Item 7. Management’s Discussion and Analysis
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.
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
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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.
Overview
We are a medical technology company that develops and provides innovative medical devices for the treatment of 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 chronic diseases in the home setting to improve patient outcomes and quality of life and help control rising healthcare expenditures. Our initial area of therapeutic focus is vascular disease, with a goal of advancing the standard of care in treating lymphedema and chronic venous insufficiency. 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 policy-makers 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 proprietary products are the Flexitouch and Entre systems. 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 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.
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. and Canada, for use in all medical applications, including but not limited to swelling/edema and ulcers (including lymphedema and chronic venous insufficiency conditions), but excluding the use of the intellectual property in the field of prophylaxis for deep vein thrombosis. The Airwear wrap is indicated for the management of venous insufficiency, venous hypertension, venous ulcerations and lymphedema. We began selling the Airwear wrap in a limited market in the fourth quarter of 2019. We subsequently made the strategic decision to discontinue the Airwear wrap in the second quarter of
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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. Our direct sales force has grown to a team of over 250 employees as of December 31, 2020, compared to over 240 employees as of December 31, 2019. 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. Furthermore, in concert with COVID-19 social distancing requirements and recommendations, we temporarily 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 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. 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, 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.
In August 2017, we filed a shelf registration statement on Form S-3 with the SEC. Under the shelf registration statement, we may offer and sell from time to time up to $200 million of common stock, preferred stock, debt securities, warrants, rights or units. The shelf registration statement also registered for resale from time to time up to 5,703,534 shares of our common stock held by the selling stockholders named therein. In September 2017, certain of the selling stockholders completed a secondary offering of 3,795,000 shares of our common stock at a public offering price of $33.00 per share. We did not receive any proceeds from the sale of the shares by the selling stockholders.
We operate in one segment for financial reporting purposes.
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Components of our Results of Operations
Revenue
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. 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.
Our revenue has fluctuated, and we expect our revenue to continue to fluctuate, from quarter to quarter due to a variety of factors. For instance, our fourth quarter is consistently our strongest quarter of the year. 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.
We sell or rent our products 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. Approximately 13% of our revenue in 2020 and 17% of our revenue in 2019 came from the Veterans Administration. Approximately 16% of our revenue in 2020 and 11% of our revenue in 2019 came from Medicare patients. Changes to the level of Medicare coverage for our products, including the 2015 LCD modification to the criteria for Medicare coverage, 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 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, enhanced marketing and customer support efforts, continued focus on developing clinical and economic outcomes data, efforts related to expanded third-party reimbursement and longer term, potential introduction of our solutions outside the United States. 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. A significant portion of our cost of revenue consists of manufacturing overhead costs. These 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 on our device controllers ranging from one to two years for commercially insured patients and five years for Medicare patients, as required by Centers for Medicare and Medicaid Services. We also provide replacement garments to our patients for up to five years after purchase. We establish a reserve for warranty claims based on historical warranty replacement costs incurred. Provisions for warranty obligations, which are included in cost of revenue, are recorded at the time of shipment.
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 expect our gross margin to decrease slightly over the
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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. Our gross margin will likely fluctuate from quarter to quarter.
Sales and Marketing Expenses
Our sales and marketing expenses support our direct-to-patient and -provider model. These 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.
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.
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 and insurance costs.
Other Income (Expense), Net
Other income (expense), net consists primarily of interest income related to investment income earned on our invested capital portfolio.
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 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
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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. 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.
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 policies, which are those that are most important to the portrayal of our financial condition and results of operations and require our most difficult, subjective and complex judgments.
Revenue Recognition
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. In general, revenue from the sale or rental of a product is recognized upon shipment, unless circumstances dictate that control has not yet passed to the customer.
We provide a warranty for our products against defects in material and workmanship for a period of one to five years on garments and one to two years on controllers. In accordance with applicable accounting guidance, we have determined these were assurance warranties and therefore not considered a performance obligation. In addition, we did not evaluate immaterial promised goods or services in the context of the contract. As a result, the sale or rental of our products represent a single performance obligation that is satisfied at a point in time and are short-term in nature. In certain cases we receive payment from Medicare sales over a period of time that may exceed one year. Despite these extended payment terms, no significant financing component is deemed to exist, as the terms are not for the benefit of the patient with whom we have the contract. Rather, the extended payment terms occur as a result of an initial claim denial, which subsequently enters the Medicare appeals process as noted below.
