TACTILE SYSTEMS TECHNOLOGY INC quarterly report, Q2 FY2018

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Tactile Systems Technology, Inc. — Q2 2018 Form 10-Q

Reporting period: Quarter and six months ended June 30, 2018. Amounts are in U.S. dollars; financial statement figures are unaudited. Tactile Medical develops and sells at-home compression therapy devices for lymphedema and venous disease. Flexitouch generated 92% of revenue in the first half.

Financial performance and position

  • Revenue: Q2 revenue was $34.1 million, up 30% year over year; first-half revenue was $61.0 million, up 32%. Flexitouch sales rose 30% in Q2 and 34% in the first half.
  • Profitability: Q2 gross profit was $24.5 million and gross margin was 72%, versus 73% a year earlier. Operating income was $1.3 million, compared with $0.7 million; net income was $2.6 million, down 32% from $3.8 million. Diluted EPS was $0.13 versus $0.20.
  • First-half results: Gross profit was $44.1 million, with a 72% margin. Operating loss narrowed to $0.5 million from $2.2 million; net income increased to $2.5 million from $2.3 million. Diluted EPS was $0.13 versus $0.12.
  • Taxes and earnings quality: Income tax benefits were $1.1 million in Q2 and $2.8 million in the first half. The first-half pretax loss was $0.3 million, so the tax benefit was an important contributor to reported net income. Management attributes tax benefits partly to tax-deductible stock-based compensation activity.
  • Cash flow: First-half operating cash use was $1.4 million, improved from $3.0 million used a year earlier. Inventory growth of $5.4 million, associated with the Flexitouch Plus launch, and a $3.1 million increase in income taxes receivable were significant uses of cash. Investing activities used $5.4 million; financing provided $0.2 million. Cash and equivalents declined $6.6 million to $17.3 million.
  • Liquidity and debt: At June 30, cash and equivalents were $17.3 million, marketable securities $23.8 million, and net accounts receivable $17.5 million. Current assets were $81.2 million and current liabilities $12.5 million. No borrowings are reported on the June 30 balance sheet.
  • Other balance-sheet items: Total assets were $92.7 million and stockholders’ equity $78.8 million. Inventory increased to $16.4 million from $11.0 million at year-end 2017.

Changes versus prior comparable periods

  • Revenue growth was driven mainly by Flexitouch, supported by salesforce expansion, growth in the Veterans Administration channel, greater awareness, and expanded payer coverage. VA sales were 20% of Q2 revenue and 21% of first-half revenue; Medicare represented 4% and 5%, respectively.
  • Q2 sales and marketing expense rose 36% to $14.5 million, primarily from increased headcount and commercial launch-related activity. First-half sales and marketing expense rose 30% to $27.0 million.
  • Q2 operating expenses grew 25% to $23.2 million. Gross margin declined about one percentage point year over year, while operating income improved on revenue growth.
  • Q2 net income fell despite higher operating income, principally alongside a smaller tax benefit than in Q2 2017. For the first half, the operating loss narrowed and net income increased.

Outlook, risks, contingencies and unusual items

  • Outlook: The filing provides no numerical revenue or earnings guidance. Management expects cash, cash equivalents, marketable securities, operating cash flows and the credit facility to cover working capital and capital expenditure needs for at least 12 months. Management notes that spending is expected to rise as the business expands.
  • Seasonality: Commercially insured patient demand is typically weaker in Q1 and stronger in Q3 and Q4 as deductibles are met and flexible spending balances are used. Results for the first half are not necessarily indicative of full-year results.
  • Credit facility: On August 3, 2018, the company entered into a $10 million revolving facility, expiring August 3, 2021, with potential aggregate availability of up to $35 million subject to conditions. It is secured by substantially all company and subsidiary assets and includes a maximum leverage ratio of 3.00:1.00, a minimum cash covenant of $7.5 million (temporarily $5.0 million after a permitted acquisition), and other operating restrictions.
  • Acquisition: The company acquired certain Wright Therapy Products assets and intellectual property for approximately $875,000, plus a potential revenue-based earn-out. The acquired patents and trademarks were classified as defensive intangible assets.
  • Key risks: Reimbursement rates may remain flat or decline while labor and other operating costs rise. The company relies on third-party manufacturers and suppliers; two vendors accounted for 39% of purchases in the first half. Growth, payer coverage, Medicare reimbursement, competition, regulation and the ability to manage expansion are also identified risks.
  • Other matters: Management reported no legal proceeding likely to have a material adverse effect. The company had approximately $57,000 of unrecognized state tax benefits and was under IRS examination for its 2016 federal tax return. Management stated disclosure controls were effective as of June 30, 2018.
  • Reporting transition: The company expects to cease qualifying as an emerging growth company and become a large accelerated filer on December 31, 2018, bringing increased reporting and compliance requirements, including auditor attestation of internal control over financial reporting.

Important facts for investors to verify

  1. Whether Flexitouch Plus sales growth and the expanded salesforce can sustain revenue growth without further gross-margin pressure.
  2. Whether inventory levels normalize after the product launch and operating cash flow improves, given first-half cash use and the increase in inventory and tax receivables.
  3. The scale and persistence of tax benefits from stock-based compensation, and how results compare before those benefits.
  4. Actual use of the new revolving facility, covenant headroom, borrowing costs and compliance with its secured-debt and minimum-cash requirements.
  5. Exposure to concentrated suppliers and insurance receivables, as well as payer coverage and reimbursement changes.
  6. Potential earn-out payments for the Wright Therapy Products acquisition and the costs of the emerging-growth-company reporting transition.