TACTILE SYSTEMS TECHNOLOGY INC (TCMD) FY 2023 MD&A
This page reproduces the company's own Item 7 MD&A text from the linked SEC filing. It is filer text, not grepcent analysis, scoring, or investment advice.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and the accompanying notes thereto included elsewhere in this report.
This Management’s Discussion and Analysis of Financial Condition and Results of Operations focuses on discussion of year-over-year comparisons between 2023 and 2022. Discussion of 2021 results and year-over-year comparisons between 2022 and 2021 that are not included in this Annual Report on Form 10-K can be found in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2022, filed with the SEC on February 21, 2023.
Overview
We are a medical technology company that develops and provides innovative medical devices for the treatment of underserved chronic diseases. Our mission is to help people suffering from chronic diseases live better and care for themselves at home. We focus our efforts on advancing the standard of care in treating underserved chronic diseases in the home setting to improve patient outcomes and quality of life and help control rising healthcare expenditures. Our areas of therapeutic focus are (1) vascular disease, with a goal of advancing the standard of care in treating lymphedema and chronic venous insufficiency, (2) oncology, where lymphedema is a common consequence among cancer survivors and (3) providing airway clearance therapy for those suffering from chronic respiratory conditions. We possess a unique, scalable platform to deliver at-home healthcare solutions throughout the United States. This evolving home care delivery model is recognized by policymakers and insurance payers as a key for controlling rising healthcare costs. Our solutions deliver cost-effective, clinically proven, long-term treatment for people with these chronic diseases.
Our current lymphedema products are the Flexitouch Plus and Entre Plus systems and our airway clearance product is the AffloVest. A predecessor to our Flexitouch system received 510(k) clearance from the U.S. Food and Drug Administration (the “FDA”) in July 2002, and we introduced the system to address the many limitations of self-administered home-based manual lymphatic drainage therapy. We began selling our more advanced Flexitouch system after receiving 510(k) clearance from the FDA in October 2006. In September 2016, we received 510(k) clearance from the FDA for the Flexitouch system in treating lymphedema of the head and neck. In June 2017, we announced that we received 510(k) clearance from the FDA for the Flexitouch Plus, the third-generation version of our Flexitouch system. In December 2020, we received 510(k) clearance for two new indications for our Flexitouch Plus system: phlebolymphedema and lipedema. We introduced our Entre system in the United States in February 2013 and our Entre Plus system in March 2023. The Entre Plus system is sold or rented to patients who need a simple pump or who do not yet qualify for insurance reimbursement for an advanced compression device such as our Flexitouch Plus system. Sales and rentals of our lymphedema products represented 88% and 86% of our revenue in the years ended December 31, 2023 and 2022, respectively.
On September 8, 2021, we acquired the assets of the AffloVest airway clearance product line from International Biophysics Corporation (“IBC”), a privately-held company which developed and manufactured AffloVest. AffloVest is a portable, wearable vest that provides airway clearance to treat patients with chronic respiratory conditions such as bronchiectasis or conditions resulting from neuromuscular disorders. For the years ended December 31, 2023 and 2022, sales of AffloVest represented 12% and 14% of our revenue, respectively.
To support the growth of our business, we continue to invest in our commercial infrastructure, consisting of our direct sales force, training resources, reimbursement capabilities and clinical expertise. We market our lymphedema products in the United States using a direct-to-patient and -provider model. The AffloVest device is sold through respiratory durable medical equipment providers throughout the United States that service patients and bill third-party payers for the product. We also employ a small group of respiratory specialists, who educate DME representatives, provide product demonstrations for targeted clinicians and support technical
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questions related to the AffloVest. As of December 31, 2023, we employed 254 field sales representatives for our lymphedema products and a team of 16 supporting our airway clearance products. This compares to 241 field sales representatives (excluding 9 key account managers) for our lymphedema products and a team of 10 specialists supporting our airway clearance products as of December 31, 2022.
We invest in our reimbursement function to improve operational efficiencies and enhance individual payer expertise, while continuing our strategic focus of payer development. Our payer relations function focuses on payer policy development, education, contract negotiations, and data analysis. Our reimbursement operations function is responsible for verifying patient insurance benefits, individual patient case development, prior authorization submissions, case follow-up, and appeals when necessary.
We also have a clinical team, consisting of a scientific advisory board, in-house therapists and nurses, and a Chief Medical Officer, that serves as a resource to clinicians and patients and guides the development of clinical evidence in support of our products. Most clinical studies require observation and interaction with clinicians and patients to monitor results and progress.
We rely on third-party contract manufacturers for the sourcing of parts, the assembly of our controllers and the manufacturing of the garments used with our systems. We conduct final assembly of the garments used with our products, perform quality assurance and ship our products from our facility in Minnesota. The AffloVest device continued to be manufactured and shipped by IBC on our behalf pursuant to a Transition Services Agreement through April 30, 2022. On May 1, 2022, we began manufacturing and shipping the AffloVest device from our Minnesota-based facility.
