Please standby. Welcome, ladies and gentlemen, to the Third Quarter 2024 Earnings Conference Call for Tactile Medical. At this time, all participants have been placed in a listen-only mode. At the end of the company's prepared remarks, we will conduct a question-and-answer session. Please note that this conference call is being recorded and will be available on the company's website for replay shortly. I would now like to turn the call over to Sam Bentzinger, Investor Relations at Gilmartin Group for a few introductory comments. Please go ahead.

Good afternoon, and thank you for joining the call today. With me from Tactile's management team are Sheri Dodd, Chief Executive Officer; and Elaine Birkemeyer, Chief Financial Officer. Before we begin, I’d like to remind everyone that our remarks and responses to your questions today may contain forward-looking statements that are based on the current expectations of management and involve inherent risks and uncertainties, which could cause actual results to differ materially from those indicated, including those identified in the Risk Factors section of our annual report on Form 10-K, as well as our most recent 10-Q filing to be filed with the Securities and Exchange Commission. Such factors may be updated from time to time in our filings with the SEC, which are available on our website. We undertake no obligation to publicly update or revise our forward-looking statements as a result of new information, future events or otherwise. This call will also include references to certain financial measures that are not calculated in accordance with generally accepted accounting principles or GAAP. We generally refer to those 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. With that, I'll now turn the call over to Sherri.

Thanks, Sam. Good afternoon, everyone, and welcome to our third quarter 2024 earnings call. Here with me is Elaine Birkemeyer, our Chief Financial Officer. Today, we will review our financial results for the third quarter, discuss evolving market dynamics across our business and provide progress updates on each of our three key ongoing commercial initiatives. As a reminder, these initiatives cover technology and workflow related investments in sales and order operations, the development and launch readiness of our next-generation lymphedema platform and the generation of clinical evidence to support further patient access to our platform. We will also provide an update on our full year 2024 revenue guidance and capital allocation strategy. Total revenue in the third quarter grew 5% year-over-year to $73.1 million. In our lymphedema business, revenue increased 4.4% year-over-year to $65.3 million, and Airway Clearance revenue increased 10.3% year-over-year to $7.8 million. Our gross margin increased 410 basis points year-over-year. Margin expansion was primarily a result of lower material costs and warranty expenses, resulting from improvements in the design of our products over the past several years. Adjusted EBITDA grew 39.3% year-over-year in Q3, representing the 10th consecutive quarter of year-over-year improvement and reflecting our commitment to delivering continued improvements in operating leverage. From a cash perspective, cash and cash equivalents increased sequentially by $8.5 million, increasing our cash balance to $82.1 million as of September 30, 2024. The sequential growth in both adjusted EBITDA and cash balance are indicative of our operational maturity and continued focus on balancing profitability and cash generation with investments in our business. While pleased with our third quarter performance across key multiple metrics, our revenue results were below our expectations due to a confluence of two main factors: on our Q2 call, I spoke to the impact of increased documentation requirements…

Thanks, Sheri. Unless noted otherwise, all references to third quarter financial results are on a GAAP and year-over-year basis. Total revenue in the third quarter increased $3.5 million or 5% to $73.1 million. By product line, sales and rentals of lymphedema products, which includes our Flexitouch and Entre Systems, increased $2.8 million or 4% to $65.3 million and sales of our airway clearance products which includes our AffloVest System, increased $0.7 million or 10% to $7.8 million. Continuing down the P&L. Gross margin was 75% of revenue compared to 70.9% in the third quarter of 2023. Non-GAAP gross margin, which excludes non-cash intangible amortization in both periods, was 75.4% compared to 71.4% in the prior year. The increase in non-GAAP gross margin was attributable primarily to lower manufacturing and warranty costs and improving collections reflected in our revenue. Third quarter operating expenses increased $6.6 million or 16% to $48 million. The change in GAAP operating expenses reflected a $0.8 million increase in sales and marketing expenses, a $0.5 million increase in research and development expenses and a $1.7 million increase in reimbursement, general and administrative expenses, including and primarily driven by strategic technology investments, and a $3.7 million onetime earn-out benefit that occurred in the prior year related to the final true-up of our earn-out liability related to the AffloVest acquisition. Operating income decreased $1.2 million or 15% to $6.8 million. Non-GAAP operating income increased $2.7 million or 50% to $7.9 million. As a reminder, our non-GAAP operating income excludes non-cash intangible amortization and earn-out expense, as well as certain non-reoccurring operating expenses. We provided a detailed GAAP to non-GAAP reconciliation in our earnings press release. Other income net increased $0.9 million, or 225% to $0.5 million. The increase was primarily driven by higher interest income on our increased cap…

