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Item 7. Management’s Discussion and Analysis

2021-02-23 compared with 2020-02-26 · 142 added, 106 removed, 300 unchanged (45% of the section changed)

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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.

Coronavirus (COVID-19)

The United States economy in general and our business specifically have been negatively affected by the COVID-19 pandemic.

We have seen adverse impacts as it relates to the decline in the number of patients that healthcare facilities and clinics are able to treat due to enhanced safety protocols.

There are no reliable estimates of how long the pandemic will last or how many people are likely to be affected by it.

For that reason, we are unable to reasonably estimate the long-term impact of the pandemic on our business at this time.

Our first priority with regard to the COVID-19 pandemic is to ensure the safety and health of our employees, clinicians and patients.

Subject to that, we are focusing our efforts on attempting to continue our business operations in this unprecedented environment.

Part of our strategy includes changing many of our processes and practices in an effort to help mitigate the impact of COVID-19 on our business so that we can support our clinicians and safely make our at-home therapies available to patients.

Since the onset of COVID-19, we have remained proactive to ensure we continue to adapt to our employees, clinicians and patients needs.

These changes to our business include, but are not limited to:

● Initially, we modified our operations with the primary focus on keeping our employees safe while continuing to serve our clinicians and patients.

As an essential business under federal guidelines, we continued to manufacture product and implemented multiple, smaller rotational shifts and other best practices to help protect the health and safety of our workforce.

More recently, we have migrated closer to our pre-COVID work shifts, however we have implemented more stringent safety measures including mandatory use of face masks, social distancing and temperature checks for our employees.

● We have continued to incorporate remote and flexible work arrangements for employees whenever possible, including real-time, online training of our new sales representatives.

● We have continued to limit employee travel and contact restrictions to reduce exposure.

● We have continued to collaborate with payers to modify coverage requirements by serving patients virtually.

● In concert with COVID-19 social distancing requirements and recommendations, we moved to a “no contact” virtual patient training model.

This new model substantially reduced the need for in-person contact and visits to patients’ homes and clinics in order to protect the health and limit the exposure of both our trainers and patients.

Accordingly in the second quarter of 2020, we inactivated our independent healthcare practitioners, who acted as at-home trainers to educate patients on the proper use of our systems, in order to allow these individuals to have access to specific COVID related financial relief.

We have since reactivated a small number of healthcare

practitioners in the same capacity as trainers who educate patients on the proper use of our solutions.

● We continue to transition large, in-person medical education programs in favor of conducting virtual meetings whenever possible.

● When in-person visits are required, we are supporting clinicians and patients by using rigorous infection control practices.

We cannot assure you that these changes to our processes and practices will be successful in mitigating the impact of COVID-19 on our business.

We continue to evaluate and, if appropriate, will adopt other measures in the future related to the ongoing safety of our employees, clinicians and patients.

Additional information related to the COVID-19 pandemic is included in the MD&A sections below.

We are a medical technology company that develops and provides innovative medical devices for the treatment of chronic diseases.

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Our solutions deliver cost-effective, clinically proven, long-term treatment for people with these chronic diseases.

Our proprietary products are the Flexitouch, Entre, and Actitouch systems.

Our proprietary products are the Flexitouch and Entre systems.

A predecessor to our Flexitouch system received 510(k) clearance from the U.S.

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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 derive the vast majority of our revenue from our Flexitouch system.

Sales and rentals of our Flexitouch system represented 88% and 90% of our revenue in the years ended December 31, 2020 and 2019, respectively.

In September 2012, we acquired our second proprietary product, the Actitouch system.

The system received 510(k) clearance from the FDA in June 2013 and we began selling the product in September 2013 to address the many limitations of multilayered bandages that are worn by patients suffering from venous leg ulcers.

We also introduced our Entre system in the United States in February 2013.

The Entre and Actitouch systems are sold or rented to patients who need a more basic pump or who do not yet qualify for insurance reimbursement for an advanced compression device such as our Flexitouch system.

For the years ended December 31, 2019 and 2018, sales and rentals of our Entre and Actitouch systems combined represented 10% and 8% of our revenue, respectively.

During fiscal year 2018, we recorded a $2.5 million non-cash impairment charge to fully impair the inventory and intangible assets related to our Actitouch system, and we now intend to discontinue this product line in the first quarter of 2020.

See Note 3 - “Summary of Significant

Accounting Policies” to the consolidated financial statements in this report for more information regarding this impairment charge and discontinuation.