In July 2022, we launched Kylee™, a free mobile application that allows for patients to manage their conditions by tracking treatments and symptoms, as well as having direct access to educational resources.
For the year ended December 31, 2023, we generated revenue of $274.4 million and had net income of $28.5 million, compared to revenue of $246.8 million and a net loss of $17.9 million for the year ended December 31, 2022, and revenue of $208.1 million and a net loss of $11.8 million for the year ended December 31, 2021. Our primary sources of capital since our initial public offering in 2016 have been from operating income, bank financing and our public offering in February 2023.
We operate in one segment for financial reporting purposes.
Current Economic Conditions
General global economic downturns and macroeconomic trends, including heightened inflation, capital market volatility, interest rate fluctuations, increased unemployment and economic slowdown or recession, may result in unfavorable conditions that could negatively affect demand for our products and exacerbate some of the other risks that affect our business, financial condition and results of operations.
Components of our Results of Operations
Revenue
We derive revenue from sales and rentals of our Flexitouch Plus and Entre Plus systems to patients in the United States. Revenue growth has been driven by increased clinician, patient and payer awareness of lymphedema and the clinical efficacy of our Flexitouch Plus system, and the launch of our Entre Plus system in March 2023. We have expanded our direct sales force, which helps us drive and support our revenue growth and intend to continue this expansion. However, any reversal in these recent trends could have a negative impact on our future revenue.
We sell or rent our Flexitouch Plus and Entre Plus systems either directly to patients or to the Veterans Administration on behalf of patients, who are referred to us by physicians, therapists or nurses. We bill payers, such as private insurers, Medicare, or Medicaid, on behalf of our patients and bill patients directly for their cost-sharing amounts, including any portion of an unsatisfied deductible and any copayments or co-insurance. We bill the Veterans Administration directly for the purchase or lease of our product on behalf of the patient.
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Approximately 10% of our revenue in each of 2023 and 2022 came from the Veterans Administration. Approximately 24% of our revenue in 2023 and 19% of our revenue in 2022 came from Medicare patients. Changes to the level of Medicare coverage for our products could reduce the number of Medicare patients who have access to our products. Our products currently are not subject to the competitive bidding process for supplying covered items to Medicare recipients.
We also derive revenue from sales of our AffloVest product to accredited DME providers. These respiratory DME providers provide a full range of solutions for these patients with complex diseases, and represent a large, developed channel. Respiratory DME partners serve the role of receiving prescriptions, verifying coverage criteria, shipping, billing and training the patient. We intend to expand and support our respiratory DME partners, in an effort to help demonstrate High Frequency Chest Wall Oscillation (“HFCWO”) as a staple among the host of treatments they bring to chronic respiratory patients, thereby allowing us to continue to grow revenue from this product offering.
Our revenue has fluctuated, and we expect our revenue to continue to fluctuate, from quarter to quarter due to a variety of factors, including seasonality. See Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Seasonality” for a further discussion of factors contributing to our seasonality. Further, our revenue is impacted by fluctuations in the mix of products being sold and rented during each period and changes in the mix of our payers and contract pricing.
Furthermore, we expect our revenue to continue to increase in the future as a result of increased awareness of our solutions, expansion of our direct sales force, our DME partners, enhanced marketing and customer support efforts, continued focus on developing clinical and economic outcomes data, and efforts related to expanded third-party reimbursement. However, we also anticipate pricing pressure from private insurers, which will result in continued downward pressure on our revenue growth rate.
Cost of Revenue and Gross Margin
Cost of revenue consists primarily of component costs, direct labor, overhead costs, product warranties, provisions for slow-moving and obsolete inventory, delivery costs for items sold or rented, and amortization related to the intangible assets related to our products. Overhead costs include the cost of quality assurance, material procurement, inventory control, facilities, equipment and operations supervision and management. Cost of revenue also includes depreciation expense for product tooling and equipment as well as shipping costs. We expect overhead costs as a percentage of revenue to decrease as a result of expected increases in production volume and yields. We expect cost of revenue to increase in absolute dollars primarily if, and to the extent, our revenue grows.
We provide a warranty for our products against defects in material and workmanship for a period of one to five years. We record a liability for future warranty claims at the time of sale for the warranty period offered to a customer in cost of revenue. If the assumptions used in calculating the provision were to materially change, such as incurring higher than anticipated warranty claims, an additional provision may be required.
We calculate gross margin as gross profit divided by revenue. Our gross margin has been and will continue to be affected by a variety of factors, including product and payer mix, production volumes, manufacturing costs and cost-reduction strategies. We continue to work to reduce product manufacturing costs through enhanced product design efforts as well as supply chain initiatives in an effort to offset anticipated price erosion. Our gross margin will likely fluctuate from quarter to quarter.
