Please standby. Good afternoon, ladies and gentlemen, and welcome to the Fourth Quarter and Fiscal Year 2018 Earnings Conference Call for Tactile Medical. [Operator Instructions]. Please note that this conference call is being recorded, and that the recording will be available on the company's website for replay shortly. Before we begin, I would like to remind everyone that our remarks and responses to your questions today may contain forward-looking statements that are based on current expectations of management and involve inherent risks and uncertainties that could cause actual results to differ materially from those indicated, including those identified in the Risk Factors section of our most recent annual report on Form 10-K filed today with the Securities and Exchange Commission as well as our most recent 10-Q filing. 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 and otherwise. This call will also include references to certain financial measures that are not calculated in accordance with the generally accepted accounting principles, or GAAP. We generally refer to these as non-GAAP financial measures. Reconciliations of these 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. I would now like to turn the call over to Mr. Jerry Mattys, Tactile Medical's Chief Executive Officer. Please go ahead, sir.

Thank you, Operator. Good afternoon, and welcome, everyone, to our fourth quarter and full year 2018 earnings call. I am joined on the call today by our Chief Financial Officer, Brent Moen. Let me provide you with a brief outline of today's call. I'll begin by prepared remarks with a review of our financial performance highlights for the full year 2018, during which I'll also discuss the primary drivers of our revenue performance. Then I'll turn to a discussion of our 2018 operating highlights, including the commercialization of our new products, Flexitouch Plus and Flexitouch Head and Neck and our strategic transactions with Sun Scientific and Wright Therapy Products. Following this discussion, I'll walk you through our financial performance during the fourth quarter before turning it over to Brent for a detailed review of our financial results as well as our financial guidance for 2019, which we introduced in our earnings press release this afternoon. I'll then conclude with a few remarks on our strategy and outlook for 2019 before we open the call for your questions. Simply stated, 2018 was a phenomenal year for Tactile Medical. We achieved revenue of $143.8 million for the full year, representing 32% growth year-over-year, exceeding our 2018 guidance range. Our 2018 revenue growth was driven by sales of our Flexitouch systems, which increased 31% year-over-year to $131.9 million. Sales of our Entré and ACTitouch systems also contributed to our 2018 revenue performance, increasing 32% year-over-year to $11.8 million. In 2018, our revenue growth benefited from four primary drivers that we've discussed on our quarterly earnings calls throughout the year. First, our third generation Flexitouch System, the Flexitouch Plus, was successfully introduced to our prescribing customer base in the second quarter. The features and benefits of this new design allowed prescribers to consider Flexitouch…

Thanks, Jerry. Our total revenue for the fourth quarter increased 33% to $46.4 million compared to $34.9 million for the quarter ended December 31, 2017. Our revenue performance in the quarter was driven by sales of our Flexitouch System, which increased $10.3 million or 32% year-over-year to $42.7 million. The increase in Flexitouch System sales was largely driven by expansion of our sales force, the successful rollout of our new Flexitouch Plus system, growth in the Veterans Administration channel, increased physician and patient awareness of the treatment options for lymphedema and expanded contractual coverage with national and regional insurance payers. In addition, as Jerry discussed, we experienced increased volume from the new large payer contract that was effective July 1, 2018, as the expanded coverage benefits of that contract were realized faster than we initially anticipated. Flexitouch sales accounted for 92% of our total revenue in the fourth quarter of 2018 compared to 93% last year. Entré and ACTitouch System sales increased approximately $1.3 million or 51% year-over-year to $3.7 million in the quarter. This performance was better than expected and reflects an increase in the productivity related to our strategic shift to manage these orders in-house as well as the contribution from higher-than-expected volume from the new large commercial payer contract. Fourth quarter revenue by payer was 70% commercial, 18% VA and 12% Medicare compared to 77%, 17% and 6%, respectively, last year. Fourth quarter gross profit increased $6 million or 23% to $32 million compared to $26.1 million last year. GAAP gross margin of 69% of sales in the fourth quarter was compared to 75% of gross margin sales in the fourth quarter of 2017. The current period gross margin was primarily impacted by four items: First, a $721,000 noncash inventory write-off of our ACTitouch inventory; second, incremental…

