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:

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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:

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

Consolidated Statement % of % of

of Operations Data: revenue revenue

Revenue

Cost of revenue

Gross profit

Operating expenses

Research and development 5,264 3 % 5,174 3 % 90 2 %

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

Revenue

Percentage of total revenue

Flexitouch system 88% 90%

Other products(1) 12% 10%

(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 revenuesfrom 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

Consolidated Statement % of % of

of Operations Data: revenue revenue

Revenue

Cost of revenue

Gross profit

Operating expenses

Research and development 5,174 3 % 5,289 4 % (115) (2) %

Income before income taxes 11,129 5 % 3,476 2 % 7,653 N.M. %

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

Revenue

Percentage of total revenues

Flexitouch system 90% 92%

Other products(1) 10% 8%

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,

Net cash provided by (used in):

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 agreementwith 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 $ — $ — $ —

Product royalties (3) 1 1 — — —

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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.

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

Interest Rate Risk

We are exposed to market risk from changes in interest rates, primarily related to our investment activities. The principal objectives of our investment activities are to preserve principal, provide liquidity and maximize income consistent with minimizing risk of material loss. The recorded carrying amounts of cash and cash equivalents approximate fair value due to their short maturities. Our interest income is sensitive to changes in the general level of interest rates in the United States, particularly since our investments are generally short-term in nature. Based on the nature of our short-term investments, an immediate 100 basis point change in interest rates would not have a material effect on the fair market value of our portfolio.

Inflation

Inflationary factors, such as increases in our cost of revenue, sales and marketing expenses and reimbursement expenses, may adversely affect our operating results. Although we do not believe that inflation has had a material impact on our financial condition or results of operations to date, a high rate of inflation in the future may have an adverse effect on our ability to maintain and increase our gross margin, and on our sales and marketing and reimbursement expenses as a percentage of our revenue if the prices for our products do not increase as much or more than these increased costs.

Credit Risk

As of December 31, 2020 and 2019, our cash, cash equivalents and marketable securities were maintained with three financial institutions in the United States. We perform periodic evaluations of the relative credit standing of these financial institutions and believe they have sufficient assets and liquidity to conduct their operations in the ordinary course of business with little or no credit risk to us. We have not experienced any losses on our cash or cash equivalents to date.

Our accounts receivable primarily relate to revenue from the sale of our products to patients in the United States. As of December 31, 2020 and 2019, our accounts receivable were $53.3 million and $37.6 million, respectively. We had accounts receivable from two insurers representing approximately 37% and 22% of accounts receivable as of December 31, 2020. We had accounts receivable from two insurers representing approximately 17% and 13% of accounts receivable as of December 31, 2019. The credit risks associated with customers which for these purposes are insurers considers aggregation for entities that are known to be under common control.

Foreign Currency Risk

Our business is conducted in U.S. dollars and international transactions have been nominal. As we begin building relationships to commercialize our products internationally, our results of operations and cash flows may become increasingly subject to changes in foreign exchange rates.

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Item 8. Financial Statements and Supplementary Data.

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Board of Directors and Stockholders

Tactile Systems Technology, Inc.

Opinion on the financial statements

We have audited the accompanying consolidated balance sheets of Tactile Systems Technology, Inc. (a Delaware corporation) and its subsidiary (the “Company”) as of December 31, 2020 and 2019, the related consolidated statements of operations, comprehensive (loss) income, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2020, and the related notes (collectively referred to as the “financial statements”). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2020 and 2019, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2020, in conformity with accounting principles generally accepted in the United States of America.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (“PCAOB”), the Company’s internal control over financial reporting as of December 31, 2020, based on criteria established in the 2013 Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”), and our report dated February 23, 2021 expressed an unqualified opinion.

Basis for opinion

These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.

Critical audit matter

The critical audit matter communicated below is a matter arising from the current period audit of the financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.

