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

Good morning. Thank you for joining us for the second day of the Morgan Stanley Healthcare Conference. I'm Cecilia Furlong, I'm medical device analyst here at Morgan Stanley. It's our pleasure to have Tactile Medical with us today and CEO, Dan Reuvers. And thank you for being here. Quickly disclosures, please see morganstanley.com/disclosures. With that, Dan, again, thank you for being here with us.

My pleasure. Thank you. .

And I wanted to just start with a quick overview. I've been following this company for a long time. It was a lymphedema-focused company with a unique business model to start. And I think the model has changed since one that really is targeting chronic care patients and in the home setting. But I'd love to just kind of get a background for where the business was, where we are today and kind of your outlook.

Sure. So our mission at Tactile is, we treat patients with underserved chronic conditions, and we do it in the home. And we're trying to embrace this migration from the acute care environment to where patients really want to be treated, which is in their home. We talk about underserved because it's a critical word that defines the segments that we've chosen to participate in. By definition, that means we're not going to be in the obstructive sleep apnea or diabetes spaces, which are really well served, but we've selected 2 specific chronic conditions. One is lymphedema, and that's really better tied to, I think, our legacy. And more recently, as a matter of fact, a week ago, we anniversaried our first key acquisition, which moved us into the bronchiectasis treatment market with an airway clearance device. Those are the 2 categories that we participate in. Both of them, we think, represent roughly a $5 billion space each. And our goal is to not only continue to be the leader, but expand and develop those markets with an eye towards improving profitability as we continue on this journey.

Okay. Great. And I guess just to turn to current business. As we think about your 2Q print, your forward outlook, a few moving pieces. But as you think about, what's transpired in the lymphedema component of your business? We had some sales force disruption. Where are you at this point do you think in terms of building the team back? It seems like you've kind of gotten to where you're looking to go, but productivity, how does that improve? And what have been the biggest barriers, COVID, other dynamics, that may have limited a faster ramp for some of these reps?

Sure. So we have -- since COVID, we've not seen the same growth. We kind of became accustomed to pre-COVID in the lymphedema space. And I think to Cecilia's point, a couple of contributors to that. Obviously, I think COVID had some impacts that were affecting most in health care that included staffing and also patient flow. I think we're largely on the uptick on those. I think staffing continues to be episodically an issue. But for the most part, I think those continue to improve. From a sales force standpoint, we have made a commitment to a large direct sales force with the lymphedema space. We think that, that's an important part of expanding the market, having a dedicated group that's highly educated as it relates to helping physicians identify and treat those patients. And we saw certainly more than our share of turnover in the back half of 2021. As we approach this year in the first half, one of the goals that we talked about was getting healthy again, making sure that we had all the positions staffed. And I'm pleased to say that by the end of Q2, we were largely at our target space, which is little over 240 direct salespeople in the field on the lymphedema side. We think that over the course of the next couple of quarters, as they continue -- they will continue to ramp and their productivity will improve as they gain some tenure. I think the other piece in the assumptions, going forward, is some of the impacts that we'll see from some of our new products. So we introduced a new garment that is intended to make the experience easier for patients with limited mobility and many of our patients have that. So I think between some new products and just some recovering tenure in our sales force. We think those are the 2 things that should help us continue to migrate into that recurring ramp as we exit the year.

I think you've talked about 2 just given the prior disruption, maybe you weren't engaging with some customers, but you have the new garments. For your business as a whole as you think about both ramping sales force productivity, reengaging with some of these accounts. And then as you -- is there an ASP benefit here, too? Or is it in line? How do all of those contribute to your back half outlook?

Yes. So gross margin has been something that we're pretty proud of the fact that we've been able to maintain in spite of an inflationary environment and a supply chain challenged environment. One of the things that we've done with our new product development is one of the expectations is it's got to take cost out. So we don't have a ton of pricing power on the third-party payers, especially Medicare. But I think that some lower cost opportunities help offset some of the pressures there. So I think that's a big piece of it. From a productivity standpoint, one of the things I talk a lot about is the payer policy and impacting payer policy because, frankly, it's at the core of so much of our business model. Payer policy impacts patients' access to care. It impacts the amount of productivity we can get from a rep depending on what requirements they have to be eligible for a pump. And it also impacts our ability to be efficient in the back office. And one of the things we continue to talk about is the importance in reducing not only our cost to sell, but our cost to serve, which is a lot of back-office piece. So when it comes back to the -- where do we find the catalyst and the productivity, we have a lot of work going on interacting with payers to really revisit what the appropriate eligibility criteria ought to be. And we think, ultimately, that will help some of the back-office components as well as sales force productivity.