Thanks, Elaine. In closing, my confidence in our team and our business remains high. Our market opportunity is large, growing and underpenetrated and Tactile brings the largest breadth of clinically proven solutions for our patient population from head to toe. Meanwhile, we are fortifying our business operations for scale, simplifying the patient, provider, clinician and employee experience and are amplifying the voice of the patient in our policy and payer advocacy as well as seeing improving CMS coverage conditions in the near horizon. These efforts will continue to bear fruit in the coming quarters and years and leave us optimistic about our ability to continuously adapt, grow and profitably scale. With that, operator, we'll now open the call for questions.

Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] Thank you. Our first question comes from the line of Margaret Kaczor Andrew with William Blair. Please proceed.

Hey guys. It's Jimmy on for Margaret. Thanks for taking the question. Two for me. Obviously, the Medicare documentation impact didn't play out as expected this quarter. So maybe just touch on why that was a surprise relative to your expectations. And I understand you have the LCD reverting back to the NCD. But maybe just give us some more color on the level of visibility you have on Medicare sales improving going forward.

Sure. Thanks so much, and thanks for joining. I think the best way I can answer this really comes in two parts. I mean the first is here -- from a good news standpoint, we did not see the Medicare MACs get any more strict than they had been for -- as we saw that transition happening from Q2 into Q3. So it didn't get worse. What we did, though, learn is with a full quarter under our belt, we really understood more about what was it actually going to take in order to get the documents. And that was both in terms of what was required from the sales reps and how we could augment them with different type of support, whether it was in human capital or using different type of tools, et cetera, as we discussed, both technology, process and people. So with the whole quarter now under our belt, we had a much better idea of what that looks like, which is reflected in our guidance. I think we went in with Q3 having some information of what this would look like. But obviously, it was more -- it was tougher for our business to collect all that documentation. And as I mentioned in the prepared remarks, it wasn't just for the Medicare business. Our reps support patients across different specialties as well as independent of what type of insurance they're covered under. So it impacted our Medicare business, of course, and you saw that reduction. But it also impacted our VA and commercial businesses. And yet we saw double-digit growth in both of those. So we know that the market dynamics are there, the fundamentals for the market are there, the patients are there. It just took longer than we had anticipated to gather all that documentation to move our orders through the queue and out to shipping.

Okay. That's helpful. And then maybe just the second one on guidance here. You lowered guidance by less than the miss, $2 million roughly at the midpoint. So I guess maybe what are you assuming in Q4 that's giving you confidence that you can lower by less than the miss? And then are you baking in any contribution from Nimbl or maybe you just touched on it, but is most of that improvement stemming from the Medicare documentation impact lessening in Q4, stepping down and then potentially exiting the year?

Yes. So thanks for the question. It's a good one. So I'll kind of go with the last first. So we still expect to see very minimal impact from Nimbl. We only just launched that product. It is in our upper extremity only. We're really excited about the impact it's had thus far. We were able to launch it on time with the breast cancer awareness month, but we don't expect that to have a material impact on Q4. We also know that the change from the LCD to the NCD is only going to go effective on November 14. And any orders that are in the queue right now are going to be adjudicated under the LCD, not the NCD. So we also don't expect the change to the NCD itself to have any impact on Q4. And again, there's still a lot of ambiguity about that. What we are confident in is now having had this full quarter under our belt and having accelerated tools from our CRM out into the sales force. The way that we have deployed and redeployed headcounts for order operations. The way the successes of taking our e-prescribing pilot into a national launch, all of these factors from technology and people and process, we now have a lot of experience, so what it looks like to operationalize under the Medicare stricter requirements. And we've seen the impact in progress of those initiatives. With that already seeing momentum in Q3, we're going to see more of that full momentum in Q4. And quite honestly, on into 2025, many of the initiatives that we put in place are now going to be our standard practice. And so that's what gives us confidence for a Q4, at least stabilizing Medicare seeing return to growth and continuing to take advantage of our strong market presence in both commercial and VA businesses.