We introduced our Entre system in the United States in February 2013.

The Entre system is sold or rented to patients who need a more basic pump or who do not yet qualify for insurance reimbursement for an advanced compression device such as our Flexitouch system.

For the years ended December 31, 2020 and 2019, sales and rentals of our Entre system and other products (that have since been discontinued) represented 12% and 10% of our revenue, respectively.

We previously sold and rented another proprietary product, the Actitouch system.

During fiscal year 2018, we recorded a $2.5 million non-cash impairment charge to fully impair the inventory and intangible assets related to our Actitouch system due to the lack of market demand for the product.

We formally discontinued this product line in the first quarter of 2020.

See Note 8 - “Intangible Assets” to the consolidated financial statements in this report for more information regarding this impairment charge and discontinuation.

In October 2018, we licensed the intellectual property rights related to the Airwear Gradient Compression Wrap, or the Airwear wrap, in the U.S.

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We began selling the Airwear wrap in a limited market in the fourth quarter of 2019.

A commercial release is anticipated in the first quarter of 2020.

To support the growth of our business, we invest heavily in our commercial infrastructure, consisting of our direct sales force, home training resources, contracted at-home trainers, reimbursement capabilities and clinical expertise.

We subsequently made the strategic decision to discontinue the Airwear wrap in the second quarter of

2020 and, effective July 31, 2020, Sun Scientific, Inc.

terminated the license agreement with us related to the Airwear wrap.

See Note 8 - “Intangible Assets” to the consolidated financial statements in this report for more information regarding the related impairment charge.

To support the growth of our business, we invest heavily in our commercial infrastructure, consisting of our direct sales force, training resources, reimbursement capabilities and clinical expertise.

We market our products in the United States using a direct-to-patient and -provider model.

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This model allows us to directly approach patients and clinicians, whereby we disintermediate the traditional durable medical equipment channel, allowing us to capture both the manufacturer and distributor margins.

We also utilize over 560 licensed, independent healthcare practitioners as home trainers who educate patients on the proper use of our systems.

Furthermore, in concert with COVID-19 social distancing requirements and recommendations, we temporarily moved to a “no contact” virtual patient training model.

We have since reactivated a small number of healthcare practitioners in the same capacity as trainers who educate patients on the proper use of our solutions.

We invest substantial resources in our reimbursement department, which was reorganized in 2018 to improve operational efficiencies and enhance individual payer expertise, while continuing our strategic focus of payer development.

The Reimbursement Department, composed of over 90 employees, now consists of our Payer Development and Reimbursement Operations groups.

Our Payer Development group is composed of both strategic and analytical teams, with focus on payer decision-maker relationships and education, payer policy development and revision, payer contract negotiations, and payer data analysis.

Our experienced Reimbursement Operations group 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 medical director (part-time), that serves as a resource to clinicians and patients and guides the development of clinical evidence in support of our products.

Our reimbursement function includes payer relations and reimbursement operations.

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.

Our clinical function, consisting of a scientific advisory board, in-house therapists and nurses, and our Chief Medical Officer (part-time), serves as a resource to clinicians and patients and guides our development of clinical evidence in support of our products.

We believe these investments are critical to driving payer, clinician and patient adoption of our technologies, and together with our commercial infrastructure, represent a significant competitive advantage.

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 Flexitouch system, perform quality assurance, and ship our products from our facility in Minneapolis, Minnesota.

For the year ended December 31, 2019, we generated revenue of $189.5 million and had net income of $11.0 million, compared to revenue of $143.8 million and net income of $6.6 million for the year ended December 31, 2018, and revenue of $109.3 million and net income of $5.9 million for the year ended December 31, 2017.

For the year ended December 31, 2020, we generated revenue of $187.1 million and had net loss of $0.6 million, compared to revenue of $189.5 million and net income of $11.0 million for the year ended December 31, 2019, and revenue of $143.8 million and net income of $6.6 million for the year ended December 31, 2018.

Our primary sources of capital to date have been from operating income and private placements of our capital stock, as well as our initial public offering, which closed on August 2, 2016.

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Components of our Results of Operations

We derive our revenue from the sale of our Flexitouch, Entre and Actitouch systems and the Airwear wrap to patients in the United States.

We derive our revenue from sales and rentals of our Flexitouch and Entre 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 system, and the launch of our Entre system in 2013.

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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.

In 2018, our gross margin was also impacted by a $0.7

million inventory write-off related to the impairment of our Actitouch assets.

