UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

~~(Mark One)~~

☒QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended ~~September 30, 2018~~March 31, 2019

☐~~TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934~~

~~For the transition period from to~~

Commission ~~file number:~~File Number 001-37799

Tactile Systems Technology, Inc.

(Exact ~~Name~~name of ~~Registrant~~registrant as ~~Specified~~specified in ~~Its Charter)~~its charter)


Delaware	1331 Tyler Street NE, Suite 200	41-1801204
(State or ~~Other Jurisdiction~~other jurisdiction of ~~Incorporation~~incorporation or ~~Organization)~~organization)		~~(I.R.S. Employer~~ ~~Identification Number)~~
	~~1331 Tyler Street NE, Suite 200~~ Minneapolis, Minnesota 55413	(I.R.S. employer identification number)
	(Address and Zip Code of ~~Principal Executive Offices)~~principal executive offices)

	(612) 355-5100
	(Registrant’s telephone number, including area code)

~~(612) 355-5100~~

~~(Registrant’s Telephone Number, Including Area Code)~~

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒☑ No ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒☑ No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.


Large accelerated filer	☑	Accelerated filer	☐		Non-accelerated filer	☐

~~Large accelerated filer~~ Smaller reporting company	☐	Emerging growth company	☐				~~Accelerated filer~~	☒

~~Non-accelerated filer~~	☐			~~Smaller reporting company~~	☐

~~Emerging growth company~~	☒

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒☑

AsSecurities registered pursuant to Section 12(b) of ~~November 1, 2018 there were 18,472,551~~the Act:


Title of each class	Trading Symbol(s)	Name of each exchange on which registered
Common Stock, Par Value $0.001 Per Share	TCMD	The Nasdaq Stock Market

18,825,688 shares of common stock, ~~$0.001~~ par value $0.001 per share, ~~outstanding.~~were outstanding as of May 2, 2019.

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Forward-Looking Information

All statements, other than statements of historical facts, contained in this Quarterly Report on Form 10-Q, including statements regarding our business, operations and financial performance and condition, as well as our plans, objectives and expectations for our business, operations and financial performance and condition, are forward-looking statements. In some cases, you can identify forward-looking statements by the following words: "anticipate," "believe," "continue," "could," "estimate," "expect," "intend," "may," "might," "target," "ongoing," "plan," "potential," "predict," "project," "should," "will," "would," or the negative of these terms or other comparable terminology, although not all forward-looking statements contain these words. Forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause our results, levels of activity, performance or achievements to be materially different from the information expressed or implied by the forward-looking statements in this Quarterly Report on Form 10-Q. ~~Forward-looking statements may~~These risks, uncertainties and other factors include, ~~among other things, statements relating~~but are not limited to:

~~our expectations regarding~~ the ~~potential market size and widespread adoption~~adequacy of our liquidity to pursue our complete business objectives;

our ability to obtain reimbursement from third-party payers for our products;

loss or retirement of key executives;

adverse economic conditions or intense competition;

loss of a key supplier;

entry of new competitors and products;

adverse federal, state and local government regulation;

technological obsolescence of our products;

technical problems with our research and products;

our ability to ~~increase awareness of lymphedema and chronic venous insufficiency and to demonstrate the clinical and economic benefits of our solutions to clinicians and patients;~~

~~developments and projections relating to our competitors or our industry;~~

~~the expected growth in~~expand our business ~~and our organization, including outside of the United States;~~through strategic acquisitions;

our ability to ~~achieve~~integrate acquisitions and ~~maintain adequate levels of coverage or reimbursement for our products and the effect of changes to the level of Medicare coverage;~~related businesses;

~~our financial performance, our estimates of our expenses, future revenues, capital requirements~~price increases for supplies and ~~our needs for, or ability to obtain, additional financing;~~

~~our ability to retain and recruit key personnel, including the continued development and expansion of our sales and marketing organization;~~

~~our ability to obtain an adequate supply of components for our products from our third-party suppliers;~~

~~our ability to obtain and maintain intellectual property protection for our products or avoid claims of infringement;~~

~~our ability to identify and develop new products;~~

~~our compliance with extensive government regulation;~~components;

the effects of current and future U.S. and foreign trade policy and tariff actions; and

the ~~volatility of our stock price.~~inability to carry out research, development and commercialization plans.

You should read the matters described in "Risk Factors" and the other cautionary statements made in our Annual Report on Form 10-K for the year ended December 31, ~~2017~~2018 and in this Quarterly Report on Form 10-Q. We cannot assure you that the forward-looking statements in this report will prove to be accurate and therefore you are encouraged not to place undue reliance on forward-looking statements. Actual results or events could differ materially from the plans, intentions and expectations disclosed in the forward-looking statements we make. You are urged to carefully review and consider the various disclosures made by us in this report and in other filings with the Securities and Exchange Commission (the “SEC”) that advise of the risks and factors that may affect our business. Other than as required by law, we undertake no obligation to update or revise these forward-looking statements, even though our situation may change in the future. Our forward-looking statements do not reflect the potential impact of any future acquisitions, mergers, dispositions, joint ventures or investments that we may make.

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PART I—FINANCIAL INFORMATION

Item 1. Financial Statements

~~Tactile Systems Technology, Inc.~~

~~Condensed Consolidated Balance Sheets~~

~~(Unaudited)~~


Tactile Systems Technology, Inc.					Tactile Systems Technology, Inc.
Condensed Consolidated Balance Sheets					Condensed Consolidated Balance Sheets
(Unaudited)					(Unaudited)
	September 30,		December 31,			March 31,		December 31,
(In thousands, except share and per share data)	2018		2017			2019		2018
Assets
Current assets
ASSETS
Current assets:
Cash and cash equivalents	$	23,136	$	23,968		$	23,548	$	20,099
Marketable securities		22,800		19,944			21,384		25,786
Accounts receivable, net		20,179		17,623			21,661		24,332
Net investment in leases							3,362		—
Inventories		14,919		11,040			11,321		11,189
Income taxes receivable		5,798		2,119			2,814		1,793
Prepaid expenses and other current assets		2,370		2,178			1,680		1,762
Total current assets		89,202		76,872			85,770		84,961
Non-current assets:
Property and equipment, net		4,063		3,776			4,616		4,810
Other assets
Right of use operating lease assets							3,396		—
Intangible assets, net		3,035		2,218			5,244		5,339
Medicare accounts receivable, long-term		1,011		2,718			2,172		1,884
Deferred income taxes		4,057		2,662			11,077		8,820
Other non-current assets		367		201			1,242		1,257
Total other assets		8,470		7,799
Total non-current assets							27,747		22,110
Total assets	$	101,735	$	88,447		$	113,517	$	107,071

Liabilities and Stockholders’ Equity
Current liabilities
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable	$	3,929	$	4,253		$	5,832	$	5,110
Accrued payroll and related taxes		8,292		6,706			6,837		7,421
Accrued expenses		2,290		2,598			2,685		2,780
Future product royalties		6		17			3		5
Income taxes		1,801		212			—		51
Right of use operating lease liabilities							1,147		—
Other current liabilities		439		733			800		709
Total current liabilities		16,757		14,519			17,304		16,076
Long-term liabilities
Accrued warranty reserve, long-term		1,560		1,141
Non-current liabilities:
Accrued warranty reserve, non-current							1,854		1,725
Income taxes, non-current							42		—
Right of use operating lease liabilities, non-current							2,318		—
Total non-current liabilities							4,214		1,725
Total liabilities		18,317		15,660			21,518		17,801

Commitments and Contingencies (see Note 9)

Stockholders’ equity
Preferred stock, $0.001 par value, 50,000,000 shares authorized; none issued and outstanding as of September 30, 2018 and December 31, 2017		—		—
Common stock, $0.001 par value, 300,000,000 shares authorized; 18,415,699 shares issued and outstanding as of September 30, 2018; 17,872,465 shares issued and 17,846,379 shares outstanding as of December 31, 2017		18		18
Commitments and contingencies (see Note 10)
Stockholders’ equity:
Preferred stock, $0.001 par value, 50,000,000 shares authorized; none issued and outstanding as of March 31, 2019 and December 31, 2018							—		—
Common stock, $0.001 par value, 300,000,000 shares authorized; 18,818,692 shares issued and outstanding as of March 31, 2019; 18,631,125 shares issued and outstanding as of December 31, 2018							19		19
Additional paid-in capital		76,081		70,224			80,788		79,554
Retained earnings		7,350		3,082			11,177		9,705
Accumulated other comprehensive loss		(31)		(44)
Less: treasury stock, at cost — none as of September 30, 2018 and 26,086 shares as of December 31, 2017		—		(493)
Accumulated other comprehensive income (loss)							15		(8)
Total stockholders’ equity		83,418		72,787			91,999		89,270
Total liabilities and stockholders’ equity	$	101,735	$	88,447		$	113,517	$	107,071