Thank you, Brent. With an enhanced and expanding portfolio of differentiated products, multiple tailwinds in our business and another year of strategic execution, we remain very well positioned to continue to drive strong, sustained and profitable growth. In 2019, we're again committed to growing our revenue by 20% or more, while also continuing to improve our profitability. Our 2019 revenue growth will be fueled primarily by the market's increasing adoption of our Flexitouch Plus system along with the recent expansion of our field sales team, which exceeded our hiring goals last year and our commitment to growing our sales headcount by approximately 20% again this year, the impact of our targeted sales strategy, as we continue to focus our reps on those clinicians diagnosing the highest number of lymphedema patients and improving our selling effectiveness in the VA and our widespread in-network coverage with commercial insurers. With respect to our account targeting strategy, we performed another data analysis of medical claims in December of 2018. The data showed there were 1.1 million patients diagnosed with lymphedema in the 12-month period ending June 30, 2018, compared to 700,000 patients in the 12-month period ending December 31 of 2013, the first time we performed this analysis. This represents a compounded annual growth rate of 11% over the last 4.5 years. While we're proud of the strong growth we've reported in recent years and the mounting evidence that the awareness of lymphedema is growing, remember, we remain in the early stages of penetrating the large and addressable market opportunity in the United States. Specifically, the most recent claims data showed more than 4,700 high-diagnosing facilities in the United States and nearly 50% of these facilities had at least one clinician doing business with Tactile Medical. This compares to a little more than 40%…

[Operator Instructions]. Our first question will comes from the line of Will Inglis of Piper Jaffray.

This is Will, on for JP. I guess, my first question would be regarding the sales force headcount growth you're expecting for '19 about 20%. Just curious, just the level of reps you're expected higher for the Head and Neck group? And then, beyond that, just maybe any updates on the amount of productivity that you expect to grow in '19 with existing sales force?

Will, thanks very much for the questions. Specific to growth in our sales organization, we do intend to add another 20% to the field organization in 2019. We believe that's a number that we can consistently deliver, identify, train and bring up to speed. The way our sales force is currently configured, there are no specific Head and Neck specialists at this point in time. I mentioned on the call that we did hire a sales and marketing executive to help us put together the plan for how we'll reach beyond our current call points of lymphedema clinics and the VA to gain access to the broad market for treating head and neck lymphedema, but those plans are still under development, and we should be able to update those maybe in the second quarter of this year.

Your next question comes from the line of Chris Pasquale of Guggenheim.

Jerry, I think, the first question a lot of people are going to have is why growth should drop off in '19 versus the 30% run rate you guys have been putting up for several years now understanding that the number get bigger each year. Can you quantify a couple of things; one, the volume bolus that you thought you saw from this new payer contract, just to help us gauge how difficult a comparison that sets up in the back half of 2019? And then maybe speak to what you're assuming for pricing overall in 2019 as you get a full year of that new payer contract flowing through?

You bet. Thanks, Chris. I appreciate the question. First of all, we're very confident in the growth outlook and expect the primary drivers in 2019 to be the addition of our sales reps to our base as well as the access or exposure of this compelling new technology in Flexitouch Plus. You actually hit upon 1 of the 3 items that I would point out are not assumed in our 2019 guidance. The first is that volume bolus, that was your terminology. We consider to be the large payer contract dynamic that we experienced in the fourth quarter related to getting in-network coverage from all of those added plans that this large payer was able to deliver for us. The net result of that timing that we signed the contract and brought it on board in July was that -- and then they got opened up their other plans to us, the net impact for the patient was that we went from being an out-of-network provider to an in-network provider in a time period where many of these patients had already met their deductibles. So we went from a very expensive piece of equipment to a very inexpensive piece of equipment. The second dynamic is really around pricing. And interestingly, we have historically seen pricing headwinds in the mid-single digits. In 2018, we were actually in the low single digits. And our guidance going forward, to your question, assumes mid-single digits headwinds normalized for our more long-term trend of what we have seen historically. I think the third driver that the wanted to point out that was not assumed in our 2019 guidance is the fact that Entré growth this year was significantly more of a contributor than we anticipated. You may remember, our original guidance for 2018 assumed pretty flat Entré growth for the year. We ended up driving an incremental $3 million in growth in 2018 from that product. That came to us because we moved the responsibility for processing those orders from our field team, so they could focus on Flexitouch, and because the backlog was building up of those Entré orders that weren't being addressed. We don't expect that backlog to repeat itself in 2019.