Transaction Price Adjustment – Uncollected Flexitouch Product Sales

As described further in Note 3. Summary of Significant Accounting Policies – Revenue Recognition to the consolidated financial statements, revenue is recognized upon transfer of control of the product to the customer based on a transaction price determined to be the amount of expected consideration to be received for the product. In most cases, there is a contracted third-party payer, such as a commercial insurer, Medicare or the Veteran’s Administration involved with the transaction. The transaction price is impacted by

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multiple factors, including the terms and conditions contracted by third-party payers. Thus, payments from third-party payers typically are less than the Company’s standard charge and represent an implicit price concession, resulting in variable consideration. The transaction price for commercial payers is determined based on the payment history of the payer drawn from actual write-off and collections experience over a rolling 12-month period, as well as historical patient collections by payer. The Company assesses the variable consideration for each Medicare claim as a percentage of the total invoice price based on ultimate approval and collection history. There is not variable consideration with sales to the Veterans Administration. The results of the variable consideration assessment are the primary source of information in estimating the recognition of net revenue and the net valuation of the related accounts receivable.

We identified the transaction price adjustment for uncollected Flexitouch product sales to commercial payers and Medicare as a critical audit matter. The principal considerations for our determination of this critical audit matter are:

Our audit procedures related to the transaction price adjustment for uncollected Flexitouch product sales included the following, among others:

/s/ GRANT THORNTON LLP

We have served as the Company’s auditor since 2015.

Minneapolis, Minnesota

February 23, 2021

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Tactile Systems Technology, Inc.

Consolidated Balance Sheets

December 31, December 31,

(In thousands, except share and per share data) 2020 2019

Assets

Current assets

Marketable securities — 22,464

Prepaid expenses and other current assets 2,638 2,451

Non-current assets

Property and equipment, net 6,957 7,408

Right of use operating lease assets 20,132 15,885

Accounts receivable, non-current 9,433 4,184

Liabilities and Stockholders' Equity

Current liabilities

Accrued payroll and related taxes 11,588 10,098

Operating lease liabilities 2,006 1,454

Other current liabilities 1,842 903

Non-current liabilities

Accrued warranty reserve, non-current 3,235 2,541

Income taxes, non-current — 54

Operating lease liabilities, non-current 19,388 15,134

Commitments and Contingencies (see Note 12)

Stockholders’ equity:

Accumulated other comprehensive income — 26

Total liabilities and stockholders’ equity $ 174,087 $ 151,752

The accompanying notes are an integral part of these consolidated financial statements.

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Tactile Systems Technology, Inc.

Consolidated Statements of Operations

Year Ended

December 31,

(In thousands, except share and per share data) 2020 2019 2018

Revenue

Cost of revenue

Gross profit

Operating expenses

Net (loss) income per common share

The accompanying notes are an integral part of these consolidated financial statements.

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Tactile Systems Technology, Inc.

Consolidated Statements of Comprehensive (Loss) Income

Year Ended

December 31,

Other comprehensive (loss) income:

Unrealized (loss) gain on marketable securities (21) 31 60

Total other comprehensive (loss) income (26) 34 36

The accompanying notes are an integral part of these consolidated financial statements.

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Tactile Systems Technology, Inc.

Consolidated Statements of Stockholders’ Equity

Accumulated

Additional Other

Common Stock Paid-In Retained Comprehensive Treasury

Stock-based compensation — — 7,974 — — — 7,974

Stock-based compensation — — 9,824 — — — 9,824

Stock-based compensation — — 10,689 — — — 10,689

The accompanying notes are an integral part of these consolidated financial statements.

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Tactile Systems Technology, Inc.