On just some of the other dynamics you called out, higher requirement in some cases for some payers for use of a basic pneumatic compression device before going to Flexitouch, that's been in place for -- with Medicare. Can you talk about just, one, what you've seen with Entre that side of your business reflective of that? But then two, where you are in some of those discussions? What do you think it takes for Medicare to revisit that and look at Flexitouch as earlier treatment option.

Yes. For those less familiar with our business, the pneumatic compression segment has really 2 categories. There's a basic pump and an advanced pump. And the basic pump is the one that we think should be more synonymous with conservative therapy. Conservative therapy is a requirement that most patients need to meet before they're eligible for an advanced pump. And the question is, what is the definition of conservative therapy. Many would say that it's the use of compression garments that the patient has to have tried and failed. And we're having dialogues trying to talk about what is the appropriate path. There was a recent consensus document that was published that was the reflection of 3 of very disparate, but complementary professional societies, that all kind of coalesced around when should a patient be diagnosed? What is a legitimate diagnosis look like? And at what point in their journey should they be treated? And the one thing, I think, that you've alluded to as well, Medicare probably has some of the most rigorous criteria. We had seen some of the commercially applied Medicare Advantage program start to adopt that as well. As far as progress made, we have -- I think one of the best pieces is our head of payer relations has been able to establish a very real and active dialogue with the [ MACs ], the administrators of the Medicare plans. And I think that agreeing more clearly on submission criteria and how it's presented is something we expect progress to be made here. We're optimistic that, for example, our Flexitouch, which historically has taken a very long time to get paid because it's regularly denied and goes to subsequent rounds of appeal, at which point we are successful, more than 90% of the time. I think we have a path to potentially move that up, see the adjudication earlier, which would certainly have a positive impact on cash flow and also on our balance sheet. So I think the progress that we expect to make with Medicare over the course of the next few quarters, I'm confident with.

As you think about 2, just stepping back in your business in the second half guide, what are you factoring in from inflation in supply chain? And I want to ask to and go into AffloVest, specifically. You talked about recently acquired within the last year. I know you're looking to expand supplier production capacity. With your current guidance in place, is there upside with the capacity that you have today? And how would you frame the puts and takes fairly in line run rate with what we saw in 2Q, if you annualize that. So just curious...

Sure. So let me tackle the inflation one and then maybe frame out the AffloVest piece. From an inflation standpoint, we haven't been immune to that. We've seen increases that we've applied into our direct labor team. We've seen increases on freight specifically, to some extent on components. On the flip side, I think we've probably benefited a little bit from mix. And I think our team has done a very good job of negotiating with some of our current suppliers to offset some of those headwinds. The ongoing product development efforts that we have, as I said, are an attempt to try and offset some of those also by taking some cost out as we improve the products. All of that said, they kind of net themselves out to what we believe is a continued profile, well above 70% gross margin. So we feel confident that, that's sustainable. On the AffloVest, I think it's worth taking a step back, maybe, Cecilia, just to reframe this one, especially since it's kind of our birthday. Anniversary was last week on the deal. It's the first real acquisition that we made at Tactile. And it's a device that's a portable vest that helps mobilize secretions for patients with chronic retained secretions. The consequence of going untreated is these patients are typically finding themselves in the hospital with a pneumonia recurringly or recurring requirement for IV antibiotics or oral antibiotics or nebulized antibiotics because of pulmonary infections. And when we acquired this business, there were basically 3 other players in the space. I've had experience with 2 of them. The largest 2, one I ran and the other one I was on their Board. So I knew the space well. And I found that there was a component of this one that was particularly appealing. The competitive landscape looks like our lymphedema business. They have direct sales people, and there's roughly 200 among all competitors combined. This one, because it had a unique mobility component, it's battery operated. There's no compressor or hoses. So it's got a differentiating characteristic on the device itself. But using the respiratory DME as a channel, we believed was a competitive advantage. There's over 4,000 respiratory DME reps in the United States, and they have a front row seat to every single patient that's eligible for airway clearance. The criteria I just described typically leads to these patients to be prescribed with oxygen and nebulizers. And the only place they go to get them is a respiratory DME. So by introducing this, now these DMEs can go back to their referral sources and say, "Hey, doc, the patient had a round of antibiotics." They've had a recent pneumonia. They've been hospitalized for a pulmonary infection. You know they're eligible. Right now, they meet the criteria for airway clearance therapy. Have you considered that as an adjunct? And what we're finding is the attach rate has been very much organic. This is not about a [indiscernible] deal. This is about a big market that we believe we can expand. And I'm really pleased that most of the business that we're enjoying is new patients that wouldn't have otherwise been treated. So we're enthusiastic about that one. Back to the question about supply. It was a business that was roughly $16 million to $17 million pre-acquisition. When we acquired it, we had guidance that was just north of $20 million for this year, our first year on our books. We did $7 million and $8 million in Q1 and Q2, respectively, and have since raised guidance to $30-plus million this year. That is still a function of some supply constraints to your point. We inherited a sole-source supplier, and they had some capacity limitations. We are not their biggest customer. So we started initially to try and develop secondary sourcing. We are well down that road. But our current updated guidance still assumes that we are with a sole-source supplier through the end of the year.