Just to backstep one question, Chris, hold on. I just want to make sure that we address Will's second question yet. And his second question related to productivity per rep in 2019 and just to make sure we cover off on Will's open question, I will tell you that we do have modest improvement relative to rep productivity in 2019 relative to 2018. So I just want to make sure we cover up on Will's question. Sorry, Chris, didn't mean to interrupt.

No. That's okay. Thanks, Brent. And my second question was just around next steps for the head and neck indication. You've got two studies published now. I believe you have a third one that has completed enrollment. So what's the timing around that? And does that complete, you think, the clinical work that you're going to need to get these new codes, when could those actually be in place?

Thanks, Chris. First of all, just to level set everyone, the head and neck progress that's being made is -- we actually thought in 2018, we'd be exactly where we are from a revenue perspective. I have to say, though, it's taken us a little longer to establish these commercial plans and get these clinicals published than we anticipated. We would like to have had our sales and marketing executive hired by mid-year. It actually happened later in the year. And we've had, to your point, two studies published, but we've had a third one complete for more than six months now. So I think, we're a little behind in where we thought we'd be on the head and neck development. You're correct, two clinical publications to date with one of them happening in January of this year, two more expected in '19. Our focus in 2019 for the head and neck is to continue to invest in clinical evidence development. I do not believe we have enough clinical evidence in place today to go get coding coverage for the head and neck accessories or the head and neck garments. So I think, we have to continue to invest in that head and neck evidence development. We're going to continue to educate the market as we are the only ones with a solution for that particular indication as well as finish the definition of our go-to-market strategy outside of our current call points. So we're expecting it to be a contributor, again, in 2019, but in the low- to mid-single-digits is what we're looking for contribution from head and neck.

Your next question comes from the line of Anna Nussbaum of William Blair.

Can you hear, me?

Yes, Anna.

This is Anna, in for Margaret. I wanted to touch base, again, on guidance relative to the volume benefit seen in the fourth quarter. Are you essentially assuming these benefits aren't continuing into 2019? And then, what are you assuming in guidance in terms of those VA contribution, given the new supply scheduled for Plus and then any changes in commercial contracts?

So we've got VA, commercial and volume from the new contracts. So we'll start with VA. Our growth in last year was about 42%, which pushed the total sales to 20% of revenue. The VA specialists that we put in place have been extraordinarily helpful for our local sales team in supporting them and navigating the VA channel. We think there is a tremendous opportunity to continue going deeper into the accounts we've already opened. And as we included in our 10-K this afternoon, we've gone from 140 to 150 of the VA hospitals being active in terms of ordering product from us. I think the biggest addition is the Flexitouch Plus to the Federal Supply Schedule. So we anticipate that's going to be a nice tailwind for us coming into 2019. So we expect it to be a contributor in that 20% range in 2019 as well, that's the VA piece. On the commercial payer piece, we actually are on contract with all five of the top payers, so don't anticipate a big movement from any new payer. We still have some regionals that we're working with to try to get on contract as an in-network provider, but I think a lot of that work is already done. So might expect that we're going to see a big impact on adding new lives, new covered lives to our queue. We do expect we're going to have more volume coming from the new payer. I think what we were trying to get across is because of the timing and because of the fact that we were out of network last year, we got an unexpected bolus of orders in the third and fourth quarter, mostly in the fourth quarter, as a result of our contract with that payer. The patient that might have seen our product before we got on contract pretty much didn't buy it because the co-payments were too high or the deductible plan -- their deductible or their out-of-pocket costs were too high. And we had a number of those as we came through the fourth quarter with literally zero deductibles. So that's the part of that we don't think is going to repeat. We do expect that volume will continue, but remember, we gave this payer a pretty sizable reduction in price. So we expect the volume to offset that deduction in 2019. Does that answer...