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

Table of Contents

~~Tactile Systems Technology, Inc.~~

~~Condensed Consolidated Statements of Operations~~

~~(Unaudited)~~


Tactile Systems Technology, Inc.									Tactile Systems Technology, Inc.
Condensed Consolidated Statements of Operations									Condensed Consolidated Statements of Operations
(Unaudited)									(Unaudited)
	Three Months Ended				Nine Months Ended					Three Months Ended
	September 30,				September 30,					March 31,
(In thousands, except share and per share data)	2018		2017		2018		2017			2019		2018
Revenues, net	$	36,322	$	28,283	$	97,303	$	74,397
Cost of goods sold		10,141		7,528		27,060		20,186
Revenue
Sales revenue										$	30,831	$	23,647
Rental revenue											6,786		3,201
Total revenue											37,617		26,848
Cost of revenue
Cost of sales revenue											9,412		6,409
Cost of rental revenue											1,947		900
Total cost of revenue											11,359		7,309
Gross profit
Gross profit - sales revenue											21,419		17,238
Gross profit - rental revenue											4,839		2,301
Gross profit		26,181		20,755		70,243		54,211			26,258		19,539
Operating expenses
Sales and marketing		15,632		10,915		42,641		31,726			17,391		12,557
Research and development		1,223		1,116		3,949		3,699			1,281		1,437
Reimbursement, general and administrative		7,956		7,551		22,799		19,815			9,388		7,372
Total operating expenses		24,811		19,582		69,389		55,240			28,060		21,366
Income (loss) from operations		1,370		1,173		854		(1,029)
Loss from operations											(1,802)		(1,827)
Other income		128		85		351		204			161		91
Income (loss) before income taxes		1,498		1,258		1,205		(825)
Loss before income taxes											(1,641)		(1,736)
Income tax benefit		(248)		(84)		(3,063)		(4,450)			(3,113)		(1,686)
Net income	$	1,746	$	1,342	$	4,268	$	3,625
Net income (loss)										$	1,472	$	(50)
Net income per common share
Basic	$	0.10	$	0.08	$	0.23	$	0.21		$	0.08	$	0.00
Diluted	$	0.09	$	0.07	$	0.22	$	0.19		$	0.08	$	0.00
Weighted-average common shares used to compute net income per common share
Basic		18,344,956		17,603,293		18,166,999		17,222,072			18,746,751		17,996,672
Diluted		19,525,686		19,083,975		19,328,947		18,818,609			19,579,847		17,996,672

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

Table of Contents

~~Tactile Systems Technology, Inc.~~

~~Condensed Consolidated Statements of Comprehensive Income~~

~~(Unaudited)~~


Tactile Systems Technology, Inc.									Tactile Systems Technology, Inc.
Condensed Consolidated Statements of Comprehensive Income									Condensed Consolidated Statements of Comprehensive Income
(Unaudited)									(Unaudited)
	Three Months Ended				Nine Months Ended					Three Months Ended
	September 30,				September 30,					March 31,
(In thousands)	2018		2017		2018		2017			2019		2018
Net income	$	1,746	$	1,342	$	4,268	$	3,625
Net income (loss)										$	1,472	$	(50)
Other comprehensive income (loss):
Unrealized gain (loss) on marketable securities		10		3		29		(18)			30		(7)
Income tax related to items of other comprehensive income (loss)		(3)		(1)		(16)		11			(7)		1
Total other comprehensive income (loss)		7		2		13		(7)			23		(6)
Comprehensive income	$	1,753	$	1,344	$	4,281	$	3,618
Comprehensive income (loss)										$	1,495	$	(56)

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

Table of Contents

~~Tactile Systems Technology, Inc.~~

~~Condensed Consolidated Statements of Stockholders’ Equity~~

~~(Unaudited)~~


Tactile Systems Technology, Inc.														Tactile Systems Technology, Inc.
Condensed Consolidated Statements of Stockholders’ Equity														Condensed Consolidated Statements of Stockholders’ Equity
(Unaudited)														(Unaudited)
						Retained		Accumulated														Accumulated
				Additional		Earnings		Other										Additional				Other
	Common Stock			Paid-In		(Accumulated		Comprehensive		Treasury					Common Stock			Paid-In		Retained		Comprehensive		Treasury
(In thousands, except share data)	Shares	Par Value		Capital		Deficit)		Loss		Stock		Total			Shares	Par Value		Capital		Earnings		(Loss) Income		Stock		Total
Balances, December 31, 2016	16,833,737	$	17	$	62,406	$	(2,773)	$	(11)	$	—	$	59,639
Stock-based compensation	—		—		3,104		—		—		—		3,104
Exercise of common stock options and warrants and vesting of restricted stock units	583,360		1		672		—		—		—		673
Taxes paid for net share settlement of restricted stock units	—		—		(278)		—		—		—		(278)
Common shares issued for employee stock purchase plan	259,981		—		2,210		—		—		—		2,210
Shares repurchased to cover taxes from restricted stock award vesting	(26,086)		—		—		—		—		(493)		(493)
Comprehensive income for the period	—		—		—		3,625		(7)		—		3,618
Balances, September 30, 2017	17,650,992	$	18	$	68,114	$	852	$	(18)	$	(493)	$	68,473

Balances, December 31, 2017	17,846,379		18		70,224		3,082		(44)		(493)		72,787		17,846,379	$	18	$	70,224	$	3,082	$	(44)	$	(493)	$	72,787
Stock-based compensation	—		—		5,638		—		—		—		5,638		—		—		1,481		—		—		—		1,481
Exercise of common stock options and vesting of restricted stock units	479,656		—		1,218		—		—		—		1,218		230,532		—		138		—		—		—		138
Taxes paid for net share settlement of restricted stock units	—		—		(1,922)		—		—		—		(1,922)		(40,202)		—		(1,188)		—		—		—		(1,188)
Treasury stock issued for option exercises	26,086		—		(493)		—		—		493		—
Common shares issued for employee stock purchase plan	63,578		—		1,416		—		—		—		1,416
Comprehensive loss for the period															—		—		—		(50)		(6)		—		(56)
Balances, March 31, 2018															18,036,709	$	18	$	70,655	$	3,032	$	(50)	$	(493)	$	73,162

Balances, December 31, 2018															18,631,125		19		79,554		9,705		(8)		—		89,270
Stock-based compensation															—		—		2,783		—		—		—		2,783
Exercise of common stock options and vesting of restricted stock units															231,814		—		861		—		—		—		861
Taxes paid for net share settlement of restricted stock units															(44,247)		—		(2,410)		—		—		—		(2,410)
Comprehensive income for the period	—		—		—		4,268		13		—		4,281		—		—		—		1,472		23		—		1,495
Balances, September 30, 2018	18,415,699	$	18	$	76,081	$	7,350	$	(31)	$	—	$	83,418
Balances, March 31, 2019															18,818,692	$	19	$	80,788	$	11,177	$	15	$	—	$	91,999