Consolidated Statements of Cash Flows

Year Ended December 31,

Cash flows from operating activities

Impairment losses 4,025 — 2,534

Loss on termination of lease — 1,148 —

Changes in assets and liabilities:

Net investment in leases (2,561) (8,147) —

Prepaid expenses and other assets (528) (1,166) (1,140)

Right of use operating lease assets 559 625 —

Medicare accounts receivable, non-current (5,249) (2,300) 834

Accrued payroll and related taxes 1,490 2,677 715

Accrued expenses and other liabilities 1,308 1,729 734

Net cash provided by operating activities 2,794 2,510 9,007

Cash flows from investing activities

Proceeds from sales of securities available-for-sale — 1,493 2,000

Purchases of securities available-for-sale — (22,840) (21,680)

Purchases of property and equipment (2,059) (5,446) (4,196)

Intangible assets costs (232) (542) (5,350)

Other investments (30) — (500)

Cash flows from financing activities

Proceeds from exercise of common stock options 1,068 2,834 1,515

Net cash provided by financing activities 2,112 2,496 1,850

Cash and cash equivalents – beginning of period 22,770 20,099 23,968

Supplemental cash flow disclosure

Cash paid for interest $ — $ — $ 9

Capital expenditures incurred but not yet paid $ 17 $ 122 $ 167

The accompanying notes are an integral part of these consolidated financial statements.

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Tactile Systems Technology, Inc.

Notes to the Consolidated Financial Statements

Note 1. Nature of Business and Operations

Tactile Systems Technology, Inc. (“we,” “us,” and “our”) is the sole manufacturer and distributor of the Flexitouch and Entre systems, medical devices that help control symptoms of lymphedema, a chronic and progressive medical condition. We provide our products for use in the home and sell or rent them through vascular, wound and lymphedema clinics throughout the United States.

We were originally incorporated in Minnesota under the name Tactile Systems Technology, Inc. on January 30, 1995. During 2006, we established a merger corporation and subsequently, on July 21, 2006, merged with and into this merger corporation, resulting in us being reincorporated as a Delaware corporation. The resulting corporation assumed the name Tactile Systems Technology, Inc. In September 2013, we began doing business as “Tactile Medical.”

On August 2, 2016, we closed the initial public offering of our common stock, which resulted in the sale of 4,120,000 shares of our common stock at a public offering price of $10.00 per share. We received net proceeds from the initial public offering of approximately $35.4 million, after deducting underwriting discounts and approximately $2.9 million of transaction expenses. In connection with the closing of the initial public offering, all of our outstanding redeemable convertible preferred stock automatically converted to common stock on August 2, 2016.

Note 2. Basis of Presentation

Our accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and pursuant to the rules and regulations of the SEC. We have reclassified certain prior year amounts to conform to the current year’s presentation.

The results for the year ended December 31, 2020, are not necessarily indicative of results to be expected for any future year.

Principles of Consolidation

Our accompanying consolidated financial statements include the accounts of Tactile Systems Technology, Inc. and its wholly owned subsidiary, Swelling Solutions, Inc. All intercompany balances and transactions have been eliminated in consolidation.

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Risks and Uncertainties

Coronavirus (COVID-19)

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Use of Estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and to disclose contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.

Coronavirus Aid, Relief, and Economic Security Act

We may receive cash payments from the government during a public health emergency (PHE). We consider the nature and substance of the government funds received and record the cash payment in accordance with the terms and conditions of the funds. In the year ended December 31, 2020, we received a grant of $1.2 million from the Public Health and Social Services Emergency Fund (Relief Fund), which was among the provisions of the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) signed into law on March 27, 2020. During the year ended December 31, 2020, we recorded $1.2 million in other income, which was associated with lost revenues from the COVID-19 PHE incurred in the period based on our interpretation of guidance issued by the Department of Health and Human Services through January 2021.

Comprehensive Income (Loss)

Comprehensive income (loss) reflects the change in equity of a business enterprise during a period from transactions and other events and circumstances from non-owner sources. Our comprehensive income (loss) represents net income (loss) adjusted for unrealized gains and losses on available-for-sale marketable securities and the related taxes.

Note 3. Summary of Significant Accounting Policies

Cash and Cash Equivalents

Cash and cash equivalents consist of all cash on hand, deposits and funds invested in available-for-sale securities with original maturities of three months or less at the time of purchase. At December 31, 2020 and 2019, our cash was held primarily in checking and money market accounts.