We commercially distribute our products directly to patients, who are referred to us by physicians, therapists or nurses. In most cases, there is a third-party payer such as a commercial insurer, Medicare or the Veterans Administration involved with the transaction. Our contractual relationship resides with the patient when the third-party payer is either a commercial insurer or Medicare, and with the Veterans Administration if the patient is covered under their services. Revenue is recognized from such sales upon transfer of control of the product to the customer at a transaction price determined by collection history. As a result, the transaction price is impacted by multiple factors, including the terms and conditions contracted by various third-party payers, and therefore payments from third-party payers typically are less than our standard charge and represent an implicit price concession, resulting in variable consideration. As most contracts are with each individual sale to a patient, we have elected the portfolio approach to determine the transaction price, and ultimately the expected consideration. The portfolios used to determine transaction price are at the payer level, with pricing for each payer assessed based on the underlying similar characteristics.
For any of our products sold to patients covered by private payers, such as commercial insurance companies, revenue is recognized upon shipment. A product is not shipped until we have received a prescription from a physician for our products and, as applicable, receipt of prior authorization from payers. 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 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.
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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 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. We assess the variable consideration for each of these claims as a percentage of the total invoice price based on ultimate approval and collection history.
For our products sold to the Veterans Administration on behalf of the patient, our contract is with the Veterans Administration rather than the patient. We enter into individual sales contracts with the Veterans Administration on behalf of each patient. These contracts determine the amount of consideration, which is typically paid in full within 2-3 days of shipment, and therefore there is no implicit price concession. In addition, the contracts provide for the right of control to transfer to the Veterans Administration upon delivery of the product to the patient, at which time revenue is recognized.
We incur incremental costs that directly relate to the sales of our products; however, as the amortization period would be less than one year, we have elected the practical expedient to expense these costs as incurred.
We sell and rent our products 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 private insurers and other payers, Medicare, and the Veterans Administration directly for purchases or rentals of our product on behalf of a patient and bill patients directly for their cost-sharing amounts, including any portion of an unsatisfied deductible and any copayments or co-insurance obligation.
A portion of our revenue is derived from patients who obtain our products under multiple-month rental arrangements. We bill these patients’ insurance payers monthly over the duration of the rental term. Title to these products passes to the patients at the end of the rental period. Patients may return the product before the end of the rental period, and as such these arrangements are deemed to be month-to-month cancelable leases in accordance with Accounting Standards Codification (“ASC”), or ASC 840, “Leases,” if they commenced prior to December 31, 2018. 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 Accounting Standards Update (“ASU”) No. 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.
Accounts Receivable
The majority of our accounts receivable and revenue are from commercial insurance payers and government payers, such as Medicare, the Veterans Administration and Medicaid.
Accounts receivable are recorded at management’s assessment of the expected consideration to be received, based on a detailed review of historical pricing adjustments and collections. Management relies on the results of the assessment, which includes payment history of the applicable payer as well as historical patient collections, as a primary source of information in estimating the collectability of our accounts receivable. We update our assessment on a quarterly basis, which to date has not resulted in any material adjustments to the valuation of our accounts receivable. We believe the assessment provides reasonable estimates of our accounts receivable valuation, and therefore we believe that substantially all accounts receivable are fully collectible.
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). The appeals process can be lengthy, lasting more than a year in most cases. Accordingly, we classify
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a portion of our Medicare accounts receivable as non-current based on our experience with Medicare collections.
Stock-Based Compensation
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 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. 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:
● Expected term . We use the "simplified method" to determine the expected term of the stock option.
● Expected volatility . Our expected volatility is derived using the average historical volatility of public companies of similar size and industry because we believe the expected volatility will approximate historical volatility, due to the fact that we had no trading history prior to our initial public offering.
● 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.