Sales and Marketing Expenses
Our sales and marketing expenses consist primarily of personnel-related expenses, including salaries, bonuses, commissions and benefits for employees. They also include expenses for patient training, social media and advertising, informational kits, public relations and other promotional and marketing activities, field sales travel and entertainment expenses, trade shows and conferences, stock-based compensation, as well as customer service. We expect sales and marketing expenses to continue to increase in absolute dollars as we expand our commercial infrastructure to drive and support our planned revenue growth. To the extent our revenue grows, we expect sales and marketing expenses to decrease as a percentage of revenue over time.
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Research and Development Expenses
Research and development, or R&D, expenses consist primarily of personnel-related expenses, third-party product development costs, laboratory supplies, consulting fees and related costs, clinical research expenses, expenses related to clinical and regulatory affairs, patent amortization costs, stock-based compensation and patent legal fees, including defense costs, and testing costs for new product launches. Clinical research expenses include clinical trial management and monitoring, payment to clinical investigators, consulting fees, data management, stock-based compensation, travel expenses and the cost of manufacturing products for clinical trials. We have made substantial investments in R&D since our inception. Our R&D efforts have focused primarily on activities designed to enhance our technologies and to support development and commercialization of new and existing products. We expect R&D expenses to increase for the foreseeable future as we continue to develop, enhance and commercialize new products and expand clinical trial efforts. We expect R&D expenses as a percentage of our revenue to vary over time depending on the level and timing of initiating new product development efforts, as well as our clinical trial activities.
Intangible Asset Amortization and Earn-Out
Amortization of intangible assets includes the amortization expense of our definite-lived intangible assets, consisting of patents, customer relationships, customer accounts, developed technology and defensive intangible assets. The costs of definite-lived intangibles are amortized to expense over their useful lives. Indefinite-lived intangible assets, such as goodwill and tradenames, are not amortized; we test for impairment on these assets annually.
The fair value of the earn-out, which was payable based on certain U.S. revenues of AffloVest being met, was recorded as a liability. On a quarterly basis the earn-out was revalued to fair value until the end of the earn-out period, which was September 30, 2023. Any gain or loss related to the revaluation was recorded through the income statement.
Reimbursement, General and Administrative Expenses
Reimbursement, general and administrative expenses consist primarily of compensation, including salaries, bonuses and benefits for employees in our patient services and advocacy, billing and collections, case management, payer relations and governmental affairs and reimbursement operations departments, as well as finance, human resources and administration, information technology, business development and general management functions, and facilities costs. Reimbursement expenses also include consulting, travel to payer case manager seminars, professional development and training, and certification expenses. General and administrative expenses also include professional services such as legal, consulting and accounting services, stock-based compensation, travel expenses, insurance and acquisition costs.
Other Income (Expense), Net
Other income (expense), net consists primarily of interest income related to investment income earned on our invested capital portfolio and interest expense related to our debt obligations.
Income Tax Expense (Benefit)
Our income tax expense (benefit) consists primarily of permanent differences related to share-based compensation activity, as well as deferred income taxes resulting from temporary differences between the reporting of amounts for financial statement purposes and income tax purposes.
Critical Accounting Estimates
Our discussion and analysis of our financial condition and results of operations are based upon our financial statements, which have been prepared in accordance with generally accepted accounting principles in the United States, or GAAP. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets and liabilities, and related disclosure of contingent
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assets and liabilities, revenue and expenses at the date of the financial statements. Generally, we base our estimates on historical experience and on various other assumptions in accordance with GAAP that we believe to be reasonable under the circumstances. Actual results may differ from these estimates and such differences could be material to our financial position and results of operations. Critical accounting estimates are those that involve a significant level of estimation uncertainty and have had or are reasonably likely to have a material impact on our financial condition and results of operations.
While our significant accounting policies are more fully described in Note 3 to our consolidated financial statements included elsewhere in this report, we believe the following discussion addresses our most critical accounting estimates, which involve significant subjectivity and judgment, and changes to such estimates or assumptions could have a material impact on our financial condition or operating results. Therefore, we consider an understanding of the variability and judgment required in making these estimates and assumptions to be critical in fully understanding and evaluating our reported financial results.
Revenue Recognition
We derive revenue from the sales and rentals of our proprietary line of Flexitouch Plus and Entre Plus systems, and from sales of our AffloVest product. We recognize revenue when control of the product has been transferred to our customer, in the amount of the expected consideration to be received for the product. Expected consideration is estimated as follows:
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| ● | Flexitouch Plus and Entre Plus systems. Expected consideration to be received is estimated based on a detailed review of historical pricing adjustments and collections. Specifically, payment history of the applicable payer, as well as historical patient collections, serve as primary sources of information in estimating expected consideration. |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| ● | AffloVest product. Expected consideration to be received is based on agreements in place with DME providers. |
We update our assessment of collectability on a quarterly basis, with any adjustments for Flexitouch Plus and Entre Plus systems being reflected as sales and rental revenue and AffloVest products being reflected as bad debt expense within reimbursement, general and administrative expenses in the Consolidated Statements of Operations in the period of adjustment.