That's very helpful. Thanks for taking the question.

You bet. Thank you very much. Send our best to Margaret.

Thank you. Our next question comes from the line of Ryan Zimmerman with BTIG. Please proceed.

Hi, everyone. This is Izzy…

Hi, Ryan.

This is Izzy on for Ryan tonight, but thanks for taking the questions. We're about a year -- almost a year out from when the lymphedema treatment Act was enacted back in January. So I was just wondering if you guys are starting to see any benefits from that or more patients starting to come into the funnel?

Yes, it's a great question. That policy came into effect in January, but of course, brand new policy, it does take a while for the full education and understanding of that policy to start rolling out. I will say that we definitely have heard from our providers and our industry partners that say they are starting to see an impact of patients coming through and taking advantage of the LTA. What's interesting about this or just to make sure that everyone is kind of grounded for patients to get a garment through the LTA, they have to have -- they still need to get the diagnosis of lymphedema and we know that takes a while for patients to ultimately get that diagnosis. They have to have the physician visit where measurements need to be taken. There needs to be documentation in the medical record to some degree of medical necessity and they have to get the prescription. So there still is a process that's evolved with the patient being able to take full advantage of the LTA from that reimbursement standpoint, but we are starting to see and hear about those coming through. While we're not seeing the impact fully in the pumps, we know that, that's going to start to trickle through as patients both become more aware of the LTA policy, physicians, prescribers become more aware, they're able to get the documentation in place, get the claims approved, use the government for a conservative trial, and then if those patients fail then they move on to an opportunity of being in the PCD area. So, yes, we understand that it's starting to gain momentum. No, not material to our business to-date, but we're excited. We know this is the right thing to do for patients, and we're ready and helping to support patients as they transition from conservative therapy into pump therapy.

Got it. That's really helpful. Thank you. And then, I know there's a lot of moving pieces with all of the documentation requirements and kind of the headwinds that we're facing right now. But as we start to think about 2025, do you see the opportunity for these headwinds to kind of start to subside and get to a more normalized rate once the e-prescribing tool is more broadly rolled out at a national level? Or do you think we'll still face some challenges as we move into next year?

Yes. It's such a good question, because policy changes do create a degree of turbulence. As I said in Q2, I mentioned a little bit in the prepared remarks, where we're optimistic is that with the change from LCD to NCD, there will now just be one policy. Previously, there have been these two policies. They were sometimes in conflict with each other. We've had experience operating under both of those policies. So we believe that this change to one sole policy is the right thing for patients, and we think it's going to be good for our business as well. We also have experience working under this policy. So we're aware of where there's ambiguity in the language, and we have experiences through previous audits, et cetera, to see where sometimes that ambiguity can create challenges on different type of documentation, et cetera. So, having been there and kind of seen how this plays out, we're also feeling that this change in policy is actually going to be less of turbulence, less headwind for us, and it creates more of a like a new normal, hopefully, for us as we move forward. So there's a lot of advantage of the one policy. The other thing is, that I would say and ask Elaine to weigh in as well is the mitigations that we put in place, whether it's e-prescribing and moving that from pilot to national launch or E-Verify or the CRM tool that helps our reps be more efficient, our back-office streamlining and simplifying, all of these things are just good for business. And so, if the policy environment changes again, which it could, and you have to be prepared at any time. I think we're ready. We are fortifying truly and simplifying the way we're doing our business. So I anticipate that we're going to be in a good position with the NCD coming forward. And then as policy evolves, and we see how the MACs are going to adjudicate under that NCD, we’ll be ready.

Very helpful. Thanks for taking the question.

Thanks Izzy.

Thank you. [Operator Instructions] Our next question comes from the line of Kyle Bauser with B. Riley. Please proceed.

Hi Kyle.

Hi. Good evening. Thanks.

Welcome, and things to be in spirit [ph] picking up coverage.

Thank you. Our pleasure. And thank you for all the updates and taking my questions here. So maybe I'll start with guidance. The top-line came down a little bit as you talked about, but bumping up the EBITDA expectations is great. We also saw a 50% growth in non-GAAP operating income in the quarter. So despite the mix, the bump up in EBITDA for the full year it just kind of curious, how would you rank kind of the factors that are contributing to the expanding margins and kind of outpacing top-line growth here?