Marketable Securities and Equity Investments

We determine the appropriate classification of our marketable securities as available-for-sale or held-to-maturity at the time of purchase and periodically reevaluate such classification. Debt securities are classified as held-to-maturity when we have the positive intent and ability to hold the securities to maturity. Debt securities for which we do not have the intent or ability to hold to maturity are classified as available-for-sale.

Debt securities not classified as held-to-maturity are classified as available-for-sale and are reported at fair value, with unrealized gains and losses included in the determination of comprehensive income, a component of stockholders' equity. We review our available-for-sale securities for impairment to determine if the impairment is temporary or other-than-temporary. A temporary impairment charge results in an unrealized loss being recorded in other comprehensive income. Other-than-temporary impairments are recorded in net income in the period the impairment is determined to be other-than-temporary. Realized gains and losses on the sale of marketable securities are determined using the specific-identification method.

Equity investments (including equity securities) with readily determinable fair value are reported at fair value, with unrealized gains and losses included in the determination of net income. For equity investments with no readily determinable fair value, we measure these investments at cost less impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. Such observable price changes may include instances where the investee issues equity securities to new investors, thus creating a new indicator of fair value, as an example. As of December 31, 2020 and 2019, the total carrying value of our equity investments, with no readily determinable fair value, were $0.3 million and $0.7 million, respectively, and are included in other non-current assets on our consolidated balance sheets. On an annual basis, we perform a qualitative assessment considering impairment

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indicators to evaluate whether these investments are impaired and also monitor for any observable price changes. During the years ended December 31, 2020 and 2019, we did not have any impairment loss on these investments.

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

Inventories

Inventories are valued at the lower of cost (first-in, first-out method) or net realizable value.

Property and Equipment

Property and equipment are stated at cost and are depreciated using the straight-line method over their estimated useful lives of three to seven years. Leasehold improvements are depreciated over the remaining life of the respective building lease agreement.

Major expenditures for property and equipment are capitalized. Maintenance, repairs and minor renewals are expensed as incurred. When assets are retired or otherwise disposed of, their costs and related accumulated depreciation are removed from the accumulated depreciation accounts and the resulting gains or losses are included in income. The value of demonstration equipment in the possession of our field sales representatives is capitalized and depreciated over the estimated useful life of the equipment.

Revenue Recognition

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

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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.

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 systems 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 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.

We sell and rent our products either directly to patients or 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.

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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. 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. We elected the practical expedient to not reassess the lease classification for leases in existence at December 31, 2018.

Advertising

Advertising costs are charged to operations when incurred. Advertising expense was $0.1 million for each of the years ended December 31, 2020, 2019 and 2018.

Research and Development Costs

We expense research and development costs as incurred, including expenses associated with clinical research studies and development.

Shipping and Handling Costs

We do not charge any shipping and handling costs to our customers. Shipping and handling costs incurred are included in cost of revenue.

Product Warranty

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. We record a liability for future warranty claims at the time of sale for the warranty period offered to a customer. If the assumptions used in calculating the provision were to materially change, resulting in more defects than anticipated, an additional provision may be required.

Impairment of Long-Lived Assets

We review long-lived assets, including property and equipment and patents, for impairment whenever events or changes in business circumstances indicate that the carrying amount of an asset may not be fully recoverable. We will assess long-lived assets used in operations for impairment indicators, including when undiscounted cash flows estimated to be generated by those assets are less than the assets’ carrying amount (see Note 8 – “Intangible Assets”).

Stock-Based Compensation

Stock options are valued using the Black-Scholes option-pricing model, except that the valuation of certain “CEO” related stock options subject to a market condition involve the use of the Monte Carlo Simulation model. The Monte Carlo Simulation and the Black-Scholes valuation models require the input of highly subjective assumptions. The assumptions include the expected term of the option, the expected volatility of the price of our common stock, expected dividend yield and the risk-free interest rate. 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 recognize compensation expense for these options on a straight-line basis over the requisite service period (see Note 13 – “Stockholders’ Equity”).