That's helpful. And then just on adjusted EBITDA, margins came in pretty strong, roughly 18% in the quarter, though looks like it did benefit from about $2.5 million in impairment and inventory write-offs. Can you just remind us some of the puts and takes there and how we should think about profitability throughout 2019?

Sure Anna, I'll help you with that one. So you're right, we did have nice adjusted EBITDA performance for Q4 and for the full year, and that doesn't exclude the impairment charge that we did take relative to ACTitouch. Probably the biggest put and take relative to our adjusted EBITDA was the gross margin impact that I alluded to in my remarks. Our GAAP gross margin came in at 68.9%, but if you add back the inventory impairment associated with ACTitouch that we took, our adjusted margin is 70.5%. And then, we're certain it was within our full year kind of guidance range, but the delta between this year and last year really ends up being the pricing impact from the large payer contract that Jerry was talking about as well as mix that we're experiencing on payer and product differences between 2018 and 2017. So those are the biggest items that impacted our adjusted EBITDA.

Okay. And then just, how we should think about that going into this year?

Yes, happy to help. Our 2019 guidance that we set forth was we expected adjusted EBITDA to come in at 13%, so a step up of approximately 32% year-over-year compared to our revenue growth expectations of 20% to 22%. So we should see some leverage certainly in our adjusted EBITDA. And just keep in mind, as I pointed out on my comments to that 13% includes some incremental rent expense as we plan to move from our existing headquarter facility into the new facility and -- later this year.

Your next question comes from the line of Jason Mills of Canaccord Genuity.

It's David, on for Jason, can you hear me all right? First question I want to ask is around FY '19 guidance. Could you provide any color around or additional color around the assumptions kind of baked in specifically regarding the cadence of sales or payers in the year, and as well as where you kind of see any propensity to deliver on the upside and what kind of drivers within your assumptions are -- kind of have the highest opportunity to deliver on the upside?

So you may remember from last year, we got out of the gate rather slowly in our hiring. And in fact, we're behind in our hiring plans for, certainly, the first half of the year and made most of our hires in the second half. We learned a lot from that experience. We brought on a new Chief Human Resources Officer, a couple of dedicated sales recruiters. We've revamped our approach as to how we go about bringing on new folks, and I believe it served us very well. So that explains all the way up to the beginning of 2019. Our plans for 2019 is to do as much as we can in the first 2 to 3 quarters so that we don't have to bring anyone else on in the fourth quarter. That's the way we built our plan, that's what we've been able to execute in years past other than 2018 and that's the way we would prefer to see it done. We're pretty comfortable with the growth outlook that we've put in place other than the things I mentioned that we did not assume are in our plan, our biggest drivers are Flexitouch Plus, the attractiveness of that product versus our competition, and more importantly allowing our physicians and clinicians to think about Flexitouch for more of their patients, I think will be the biggest driver and then we just talked about the sales reps. Those are the two things that I would point to as the biggest drivers for our success in '19.

All right. And then, maybe touching on the Aero-Wrap product. Looking out, I guess, into 2020, if it's not kind of contributing to 2019, could you provide any color on kind of what type of cross-selling opportunities you see with the product, given that it kind of gives you the ability to accept patients earlier kind of in that continuum of care, and then maybe in so far as if you've -- you quantify the size of the opportunity you have maybe over the mid- or the long term with the product?

Yes, I'd be happy to. We are really excited about the Airwear technology. We're in the midst of securing the supply chain. We think it is the best of all of the static compression systems that are on the market today in terms of addressing a patient's ease of use and ability to put on and take off the static compression system that they inevitably need to treat their chronic swelling problem. We are excited about it because all payers require a trial of conservative therapy before they'll move a patient up to considering one of our pneumatic compression systems. And thus Airwear is a potential solution for those patients with lower extremity swelling that they can get into right away. Once we get to know that patient, we believe we can pull through some additional sales of our Entré and Flexitouch products once we've had exposure to that patient, which we currently don't have today. The market itself, we're really relying on that pull through to be significant in 2020 because we're not planning a launch, we'll do a limited launch, which is our usual cadence in the second half of '19 and then roll it out to the rest of the sales organization toward the end of the year.