If in the future we determine that another method is more reasonable, or if another method for calculating these input assumptions is prescribed by authoritative guidance, the expected consideration associated with the sales and rentals of our products could change significantly. Changes in contractual pricing, payment trends and rebate structures would impact, either positively or negatively, our sales and rental revenue.
Stock-Based Compensation
The fair value of stock options is estimated at the date of grant, using the Black-Scholes option-pricing model. We recognize the fair value of each award as an expense on a straight-line basis over the requisite service period, which is generally the vesting period of the equity grant.
The Black-Scholes valuation model requires the input of highly subjective assumptions, including the expected term of the option, the expected volatility of the price of our common stock, the risk-free interest rate and the expected dividend yield. These estimates involve inherent uncertainties and the significant application of management's judgment. If factors change and different assumptions are used, our stock-based compensation expense could be materially different in the future. We determined weighted-average valuation assumptions as follows:
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| ● | Expected term. We use the "simplified method" to determine the expected term of the stock option. |
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| Column 1 | Column 2 | Column 3 |
|---|---|---|
| ● | Expected volatility. Expected volatility for grants issued in and prior to the first fiscal quarter of 2021 was estimated using the average historical volatility of public companies of similar size and industry over a similar period as the expected term assumption used for our options. Beginning in the second fiscal quarter of 2021, we had sufficient historical data to transition to utilizing our average historical volatility over a similar period as the expected term assumption used for our options as the expected volatility. |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| ● | Risk-free interest rate. The risk-free interest rate is based on the yields of U.S. Treasury securities with maturities similar to the expected term of the options for each option group. |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| ● | Expected dividend yield. We have never declared or paid any cash dividends on our common stock and do not presently plan to pay cash dividends on our common stock in the foreseeable future. Consequently, we use an expected dividend yield of zero. |
If in the future we determine that another method is more reasonable, or if another method for calculating these input assumptions is prescribed by authoritative guidance, the fair value calculated for our stock options could change significantly. Higher volatility and longer expected lives would result in an increase to stock-based compensation expense determined at the date of grant. Stock-based compensation expense affects our cost of revenue, sales and marketing expenses, research and development expenses, and reimbursement, general and administrative expenses.
We estimate our forfeiture rate based on an analysis of our actual forfeitures and will continue to evaluate the appropriateness of the forfeiture rate based on actual forfeiture experience, analysis of employee turnover behavior and other factors. Quarterly changes in the estimated forfeiture rate can have a significant effect on reported stock-based compensation expense, as the cumulative effect of adjusting the rate for all expense amortization is recognized in the period the forfeiture estimate is changed. If a revised forfeiture rate is higher than the previously estimated forfeiture rate, an adjustment is made that will result in a decrease to the stock-based compensation expense recognized in the consolidated financial statements. If a revised forfeiture rate is lower than the previously estimated forfeiture rate, an adjustment is made that will result in an increase to the stock-based compensation expense recognized in the consolidated financial statements. The effect of forfeiture adjustments was insignificant for the years ended December 31, 2023, 2022 and 2021. We will continue to use significant judgment in evaluating the expected term, volatility and forfeiture rate related to our stock-based compensation.
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Results of Operations
Comparison of the Years Ended December 31, 2023 and 2022
The following table presents our results of operations for the periods indicated:
| | | | | | | | | | | | | | | | | | | |
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | Year Ended | | | | | | | |||||||||||
| | | December 31, | | Change | ||||||||||||||
| (In thousands) | | 2023 | | 2022 | | $ | | % | ||||||||||
| Consolidated Statement | | | | | % of | | | | | % of | | | | | | | ||
| of Operations Data: | | | | | revenue | | | | | revenue | | | | | | | ||
| Revenue | | | | | | | | | | | | | | | | | | |
| Sales revenue | | $ | 239,493 | | 87 | % | | $ | 211,345 | | 86 | % | | $ | 28,148 | | 13 | % |
| Rental revenue | | | 34,930 | | 13 | % | | | 35,440 | | 14 | % | | | (510) | | (1) | % |
| Total revenue | | | 274,423 | | 100 | % | | | 246,785 | | 100 | % | | | 27,638 | | 11 | % |