In addition, the up-front payment we made under our license agreement with Sun Scientific Inc.

is being amortized as a cost of revenue.

We expect our gross margin to decrease slightly over the near term as we experience pricing pressure from third-party payers.

We expect our gross margin to decrease slightly over the

near term as we experience pricing pressure from third-party payers.

We continue to work to reduce product manufacturing cost through enhanced product design efforts as well as supply chain initiatives in an effort to offset anticipated price erosion.

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These expenses consist primarily of personnel-related expenses, including salaries, bonuses, commissions and benefits for employees.

They also include expenses for patient home 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.

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.

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General and administrative expenses also include professional services such as legal, consulting and accounting services, stock-based compensation, travel expenses and insurance costs.

Our reimbursement, general and administrative expenses were impacted by a net $1.1 million charge in 2019 related to the lease termination for our former headquarters and a $1.8 million intangible asset impairment charge in 2018 related to our Actitouch assets.

Other Income (Expense), Net

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Critical Accounting Policies and Significant 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.

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 assets and liabilities, revenue and expenses at the date of the financial statements.

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Revenue Recognition

We derive revenue from the sales and rentals of our products, which consist of our proprietary line of Flexitouch, Entre and Actitouch systems as well as the Airwear wrap.

We derive revenue from the sales and rentals of our products, which consist of our proprietary line of Flexitouch and Entre systems.

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.

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At shipment, we invoice the payer for the total product price and we recognize revenue in the amount of cash consideration anticipated to be received based on the transaction price.

After the insurance payer has remitted payment, we separately invoice the patient for their portion of the payment obligation, such as copayments and

After the insurance payer has remitted payment, we separately invoice the patient for their portion of the payment obligation, such as copayments and deductibles.

The transaction price is determined based on the payment history of the applicable payer drawn from actual write-off and collections experience from the payer over a rolling 12-month period, as well as historical patient collections.

For our products sold to Medicare patients, we recognize revenue from such sales upon shipment of our products, which can occur only after we have received a prescription from a physician and all applicable patient documentation is obtained.

The transaction price for our Actitouch and Entre systems is determined based on the payment history using the same methodology as our private insurers.

The transaction price for our Entre system is determined based on the payment history using the same methodology as our private insurers.

A portion of our claims for our Flexitouch system are initially denied and thereupon enter the appeals process, which can be lengthy.

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Accordingly, we recognized the related revenue for these rental arrangements monthly, on a pro rata basis, over the lesser of the duration of the rental period or the period during which the patient possesses the product.

As we elected the practical expedient to not reassess the lease classification for leases in existence at December 31, 2018, rental agreements commencing after January 1, 2019, are recorded as sales-type leases in accordance with ASC 842.

2016-02, “Leases” (Topic 842) (“ASC 842”).

Accordingly, as sales-type leases, the transaction price for the entire rental term is recognized upon transfer of control.

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A portion of our claims to Medicare are initially denied, and enter the appeals process, where many are ultimately reviewed by an Administrative Law Judge.

After final adjudication of all claims, approximately 90%

of the claims submitted are approved (this is on a number of claims, not a dollars claimed, basis across all our products).

After final adjudication of all claims, approximately 90% of the claims submitted are approved (this is on a number of claims, not a dollars claimed, basis across all our products).

The appeals process can be lengthy, lasting more than a year in most cases.

Accordingly, we classify a portion of our Medicare accounts receivable as non-current based on our experience with Medicare collections.

Accordingly, we classify

a portion of our Medicare accounts receivable as non-current based on our experience with Medicare collections.

Stock-Based Compensation

We account for stock-based compensation awards at the fair value on the date of grant, expensed over the applicable vesting period.

The fair value of options on the grant date is estimated using the Black-Scholes option-pricing model.

The fair value of stock options is estimated, at the date of grant, using the Black-Scholes option-pricing model, except for the valuation of certain “CEO” related stock options subject to a market condition which uses the Monte Carlo Simulation 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 option-pricing 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.

The Monte Carlo Simulation and Black-Scholes valuation models require 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.

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Consequently, we use an expected dividend yield of zero.

The following table sets forth the estimated fair values of our stock options granted in the years ended December 31, 2019, 2018 and 2017, and the assumptions on which they were based:

Expected term

Expected volatility

Risk-free interest rate

Expected dividend yield

Fair value on the date of grant

$19.57 - $33.12

$12.46 - $29.07

$7.82 - $16.23

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.