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

Table of Contents

~~Tactile Systems Technology, Inc.~~

~~Condensed Consolidated Statements of Cash Flows~~

~~(Unaudited)~~


Tactile Systems Technology, Inc.					Tactile Systems Technology, Inc.
Condensed Consolidated Statements of Cash Flows					Condensed Consolidated Statements of Cash Flows
(Unaudited)					(Unaudited)
	Nine Months Ended					Three Months Ended
	September 30,					March 31,
(In thousands)	2018		2017			2019		2018
Cash flows from operating activities
Net income	$	4,268	$	3,625
Adjustments to reconcile net income to net cash provided by operating activities
Net income (loss)						$	1,472	$	(50)
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
Depreciation and amortization		2,474		1,073			996		463
Deferred income taxes		(1,411)		—			(2,264)		—
Stock-based compensation expense		5,638		3,104			2,783		1,481
Change in allowance for doubtful accounts		414		(36)
Loss on disposal of equipment		3		—
Changes in assets and liabilities:
Accounts receivable		(2,970)		460			2,671		3,414
Net investment in leases							(3,362)		—
Inventories		(3,879)		(3,821)			(132)		(3,616)
Income taxes		(2,090)		(5,373)			(1,030)		(1,952)
Prepaid expenses and other assets		(1,358)		130			97		63
Right of use operating lease assets							(3,396)		—
Medicare accounts receivable – long-term		1,707		52			(288)		(253)
Accounts payable		(508)		87			722		885
Accrued payroll and related taxes		1,586		(812)			(584)		(1,850)
Accrued expenses and other liabilities		(179)		1,585			125		(756)
Right of use operating lease liabilities							3,465		—
Future product royalties		(11)		(41)			(2)		(2)
Net cash provided by operating activities		3,684		33
Net cash provided by (used in) operating activities							1,273		(2,173)
Cash flows from investing activities
Proceeds from sales and maturities of marketable securities		13,000		1,000
Purchases of marketable securities		(14,792)		(12,051)
Proceeds from sales of securities available-for-sale							—		1,000
Proceeds from maturities of securities available-for-sale							4,500		4,000
Purchases of property and equipment		(2,384)		(1,953)			(731)		(432)
Intangible asset costs		(1,052)		(44)
Other investments		—		(145)
Net cash used in investing activities		(5,228)		(13,193)
Intangible assets costs							(44)		—
Net cash provided by investing activities							3,725		4,568
Cash flows from financing activities
Taxes paid for net share settlement of restricted stock units		(1,922)		(278)			(2,410)		(1,188)
Proceeds from exercise of common stock options and warrants		1,218		673
Proceeds from the issuance of common stock from the employee stock purchase plan		1,416		2,210
Shares repurchased to cover taxes from restricted stock award vesting		—		(493)
Net cash provided by financing activities		712		2,112
Net change in cash and cash equivalents		(832)		(11,048)
Proceeds from exercise of common stock options							861		138
Net cash used in financing activities							(1,549)		(1,050)
Net increase in cash and cash equivalents							3,449		1,345
Cash and cash equivalents – beginning of period		23,968		30,701			20,099		23,968
Cash and cash equivalents – end of period	$	23,136	$	19,653		$	23,548	$	25,313
Supplemental cash flow disclosure
Cash paid for interest	$	3	$	1		$	—	$	—
Cash paid for taxes	$	448	$	923		$	181	$	284
Capital expenditures incurred but not yet paid	$	184	$	97		$	176	$	96

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

Table of Contents

Tactile Systems Technology, Inc.

Notes to the Condensed Consolidated Financial Statements

(Unaudited)

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, ~~and~~ the Actitouch system, a medical device used to treat venous leg ulcers and chronic venous ~~insufficiency.~~insufficiency, and the Airwear wrap, a medical device used for the management of venous insufficiency, venous hypertension, venous ulcerations and lymphedema. 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 do business as “Tactile Medical.”

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. At August 2, 2016, we did not have any redeemable convertible preferred stock issued or outstanding.

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 ~~sales~~revenues in the third and fourth quarters as a result of patients having paid their annual insurance deductibles in full, thereby reducing their out-of-pocket costs for our products, and because patients often spend the remaining balances in their healthcare flexible spending accounts at that time. 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 or do not have plans that include patient deductibles for purchases or rentals of our products.

Note 2. Basis of Presentation

Our accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) for interim financial reporting and pursuant to the rules and regulations of the SEC. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments (including those which are normal and recurring) considered necessary for a fair presentation of the interim financial information have been included. We have reclassified certain prior year amounts to conform to the current year’s presentation.

The results for the ~~nine~~three months ended ~~September 30, 2018~~March 31, 2019 are not necessarily indicative of results to be expected for the year ending December 31, ~~2018,~~2019, or for any other interim period or for any future year. The condensed consolidated interim financial statements should be read in conjunction with the audited financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, ~~2017.~~2018.

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Principles of Consolidation

~~The~~Our accompanying unaudited condensed 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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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 ~~disclosure of~~to disclose contingent assets and liabilities at the date of the ~~condensed consolidated~~ financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Comprehensive Income

Comprehensive income 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 represents net income adjusted for unrealized gains and losses on available-for-sale marketable securities.

JOBS Act Accounting Election

AsPrior to December 31, 2018, we were an ~~emerging~~“emerging growth ~~company under~~company” as defined by the Jumpstart Our Business Startups Act of 2012 (the “JOBS Act”), and as a result we ~~currently are~~were eligible to take advantage of certain exemptions from various reporting requirements that are applicable to other public companies that are not emerging growth companies. We elected to take advantage of the extended transition period for adopting new or revised accounting standards that have different effective dates for public and private companies until such time as those standards apply to private companies. However, as of the last business day of our second fiscal quarter of 2018, the market value of our common stock that was held by non-affiliates exceeded $700 million, and as a result, we ~~will~~ no longer ~~qualify~~qualified as an emerging growth company as of December 31, ~~2018. Therefore, after that date, we will~~2018 and are no longer be able to take advantage of the extended transition period for adopting new or revised accounting standards. Therefore, beginning December 31, 2018, we were required to adopt new or revised accounting standards when they are applicable to public companies that are not emerging growth companies.

Note 3. Summary of Significant Accounting Policies

Significant Accounting Policies

~~During~~Excluding the ~~nine months ended September 30, 2018~~adoption of ASC 842 “Leases”, as described below, there were no material changes in our significant accounting ~~policies.~~policies during the three months ended March 31, 2019. See Note 3 - “Summary of Significant Accounting Policies” to the consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, ~~2017~~2018 for information regarding our significant accounting policies.

~~Inventories~~

Inventories are valued at the lower of cost (first-in, first-out method) or net realizable value. Inventories consisted of 45% finished goods and 55% component parts and work-in-process as of September 30, 2018 and 39% finished goods and 61% component parts and work-in-process as of December 31, 2017.

Recent Accounting Pronouncements

We currently are an “emerging growth company” as defined by the JOBS Act. The JOBS Act provides that an emerging growth company can take advantage of the extended transition period provided in Section 7(a)(2)(B) of the Securities Act of 1933, as amended, (the “Securities Act”), for complying with new or revised accounting standards. In other words, an emerging growth company can selectively delay the adoption of certain accounting standards until those standards would otherwise apply to private companies. In accordance with the JOBS Act, we elected to participate in the exemption and, as a result, our financial statements may not be comparable to the financial statements of issuers that are required to comply with the effective dates for new or revised accounting standards that are applicable to public companies. Section 107 of the JOBS Act provides that we can elect to opt out of the extended transition period at any time, which election is irrevocable. However, as of the last business day of our second fiscal quarter of 2018, the market value of our common stock that was held by non-affiliates exceeded $700 million, and as a result, we will no longer qualify as an emerging growth company as of December 31, 2018 and will no longer be able to take advantage of the extended transition period. Therefore, as of December 31, 2018, we will be required to adopt new or revised accounting standards when they are applicable to public companies that are not emerging growth companies.

~~In May 2014,~~February 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. ~~2014-09, “Revenue~~2016-02, “Leases” (Topic 842) (“ASC 842”), which supersedes the existing guidance for lease accounting, “Leases” (Topic 840) (“ASC 840”). ASC 842 requires lessees to recognize a lease liability and a right of use asset for all leases that extend beyond one year. As a result of our change in filing status, we adopted this standard using the modified retrospective transition approach at the adoption date of January 1, 2019. This approach does not require restatement of previous periods. We completed a qualitative and quantitative assessment of our leases from ~~Contracts with Customers.~~”both a lessee and lessor perspective. As part of our process, we elected to utilize certain practical expedients that were provided for transition relief. Accordingly, we did not reassess expired or existing contracts, lease classifications or related initial direct costs as part of our assessment process for either lessee or lessor leases. Additionally, we elected the practical expedient to treat lease and nonlease components of fixed payments due to the lessor as one, and therefore no separate allocation was required on the initial implementation date of January 1, 2019, and thereafter. The ~~new section replaces Section 605, “Revenue~~adoption of

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~~Recognition~~,” and creates modifications to various other revenue accounting standards for specialized transactions and industries. The section is intended to conform revenue accounting principles with concurrently issued International Financial Reporting Standards to reconcile previously differing treatment between U.S. practices and those of the rest of the world and to enhance disclosures related to disaggregated revenue information. The updated guidance will be effective for us for our annual reporting periods ending on December 31, 2018 and interim reporting periods thereafter due to the recent determination of our upcoming change in filing status. As a result, we commenced project planning for our implementation, which included engaging an accounting firm to assist us. Based on our qualitative assessment to date we have defined the contracts, determined the performance obligations, and assessed the use of the portfolio practical expedient under this standard. We will apply the portfolio approach in determining the transaction price as we have a large volume of contracts with similar characteristics. We are in the process of determining whether this standard, ~~will have~~from a ~~material impact~~lessee perspective, resulted in us recording Right of Use (“ROU”) operating lease assets and liabilities of approximately $3.1 million on ~~our financial statements. Should we determine an adjustment is required, we will apply~~ the modified retrospective approach as our transition method, which involves recognizing the cumulative effect of initially applying the new revenue standard as an adjustment to the opening balance of retained earningsCondensed Consolidated Balance Sheet as of January 1, ~~2018.~~