● 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, 2020, 2019 and 2018. 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, 2020 and 2019
The following table presents our results of operations for the periods indicated:
Year Ended
December 31,
Change
(In thousands)
2020
2019
$
%
Consolidated Statement
% of
% of
of Operations Data:
revenue
revenue
Revenue
Sales revenue
$
161,497
86
%
$
162,904
86
%
$
(1,407)
(1)
%
Rental revenue
25,633
14
%
26,588
14
%
(955)
(4)
%
Total revenue
187,130
100
%
189,492
100
%
(2,362)
(1)
%
Cost of revenue
Cost of sales revenue
45,309
24
%
47,034
25
%
(1,725)
(4)
%
Cost of rental revenue
9,011
5
%
8,222
4
%
789
10
%
Total cost of revenue
54,320
29
%
55,256
29
%
(936)
(2)
%
Gross profit
Gross profit - sales revenue
116,188
62
%
115,870
61
%
318
0
%
Gross profit - rental revenue
16,622
9
%
18,366
10
%
(1,744)
(9)
%
Gross profit
132,810
71
%
134,236
71
%
(1,426)
(1)
%
Operating expenses
Sales and marketing
79,634
43
%
78,920
42
%
714
1
%
Research and development
5,264
3
%
5,174
3
%
90
2
%
Reimbursement, general and administrative
51,540
28
%
39,644
21
%
11,896
30
%
Total operating expenses
136,438
74
%
123,738
66
%
12,700
10
%
(Loss) income from operations
(3,628)
(3)
%
10,498
5
%
(14,126)
(135)
%
Other income
1,367
1
%
631
—
%
736
117
%
(Loss) income before income taxes
(2,261)
(2)
%
11,129
5
%
(13,390)
(120)
%
Income tax (benefit) expense
(1,641)
(1)
%
158
—
%
(1,799)
N.M.
%
Net (loss) income
$
(620)
(1)
%
$
10,971
5
%
$
(11,591)
(106)
%
Revenue
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.
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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:
Year Ended
December 31,
Change
(In thousands)
2020
2019
$
%
Revenue
Flexitouch system
$
163,914
$
171,323
$
(7,409)
(4)%
Other products (1)
23,216
18,169
5,047
28%
Total
$
187,130
$
189,492
$
(2,362)
(1)%
Percentage of total revenue
Flexitouch system
88%
90%
Other products (1)
12%
10%
Total
100%
100%
(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 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 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 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, 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
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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 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.
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Comparison of the Years Ended December 31, 2019 and 2018
The following table presents our results of operations for the periods indicated:
Year Ended
December 31,
Change
(In thousands)
2019
2018
$
%
Consolidated Statement
% of
% of
of Operations Data:
revenue
revenue
Revenue
Sales revenue
$
162,904
86
%
$
128,786
90
%
$
34,118
26
%
Rental revenue
26,588
14
%
14,965
10
%
11,623
78
%
Total revenue
189,492
100
%
143,751
100
%
45,741
32
%
Cost of revenue
Cost of sales revenue
47,034
25
%
36,969
26
%
10,065
27
%
Cost of rental revenue
8,222
4
%
4,524
3
%
3,698
82
%
Total cost of revenue
55,256
29
%
41,493
29
%
13,763
33
%
Gross profit
Gross profit - sales revenue
115,870
61
%
91,817
64
%
24,053
26
%
Gross profit - rental revenue
18,366
10
%
10,441
7
%
7,925
76
%
Gross profit
134,236
71
%
102,258
71
%
31,978
31
%
Operating expenses
Sales and marketing
78,920
42
%
60,371
42
%
18,549
31
%
Research and development
5,174
3
%
5,289
4
%
(115)
(2)
%
Reimbursement, general and administrative
39,644
21
%
33,608
23
%
6,036
18
%
Total operating expenses
123,738
66
%
99,268
69
%
24,470
25
%
Income from operations
10,498
5
%
2,990
2
%
7,508
N.M.
%
Other income
631
—
%
486
—
%
145
30
%
Income before income taxes
11,129
5
%
3,476
2
%
7,653
N.M.
%
Income tax expense (benefit)
158
—
%
(3,147)
(2)
%
3,305
(105)
%
Net income
$
10,971
5
%
$
6,623
4
%
$
4,348
66
%
N.M. (not meaningful)
Revenue
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.
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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:
Year Ended
December 31,
Change
(In thousands)
2019
2018
$
%
Revenue
Flexitouch system
$
171,323
$
131,935
$
39,388
30%
Other products (1)
18,169
11,816
6,353
54%
Total
$
189,492
$
143,751
$
45,741
32%
Percentage of total revenues
Flexitouch system
90%
92%
Other products (1)
10%
8%
Total
100%
100%
(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 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.
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 $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.
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.
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, 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.
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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 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. 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.
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.
Liquidity and Capital Resources
Overview
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.