Income Taxes

Income taxes are accounted for under the liability method. Deferred income taxes are provided for temporary differences between the financial reporting and the tax bases of assets and liabilities. If we determine in the future that it is more likely than not that we will not realize all or a portion of the deferred tax assets, we

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will record a valuation allowance in the period the determination is made (see Note 15 – “Income Taxes”). Changes in tax rates are reflected in the tax provision as they occur.

Net Income Per Common Share

Basic net income per common share is computed based on the weighted average number of shares of common stock outstanding during the period. Diluted net income per common share is computed based on the weighted average number of shares of common stock plus the effect of dilutive potential stock-based awards outstanding during the period using the treasury stock method. Dilutive potential stock-based awards include outstanding common stock options, time- and performance-based restricted stock units and employee stock purchase plan shares.

Recently Adopted Accounting Pronouncements

In June 2016, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2016-13, “Financial Instruments — Credit Losses” (“ASU 2016-13”), which introduced a new model for recognizing credit losses on financial instruments based on an estimate of the current expected credit losses. The new current expected credit losses (“CECL”) model generally calls for the immediate recognition of all expected credit losses and applies to financial instruments and other assets, including accounts receivable and other financial assets measured at amortized cost, debt securities and other financial assets. This guidance replaces the previous incurred loss model for measuring expected credit losses and requires expected losses on available-for-sale debt securities to be recognized through an allowance for credit losses rather than as reductions in the amortized cost of the securities. We adopted ASU 2016-13 as of January 1, 2020, and it did not have an impact on the consolidated financial statements.

Note 4. Marketable Securities

There were no investments in marketable securities at December 31, 2020. At December 31, 2019 investments in marketable securities were classified as available-for-sale and consisted of the following:

Amortized Unrealized Fair

(In thousands) Cost Gains Losses Value

U.S. government and agency obligations $ 19,950 $ 14 $ 1 $ 19,963

Corporate debt securities 2,493 8 — 2,501

There were no net pre-tax unrealized gains for marketable securities at December 31, 2020. There were no sales of marketable securities during the year ended December 31, 2020.

There were no marketable securities in an unrealized loss position at December 31, 2020.

At December 31, 2019, unrealized losses and the fair value of marketable securities aggregated by investment category and the length of time the securities were in a continuous loss position, were as follows:

Less than 12 months 12 months or more Total

Fair Unrealized Fair Unrealized Fair Unrealized

(In thousands) Value Losses Value Losses Value Losses

Corporate debt securities — — — — — —

Marketable securities $ 5,997 $ 1 $ — $ — $ 5,997 $ 1

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Note 5. Accounts Receivable

We had accounts receivable from two insurers representing approximately 37% and 22% of accounts receivable as of December 31, 2020. We had accounts receivable from two insurers representing approximately 17% and 13% of accounts receivable as of December 31, 2019. Revenue from these insurers accounted for 16% and 10% of our total revenue for the year ended December 31, 2020, and 11% and 8% for the year ended December 31, 2019. The credit risks associated with customers which for these purposes are insurers considers aggregation for entities that are known to be under common control.

Note 6. Inventories

Inventories consisted of the following:

At December 31,

Component parts and work-in-process 11,434 12,551

Note 7. Property and Equipment

Property and equipment consisted of the following:

At December 31,

Construction in Progress 778 97

Patient rental equipment — 91

Demonstration equipment 632 632

Less: accumulated depreciation (7,376) (5,311)

Property and equipment, net $ 6,957 $ 7,408

Depreciation expense was $2.4 million, $3.0 million and $3.3 million for the years ended December 31, 2020, 2019 and 2018, respectively.