| Cost of revenue | | | | | | | | | | | | | | | | | | |
| Cost of sales revenue | | | 66,713 | | 24 | % | | | 59,619 | | 24 | % | | | 7,094 | | 12 | % |
| Cost of rental revenue | | | 12,577 | | 5 | % | | | 11,190 | | 5 | % | | | 1,387 | | 12 | % |
| Total cost of revenue | | | 79,290 | | 29 | % | | | 70,809 | | 29 | % | | | 8,481 | | 12 | % |
| Gross profit | | | | | | | | | | | | | | | | | | |
| Gross profit - sales revenue | | | 172,780 | | 63 | % | | | 151,726 | | 62 | % | | | 21,054 | | 14 | % |
| Gross profit - rental revenue | | | 22,353 | | 8 | % | | | 24,250 | | 9 | % | | | (1,897) | | (8) | % |
| Gross profit | | | 195,133 | | 71 | % | | | 175,976 | | 71 | % | | | 19,157 | | 11 | % |
| Operating expenses | | | | | | | | | | | | | | | | | | |
| Sales and marketing | | | 107,119 | | 39 | % | | | 106,418 | | 43 | % | | | 701 | | 1 | % |
| Research and development | | | 7,823 | | 3 | % | | | 7,088 | | 3 | % | | | 735 | | 10 | % |
| Reimbursement, general and administrative | | | 62,074 | | 22 | % | | | 60,796 | | 25 | % | | | 1,278 | | 2 | % |
| Intangible asset amortization and earn-out | | | 76 | | — | % | | | 14,432 | | 5 | % | | | (14,356) | | (99) | % |
| Total operating expenses | | | 177,092 | | 64 | % | | | 188,734 | | 76 | % | | | (11,642) | | (6) | % |
| Income (loss) from operations | | | 18,041 | | 7 | % | | | (12,758) | | (5) | % | | | 30,799 | | 241 | % |
| Other expense | | | (2,271) | | (1) | % | | | (2,715) | | (1) | % | | | 444 | | (16) | % |
| Income (loss) before income taxes | | | 15,770 | | 6 | % | | | (15,473) | | (6) | % | | | 31,243 | | 202 | % |
| Income tax (benefit) expense | | | (12,745) | | (5) | % | | | 2,393 | | 1 | % | | | (15,138) | | N.M. | % |
| Net income (loss) | | $ | 28,515 | | 11 | % | | $ | (17,866) | | (7) | % | | $ | 46,381 | | 260 | % |
“N.M.” Not Meaningful
Revenue
Revenue increased $27.6 million, or 11%, to $274.4 million in the year ended December 31, 2023, compared to $246.8 million in the year ended December 31, 2022. The increase in revenue was attributable to an increase of $29.5 million, or 14%, in sales and rentals of the lymphedema product line, partially offset by a decrease of $1.8 million, or 5%, in sales of the airway clearance product line in the year ended December 31, 2023, compared to the year ended December 31, 2022.
The increase in the lymphedema product line revenue in the year ended December 31, 2023, was attributable to increasing productivity of our field sales team and enhancing our portfolio through the development and introduction of new products. The decrease in the airway clearance product line revenue in the year ended December 31, 2023, was attributable to one large DME provider experiencing slowed placements of our AffloVest system due to the expiration of the COVID-19 Public Health Emergency (PHE) waiver and a return to “pre-public health emergency” eligibility requirements.
Revenue from the Veterans Administration represented 10% of total revenue for each of the years ended December 31, 2023 and 2022. Revenue from Medicare represented 24% and 19% of total revenue for the years ended December 31, 2023 and 2022, respectively.
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The following table summarizes our revenue by product line for the years ended December 31, 2023 and 2022, both in dollars and percentage of total revenue:
| | | | | | | | | | | | |
|---|---|---|---|---|---|---|---|---|---|---|---|
| | | Year Ended | | | | | | ||||
| | | December 31, | | Change | |||||||
| (In thousands) | 2023 | | 2022 | | $ | | % | ||||
| Revenue | | | | | | | | | | | |
| Lymphedema products | | $ | 241,721 | | $ | 212,266 | | $ | 29,455 | | 14% |
| Airway clearance products | | | 32,702 | | | 34,519 | | | (1,817) | | (5)% |
| Total | | $ | 274,423 | | $ | 246,785 | | $ | 27,638 | | 11% |
| | | | | | | | | | | | |
| Percentage of total revenues | | | | | | | | | | | |
| Lymphedema products | | 88% | | 86% | | | | | |||
| Airway clearance products | | | 12% | | | 14% | | | | | |
| Total | | 100% | | 100% | | | | |
Cost of Revenue and Gross Margin
Cost of revenue increased $8.5 million, or 12%, to $79.3 million during the year ended December 31, 2023, compared to $70.8 million during the year ended December 31, 2022. The increase in cost of revenue was primarily attributable to the increase in sales and rentals of the lymphedema product line.
Gross margin was 71% in each of the years ended December 31, 2023 and 2022.
Sales and Marketing Expenses
Sales and marketing expenses increased $0.7 million, or 1%, to $107.1 million during the year ended December 31, 2023, compared to $106.4 million during the year ended December 31, 2022. The increase was primarily attributable to a:
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| ● | $0.5 million increase in IT & service fees; |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| ● | $0.4 million increase in expenses for new product introductions; |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| ● | $0.2 million increase in personnel-related compensation expense; and |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| ● | $0.2 million increase in educational grants. |
These increases were partially offset by a $0.3 million decrease in travel and entertainment expenses and a $0.3 million decrease related to sales meetings and tradeshows.
