselves. The cost of an FSS comes at about 50% less than a product specialist, and the consequence is it expands the amount of hours in a day that the product specialist can focus on market development as opposed to some of the other kind of administrative burden. So it's a blend that we're finding is effective. We started with a pilot. We've continued to expand it, and we've been able to demonstrate that where we have a tenured rep, and I'll use over a year in seat, and an FSS companion together, we're seeing the highest productivity in those. And I think that it's good evidence that this model is going to work, right?

And you've done this all with the backdrop of COVID. So how has that challenged the changes you made since joining? And I guess, secondly, how has COVID impacted and the Delta variant impacted your revenue growth and your patients getting access to your life-changing technology?

Yes. It's hard to have a conversation without talking about COVID these days, and it's certainly thrown us some curve balls and it's made this -- made me adopting this role more interesting, shall I say, 15 months. I think it's hard -- it was hard to predict kind of what the pace and the direction of the Delta variant is going to be. I think if you would have asked me 9 months ago, I would have assumed we'd be in a better position with vaccines and things like that. So we've seen challenges with throughput. They peaked at docs seeing as few as less than 70% of what they'd normally see in a given day just because of all the social distancing and things like that. We've seen recovery. We're not back to normal, but we've seen progressive recovery through the second quarter. It's prompted virtual pivots for us. So I think it's -- it's actually led to a more productive, effective way for us to train and educate docs through virtual events. We've had, I think it was 6,000 attendees last year. We wouldn't have come close to that. It was more than what we had back in the day when people had to come to an event in person. So there's a few enduring pieces, but I think maybe the most encouraging piece is the TAM is unchanged, the opportunity is the same. We just have to continue to navigate through a little bit more choppy water for a while.

Perfect. Brent's looking awfully bored. I haven't asked him any questions. So let me pivot a little bit to some financial questions. As you said, I'm not quite sure the unicorn is right here, but you guys have growth and profitability targeting 12% to 13% EBITDA margins in '21. How do you think about kind of the longer-term EBITDA margin target you can hit? And where can this business go from a profitability perspective?

Yes. No, happy to provide a little bit of color on that, Peter. And as Dan mentioned and you mentioned, too, we do believe that we're in rare air being able to grow at 20%. And one of the contributors to that growth is our strong gross margins. So we've been able to maintain gross margins north of 70%. In fact, that's one of the things we call out on a regular basis is our ability to maintain strong gross margins. And that's despite the fact that we do experience some average selling price pressure each and every year. If you harken back to 2018 and 2019, when we renewed a contract with a large payer, ASPs were feeling a little bit of pressure into the mid-single digits. They've stabilized now. We still feel the pressure of average selling price, but it's in the low single digits now. So we have a lot of opportunity, and our R&D and manufacturing teams are very successful at helping us to offset any of that ASP pressure. So it's one of those strong contributors that we believe in.

As you think about the targets and maybe it's too early to say this, but if you think about the acquisition you did, AffloVest, how does that impact your growth profile, your margin profile, obviously, your [indiscernible] gross margins? Is it all accretive, dilutive to some areas? How do you think about the financial impact of the deal?

Yes. No, that's a really good question. I think Dan pointed out earlier in his commentary that it's certainly 3 of the categories that we measured the acquisition against. And so whenever we look at an acquisition, we're focused on making sure that it's not dilutive to our top line expectations. So Afflo certainly checks that box. We expect it to mirror our 20%-plus revenue growth for the foreseeable future. Interestingly enough, the gross margins relative to Afflo are slightly accretive to our overall gross margin. So that certainly will be a helper as we go forward. And then from an adjusted EBITDA perspective, there is even more help from that organization -- from that acquisition. So to your point earlier, we expect adjusted gross margins for the core business to be 12% to 13% in 2021. And as we look forward, our kind of internal measurement stick is to continue to expand those adjusted EBITDA margins. The Afflo acquisition will help. Core business, we expect to add roughly 100 basis points each year. And then Afflo will be a contributor to that as well, but on a much smaller base, on a $17 million base, for reference purposes, for 2021.

Great. And then you got -- your first deal under your belt is behind you. You're cash flow positive. Is Tactile still open for M&A? Or how do you all think about capital allocation going forward, digesting what is kind of your first material M&A deal, I think, ever, frankly.