Your next question comes from the line of Suraj Kalia of Northland Securities.

Can you hear me all right?

Yes, Suraj. Thank you. Welcome.

Jerry, congrats on a great quarter. A couple of questions from my side, and I know you've provided qualitative commentary. I was wondering if you could put some boundaries around specifically this contract payer in a way you all are going direct. I heard a $2 million ASP impact in fourth quarter. Obviously, there is a bolus. Forgive me if I missed the exact dollar amount that came through from this contract payer and at what margin specifically this contract was provided?

Sure. So the reference to the $2 million was what we talked about at the end of Q -- in our third quarter earnings call, and we were forecasting forward that because of the pricing that we gave away, if you will, to get on this contract, it could have an impact of $2 million in the fourth quarter. The good news is, we were able to make up that whole revenue impact by increased volume in the fourth quarter. As we mentioned then Suraj, the pricing that we agreed to with this payer was roughly in line with other pricing from large commercial payers. So we don't see it being -- it came down to what I would consider to be a more normal level than where it was previously. So we don't have -- we don't release gross margins by payer. Obviously, that's a confidential negotiation between us and them, but I would say they're more in line with the others than they were previously.

And finally, Jerry, just to follow-up on that. For FY '19, I heard a low-70s gross margin. Can you help us reconcile the FY '19 gross margin guidance with expected contribution from this contract there? And forgive me, maybe it sounds unfair because you don't want to give specifics on this payer. Just help us put some goalpost somewhere so that we can triangulate and at least make some assessment from a modeling perspective.

Thank you, Suraj. This new payer we now have at what I would say normal pricing levels. So that's one of the drivers of why we feel comfortable about 70-plus percent gross margins in 2019. We build into our assumptions for that for 2019 mid-single-digit price erosion. So we've already built in what our expected impact is for this payer in that assumption of mid-single-digit price erosion. So we're very confident we can get to that and deliver on that 70-plus percent gross margin going forward.

Your next question comes from the line of Mitra Ramgopal of Sidoti.

Jerry, I was wondering, as you look out to remainder of 2019 and even beyond, any plans in terms of trying to do more on the -- outside of the U.S.? I know that's something you've talked about in the past. And I was just wondering if you're closer to getting there?

Mitra, thanks for the question, and let me address it specifically. As -- we've talked about the desire to expand beyond the U.S. borders for quite sometime now. The gating item has been and continues to be the changes in the quality system that will be required of Tactile to be able to meet the European regulations. We are still scheduled for that audit or that visit here in the first half of this year, after which we can self apply the CE mark to our product and get going, selling products internationally. In 2019, we have no revenue assumed for international. We've built in some costs as we expect to explore how we go about international distribution. But I harp in back to the fact that we are so underpenetrated in the U.S. market that, that is our laser focus for 2019. We sold 35,000 units last year -- 32,000, sorry, units last year and that's on 1.1 million patients diagnosed. So this is a vastly underpenetrated market that we're in now, and we want to try to focus our efforts there.

Okay. That's great. And then just a quick question on the reimbursement front. As you look at gross margin continue to expand, any potential headwinds there?

Mitra, it's Brent. Actually, in our gross margin, for 2018, I kind of went through it a little bit earlier on the call, but the impact that we had from a large payer certainly had an impact on our overall 2018 gross margin. As Jerry pointed out, we do have that booked into our expectation for 2019, and we feel confident that we should be able to hit our low-70% gross margin for 2019. The one thing that I will be just mindful of is, in the first half of the year, some of that pricing headwinds, because we haven't anniversaried it yet, will impact our first half of the year versus the second half when the contract came into play.

This has completed the allotted time for questions. And that does conclude our conference for today. Thank you for your participation. You may now disconnect.