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Note 8. Intangible Assets

Our patents and other intangible assets are summarized as follows:

Weighted- At December 31, 2020

Average Gross

Amortization Carrying Accumulated Net

(In thousands) Period Amount Amortization Amount

Defensive intangible assets 4 years 1,125 421 704

Customer accounts 2 years 125 63 62

Total amortizable intangible assets 1,663 549 1,114

Patents pending 566 — 566

Weighted- At December 31, 2019

Average Gross

Amortization Carrying Accumulated Net

(In thousands) Period Amount Amortization Amount

Defensive intangible assets 5 years 1,125 250 875

Customer accounts 3 years 125 37 88

Total amortizable intangible assets 5,636 734 4,902

Patents pending 410 — 410

Amortization expense was $0.4 million, $0.5 million, and $0.4 million for the years ended December 31, 2020, 2019 and 2018, respectively. Future amortization expenses are expected as follows:

(In thousands)

Thereafter 159

The weighted-average remaining amortization period for these intangible assets was 6.3 years as of December 31, 2020.

As of December 31, 2018, indicators existed, including the calculation of an undiscounted cash flow in comparison to carrying amount, that indicated the patent-related intangible assets for our Actitouch system were impaired. The primary valuation technique used in estimating the fair value of patent intangible assets is a discounted cash flow approach. Specifically, we used a relief of royalty rate method which applies a royalty rate to estimated sales, with the resulting amounts then discounted using an appropriate market discount rate. The relief of royalty rate is the estimated royalty rate a market participant would pay to acquire the right to market/produce the product. If the resulting discounted cash flows are less than the book value of the intangible asset, impairment exists, and the asset value must be written down. Based on impairment testing performed in the fourth quarter of 2018, the Actitouch assets were deemed to be fully impaired. The impairment was due to an evaluation of projected future demand and sales volume in the context of results over the prior three years, which resulted in the determination this product would be discontinued. As such, we wrote off $1.8 million of intangible assets book value, classified within the reimbursement, general and administrative expenses line of the Consolidated Statements of Operations, as well as $0.7 million in inventory related assets, classified within cost of revenue.

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In the second quarter of 2020, we reevaluated the Airwear wrap go-to market plan, and determined to focus our strategy on more advanced solutions within our core, long-standing Flexitouch and Entre franchises. Accordingly, we made the strategic decision to discontinue the Airwear wrap in the second quarter of 2020. Due to the planned discontinuation of the product line, we recorded a $4.0 million non-cash impairment charge to fully write-off the inventory and long-lived assets of the Airwear wrap in the quarter ended June 30, 2020. The majority of the impairment charge was comprised of the patent intangible assets and property and equipment, totaling $3.6 million, and was classified within the reimbursement, general and administrative expenses line of the Consolidated Statements of Operations. The inventory-related component of the impairment charge was $0.4 million, and was classified within the cost of revenue line of the Consolidated Statements of Operations.

Note 9. Accrued Expenses

Accrued expenses consisted of the following:

Legal and consulting 882 617

In-transit inventory 634 106

Travel and business 545 776

Sales and use tax 193 200

Clinical studies 67 85

Lease termination costs — 1,200

Note 10. Warranty Reserves

The reserve for warranties was as follows:

Year Ended

December 31,

Processed warranty claims (1,875) (1,383)

Accrued warranty reserve, current $ 1,606 $ 1,218

Accrued warranty reserve, non-current 3,235 2,541

Total accrued warranty reserve $ 4,841 $ 3,759

Note 11. 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. The revolving credit facility expires on August 3, 2021. Subject to satisfaction of certain conditions, we may increase the amount of the revolving loans available under the Credit Agreement and/or add one or more term loan facilities in an amount not to exceed an incremental $25.0 million in the aggregate, such that the total aggregate principal amount of loans available under the Credit Agreement (including under the revolving credit facility) does not exceed $35.0 million.

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TCMD US Equity

TCMD · 10-K · period ended 2020-12-31

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

Item 8. Financial Statements and Supplementary Data.

TCMD US Equity☆

TCMD · 10-K · period ended 2020-12-31

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

Item 8. Financial Statements and Supplementary Data.

TCMD US Equity