As you think your guidance for the back half, what are you factoring in from a seasonality standpoint, typically 4Q for the lymphedema business, thanks to deductible. So it's kind of your strongest quarter, but you have kind of this ramp back up with your sales force. You have new products with supply constraints. How are you thinking about just the balance of typical seasonality playing out this year?

Yes. So our Q4 has always historically been a healthy ramp. And as Cecilia is familiar that, one of the reasons -- the key reasons is because the product effectively gets cheaper over the course of the year. As co-pays go down or are met over the course of the year, many patients have a 0 co-pay in Q4 when they might have had a $1,500 co-pay in Q1. So we still expect that same ramp in Q4. Our current guidance would -- we haven't given Q4 guidance, but if you take Q3 and rest of year, it points to a double-digit organic growth in the lymphedema business and a double-digit sequential growth in the lymphedema business in Q4.

Do you feel like you're where you want to be with your sales force scale size-wise and noting they still need to continue to ramp. But is this the right sales force size for Flexitouch?

So I think it's where we want to be at this point this year. Will we continue to expand the sales force? I think that the likelihood is the sales force may continue to expand, but we certainly don't want to do it at the pace of revenue, and that's why we continue to look very closely at cost to serve, back office and payer policy. So introducing more intuitive products to the extent we can influence payers, not to require a presales demo for the patient. Those things, they're a little more difficult to influence via productivity. I mean, it's time to do a demo for a patient. So that's why I keep talking about the importance of payer policy. I think that over time, over the course of the next couple of years, we do expect that we'll have an impact on payer policy, that's probably one of the biggest impacts or catalysts to sales productivity. In the meantime, we're trying to make sure that we're moving in the right direction on digitizing the exchange of records, making it less manual, both to convey things from the field to our home office, but also fewer touches once it's there.

Can you talk on the digital side, Kylee, the mobile app that you are recently rolling out. How does that evolve over the longer term. Right now, seems like it's looking to capture patients ahead, bring them into the funnel. How does that interplay once the patient is actually on the device longer term?

Yes, it's a great question. We introduced our first digital app just a couple of months ago. And just to take a step back, one of the things we learned when we acquired a large data set from IBM about lymphedema patients, 84,000 patients with a diagnosis. And we were able to mine it and learn an awful lot about our constituents, our target audience. And one of the things was the average patient from the moment they declared that they recognized their first symptom, swelling, until the moment that they got a diagnosis, not treatment, just a definitive diagnosis is 3 years. The misunderstanding at the primary care level and even at the vascular in some instances or oncology is still remarkable. There's very little time spent on understanding the lymphatic system in medical school. So to some extent, we want to help patients advocate for themselves. We want an informed patient to arrive at their appointment with their physician, whether it's their PCP or their specialists. So Kylee is an app that we are starting to make available, not only through social media, but through the physician offices and even through some of the support groups. It's intended for a patient to download it, so they can learn more about their condition. They can learn about lymphedema. They can learn about what are the interventions. They can learn about what conservative therapy is, and what they can actually do for themselves. And they can even take pictures of their legs or their arms or wherever there swelling occurs and the progression. The goal here is multi. One, it's to better educate patients, so they're more informed when they go see their doctor. The second one is to allow patients to chronicle some of their progress, so they become eligible. They meet those requirements earlier. Now if I go in to see my doctor and I say, "Doctor, based on what I see, it looks like this describes me. I've tried compression garments that I got at the drugstore, and it hasn't helped. I tried elevation. I tried a low salt diet." The doctor can document those and the patient becomes eligible much quicker than having to come back for a subsequent appointment after the doctor tells them to try that. Over time, we see Kylee as an opportunity to become a more useful training tool for the patient, which is also a big component of our expense, could lead to improving our profitability profile. We see, Kylee, as an opportunity to become the manual device that will speak to their device, and it will be their controller. And it will also have an opportunity via Bluetooth embedded in the devices over time to start to download this information, learn more about our patients and be able to share their results with their HCPs.