2019, with no impact to retained earnings. In ~~February 2016,~~addition, we elected as an accounting policy, not to record leases with an initial term of less than 12 months. From a lessor perspective, the ~~FASB issued ASU No. 2016-02, “Leases” (Topic 842),~~application of ASC 842 to our rental revenue, which ~~supersedes~~was recognized as month-to-month, cancelable leases in accordance with ASC 840 through December 31, 2018, resulted in recognizing rental revenue as a sales-type lease under ASC 842 thereafter. Rental sales agreements that commenced prior to December 31, 2018, will continue to be recognized as month-to-month, cancelable leases until they are completed, as we elected the ~~existing guidance~~practical expedient to not reassess the lease classification for leases in existence upon adoption. As such, rental agreements commencing after January 1, 2019 were recorded as sales-type leases with the associated revenue and cost of revenue recognized on the lease ~~accounting, “Leases” (Topic 840). ASU No. 2016-02 requires lessees to recognize a lease liability~~commencement date and a ~~right-of-use asset~~corresponding net investment in leases on the Condensed Consolidated Balance Sheet. (See Note 10 – “Commitments and Contingencies” and Note 12 – “Revenue” for ~~all leases. Lessor accounting remains largely unchanged. The amendments in this ASU will be effective for us for interim~~additional information and annual periods beginning after December 15, 2018. ASU No. 2016-02 requires a modified retrospective approach for all leases existing at, or entered into after, the date of initial adoption, with an option to elect to use certain transition relief. Due to the recent determination of our upcoming change in filing status, which has accelerated our required implementation date of this standard, we have commenced project planning for our implementation, which has included engaging an accounting firm to assist us. We are currently evaluating whether this standard will have a material impact on our financial statements.disclosures.)

In June 2016, the FASB issued ASU No. 2016-13, “~~Financial~~“Financial Instruments — Credit Losses,,” to require the measurement of expected credit losses for financial instruments held at the reporting date based on historical experience, current conditions and reasonable forecasts. The ASU will be effective for us for interim and annual periods beginning ~~after December 15, 2019.~~January 1, 2020. Therefore, we plan to further evaluate the anticipated impact of the adoption of this ASU on our condensed consolidated financial statements in future periods.

In ~~August~~ ~~2016, the FASB issued ASU No. 2016-15, “Statement of Cash Flows (Topic 230) — Classification of Certain Cash Receipts and Cash Payments~~,” to provide clarity on how certain cash receipt and cash payment transactions are presented and classified within the statement of cash flows. The ASU will be effective for us for interim and annual periods beginning after December 15, 2018. ~~We do not anticipate any material impact on our consolidated financial statements in future periods as a result of the adoption of this ASU.~~

~~In January 2017, the FASB issued ASU No. 2017-01 “Business Combinations (Topic 805)~~ — ~~Clarifying the Definition of a Business~~,” to revise the definition of a business and provide new guidance to assist in the evaluation of transactions as either asset acquisitions (disposals) or business acquisitions (disposals). We currently are an “emerging growth company” as defined by the JOBS Act and this ASU will become effective for us on December 31, 2018 when we no longer qualify for that status. We have elected early adoption for interim transactions that have not previously been included in issued financial statements, which is permitted under this standard. The adoption of this standard did not have a material impact on our consolidated financial statements.

In July 2018, the FASB issued ASU No. 2018-07 “~~Improvements~~“Improvements to Non-employee Share-Based Payment Accounting,,” which expands the scope of ~~Topic~~ASC 718 – “Stock Based Compensation” to include share-based payment transactions for acquiring goods and services from non-employees. The ASU ~~will be~~was effective for us ~~for fiscal years~~ beginning ~~after December 15, 2018,~~January 1, 2019, including interim periods within ~~that~~the fiscal year. We dohave early adopted ASU 2018-07 for the quarter ended March 31, 2019 and it did not ~~anticipate any~~have a material impact on our condensed consolidated financial ~~statements in future periods as a result of the adoption of this ASU.~~statements.

~~Note 4. Asset Acquisition~~

On May 22, 2018, we acquired certain assets and the intellectual property of Wright Therapy Products, Inc. (“WTP”) for total consideration of approximately $875,000 plus a potential earn-out to be amortized on a straight-line basis over the life of the related asset. The earn-out is based on certain revenue metrics over the seven-month period beginning June 30, 2018 and is capitalized to intangible assets. The assets include the rights to a portfolio of thirty-one

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issued and pending patents that includes intellectual property related to WTP’s pneumatic compression therapy devices and five related trademarks, as well as certain customer accounts. Due to the nature of these patents and related trademarks, as well as our planned use, they have been classified as defensive intangible assets on the balance sheet. The acquisition was recorded as an asset acquisition, and an allocation of the purchase price, based on relative fair value, has been completed as reflected below:

Gross

Weighted-Average
(Dollars in thousands)

Carrying Amount

Amortization Period
Defensive intangible assets

$
788

7 years
Customer accounts

87

5 years
Total

$
875

Note 5.4. Marketable Securities

Our investments in marketable securities, all of which have original contractual maturities of ~~six~~ten to twenty-four months, are classified as available-for-sale and consist of the following:


	As of September 30, 2018								At March 31, 2019
			Unrealized				Fair		Amortized		Unrealized				Fair
(In thousands)	Cost		Gains		Losses		Value		Cost		Gains		Losses		Value
U.S. government and agency obligations	$	18,849	$	—	$	37	$	18,812	$	17,391	$	13	$	3	$	17,401
Corporate debt securities and certificates of deposit		3,992		—		4		3,988		3,973		11		1		3,983
Marketable securities	$	22,841	$	—	$	41	$	22,800	$	21,364	$	24	$	4	$	21,384


	As of December 31, 2017								At December 31, 2018
			Unrealized				Fair		Amortized		Unrealized				Fair
(In thousands)	Cost		Gains		Losses		Value		Cost		Gains		Losses		Value
U.S. government and agency obligations	$	11,997	$	—	$	56	$	11,941	$	19,332	$	5	$	17	$	19,320
Corporate debt securities and certificates of deposit		8,017		—		14		8,003		6,464		7		5		6,466
Marketable securities	$	20,014	$	—	$	70	$	19,944	$	25,796	$	12	$	22	$	25,786

Net pre-tax unrealized gains for marketable securities at March 31, 2019, were recorded as a component of accumulated other comprehensive income in stockholders' equity. There were no sales of marketable securities during the three months ended March 31, 2019.

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Unrealized losses and 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:


	As of September 30, 2018												At March 31, 2019
	Less than 12 months				12 months or more				Total				Less than 12 months				12 months or more				Total
	Fair		Unrealized		Fair		Unrealized		Fair		Unrealized		Fair		Unrealized		Fair		Unrealized		Fair		Unrealized
(In thousands)	Value		Losses		Value		Losses		Value		Losses		Value		Losses		Value		Losses		Value		Losses
U.S. government and agency obligations	$	12,828	$	21	$	5,984	$	16	$	18,812	$	37	$	7,474	$	2	$	999	$	1	$	8,473	$	3
Corporate debt securities and certificates of deposit		1,493		1		997		4		2,490		5		1,498		1		—		—		1,498		1
Marketable securities	$	14,321	$	22	$	6,981	$	20	$	21,302	$	42	$	8,972	$	3	$	999	$	1	$	9,971	$	4


	At December 31, 2018
	Less than 12 months				12 months or more				Total
	Fair		Unrealized		Fair		Unrealized		Fair		Unrealized
(In thousands)	Value		Losses		Value		Losses		Value		Losses
U.S. government and agency obligations	$	11,884	$	11	$	2,993	$	6	$	14,877	$	17
Corporate debt securities and certificates of deposit		2,993		3		999		2		3,992		5
Marketable securities	$	14,877	$	14	$	3,992	$	8	$	18,869	$	22

Note 5. Inventories

Inventories consisted of the following:


(In thousands)	At March 31, 2019		At December 31, 2018
Finished goods	$	4,656	$	5,318
Component parts and work-in-process		6,665		5,871
Total inventories	$	11,321	$	11,189

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As of December 31, 2017

Less than 12 months

12 months or more

Total


Fair

Unrealized

Fair

Unrealized

Fair

Unrealized
(In thousands)

Value

Losses

Value

Losses

Value

Losses
U.S. government and agency obligations

$
5,974

$
25

$
5,967

$
31

$
11,941

$
56
Corporate debt securities and certificates of deposit

7,005

13

998

1

8,003

14
Marketable securities

$
12,979

$
38

$
6,965

$
32

$
19,944

$
70

Note 6. Intangible Assets

Our patents and other intangible assets, all of which are subject to amortization, are summarized as follows:


		As of September 30, 2018						As of December 31, 2017						Weighted-	At March 31, 2019						At December 31, 2018
	Weighted-Average	Gross						Gross						Average	Gross						Gross
	Amortization	Carrying		Accumulated		Net		Carrying		Accumulated		Net		Amortization	Carrying		Accumulated		Net		Carrying		Accumulated		Net
(Dollars in thousands)	Period	Amount		Amortization		Amount		Amount		Amortization		Amount
(In thousands)														Period	Amount		Amortization		Amount		Amount		Amortization		Amount
Patents	8 years	$	3,554	$	1,504	$	2,050	$	3,536	$	1,318	$	2,218	11 years	$	4,298	$	157	$	4,141	$	4,253	$	71	$	4,182
Defensive intangible assets	6 years		930		42		888		—		—		—	5 years		1,126		130		996		1,126		82		1,044
Customer accounts	5 years		103		6		97		—		—		—	4 years		125		18		107		125		12		113
Total		$	4,587	$	1,552	$	3,035	$	3,536	$	1,318	$	2,218		$	5,549	$	305	$	5,244	$	5,504	$	165	$	5,339

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Amortization expense was $0.1 million for each of the three months ended ~~September 30, 2018~~March 31, 2019 and ~~2017, and $0.2 million for each of the nine months ended September 30, 2018 and 2017.~~2018. Future amortization expenses are expected as follows:


(In thousands)
2018 (October 1 - December 31)	$	104
2019		417
2019 (April 1 - December 31)			$	419
2020		417		558
2021		417		558
2022		417		558
2023				491
Thereafter		1,263		2,660
Total	$	3,035	$	5,244

Note 7. Accrued Expenses

Accrued expenses consisted of the following:


(In thousands)	As of September 30, 2018		As of December 31, 2017		At March 31, 2019		At December 31, 2018
Warranty	$	726	$	531	$	873	$	841
Legal and consulting						710		319
Travel and business		553		453		622		557
Legal and consulting		481		317
Deferred rent		159		173
Accrued taxes		84		1,070		262		115
Clinical studies		70		15		33		60
Acquisition earn-out						—		375
Deferred rent						—		155
Other		217		39		185		358
Total	$	2,290	$	2,598	$	2,685	$	2,780

Note 8. Warranty Reserves

The reserve for warranties was as follows:


	Three Months Ended
	March 31,
(In thousands)	2019		2018
Beginning balance	$	2,566	$	1,672
Warranty provision		418		351
Processed warranty claims		(257)		(203)
Ending balance	$	2,727	$	1,820

Accrued warranty reserve, current	$	873	$	648
Accrued warranty reserve, non-current		1,854		1,172
Total accrued warranty reserve	$	2,727	$	1,820

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Note 8.9. Credit Agreement

On August 3, 2018, we entered into a ~~Credit Agreement (the “Credit Agreement”)~~credit agreement with Wells Fargo Bank, National Association. On February 12, 2019, we entered into a first amendment to our credit agreement, which provided for an increase in our annual capital expenditure limitations. On March 25, 2019, we entered into a waiver and second amendment to our credit agreement, which provided that the business plan and budget required to be delivered annually be reduced to cover one year as opposed to the initial three-year coverage requirement. We refer to the credit agreement, as amended, as the “Credit Agreement.”

The Credit Agreement provides for a ~~new $10,000,000~~$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

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not to exceed an incremental ~~$25,000,000~~$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 ~~$35,000,000.~~$35.0 million.

Amounts drawn under the revolving credit facility bear interest, at our option, at a rate equal to (a) the highest of (i) the prime rate, (ii) the federal funds rate plus 0.50% and (iii) LIBOR for an interest period of one month plus 1% (the “Base Rate”) plus an applicable margin or (b) LIBOR plus the applicable margin. The applicable margin is 0.40% to 1.15% on loans bearing interest at the Base Rate and 1.40% to 2.15% on loans bearing interest at LIBOR, in each case depending on our consolidated total leverage ratio. Undrawn portions of the revolving credit facility are subject to an unused line fee at a rate per annum from 0.200% to 0.275%, depending on our consolidated total leverage ratio.

As of ~~September 30, 2018 and the date on which we filed this report,~~March 31, 2019, 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 limits our ability to make capital expenditures during a fiscal year in excess of the amounts set forth in the Credit Agreement, and requires that we (i) not permit, as of the last day of each fiscal quarter, our consolidated total leverage ratio to exceed 3.00 to 1.00 and (ii) maintain minimum cash and cash equivalents, measured on the last day of each fiscal quarter, of not less than $7,500,000 (subject to a temporary reduction to $5,000,000 for the two fiscal quarters immediately following a permitted acquisition). As of September 30, 2018, we were in compliance with all financial covenants under the Credit Agreement.

The Credit Agreement also contains certain other restrictions and covenants, which, among other things, restrict our ability to acquire or merge with another entity, dispose of our assets, make investments, loans or guarantees, incur additional indebtedness, create liens or other encumbrances, or pay dividends or make other distributions.

Amounts due under the Credit Agreement may be accelerated upon an Event of Default (as defined in the Credit Agreement), such as breach of a representation, covenant or agreement of ours, defaults with respect to certain of our other material indebtedness or the occurrence of bankruptcy if not otherwise waived or cured.

We may use the proceeds from advances under the revolving credit facility (i) to finance capital expenditures, (ii) to pay fees, commissions and expenses in connection with the Credit Agreement and (iii) for working capital and general corporate purposes.

Note 9.10. Commitments and Contingencies

Lease Obligations

We lease property and equipment under operating leases, typically with terms greater than 12 months, and determine if an arrangement contains a lease at inception. In general, an arrangement contains a lease if there is an identified asset and we have the right to direct the use of and obtain substantially all of the economic benefit from the use of the identified asset. We record a ROU operating lease liability at the present value of lease payments over the lease term on the commencement date. The related ROU operating lease asset reflects rental escalation clauses as well as renewal options and/or termination options. The exercise of lease renewal and/or termination options are at our discretion and are included in the determination of the lease term and lease payment obligations when it is deemed reasonably certain that the option will be exercised. When available, we use the rate implicit in the lease to discount lease payments to present value; however, certain leases do not provide a readily determinable implicit rate. Therefore, we must estimate our incremental borrowing rate to discount the lease payments based on information available at lease commencement.

We classify our leases as Buildings, Vehicles or Computer/Office Equipment and do not separate lease and nonlease components of contracts for any of the aforementioned classifications. In accordance with applicable guidance, we do not record leases with terms that are less than one year on the Condensed Consolidated Balance Sheet.

None of our lease agreements contain material restrictive covenants or residual value guarantees.

Buildings

We lease certain office and warehouse space at various locations in the United States where we provide services. These leases are typically greater than one year with fixed, escalating rents over the noncancelable terms and therefore, ROU operating lease assets and liabilities are recorded on the Condensed Consolidated Balance Sheet, with rent expense to be recognized on a straight-line basis over the term of the lease. The remaining lease terms vary from approximately 1 to 5 years as of the adoption date of January 1, 2019.

In March 2008, we entered into a ~~non-cancelable~~noncancelable operating lease agreement for building space for our corporate headquarters that provides for monthly rent, real estate taxes and operating ~~expenses. This lease~~expenses that was subsequently extended to July 31, 2021. This space is included in our ROU operating lease assets and liabilities. We are looking to sub-lease this space for the remainder of our lease obligation due to our new headquarters lease described below.

~~In July 2016, we~~We entered into a ~~non-cancelable~~lease in October 2018 for office space for our future corporate headquarters in Minneapolis, Minnesota which will commence upon our move, which is expected to occur in the fourth quarter of 2019. As such, this lease is not included in either the ROU operating lease ~~agreement~~assets or liabilities. The initial lease term is through February 2030, with an option to renew for ~~building space to accommodate the relocation~~two periods of our manufacturing, quality, engineering and research and development functions. This lease agreement extends through November 2023 and provides for monthly rent, real estate taxes and operating expenses.

~~Rent expense was $0.4 million for the each of three months ended September 30, 2018 and 2017, and $1.2 million and $1.1 million for the nine months ended September 30, 2018 and 2017, respectively.~~five years each.