Research and Development Expenses
Research and development (“R&D”) expenses increased $0.7 million, or 10%, to $7.8 million during the year ended December 31, 2023, compared to $7.1 million during the year ended December 31, 2022, which was primarily attributable to an increase in personnel-related expenses.
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Reimbursement, General and Administrative Expenses
Reimbursement, general and administrative expenses increased $1.3 million, or 2%, to $62.1 million during the year ended December 31, 2023, compared to $60.8 million during the year ended December 31, 2022. The increase was primarily attributable to a:
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| ● | $1.6 million increase in personnel-related compensation expense as a result of increased headcount in our reimbursement operations, payer relations and corporate functions; |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| ● | $0.9 million increase in IT related expenses; and |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| ● | $0.2 million increase in travel and entertainment expenses. |
These increases were partially offset by a $1.4 million decrease in occupancy costs, depreciation expense and professional fees.
Intangible Asset Amortization and Earn-out
Intangible asset amortization and earn-out expenses decreased $14.4 million to $0.1 million during the year ended December 31, 2023, compared to $14.4 million during the year ended December 31, 2022. The decrease was due to a benefit of $2.5 million being recorded for the fair value of the earn-out for the twelve months ended December 31, 2023, as actual revenues for the second year earn-out calculation were lower than the estimated 2023 revenues that were used in forecasting the earn-out liability at December 31, 2022. This compares to an earn-out expense of $11.9 million for the twelve months ended December 31, 2022.
Other Expense, Net
Other expense, net was $2.3 million for the year ended December 31, 2023, compared to $2.7 million for the year ended December 31, 2022. The decrease was primarily attributable to an increase in interest income.
Income Tax Expense
We recorded an income tax benefit of $12.7 million and an income tax expense of $2.4 million for the years ended December 31, 2023 and 2022, respectively. The current year tax benefit was primarily driven by the release of the valuation allowance related to the future realization of deferred tax assets.
Management assesses the available positive and negative evidence to estimate whether sufficient future taxable income will be generated to permit use of the existing deferred tax assets. Based on this evaluation, as of December 31, 2023, we reduced the valuation allowance related to the future realization of deferred tax assets, in part because in the current year we achieved three years of cumulative pretax income in the U.S. federal tax jurisdiction, and therefore management determined that there was sufficient positive evidence to conclude that it is more likely than not that additional deferred taxes of $19.4 million are realizable.
Seasonality
Our business is affected by seasonality. In the first quarter of each year, when most patients have started a new insurance year and have not yet met their annual out-of-pocket payment obligations, we experience substantially reduced demand for our products. We typically experience higher revenue in the third and fourth quarters of the year when more patients have met their annual insurance deductibles, thereby reducing their out-of-pocket costs for our products, and because patients desire to exhaust their flexible spending accounts at year end. This seasonality applies only to purchases and rentals of our products by patients covered by commercial insurance and is not relevant to Medicare, Medicaid or the Veterans Administration, as those payers either do not have plans that have declining deductibles over the course of the plan year and/or do not have plans that include patient deductibles for purchases or rentals of our products.
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Liquidity and Capital Resources
Overview
As of December 31, 2023, we had cash and cash equivalents of $61.0 million and net accounts receivable of $54.1 million compared to cash and cash equivalents of $21.9 million and net accounts receivable of $77.9 million as of December 31, 2022. Our primary sources of capital since our initial public offering in 2016 have been from operating income, bank financing and our public offering in February 2023.
Cash Flows
The following table summarizes our cash flows for the periods indicated:
| | | | | | | |
|---|---|---|---|---|---|---|
| | | Year Ended | ||||
| | | December 31, | ||||
| (In thousands) | 2023 | 2022 | ||||
| Net cash provided by (used in): | | | | | | |
| Operating activities | $ | 35,855 | | $ | 5,209 | |
| Investing activities | | | (2,481) | | | (1,909) |
| Financing activities | | | 5,730 | | | (9,600) |
| Net increase (decrease) in cash and cash equivalents | $ | 39,104 | | $ | (6,300) |
Net Cash Provided by Operating Activities
Net cash provided by operating activities during the year ended December 31, 2023, was $35.9 million, resulting from net income of $28.5 million and a change in operating assets and liabilities of $15.1 million, which were partially offset by non-cash net income adjustments of $7.8 million. Cash provided relating to the change in operating assets and liabilities primarily consisted of a decrease in accounts receivable of $23.8 million, a decrease in net investment in leases of $1.9 million and a decrease in inventories of $0.6 million, partially offset by a decrease in accrued expenses of $6.5 million, a decrease in accounts payable of $3.9 million, a decrease in income taxes payable of $0.7 million and a decrease in accrued payroll and related taxes of $0.3 million. The negative non-cash net income adjustments consisted primarily of $19.4 million of deferred income taxes and a $2.5 million change in the fair value of earn-out liability, partially offset by $7.5 million of stock-based compensation expense and $6.5 million of depreciation and amortization expense.