Yes. Thank you. We do believe that the bottom-line performance on our business sometimes is underappreciated and definitely, it's not just a onetime event. We've been able to show -- sequential improvement in our bottom-line and then, of course, our cash balance is in such a good place. There's a few things that are contributing meaningfully to that, I would say, on the gross margin side. Product improvements have really helped kind of reduce our overall warranty costs. So that has just been great for patients and also good on gross margins. It's some manufacturing efficiency is also playing out there. So just good fundamentals from a business standpoint and for patients. On our other expenses, I'll talk to Elaine because she can walk through some of the big drivers in that area.

Yes. I think as Sherri mentioned, the biggest impact has been due to our gross margin. And if you saw, we increased outlook for the year to 74%. We were previously at 73%, and we had taken it up all year. And so really just great work on our manufacturing team. We're gaining scale in some of our new products so the costs are coming down, the warranty expense. So all good, durable improvements that we expect to continue. And I think that's allowed us to continue to make the OpEx investments that we've needed to in order to continue to modernize our technology and also has been helpful in us launching some of the initiatives that Sheri talked about that allowed us to mitigate some of the turbulence that we've been seeing with the recent Medicare administrative changes.

Got it. I appreciate that. And maybe a follow-up. Has -- how has the conversion of training done by the patient education consultants instead of the sales reps kind of impacted? I imagine there's a nice tailwind in terms of margin expansion. So that's kind of the first part of the question. And once you get to kind of north of 50%, what's holding you back from trying to just fully convert using the PEC to do the training?

Yes. So I think, yes, you saw our sales and marketing expense, we did gain leverage there. And so it's not only due to the trainers I referenced. But also, we did continue to leverage kind of our back office. We continue to give the sales reps some additional tools we talked about pulling forward -- some of the CRM toolkit that we're putting in place more robustly next year. So those are all things that have helped from the specifically your question around leveraging the trainers. Our -- we set out a goal for 50%. We thought that was a reasonable goal. I'm just thinking about where the demos are taking place, geographic density and also just the sales reps -- partnership with the PEC and making that transition. So definitely, we continue to evaluate that goal each quarter, but we're really happy with the progress that we've made this year and the improvement is made from a sales rep capacity perspective.

The other thing that I would say about that is some of our clinicians prefer that the demos are done in their office, and they have the relationship, most deeply with the sales reps.

Yes.

So in that case, that's the preference of the provider. So we also go with that as being kind of the primary that's where the provider is comfortable and then very opportunistic in the other ones where it makes sense that the PECs are able to be in the home with the patients for those demos.

Okay. Got it. And then just one quick one, if I may, it sounds like there's no change in the success rate of the Medicare claims on the edema side of the business, despite the more stringent documentation requirements, which is great. Does that mean that there could be a buildup or kind of a backlog out there as we kind of move through this issue going forward? Thank you.

You know what we actually feel that we've really got ourselves caught up. And so while there was a bit of a backlog the way we redeploy tools and process and people, we feel generally caught up. One of the challenges, though, is you get some leakage, right? So if patients aren't able to get access to the product, that process takes too long, they drop out, not different from when there's back order on elective surgery and a patient may decide to drop out and go to a different vendor or drop out of having the surgery altogether. So we feel like we're in a good place for stemming that patient leakage feel very caught up on the claims. And so now it's just a matter of the referrals to keep coming in. Medicare referrals keep coming in. We know there's a patient there. We know our providers see us as a leader in this space. So none of those market pieces are problematic for us, and we have streamlined our internal process. And we'll just continue to do this. But do it in a way that's efficient and best for patients. The other thing just on the claims approval, there's been a history where we had had exposure and understanding audits and documentation that was missing. And so for a number of quarters, the process has been getting better for that first pass claims approval. So we're not looking for that to improve at all. In fact, it's very good right now. It's going to continue and sustain to be very good. So not a backlog and not an issue with now suddenly having a bolus of claims that we think are going to get approved, you can see our balance sheet, our revenue recognition is super healthy. So it's just now about continuing to operationalize the tools, process and people that we have and continue to serve patients in the best and most effective way we can.

Excellent. That makes sense. And I really appreciate all the detail here. I'll jump back in queue.

Thank you. Yeah. Thanks.

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