Yes. No, that's right. And I'll start and Dan can add to this. But certainly, it's our -- we're going to sit back and digest this, to your point, Peter. We finished the second quarter with $49 million of cash in the bank. We used a chunk of that cash to help finance the acquisition along with leaning into our lender at Wells Fargo to help us finance about $55 million of this. So we think that over the course of the next year or 2, our main focus is going to be on deleveraging that bank debt out there. But that said, we're always -- eyes are open and ears are open for opportunities that may present themselves. But right now, I think we are dead center focused on integration, execution and paying down debt.

Great. Helpful. And then we have a question from the audience. Related, Dan, to your payer policy comment, what is needed by the payers to unlock the TAM? Is a large-scale clinical trial needed to understand the value? Would you be willing to sacrifice profitability in order to increase spending on clinical evidence?

Yes. I don't think large-scale clinical trials are going to be required with the possible exception of head and neck, which is a path we intend to go down. I think that there's enough evidence out there that we're starting to have more dialogue with payers to actually work with them to use their own database that we can help mine and be able to demonstrate which patients are going to benefit and how to make sure that policy aligns with fact. We've got a big data set that we just acquired. We're sifting through right now, and I think we're learning some really interesting things that ultimately can lead to publication and I think also better decisions. In the meantime, I'm really impressed with the quality of audit results that we get. So when you're in the third-party billing business, you tend to get audits from time to time, whether it's from Medicare or whether it's from the privates. And our audit success has been incredibly high. And one of the observations from our new payer relations leader is this is probably an opportunity for us to lean into this, to revisit these and use this as a marketing position and say, "Look, we're a really great actor. Our evidence shows that we follow all of these, might be a good reason to even have a preferred relationship with us." So I think that -- I think there's good evidence, some of it is just reengaging a dialogue that I think perhaps we hadn't been as creative with and [indiscernible] run in some fresh eyes.

Great. And then a few final questions here. Obviously, the company has been embroiled in a lawsuit for a few years now. Is there any updates you can provide in our key milestones that the investment community should be mindful of as hopefully that unwinds over time?

Yes. Sure, Peter. I can give you a little bit of color on that. So during the course of spring and into the early summer, we wrapped up depositions and all of the discovery phase. We're in the kind of exchanging of briefs to the judge and compelling positions. Right now, the trial date is on the docket for early December. So we're looking at preparatory trial over the course of the next couple of months and then a trial early December. So...

Great. That's a long journey.

It's getting behind us. Yes. It's definitely getting behind us.

Coming to a close, it sounds like. And then lastly, one of the key themes we're seeing with investment communities these days is ESG. Look, I know you're an earlier stage company, but maybe talk a little bit about what you're all doing on that front and your plans on focusing on ESG.

Yes, I'll start and then Dan can certainly chime in, too. But as you might expect, we take ESG very seriously. In fact, in 2020, we published our ESG report. You can find it on our website. But certainly, the sustainability about it, the social responsibility that we have and then also the governance, all of those things are front and center for us in terms of focus as we look at the remainder of 2021 and 2022. We'll continue to publish our report. So it's top of mind for us for sure.

Right. And look, at the last minute we have, the last question I would ask is kind of any new product introductions or R&D initiatives that -- the Street should be focused on as we move into '22 and beyond?

Yes. So the company has been on the sidelines too long as it relates to that. So it's been a priority of mine since I got here to try and bring -- breathe some new life into the PD side. We've got a couple of projects that are underway in our lymphedema business. One is on ease-of-use garments and some new materials and things that I think will make the device just a much better experience for the patient. And we think that there's intersection points, some of what we're working on, we're convinced can bring value additionally to the vest business as well. And then we've got a digital road map that we started. We brought in some new talent here this year. And in 2022, in addition to some fresh garment introductions, we expect to introduce the first chapter of our digital path, which will be allowing patients to engage digitally, help them manage their disease and then ultimately be adding the ability to connect to their device with smartphones and even for us to collect the information so we can see a better source of resources, both to the payers and to the prescribers.

Great. Well, with that, we're essentially out of time. So I want to thank you all for attending the conference, and best of luck on the integration of AffloVest and so many exciting times for you all. Thanks very much.

Thanks, Peter.