Net cash provided by operating activities during the year ended December 31, 2022, was $5.2 million, resulting from a net loss of $17.9 million and non-cash net income adjustments of $27.7 million, which were offset by a change in net operating assets and liabilities of $4.6 million. The non-cash net income adjustments primarily consisted of $11.9 million change in fair value of earn-out liability, $9.6 million of stock-based compensation expense, and $6.3 million of depreciation and amortization expense. Changes in operating assets and liabilities were unfavorably impacted by increasing accounts receivable, net investment in leases and continued investment in inventory designed to meet future projected demand, partially offset by an increase in current liabilities.
Net Cash Used in Investing Activities
Net cash used in investing activities during the year ended December 31, 2023, was $2.5 million, primarily consisting of $2.3 million in purchases of property and equipment primarily related to production tooling and office equipment and $0.2 million related to the acquisition of patents and other intangible assets.
Net cash used in investing activities during the year ended December 31, 2022, was $1.9 million, primarily consisting of $1.8 million in purchases of property and equipment primarily related to office equipment, production tooling and tenant improvements and $0.1 million related to the acquisition of patents and other intangible assets.
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Net Cash Provided by (Used in) Financing Activities
Net cash provided by financing activities during the year ended December 31, 2023, was $5.7 million, primarily consisting of net proceeds from the offering of our common stock of $34.6 million, $8.3 million in borrowings under our term loan, and $1.5 million in proceeds from the issuance of common stock under the ESPP, partially offset by payments of $25.0 million on the revolving credit facility, $10.6 million on the AffloVest earn-out, and $3.0 million on our term loan.
Net cash used in financing activities during the year ended December 31, 2022, was $9.6 million, primarily consisting of payments of $6.0 million on our term loan and a payment of $5.0 million on the AffloVest earn-out, partially offset by $1.4 million in proceeds from exercises of common stock options and the issuance of common stock under the ESPP.
Credit Agreement
On April 30, 2021, we entered into an Amended and Restated Credit Agreement (the “Restated Credit Agreement”) with the lenders from time to time party thereto, and Wells Fargo Bank, National Association, as Administrative Agent. The Restated Credit Agreement amended and restated in its entirety our prior credit agreement.
On September 8, 2021, we entered into a First Amendment Agreement (the “Amendment”), which amended the Restated Credit Agreement (as amended by the Amendment, the “Credit Agreement”) with the lenders from time to time party thereto and Wells Fargo Bank, National Association, as administrative agent. The Amendment, among other things, added a $30.0 million incremental term loan to the $25.0 million revolving credit facility provided by the Restated Credit Agreement. The term loan is reflected on our consolidated financial statements as a note payable. The Credit Agreement provides that, subject to satisfaction of certain conditions, we may increase the amount of the revolving loans available under the Credit Agreement and/or add one or more term loan facilities in an amount not to exceed $25.0 million in the aggregate, such that the total aggregate principal amount of loans available under the Credit Agreement (including under the revolving credit facility) does not exceed $80.0 million.
On September 8, 2021, in connection with the closing of the acquisition of the AffloVest business, we borrowed the $30.0 million term loan and utilized that borrowing, together with a draw of $25.0 million under the revolving credit facility and cash on hand, to fund the purchase price.
On February 22, 2022, we entered into a Second Amendment Agreement (the “Second Amendment”), which further amends the Credit Agreement. The Second Amendment modified the maximum leverage ratio, the minimum fixed charge coverage ratio and the minimum consolidated EBITDA covenants under the Credit Agreement, and added a minimum liquidity covenant, through the quarter ended June 30, 2023. The Second Amendment also increased the applicable margin for LIBOR rate loans under the Credit Agreement during the period commencing on the date of the Second Amendment and ending on the last day of the fiscal quarter ending June 30, 2023. Pursuant to the Second Amendment, we made a mandatory principal prepayment of the term loan of $3.0 million on February 22, 2022.
On June 21, 2023, we entered into a Third Amendment Agreement (the “Third Amendment”) that replaced the interest rate benchmark under the Credit Agreement from LIBOR to the term Secured Overnight Financing Rate (“SOFR”). All tenors of term SOFR are subject to a credit spread adjustment of 0.10% (“Adjusted Term SOFR”).