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~~In July 2016, we entered into a fleet vehicle~~Vehicles

We lease ~~program~~vehicles for certain members of our field sales ~~organization.~~organization under a vehicle fleet program whereby the initial, noncancelable lease is for a term of 367 days, thus more than one year. Subsequent to the initial term, the lease becomes a month-to-month, cancelable lease. As of March 31, 2019, we had approximately 40 vehicles with agreements within the initial, noncancelable lease term that are recorded as ROU operating lease assets and liabilities. In addition to monthly rental fees specific to the vehicle, there are fixed monthly nonlease components that have been included in the ROU operating lease assets and liabilities. The nonlease components are not significant.

Computer and Office Equipment

We also have operating lease agreements for certain computer and office ~~equipment~~equipment. The remaining lease terms at the adoption date of January 1, 2019 range from seven months to approximately four and a half years with fixed monthly payments that ~~expire~~are included in ~~2021.~~the ROU operating lease assets and liabilities. The leases provide an option to purchase the related equipment at fair market value at the end of the lease. The lease will automatically renew as a month-to-month rental at the end of the lease if the equipment is not purchased or returned.

~~Future base minimum~~Lease Position, Undiscounted Cash Flow and Supplemental Information

The table below presents the lease-related assets and liabilities recorded on our Condensed Consolidated Balance Sheet:


(In thousands)	At March 31, 2019
Right of use operating lease assets	$	3,396

Right of use operating lease liabilities:
Current	$	1,147
Non-current		2,318
Total	$	3,465

Operating leases:
Weighted average remaining lease term		3.5 years
Weighted average discount rate (1)		5.05%

(1)

Discount rates were established as of January 1, 2019, the adoption date

The table below reconciles the undiscounted cash flows under the operating leases recorded on the Condensed Consolidated Balance Sheet for each of the next five years and total of the remaining years:


(In thousands)
2019 (April 1 - December 31)	$	1,000
2020		1,082
2021		741
2022		456
2023		383
Thereafter		32
Total minimum lease payments		3,694
Less: amount of lease payments representing interest		(229)
Present value of future minimum lease payments		3,465
Less: current obligations under leases		(1,147)
Long-term lease obligations	$	2,318

As of March 31, 2019, we have additional lease ~~payments~~commitments of $19.9 million related to our future headquarters that we anticipate will commence in the fourth quarter of 2019. As the lessee we are involved in

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providing guidance to the lessor for ~~all~~related improvements, however these improvements are managed and owned by the lessor.

Operating lease ~~obligations are expected to be as follows~~costs accounted for under ASC 842, for the ~~years ending December 31:~~three months ended March 31, 2019, were $0.3 million. Cash paid for the three months ended March 31, 2019 for operating lease liabilities included in the measurement of the lease liability was $0.3 million.

Computer/Office

Fleet Vehicle

(In thousands)

Buildings

Equipment

Program

Total
2018 (October 1 - December 31)

$
227

$
14

$
55

$
296
2019

948

51

85

1,084
2020

954

34

—

988
2021

701

3

—

704
2022

352

—

—

352
Thereafter

268

—

—

268
Total

$
3,450

$
102

$
140

$
3,692

Rent expense accounted for under ASC 840, for the three months ended March 31, 2018 was $0.3 million.

Major Vendors

~~We had purchases from two major vendors that accounted for 45% and 41% of our total purchases for the three and nine months ended September 30, 2018, respectively.~~ We had purchases from three major vendors that accounted for ~~47% and 39%~~40% of our total purchases for the three ~~and nine~~ months ended ~~September 30, 2017, respectively.~~March 31, 2019 and from two major vendors that accounted for 33% of our total purchases for the three months ended March 31, 2018.

Purchase Commitments

We issued purchase orders ~~in 2017~~prior to March 31, 2019, totaling ~~$1.7~~$19.5 million for ~~items~~goods that we expect to receive between ~~October~~April and December of ~~2018. We issued purchase orders in the nine months ended September 30, 2018 totaling $15.0 million for items that we expect to receive in~~ 2019.

Retirement Plan

We maintain a 401(k) retirement plan for our employees in which eligible employees can contribute a percentage of their pre-tax compensation. ~~We may also make discretionary~~Discretionary contributions to the 401(k) ~~plan. We made contributions~~plan totaled $0.1 million for each of ~~$63,000 and $42,000 for~~ the threemonths ended ~~September 30, 2018~~March 31, 2019 and ~~2017, respectively, and $174,000 and $135,000 for the nine months ended September 30, 2018 and 2017, respectively.~~2018.

Note ~~10.~~11. Stockholders' Equity

We completed an initial public offering of our common stock on August 2, 2016, in which we sold 4,120,000 shares of our common stock at a public offering price of $10.00 per share. Immediately prior to the completion of the initial public offering, all then-outstanding shares of our Series A and Series B preferred stock were converted into 5,924,453 shares of our common stock. Our Series A preferred stock converted to common stock at a ratio of 1-for-1.03 and our Series B preferred stock converted to common stock at a ratio of 1-for-1. In addition, immediately prior to the completion of the initial public offering, we issued 2,354,323 additional shares of our common stock that our Series A and Series B preferred stockholders were entitled to receive in connection with the conversion of the preferred stock, and we issued 956,842 shares of our common stock to pay accrued dividends on our Series B preferred stock. We also paid $8.2 million in cumulative accrued dividends to our Series A convertible preferred stockholders in connection with the initial public offering, including $0.1 million of dividends paid to the holders of the common restricted shares.

Stock-Based Compensation

Our 2016 Equity Incentive Plan (the “2016 Plan”) authorizes us to grant stock options, stock appreciation rights, restricted stock, stock units and other stock-based awards to employees, non-employee directors and certain consultants and advisors. There were up to 4,800,000 shares of our common stock initially reserved for issuance pursuant to the 2016 Plan. The 2016 Plan provides that the number of shares reserved and available for issuance under the 2016 Plan will

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automatically increase annually on January 1 of each calendar year, commencing in 2017 and ending on and including January 1, 2026, by an amount equal to the lesser of: (a) 5% of the number of common shares of stock outstanding as of December 31 of the immediately preceding calendar year, or (b) 2,500,000 shares; provided, however, that our Board of Directors may determine that any annual increase be a lesser number. In addition, all awards granted under our 2007 Omnibus Stock Plan and our 2003 Stock Option Plan that were outstanding when the 2016 Plan became effective and that are forfeited, expire, are cancelled, are settled for cash or otherwise not issued, will become available for issuance under the 2016 Plan. ~~Effective January 1, 2017, 841,686 shares were added to the 2016 Plan, as available for issuance thereunder, pursuant~~Pursuant to the automatic increase feature of the 2016 ~~Plan.~~ ~~Effective January 1, 2018,~~Plan, 892,318 and 841,686 shares were added ~~to the 2016 Plan,~~ as available for issuance thereunder ~~pursuant~~on January 1, 2018 and 2017, respectively. Our Board of Directors exercised its prerogative to forego the automatic increase ~~feature of the 2016 Plan.~~on January 1, 2019. As of ~~September 30, 2018, 5,226,592~~March 31, 2019, 5,092,296 shares were available for future grant pursuant to the 2016 Plan.

Upon adoption and approval of the 2016 Plan, all of our previous equity incentive compensation plans were terminated. However, existing awards under those plans continue to vest in accordance with the original vesting schedules and will expire at the end of their original terms.

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We recorded stock-based compensation expense of ~~$2.4~~$2.8 million and ~~$1.0~~$1.5 million for the threemonths ended ~~September 30,~~March 31, 2019 and 2018, ~~and 2017, respectively, and $5.6 million and $3.1 million for the nine months ended September 30, 2018 and 2017,~~ respectively. This expense was allocated as follows:


	Three Months Ended				Nine Months Ended				Three Months Ended
	September 30,				September 30,				March 31,
(In thousands)	2018		2017		2018		2017		2019		2018
Cost of goods sold	$	69	$	4	$	178	$	102
Cost of revenue									$	98	$	40
Sales and marketing expenses		834		361		2,272		1,030		1,166		652
Research and development expenses		52		29		146		73		80		69
Reimbursement, general and administrative expenses		1,425		573		3,042		1,899		1,439		720
Total stock-based compensation expense	$	2,380	$	967	$	5,638	$	3,104	$	2,783	$	1,481

The stock-based compensation expense ~~includes~~included modifications of share-based awards totaling $0.3 million for the three months ended March 31, 2019. This amount included the acceleration of vesting pursuant to the terms of an employee’s award agreement of $0.2 million and a ~~modification~~final charge of ~~share-based~~$0.1 million pertaining to the January 1, 2019 revaluation of the unvested portion of outstanding awards held by a former executive ~~resulting in a charge~~upon our adoption of ~~$0.6 million for the three and nine months ended September 30, 2018. At September 30, 2018, there was approximately $0.7 million of estimated unrecognized pre-tax compensation expense that is expected~~ASU No. 2018-07 “Improvements to ~~be recognized on a straight-line basis over 0.4 years.~~

Non-employee Share Based Payment Accounting”.