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(In thousands)

Condensed Consolidated Statement

Consolidated Statement

of Operations Data:

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Total operating expenses

Income from operations

Income before income taxes

Income tax expense (benefit)

Revenue increased $45.7 million, or 32%, to $189.5 million in the year ended December 31, 2019, compared to $143.8 million in the year ended December 31, 2018.

The growth in revenue was attributable to an increase of approximately $39.4 million, or 30%, in sales and rentals of our Flexitouch system and an increase of approximately $6.4 million, or 54%, in sales and rentals of our Entre and Actitouch systems in the year ended December 31, 2019, compared to the year ended December 31, 2018.

The increase in Flexitouch system sales was largely driven by expansion of our sales force, increased physician and patient awareness of the treatment options for lymphedema, broad in-network coverage with national and regional insurance payers and growth in the number of Medicare patients served.

The increase in Entre and Actitouch systems sales was largely driven by managing these orders in-house with our internal team of specialists.

These specialists are dedicated to selling the Entre system, allowing us to focus on marketing and distributing this system more efficiently.

(Loss) income from operations

(Loss) income before income taxes

Income tax (benefit) expense

Net (loss) income

Revenue decreased $2.4 million, or 1%, to $187.1 million in the year ended December 31, 2020, compared to $189.5 million in the year ended December 31, 2019.

The decrease in revenue was attributable to a decrease of approximately $7.4 million, or 4%, in sales and rentals of our Flexitouch system partially offset by an increase of approximately $5.0 million, or 28%, in sales and rentals of our other products, primarily our Entre system, in the year ended December 31, 2020, compared to the year ended December 31, 2019.

Beginning in March 2020 and continuing through the fourth quarter, revenue was impacted by the COVID-19 pandemic, which limited our ability to access our clinician customers and their patients.

Specifically, we saw healthcare facilities and clinics restricting access to their clinicians, reducing patient consultations, or closing temporarily due to COVID-19.

The following table summarizes our revenue by product for the years ended December 31, 2020 and 2019, both in dollars and percentage of total revenue:

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Flexitouch system

Entre/Actitouch systems

Other products (1)

Percentage of total revenue

Flexitouch system

Entre/Actitouch systems

Other products (1)

(1) The “other products” line primarily includes revenue from our Entre system.

The Actitouch system and the Airwear wrap contributed immaterial amounts of revenue for the years ended December 31, 2020 and 2019.

Cost of Revenue and Gross Margin

Cost of revenue increased $13.8 million, or 33%, to $55.3 million during the year ended December 31, 2019, compared to $41.5 million during the year ended December 31, 2018.

The increase in cost of revenue was primarily attributable to an increase in the number of systems sold or rented and additional manufacturing headcount and higher related manufacturing costs to support increased volumes.

Gross margin was 71% for both of the years ended December 31, 2019 and 2018, respectively.

Cost of revenue decreased $0.9 million, or 2%, to $54.3 million during the year ended December 31, 2020, compared to $55.3 million during the year ended December 31, 2019.

The decrease in cost of revenue was primarily attributable to a decrease in the number of Flexitouch systems sold or rented slightly offset by an increase in other products sales and rentals, and the $0.4 million inventory impairment charge recorded in the second quarter of 2020 related to discontinuing the Airwear wrap product line.

Gross margin was 71% for both of the years ended December 31, 2020 and 2019.

Sales and Marketing Expenses

Sales and marketing expenses increased $0.7 million, or 1%, to $79.6 million during the year ended December 31, 2020, compared to $78.9 million during the year ended December 31, 2019.

The increase was primarily attributable to our continued investment in our field sales team, patient training and marketing initiatives to increase clinician awareness, resulting in an increase of $13.1 million in personnel-related compensation expenses, including $1.1 million of incremental stock-based compensation expense, as well as a $5.4 million increase in associated expenses.

The increase was primarily attributable to our continued investment in our field sales team and marketing initiatives to increase clinician awareness, resulting in an increase of $9.2 million in personnel-related compensation expenses, including $0.7 million of incremental stock-based compensation expense, partially offset by a reduction of $4.3 million in our external patient training expense as a result of moving to increased virtual patient trainings, $2.3 million in reduced travel and entertainment expense due to decreased travel activities and a $1.8 million decrease from reduced tradeshows, professional services and other sales expense.

Research and Development Expenses

R&D expenses decreased $0.1 million, or 2%, to $5.2 million during the year ended December 31, 2019, compared to $5.3 million during the year ended December 31, 2018.