What is the time frame right now as you're thinking about Bluetooth connectivity? And do you see a similar type of use case AffloVest leveraging the same components that you're rolling out today?

So we want to have Bluetooth compatibility and Flexitouch next year. I'll be a little cagey on when. But in '23, we'll have Bluetooth compatibility. As far as AffloVest, it's a little bit different. We -- Bluetooth aside, one of the important pieces of AffloVest is to make sure that it's providing the absolute best therapy for the patient and that it's an efficient product for the sales channel of the DME. So from the patient standpoint, we believe we have the best product. When we acquired this, the beauty is it was on Generation 5. So every time they had introduced it from the very first stage, they continue to refine. So we'll continue to do that as well. But I think the point is, we have a very well tested product in Generation 5. Now one of the goals is to continue to make sure that we're easy to do business with, that our product is easy to train, easy to interface with that we are a good resource to the DME. Our Head of Marketing came from ResMed, our Head of Sales came from Respironics, they learned a lot about how to create stickiness with the DME channel, and how to make sure that by demonstrating an ease of doing business and more difficult to replicate that becomes valuable. And as I think we're not insensitive to eventual competition, but we think that those will be helpful and continuing to embed that relationship.

As you think about what you've seen to date with AffloVest, some of your competitors, either mergers, other dynamics, a little bit of disruption, has that created any opportunity for you? And then also, as you think about just incentives DME rather incentives to push AffloVest, the relative ASP of AffloVest versus a lot of the other products, how has that played into what you've seen today as well?

Yes. So look, have we probably benefited a little bit from a couple of things going on with the 2 chief competitors? Probably. So just to remind Hill-Rom is the market leader, was -- they acquired Welch Allyn, then they were acquired by Baxter. My suspicion is this is not an important part of Hill-Rom's strategic road map. So I think that we may benefit there a little bit from their eye off the ball. Philips had acquired a business called RespirTech that I think has also probably faced some distraction. Philips has had a bit of their hands full with some CPAP devices and ventilators and things like that. And I think the likelihood that this will be the spade that will dig them out of that hole is probably not a needle mover for them at least at this point. So it comes back to organic expansion. And again, while maybe we've gotten some business that would have otherwise went somewhere else, the majority of what we're seeing is patients that would not have otherwise gotten the vest. So it's not so much a share exchange, but I think the growth we're demonstrating is growth in the space overall. And I think as far as the economics are concerned, one of the reasons that we're seeing success is the reimbursement price when you bill on behalf of the patient for HFCWO vest, approach is $10,000. And we sell to the DME for roughly half of that. There's not a lot of things in the DME bag that generate that kind of revenue and gross margin for them either. So it's become increasingly relevant in how they incentivize their sales people, quotas, things like that. So they -- it's probably only beat by maybe noninvasive ventilation, but they have to do 25 CPAP starts to generate the same revenue. Now there's a razor blade that over time will continue to contribute. But this is a meaningful contributor to them and a piece of the space that so well fits with their portfolio, but they've not had an opportunity to participate.

As you think to just longer-term gross margin with AffloVest now in the business, you look back and it was the lymphedema business itself, kind of 70 plus or minus, usually just north of 70% gross margin type of business, a few puts and takes, pricing pressure and volume mainly. But as you think going forward with AffloVest, what is the longer-term gross margin profile? Do you have room for expansion?