Stock Options

Stock options issued to participants other than non-employees vest over three or four years and typically have a contractual term of seven or ten years. Annually, stock options are granted to our non-employee directors on the date of the annual meeting of stockholders and vest in full on the earlier of one year after the date of grant or on the date of the next year’s annual meeting of stockholders. These options have a contractual term of seven years.

Stock-based compensation expense included in our Condensed Consolidated Statements of Operations for stock options was ~~$0.8~~$0.7 million and ~~$0.3~~$0.5 million for the three months ended ~~September 30,~~March 31, 2019 and 2018, ~~and 2017, respectively, and $1.8 million and $0.8 million for the nine months ended September 30, 2018 and 2017,~~ respectively.

At ~~September 30, 2018,~~March 31, 2019, there was approximately ~~$5.0~~$7.2 million of total unrecognized pre-tax stock option expense under our equity compensation plans, which is expected to be recognized on a straight-line basis over a weighted-average period of ~~2.7~~2.9 years.

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Stock option activity for the ~~nine~~three months ended ~~September 30, 2018~~March 31, 2019 is summarized as follows:

Weighted-

Weighted-

Average

Average

Aggregate

Options

Exercise Price

Remaining

Intrinsic
(In thousands except share, per share and years data)

Outstanding

Per Share (1)

Contractual Life

Value (2)
Balance at December 31, 2017

1,487,720

$
8.41

6.2 years

$
29,611
Granted

136,224

$
39.46

Exercised

(388,261)

$
3.14

$
16,826
Cancelled

(28,824)

$
20.50

Balance at September 30, 2018

1,206,859

$
13.32

6.3 years

$
69,667

Options exercisable at September 30, 2018

706,423

$
3.80

4.8 years

$
47,505


		Weighted-		Weighted-
		Average		Average	Aggregate
	Options	Exercise Price		Remaining	Intrinsic
(In thousands except options and per share data)	Outstanding	Per Share (1)		Contractual Life	Value (2)
Balance at December 31, 2018	1,076,535	$	17.94	6.5 years	$	31,172
Granted	73,948	$	72.64
Exercised	(101,016)	$	8.53		$	5,731
Forfeited	(10,416)	$	28.44
Balance at March 31, 2019	1,039,051	$	22.64	6.4 years	$	33,527

Options exercisable at March 31, 2019	586,039	$	8.57	5.1 years	$	25,887

(1)

The exercise price of each option granted during the period shown was equal to the market price of the underlying stock on the date of grant.

(2)

The aggregate intrinsic value of options exercised represents the difference between the exercise price of the option and the closing stock price of our common stock on the date of exercise. The aggregate intrinsic value of options outstanding represents the difference between the exercise price of the option and the closing stock price of our common stock on the last trading day of the period.

Options exercisable of ~~1,098,882~~906,063 as of ~~September 30, 2017~~March 31, 2018 had a weighted-average exercise price of ~~$2.12~~$2.75 per share.

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Time-Based Restricted Stock Units

We have granted time-based restricted stock units to certain participants under the 2016 Plan that are stock-settled with common shares. Time-based restricted stock units granted under the 2016 Plan vest over one to three years. Stock-based compensation expense included in our Condensed Consolidated Statements of Operations for time-based restricted stock units was ~~$1.3 million and $0.6~~$0.8 million for each of the ~~three months~~three-month periods ended ~~September 30, 2018~~March 31, 2019 and ~~2017, respectively, and $2.9 million and $1.8 million for the nine months ended September 30, 2018 and 2017, respectively.~~2018. As of ~~September 30, 2018,~~March 31, 2019, there was approximately ~~$5.4~~$7.0 million of total unrecognized pre-tax compensation expense related to outstanding time-based restricted stock units that is expected to be recognized over a weighted-average period of ~~1.8~~2.2 years.

Our time-based restricted stock unit activity for the ~~nine~~three months ended ~~September 30, 2018~~March 31, 2019 was as follows:


		Weighted-					Weighted-
		Average Grant		Aggregate			Average Grant		Aggregate
	Units	Date Fair Value		Intrinsic		Units	Date Fair Value		Intrinsic
(In thousands except unit and per unit data)	Outstanding	Per Unit		Value (1)		Outstanding	Per Unit		Value (1)
Balance at December 31, 2017	441,507	$	16.38	$	12,795
Balance at December 31, 2018						309,632	$	23.69	$	14,104
Granted	92,109	$	35.27			43,258	$	72.38
Vested	(175,164)	$	14.75			(131,363)	$	15.76
Cancelled	(27,229)	$	21.00			(244)	$	17.35
Balance at September 30, 2018	331,223	$	22.11	$	23,533
Balance at March 31, 2019						221,283	$	37.92	$	11,666

Deferred and unissued at September 30, 2018 (2)	3,427	$	31.28	$	243
Deferred and unissued at March 31, 2019(2)						4,432	$	35.43	$	234

(1)

The aggregate intrinsic value of restricted stock units outstanding was based on our closing stock price on the last trading day of the period.

(2)

For the ~~nine~~three months ended ~~September 30, 2018,~~March 31, 2019, there were ~~1,214~~567 restricted stock units granted to non-employee directors in lieu of their quarterly cash retainer payments. These restricted stock units were fully vested upon grant and represent the right to receive one share of common stock, per unit, upon the earlier of the directors’ termination of service as a director of ours or the occurrence of a change of control of us. These restricted stock units are included in the “Granted” line in the table above and are also included in the “Vested” line in the table above due to their being fully vested upon grant. As of ~~September 30, 2018,~~March 31, 2019, there were ~~3,427~~4,432 outstanding restricted stock units that have been previously granted to non-employee directors in lieu of their quarterly director retainer payments. These restricted stock units are not included in the “Balance at ~~September 30, 2018”~~March 31, 2019” line in the table above because they are fully vested.

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Performance-Based Restricted Stock Units

~~In February 2018, we~~We have granted ~~67,982~~ performance-based restricted stock units (“PSUs”)~~, which represents the target number of PSUs under these awards,~~ to certain participants under the 2016 Plan. These PSUs have both performance-based and time-based vesting features. The PSUs granted in 2018 will be earned if and to the extent performance goals based on revenue and adjusted EBITDA are achieved in 2019. The PSUs granted in 2019 will be earned if and to the extent performance goals based on revenue and adjusted EBITDA are achieved in 2020. The number of PSUs earned will depend on the level at which the performance targets are achieved, and can range from 50% of target if threshold performance is achieved and up to 150% of target if maximum performance is achieved. ~~One third~~One-third of the earned PSUs will vest on the date the Compensation and Organization Committee certifies the number of PSUs earned, and the remaining two thirds of the earned PSUs will vest on the first anniversary of that certification date. All earned and vested PSUs will be settled in shares of common stock. Stock-based compensation expense included in our Condensed Consolidated Statements of Operations for PSUs was ~~$0.2~~$0.7 million and ~~$0.5~~$0.1 million for the three ~~and nine~~ months ended ~~September 30,~~March 31, 2019 and 2018, ~~respectively, and $0~~respectively. The stock-based compensation expense for the ~~same periods~~three months ended March 31, 2019 reflects a $0.4 million charge due to a change in ~~2017.~~the estimated payout to 150% of target for those PSUs granted in 2018. As of ~~September 30, 2018,~~March 31, 2019, there was approximately ~~$1.6~~$3.8 million of total unrecognized pre-tax compensation expense related to outstanding PSUs that is expected to be recognized over a weighted average period of 2.4 years.

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Our performance-based restricted stock unit activity reflected at target for the ~~nine-months~~three-months ended ~~September 30, 2018~~March 31, 2019 was as follows:


	Performance-	Weighted-				Performance-	Weighted-
	Based	Average Grant		Aggregate		Based	Average Grant		Aggregate
	Units	Date Fair Value		Intrinsic		Units	Date Fair Value		Intrinsic
(In thousands except unit and per unit data)	Outstanding	Per Unit		Value (1)		Outstanding	Per Unit		Value (1)
Balance at December 31, 2017	—	$	—	$	—
Balance at December 31, 2018						65,427	$	33.62	$	2,980
Granted	67,982	$	32.36			25,724	$	72.64
Vested	—	$	—			—	$	—
Cancelled	(5,253)	$	32.36			—	$	—
Balance at September 30, 2018	62,729	$	32.36	$	4,457
Balance at March 31, 2019						91,151	$	44.63	$	4,805

(1)

The aggregate intrinsic value of performance-based restricted stock units outstanding was based on our closing stock price on the last trading day of the period.