The decrease in R&D expenses was primarily attributable to a $0.1 million decrease of post launch related product support costs of our Flexitouch Plus launched in 2018.

R&D expenses increased $0.1 million, or 2%, to $5.3 million during the year ended December 31, 2020, compared to $5.2 million during the year ended December 31, 2019.

The increase in R&D expenses was primarily attributable to investments in our R&D team and clinical studies projects.

Reimbursement, General and Administrative Expenses

Reimbursement, general and administrative expenses increased $11.9 million, or 30%, to $51.5 million during the year ended December 31, 2020, compared to $39.6 million during the year ended December 31, 2019.

The increase in reimbursement, general and administrative expenses for the year ended December 31, 2019, was primarily attributable to a $2.8 million increase in personnel-related expenses, resulting from increased headcount in our reimbursement operations, payer relations, patient services and corporate functions, a $0.5 million increase in stock-based compensation expense, an increase of $1.2 million in professional fees, legal, accounting, audit and tax expenses and software fees and a $2.0 million increase in other operating expenses, including facilities, depreciation and service charges.

Facilities expenses include a $1.1 million one-time lease termination charge and associated costs for our former corporate headquarters.

The increase in reimbursement, general and administrative expenses for the year ended December 31, 2020, was primarily attributable to a $4.1 million increase in personnel-related expenses, resulting from increased headcount in our reimbursement operations, payer relations, patient services and corporate functions, an increase of $4.8 million in other operating expenses, including facilities, depreciation and service charge and an increase of $2.4 million in litigation defense costs and other professional fees.

Our reimbursement, general and administrative expenses in the year ended December 31, 2020, included a $3.6 million non-cash impairment charge related to the write-off of our Airwear wrap-related long-lived assets

compared to a $1.1 million lease termination charge for our former corporate headquarters in the year ended December 31, 2019.

Other Income, Net

Other income, net was $1.4 million for the year ended December 31, 2020, compared to $0.6 million for the year ended December 31, 2019.

The increase in other income was due to investment income earned on the capital derived from our initial public offering proceeds.

Income Tax Expense (Benefit)

We recorded an income tax expense of $0.2 million and an income tax benefit of $3.1 million for the years ended December 31, 2019 and 2018, respectively.

The current year tax expense was primarily due to a significant decrease in the benefit related to tax-deductible share-based compensation activity, as compared to the previous year.

This activity included vesting of restricted stock units, excess tax benefits associated with exercises of non-qualified stock options, and disqualifying dispositions of incentive stock options and employee stock purchase plan, or ESPP, shares.

The increase in other income was primarily due to $1.2 million received under the CARES Act Provider Relief Fund to compensate us for lost revenues from the COVID-19 public health emergency (PHE) which was recognized in the period based on our interpretation of guidance issued by the Department of Health and Human Services through January 2021.

Income Tax (Benefit) Expense

We recorded an income tax benefit of $1.6 million and an income tax expense of $0.2 million for the years ended December 31, 2020 and 2019, respectively.

The current year tax benefit was primarily due to a decrease in income tax recognized related to tax-deductible share-based compensation activity, as compared to the previous year.

This activity included lower expense related to vesting of restricted stock units, excess tax benefits associated with exercises of non-qualified stock options, and disqualifying dispositions of incentive stock options and employee stock purchase plan, or ESPP, shares.

Comparison of the Years Ended December 31, 2019 and 2018

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(In thousands)

Condensed Consolidated Statement

Consolidated Statement

of Operations Data:

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Revenue increased $45.7 million, or 32%, to $189.5 million in the year ended December 31, 2019, compared to $143.8 million in the year ended December 31, 2018.

The growth in revenue was attributable to an increase of approximately $31.6 million, or 31%, in sales and rentals of our Flexitouch system and an increase of approximately $2.9 million, or 32%, in sales and rentals of our Entre and Actitouch systems in the

year ended December 31, 2018.

The increase in Flexitouch system sales was largely driven by expansion of our sales force, increased volume due to a new contract with a large private insurer, the launch of the Flexitouch Plus product, our third-generation Flexitouch product, and sales growth in the Veterans Administration channel.

The increase in Entre and Actitouch systems sales was largely driven by our creation of a separate in-house team of specialists.

These internal specialists are dedicated to selling the Entre and Actitouch systems, allowing us to focus on marketing and distributing these systems more efficiently.

The increase in Entre and Actitouch systems sales was largely driven by managing these orders in-house with our internal team of specialists.