Cash Flows
The following table summarizes our cash flows for the periods indicated:
Year Ended
December 31,
(In thousands)
2020
2019
2018
Net cash provided by (used in):
Operating activities
$
2,794
$
2,510
$
9,007
Investing activities
20,179
(2,335)
(14,726)
Financing activities
2,112
2,496
1,850
Net increase (decrease) in cash and cash equivalents
$
25,085
$
2,671
$
(3,869)
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
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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. The non-cash net income adjustments primarily consisted of $9.8 million of stock-based compensation expense, $3.5 million of depreciation and amortization and a $1.1 million non-cash adjustment for the loss on lease termination. The uses of cash related to changes in operating assets primarily consisted of increases in accounts receivable, net investment in leases, and inventories. The changes in operating liabilities primarily consisted of increases in accrued payroll and related taxes and accrued expenses and other liabilities, partially offset by a decrease in accounts payables. 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, 2018, was $9.0 million, resulting from net income of $6.6 million and non-cash net income adjustments of $8.0 million, which were partially offset by an increase in net operating assets of $5.6 million. The non-cash net income adjustments primarily consisted of $8.0 million of stock-based compensation expense, $3.7 million of depreciation and amortization and a $2.5 million non-cash impairment charge to fully write off the inventory and intangible assets related to our Actitouch product, partially offset by an increase of $6.2 million in deferred tax assets driven by the current period tax benefit associated with tax-deductible stock-based compensation activity. The uses of cash related to changes in operating assets primarily consisted of an increase in accounts receivable. The changes in operating liabilities primarily consisted of increases in accounts payable 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 other expenditures, including compensation and personnel-related costs.
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 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
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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.
Credit Agreement
On August 3, 2018, we entered into a credit agreement with Wells Fargo Bank, National Association, which was amended by a First Amendment dated February 12, 2019, a Waiver and Second Amendment dated March 25, 2019, and a Third Amendment dated August 2, 2019 (collectively, the “Credit Agreement”), which expires on August 3, 2021.
The Credit Agreement provides for a $10.0 million revolving credit facility, with the ability to increase the amount of the revolving loans available and/or add one or more term loan facilities not to exceed an incremental $25.0 million, subject to satisfaction of certain conditions. As of December 31, 2020, and the date on which we filed this report, we did not have any outstanding borrowings under the Credit Agreement.
Our obligations under the Credit Agreement are secured by a security interest in substantially all of our and our subsidiaries’ assets and are also guaranteed by our subsidiaries. The Credit Agreement contains a number of restrictions and covenants, including that we maintain compliance with a maximum leverage ratio and a minimum liquidity covenant. As of December 31, 2020, we were in compliance with all financial covenants under the Credit Agreement. For additional information on the Credit Agreement, see Note 11 – “Credit Agreement” to the consolidated financial statements in this report.
Adequacy of Capital Resources
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;
● expansion of our operations domestically and/or internationally;
● response of competitors to our solutions and applications;
● costs associated with clinical research activities;
● costs to develop and implement new products; and
● 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.
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.
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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.
In August 2017 we filed a shelf registration statement on Form S-3 with the SEC. Under the shelf registration statement, we may offer and sell from time to time up to $200 million of common stock, preferred stock, debt securities, warrants, rights or units. The shelf registration statement also registered for resale from time to time up to 5,703,534 shares of our common stock held by the selling stockholders named therein. In September 2017 certain of the selling stockholders completed a secondary offering of 3,795,000 shares of our common stock at a public offering price of $33.00 per share. 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
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.
Contractual and Commercial Commitments Summary
Our contractual obligations and commercial commitments as of December 31, 2020, 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)
$
19,502
$
19,502
$
—
$
—
$
—
Operating lease obligations (2)
28,716
2,894
5,248
5,229
15,345
Product royalties (3)
1
1
—
—
—
Total
$
48,219
$
22,397
$
5,248
$
5,229
$
15,345
(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 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. We entered into a fleet vehicle program for certain members of our field sales organization in 2016. At December 31, 2020, we had 59 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.
(3) We are required to make quarterly royalty payments to a third-party for our Actitouch system revenue through August 2023. 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
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under. 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 discontinued the current Actitouch product line in 2020.
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.
Text extracted from the filing as submitted to EDGAR. Formatting, tables and exhibits are simplified for reading; the original document is authoritative for anything you rely on.