So we haven't talked a lot about longer term, but I think that I'll start with kind of what the threshold is. We're pretty confident that we've got a gross margin in the 70s as far out as we can see on the horizon. I think that AffloVest certainly is a modest contributor. It's modestly accretive to our overall gross margin. And while we've continued, as I said, to face some of the same headwinds that everybody else has in supply chain and inflationary pressures, I think that as we continue to refresh our lymphedema portfolio, even if we saw some pricing pressures, we think that there's an offset opportunity in cost out as we introduce new generations and new solutions.

Longer term, too, and turning to your core lymphedema business, it was going back in time, kind of 20% or so grower. This year has been challenged and a lot of that is the rep dynamic. You can probably talk to certain components on the -- getting the patients where they need to be, thanks to COVID. But looking beyond, you have sales force ramping maybe filling in some of the holes, you have new garments helping you reengage with the app. What is the longer-term growth? Do you get back to that 20% type of CAGR? Is that realistic?

I think that I always come back to -- first of all, it's not a question of the TAM. So the TAM is really big. Lots of underserved patients. They're just not easy to convert and get to. That's why this is a space we've picked largely because we think that we can be the ones that can help develop that. We grew in Q2 in our lymphedema business organically. We expect to see growth in Q3, albeit low single digits. But I think as we get to Q4, we certainly start to see some inflection. Our guidance, I think underlying guidance implies probably closer to 10% organic growth in Q4. And I think our goal right now is to make sure that we recover the productivity of this sales force that's been kind of repopulated and hopefully reenergized and that we can exit demonstrating that we've redeveloped some wind at our back.

As you think about target areas for investment, too, new product iterations, we've seen the new garments, how do you balance that with market development, clinical data generation. What is kind of the mix as you look at the business today? What are the greatest needs?

Yes. I think from an R&D standpoint, when I got to the company almost 2.5 years ago, we were probably close to a 2% R&D spend. And for those that are familiar with that. That includes clinical studies. And when you're trying to develop a market, that's an important part of market development. So I think we had to demonstrate an increase in our commitment there, especially as we're trying to develop this market. There's more than half of it continues to go into traditional, what I would call, R&D somewhat less than half in the clinical studies. We've made a pretty healthy bet in the head and neck space. We have IP that effectively really, we believe, protects that entire therapeutic space for lymphedema. And we know that the majority of head and neck cancer survivors will develop lymphedema, whether externally or internally, the swelling occurs. So we think that's an important one for us. And that's a long bet. We started an RCT based out of Vanderbilt. We've got 6 contributing sites. But the enrollment, I think, a little bit from staffing and COVID, et cetera, it stretches out a little bit, but it's a 2- to 3-year endeavor. We're getting into the middle of that. So I think by the time we get to end of '23, our investment in that one, we hope we'll have the kind of results and compelling as we expect to influence payer policy on that one. It's a very small piece of the business today, but there's about 1 million patients out there in the United States that suffer from head neck cancer survivorship that I think ultimately we can help.

And it's definitely been a focus point or longer-term TAM opportunity. I think at some point, you were treating some of these patients, but it wasn't with reimbursement.

Correct.

So it's very much -- you talked about 2 to 3 years.

Yes.

In the interim, too, -- and I know we're running out of time, but just if you have the new garments, you have the apps, what else are the -- from a product development standpoint as you look kind of nearer term, what are the key focus areas?

Yes. So while I think from competitive reasons, we don't get a little too descriptive, but I can tell you that there's 3 key themes in our product development goals. The first one is what I would call seamlessness. Seamlessness in, when you have a chronic disorder, you are associated with your device. It's something you do every day, and we want to make it easier, more seamless in people's lifestyles more effortless that may mean more portability. Mobility, we stopped short of because most doctors and eligibility criteria says, have you tried elevation and you should do elevation during your therapy. So in practical, lymphedema patients will benefit from mobility, but portability, the ability to ubiquitously take this wherever I go is going to be important. So smaller is good, a consumer appeal. So knowing this is something that might be sitting out on somebody's coffee table. We want them to be less self-conscious, so making this a bit more consumer-oriented I think is another one and the whole digital road map where we can connect the devices and ultimately collect more information, but perhaps as importantly, influence our business model in training and back-office work that I think will benefit from that.

With that, I think we're out of time. Dan, thank you very much for joining us. I appreciate the conversation.

Thanks, Cecilia.

Thank you.