These specialists are dedicated to selling the Entre system, allowing us to focus on marketing and distributing this system more efficiently.

The following table summarizes our revenue by product for the years ended December 31, 2018 and 2017, both in dollars and percentage of total revenue:

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Flexitouch system

Entre/Actitouch systems

Percentage of total revenue

Other products (1)

Percentage of total revenues

Flexitouch system

Entre/Actitouch systems

Other products (1)

(1) The “other products” line primarily includes revenue from our Entre system.

The Actitouch system and the Airwear wrap contributed immaterial amounts of revenue for the years ended December 31, 2019 and 2018.

Cost of Revenue and Gross Margin

Cost of revenue increased $13.8 million, or 33%, to $55.3 million during the year ended December 31, 2019, compared to $41.5 million during the year ended December 31, 2018.

The increase in cost of revenue was primarily attributable to an increase in the number of systems sold, additional manufacturing headcount to support increased volumes, incremental manufacturing costs specific to the introduction of the Flexitouch Plus, and the $0.7 million write-off of Actitouch inventory.

Gross margin was 71% and 73% for the years ended December 31, 2018 and 2017, respectively.

The decrease in gross margin was primarily attributable to lower pricing under a new contract with a large private insurer.

Gross margin was 71% for both of the years ended December 31, 2019 and 2018.

Sales and Marketing Expenses

Sales and marketing expenses increased $18.5 million, or 31%, to $78.9 million during the year ended December 31, 2019, compared to $60.4 million during the year ended December 31, 2018.

The increase was primarily attributable to our continued investment in our field sales team, patient training and marketing initiatives to increase clinician awareness, resulting in an increase of $11.8 million increase in personnel-related compensation expense, including $1.7 million of incremental stock-based compensation expense, as well as an increase of $4.2 million in associated expenses.

Research and Development Expenses

R&D expenses increased $0.2 million, or 5%, to $5.3 million during the year ended December 31, 2018, compared to $5.1 million during the year ended December 31, 2017.

The increase in R&D expenses was primarily attributable to a $0.2 million increase in clinical studies, consulting and product development costs, including those related to the development of our Flexitouch Plus.

R&D expenses decreased $0.1 million, or 2%, to $5.2 million during the year ended December 31, 2019, compared to $5.3 million during the year ended December 31, 2018.

The decrease in R&D expenses was primarily attributable to a $0.1 million decrease of post launch related product support costs of our Flexitouch Plus launched in 2018.

Reimbursement, General and Administrative Expenses

Reimbursement, general and administrative expenses increased $6.0 million, or 18%, to $39.6 million during the year ended December 31, 2019, compared to $33.6 million during the year ended December 31, 2018.

The increase in reimbursement, general and administrative expenses for the year ended December 31, 2018, was primarily attributable to a $2.5 million increase in personnel-related expenses, resulting from increased headcount in our reimbursement operations, payer relations, patient services and corporate

functions, a $1.9 million increase in stock-based compensation expense, an impairment charge of $1.8 million due to the determination that the carrying amount of the intangible assets related to our Actitouch system would not be recoverable, a $1.3 million increase in other operating expenses, including facilities, depreciation and service charges and an increase of $0.2 million in professional fees, legal, accounting, audit and tax expenses and software fees, which were partially offset by a decrease of $0.8 million in accrued sales and use and franchise taxes due to one-time related sales and use taxes in 2017.

Other Income (Expense), Net

Facilities expenses include a $1.1 million one-time lease termination charge and associated costs for our former corporate headquarters.

Other Income, Net

Other income, net was $0.6 million for the year ended December 31, 2019, compared to $0.5 million for the year ended December 31, 2018.

The increase in other income was due to investment income earned on the capital derived from our initial public offering proceeds.

Income Tax Benefit

We recorded an income tax benefit of $3.1 million and $1.7 million for each of the years ended December 31, 2018 and 2017, respectively.

The current year tax benefit was primarily due to a significant increase related to tax-deductible share-based compensation activity, as compared with the previous year.

Income Tax Expense (Benefit)

We recorded an income tax expense of $0.2 million and an income tax benefit of $3.1 million for the years ended December 31, 2019 and 2018, respectively.

The 2019 tax expense was primarily due to a significant decrease in the benefit related to tax-deductible share-based compensation activity, as compared to the previous year.

The prior year income tax benefit was partially offset by approximately $1.2 million of incremental tax expense associated with revaluation of our deferred tax assets and liabilities, resulting from the enactment of the Tax Cuts and Jobs Act in December 2017.