On August 1, 2023, we entered into a Fourth Amendment Agreement (the “Fourth Amendment”), which further amends the Credit Agreement. The Fourth Amendment, among other things, decreased the commitment fees payable under the revolving credit facility and eliminated the temporary increase in the applicable margin for Adjusted Term SOFR loans. The Fourth Amendment also eliminated the liquidity financial covenant and modified the remaining financial covenants to reflect the termination of the temporary covenant relief period that was in place until June 30, 2023 pursuant to the Second Amendment. In addition, the Fourth Amendment provided for an additional term loan in the amount of $8.25 million, which we used for a paydown of the revolving
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credit facility. The Fourth Amendment also extended the maturity date of the term loans and revolving credit facility under the Credit Agreement from September 8, 2024 to August 1, 2026.
On December 21, 2023, we made a payment of $16.8 million to repay in full the outstanding balance on the revolving credit facility.
As of December 31, 2023, we had outstanding borrowings of $29.3 million under the Credit Agreement, comprised entirely of the term loan. The principal of the term loan is required to be repaid in quarterly installments of $750,000.
For additional information regarding the Credit Agreement, including interest rates, fees and maturities, see Note 11 – “Credit Agreement” of the consolidated financial statements contained in this report.
Future Cash Requirements
Our material estimated future cash requirements under our contractual obligations and commercial commitments as of December 31, 2023, in total and disaggregated into current (payable in 2024) and long-term (payable after 2024) obligations, are summarized as follows:
| | | | | | | | | | | | | | | | |
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| | | Payments Due By Period | |||||||||||||
| | | Less Than | | | More Than | ||||||||||
| (In thousands) | Total | 1 Year | 1-3 Years | 3-5 Years | 5 Years | ||||||||||
| Purchase commitments (1) | | $ | 24,291 | | $ | 24,291 | | $ | — | | $ | — | | $ | — |
| Operating lease obligations (2) | | | 24,232 | | | 3,539 | | | 7,359 | | | 6,395 | | | 6,939 |
| Note payable payments (3) | | | 29,250 | | | 3,000 | | | 26,250 | | | — | | | — |
| Interest payments (4) | | | 5,160 | | | 2,189 | | | 2,971 | | | — | | | — |
| Total | | $ | 82,933 | | $ | 33,019 | | $ | 36,580 | | $ | 6,395 | | $ | 6,939 |
| Column 1 | Column 2 |
|---|---|
| (1) | We issued purchase orders in 2023 totaling $24.3 million for goods that we expect to receive and pay for in 2024. |
| Column 1 | Column 2 |
|---|---|
| (2) | We currently lease approximately 150,000 square feet of office space for our corporate headquarters in Minneapolis, Minnesota, under a lease that expires in February 2031 and approximately 63,000 square feet of office, assembly and warehouse space at another facility in Minneapolis, Minnesota, under a lease that expires in March 2027. We entered into a fleet vehicle program for certain members of our field sales organization in 2016. At December 31, 2023, we did not have any vehicles under this program with current lease commitments. Furthermore, we lease office equipment from time-to-time based on our needs and these commitments are classified as operating leases. |
| Column 1 | Column 2 |
|---|---|
| (3) | Reflects principal payment obligations under our term loan. Refer to Note 11 ‘‘Credit Agreement’’ to our consolidated financial statements included in this report for additional information regarding the maturities of debt principal. |
| Column 1 | Column 2 |
|---|---|
| (4) | Interest payment amounts on long-term debt are calculated using outstanding balances and interest rates in effect on December 31, 2023. |
Adequacy of Resources
Our future cash requirements may vary significantly from those now planned and will depend on many factors, including:
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| ● | the impact of inflation, rising interest rates or a recession on our business; |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| ● | sales and marketing resources needed to further penetrate our market; |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| ● | expansion of our operations; |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| ● | response of competitors to our solutions and applications; |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| ● | costs associated with clinical research activities; |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| ● | increases in interest rates; |
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| Column 1 | Column 2 | Column 3 |
|---|---|---|
| ● | labor shortages and wage inflation; |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| ● | component price inflation; |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| ● | costs to develop and implement new products; and |
| Column 1 | Column 2 | Column 3 |
|---|---|---|
| ● | use of capital for acquisitions or licenses, if any. |
Historically, we have experienced increases in our expenditures consistent with the growth in our revenue, operations and personnel, and we anticipate that our expenditures will continue to increase as we expand our business.
We believe our cash, cash equivalents and cash flows from operations will be sufficient to meet our working capital, capital expenditure, debt repayment and related interest, and other cash requirements for at least the next twelve months.
Inflation and changing prices did not have a material effect on our business during the year ended December 31, 2023, and we do not expect that inflation or changing prices will materially affect our business for at least the next twelve months.
Off-Balance Sheet Arrangements
We did not have during the periods presented, and we do not currently have, any off-balance sheet arrangements, as defined under the applicable regulations.
Recent Accounting Pronouncements
Refer to Note 3 - “Summary of Significant Accounting Policies,” of our consolidated financial statements contained in this report for a description of recently issued accounting pronouncements that are applicable to our business.