The net income tax benefit in the current year resulted in a significant increase in our net income for the year ended December 31, 2018.

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 when 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.

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.

Liquidity and Capital Resources

As of December 31, 2019, we had cash and cash equivalents of $22.8 million and marketable securities of $22.5 million, compared with cash and cash equivalents of $20.1 million and marketable securities of $25.8 million as of December 31, 2018.

As of December 31, 2020, we had cash and cash equivalents of $47.9 million with no marketable securities, compared with cash and cash equivalents of $22.8 million and marketable securities of $22.5 million as of December 31, 2019.

Our primary sources of capital to date have been from operating income and private placements of our capital stock, as well as proceeds from our initial public offering, which closed on August 2, 2016.

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Net Cash Provided by Operating Activities

Net cash provided by operating activities during the year ended December 31, 2020, was $2.8 million, resulting from net loss of $0.6 million and non-cash net income adjustments of $16.2 million, which were offset by an increase in net operating assets of $12.8 million.

The non-cash net income adjustments primarily

consisted of $10.7 million of stock-based compensation expense, a $4.0 million non-cash adjustment for impairment losses and $2.8 million of depreciation and amortization.

The uses of cash related to changes in operating assets primarily consisted of increases in accounts receivable and net investment in leases.

The changes in operating liabilities primarily consisted of increases in accrued payroll and related taxes and accrued expenses and other liabilities and income taxes payable.

Net cash provided by operating activities during the year ended December 31, 2019, was $2.5 million, resulting from net income of $11.0 million and non-cash net income adjustments of $14.1 million, which were offset by an increase in net operating assets of $22.5 million.

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These changes generally were driven by our increased business volume year-over-year, which resulted in increases to customer accounts receivable and other expenditures, including compensation and personnel-related costs.

Net cash provided by operating activities during the year ended December 31, 2017, was $4.2 million, resulting from net income of $5.9 million, net non-cash expense add-backs of $6.5 million, and a net increase in operating liabilities of $2.7 million, partially offset by a net increase in operating assets of $10.9 million.

The non-cash expense add-back items consisted primarily of $4.2 million of stock-based compensation, $1.8 million of depreciation and amortization, and a $0.3 million increase in our allowance for doubtful accounts.

The uses of cash related to changes in operating assets primarily consisted of increases in accounts receivable, inventories and income taxes.

The changes in operating liabilities primarily consisted of increases in accounts payable and accrued expenses and other liabilities.

These changes generally were driven by our increased business volume year-over-year, which resulted in increases to customer accounts receivable and required increases to our levels of inventory and other expenditures, including compensation and personnel-related costs.

Net Cash Used in Investing Activities

Net Cash Provided by (Used in) Investing Activities

Net cash provided by investing activities during the year ended December 31, 2020, was $20.2 million, consisting primarily of $22.5 million in net proceeds from maturities of securities available-for-sale, offset by $2.1 million in purchases of property and equipment primarily related to IT infrastructure, 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, 2019, was $2.3 million, consisting primarily of $3.7 million in net proceeds from securities available-for-sale, offset by $5.4 million in purchases of property and equipment primarily related to IT infrastructure, production tooling and office equipment and $0.5 million related to the acquisition of patents and other intangible assets.

Net cash used in investing activities during the year ended December 31, 2018, was $14.7 million, consisting primarily of $5.4 million related to the acquisition of patents and other intangible assets, $4.7 million in net purchases of securities available-for-sale, $2.1 million in purchases of rental and demonstration equipment, $2.0 million in purchases of product tooling and computer and manufacturing equipment, leasehold improvements and furniture and fixtures and $0.5 million of other investments.

Net cash used in investing activities during the year ended December 31, 2017, was $14.0 million, consisting primarily of net purchases of marketable securities of $10.1 million, $3.7 million in purchases of product tooling and computer and manufacturing equipment, $0.1 million of patent costs, and $0.1 million of other investments.

Net Cash Provided by Financing Activities

Net cash provided by financing activities during the year ended December 31, 2020, was $2.1 million, consisting of proceeds from the issuance of common stock under the ESPP of $2.9 million and proceeds from exercises of common stock options of $1.1 million, partially offset by $1.9 million in taxes paid for the net share settlement of restricted stock units.

Net cash provided by financing activities during the year ended December 31, 2019, was $2.5 million, consisting of proceeds from the issuance of common stock under the ESPP of $3.1 million and proceeds from

exercises of common stock options of $2.8 million, partially offset by $3.4 million in taxes paid for the net share settlement of restricted stock units.

Net cash provided by financing activities during the year ended December 31, 2018, was $1.9 million, consisting of proceeds from the issuance of common stock under the ESPP of $2.7 million and proceeds from exercises of common stock options of $1.5 million, partially offset by $2.4 million in taxes paid for the net share settlement of restricted stock units.

Net cash provided by financing activities during the year ended December 31, 2017, was $3.1 million, which was primarily due to $3.1 million of proceeds from the issuance of common stock under the ESPP and $0.8 million of proceeds from exercises of common stock options and warrants, partially offset by $0.5 million in purchases of treasury stock to cover withholding taxes upon the lapse of restrictions on restricted stock awards and $0.4 million in taxes paid for the net share settlement of restricted stock units that vested during the year.

Credit Agreement

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Our future capital requirements may vary significantly from those now planned and will depend on many factors, including:

● the impact of the COVID-19 pandemic on our business;

● sales and marketing resources needed to further penetrate our market;

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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, marketable securities and cash flows from operations, together with the Credit Agreement, will be sufficient to meet our working capital and capital expenditure requirements for at least the next twelve months.

Although the impact of the COVID-19 pandemic is difficult to predict, we believe our cash, cash equivalents and cash flows from operations, together with the Credit Agreement, will be sufficient to meet our working capital and capital expenditure 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, 2020, and we do not expect that inflation or changing prices will materially affect our business for at least the next twelve months.

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We did not receive any proceeds from the sale of the shares by the selling stockholders.

Coronavirus Aid, Relief, and Economic Security (CARES) Act

On March 27, 2020 the CARES Act was signed into law.

The CARES Act is a tax-and-spending package intended to provide economic relief to address the impact of the COVID-19 pandemic.

The CARES Act includes several tax provisions that, among other things, allow businesses to carry back net operating losses (“NOLs”) arising in 2018, 2019, and 2020 to the prior five tax years.

In the third quarter, we collected $2.9 million related to the carry back of our NOLs arising from these prior tax years.

In addition, the CARES Act provided $100 billion in relief funds to hospitals and other healthcare providers on the front lines of the COVID-19 pandemic.

An initial $30 billion of the funds were released for immediate infusion and were distributed to all facilities and providers that received Medicare fee-for-service (“FFS”) reimbursements in 2019.

On April 10, 2020, we received $1.2 million of the initial allotment to all facilities and providers which was determined to be our proportionate share.

Within 45 days of each reporting period end, we are required to comply with reporting requirements confirming funds were utilized in a manner described within the terms and conditions outlined by the U.S.

Department of Health & Human Services.

As of December 31, 2020, we recognized all of the funds received in the initial allotment as other income.

Off-Balance Sheet Arrangements

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(1) We issued purchase orders in 2020 totaling $19.5 million for goods that we expect to receive in 2021.

(2) We currently lease approximately 80,000 square feet of office space for our new corporate headquarters in Minneapolis, Minnesota, under a lease that expires in February 2031 and approximately 51,000 square feet of office, assembly and warehouse space at another facility in Minneapolis, Minnesota, under a lease that expires in March 2027.

(2) We currently lease approximately 113,000 square feet of office space for our corporate headquarters in Minneapolis, Minnesota, under a lease that expires in February 2031 and approximately 57,000 square feet of office, assembly and warehouse space at another facility in Minneapolis, Minnesota, under a lease that expires in March 2027.

As of December 31, 2020, we had additional lease commitments of $7.1 million related to amendments to existing building leases that have not commenced.

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Beginning in September 2017, the payments are equal to 6% of our quarterly revenue attributable to our Actitouch system.

In any year that this revenue exceeds $40.0 million, we are required to pay 7% on revenue over $40.0 million and 6% on revenue of $40.0 million and under.

In any year that this revenue exceeds $40.0 million, we are required to pay 7% on revenue over $40.0 million and 6% on revenue of $40.0 million and

Because our revenue attributable to our Actitouch system, and therefore the amount of royalty payments we will be required to pay in the future, are unknown, this amount only reflects royalties due associated with a portion of our 2020 Actitouch revenue.

We plan to discontinue the current Actitouch product line in the first quarter of 2020.

We discontinued the current Actitouch product line in 2020.

Recent Accounting Pronouncements

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Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-K

Item 7. Management’s Discussion and Analysis