Employee Stock Purchase Plan

Our employee stock purchase plan (“ESPP”), which was approved by our Board of Directors on April 27, 2016 and by our stockholders on June 20, 2016, allows participating employees to purchase shares of our common stock at a discount through payroll deductions. The plan is available to all our employees and employees of participating subsidiaries. Participating employees may purchase common stock, on a voluntary after-tax basis, at a price equal to 85% of the lower of the closing market price per share of our common stock on the first or last trading day of each stock purchase period. The plan provides for six-month purchase periods, beginning on May 16 and November 16 of each calendar year.

A total of 1.6 million shares of common stock was initially reserved for issuance under the ESPP, and this share reserve will automatically be supplemented each January 1, commencing in 2017 and ending on and including January 1, 2026, by an amount equal to the least of (1) 1% of the shares of our common stock outstanding on the immediately preceding December 31, (2) 500,000 shares or (3) such lesser amount as our Board of Directors may determine. ~~Effective January 1, 2018, 178,463 shares were added to the ESPP, as available for issuance thereunder, pursuant~~Pursuant to the automatic increase feature of the ~~plan. On May 15, 2018, 63,578~~plan, 178,463 and 168,337 shares were ~~purchased under~~added to the ESPP ~~utilizing $1.4 million~~on January 1, 2018 and 2017, respectively. Our Board of ~~employee contributions.~~Directors exercised its prerogative to forego the automatic increase on January 1, 2019. As of ~~September 30, 2018, 1,576,090~~March 31, 2019, 1,542,576 shares were available for future issuance under the ESPP. We recognized stock-based compensation expense associated with the ESPP of $~~0.1~~ $0.3 million for each of the three-month periods ended ~~September 30, 2018~~March 31, 2019 and ~~2017,~~2018.

Note 12. Revenue

We derive our revenues from the sale and $~~0.5~~ ~~million~~rental of our Flexitouch, Entre and Actitouch systems to our customers in the United States. While our primary source of revenue is from the sale of our products, a portion of our revenues are derived from patients who obtain our products under rental arrangements. (See description below for ~~each~~additional information on rental revenue as it relates to ASC 842 “Leases”.) These arrangements are primarily for rentals of the ~~nine-month periods~~Flexitouch system and are mostly related to private insurers, and the Veterans Administration.

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The following table presents our revenue, inclusive of sales and rental revenue, disaggregated by product:


	Three Months Ended
	March 31,
(In thousands)	2019		2018
Revenues
Flexitouch system	$	34,109	$	24,530
Entre/Actitouch systems		3,508		2,318
Total	$	37,617	$	26,848

Percentage of total revenues
Flexitouch system		91 %		91 %
Entre/Actitouch systems		9 %		9 %
Total		100 %		100 %

Our revenues from third-party payers, inclusive of sales and rental revenue, for the three months ended ~~September 30,~~March 31, 2019 and 2018 are summarized in the following table:


	Three Months Ended
	March 31,
(In thousands)	2019		2018
Private insurers and other payers	$	25,929	$	18,115
Veterans Administration		7,670		6,179
Medicare		4,018		2,554
Total	$	37,617	$	26,848

Our rental revenue is derived from rent to purchase arrangements that typically range from three to ten months. Under ASC 840, our rental revenue was recognized as month-to-month, cancelable leases, however, because title transfers to the patient, with whom we have the contract, upon the termination of the lease term and ~~2017.~~because collectability is probable, under ASC 842, these are recognized as sales-type leases. Each rental agreement contains two components, the controller and related garments, both of which are interdependent and recognized as one lease component.

In accordance with applicable guidance, we will continue to recognize rental agreements commencing prior to December 31, 2018 on a month-to-month basis as an operating lease until they are completed, which we anticipate to be in the fourth quarter of this fiscal year. Those initiated subsequent to January 1, 2019 are recorded as sales-type leases in accordance with ASC 842, whereby rental revenue and cost of rental revenue are recognized upon the lease commencement date. Total rental revenue in the three months ended March 31, 2019 includes both operating and sales-type lease revenue. Operating lease revenue for the three months ended March 31, 2019 was $2.8 million. Rental revenue for the three months ended March 31, 2018 related to operating leases under ASC 840 and includes garment revenue of approximately $0.2 million previously included as a purchase.

The revenue and associated cost of revenue of sales-type leases are recognized on the lease commencement date and a net investment in leases is recorded on the Condensed Consolidated Balance Sheet. We bill the patients’ insurance payers monthly over the duration of the rental term. We record the net investment in leases and recognize revenue upon commencement of the lease in the amount of the expected consideration to be received through the monthly payments. Similar to our sales revenue, the transaction price is impacted by multiple factors, including the terms and conditions contracted by various third party payers. As the rental contract resides with the patients, we have elected the portfolio approach, at the payer level, to determine the expected consideration, which considers the impact of early terminations. While the contract is with the patient, in certain circumstances, the third party payer elects an initial rental period with an option to extend. We assess the likelihood of extending the lease at the onset of the lease to determine if the option is reasonably certain to be exercised. As the lease is short-term in nature, we anticipate collection of substantially

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all of the net investment within the first year of the lease agreement. Completion of these payments represents the fair market value of the equipment, and as such, interest income is not applicable.

Sales-type lease revenue and the associated cost of revenue for the three months ended March 31, 2019 was:


	Three Months Ended
	March 31,
(In thousands)	2019
Sales-type lease revenue	$	3,965
Cost of sales-type lease revenue		1,543
Gross profit	$	2,422

Note ~~11.~~13. Income Taxes

We record our interim provision for income taxes by applying our estimated annual effective tax rate to our year-to-date pre-tax income and adjusting for discrete tax items recorded in the period. Deferred income taxes result from temporary differences between the reporting of amounts for financial statement purposes and income tax purposes. These differences relate primarily to different methods used for income tax reporting purposes, including for depreciation and amortization, warranty and ~~certain employee compensation related~~vacation accruals, and deductions related to allowances for

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doubtful accounts receivable and inventory reserves. Our provision for income taxes included current federal and state income tax expense, as well as deferred federal and state income tax expense.

The effective tax rate for the three months ended ~~September 30, 2018~~March 31, 2019 was a benefit of ~~16.5%~~189.7%, compared to a benefit of ~~6.7%~~97.1% for the three months ended ~~September 30, 2017.~~March 31, 2018. The primary driver of the change in ~~the~~our effective tax rate was attributable to an increase in the tax benefits related to share-based compensation proportionate to pre-tax book income as compared to the ~~same~~ prior ~~year period. We recorded an income tax benefit of $0.2 million and $0.1 million for the three months ended September 30, 2018 and 2017, respectively.~~

The effective tax rate for the nine months ended September 30, 2018 was a benefit of 254.3%, compared to a benefit of 539.1% for the nine months ended September 30, 2017. The primary driver of the change in our effective tax rate was a significant increase in tax benefits related to share-based compensation proportionate to pre-tax book income as compared to the same prior yearyear's reporting period. We recorded an income tax benefit of $3.1 million and ~~an income tax benefit of $4.5~~$1.7 million for the ~~nine~~three months ended ~~September 30,~~March 31, 2019 and 2018, ~~and 2017,~~ respectively.

We recognize the financial statement benefit of a tax position only after determining that the relevant tax authority is ~~more likely than not~~more-likely-than-not to sustain the position following an audit. For tax positions meeting the ~~more likely than not~~more-likely-than-not threshold, the amount recognized in the condensed consolidated financial statements is the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement with the relevant tax authority. As of ~~September 30, 2018~~March 31, 2019 we had an unrecognized tax benefit ~~of approximately $1.8 million. Included in the balance of unrecognized tax benefits~~classified as of September 30, 2018 was $0.4 million of tax benefits that, if recognized, would impact the effective tax rate. Also included in the balance of unrecognized tax benefits as of September 30, 2018 was $1.4 million of tax benefits that, if recognized, would result in adjustments to other tax accounts, primarily deferred taxes.a non-current liability.

~~We are currently under examination for our 2016 federal tax return.~~ We are not currently under ~~exam for income taxes by~~examination in any ~~other taxing jurisdictions.~~jurisdiction. In the event of any future tax assessments, we have elected to record the income taxes and any related interest and penalties as income tax expense on our statement of operations.

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Note ~~12.~~14. Net Income Per Share

The following table sets forth the computation of our basic and diluted net income (loss) per ~~share:~~share attributable to common stockholders:


	Three Months Ended				Nine Months Ended				Three Months Ended
	September 30,				September 30,				March 31,
(In thousands, except share and per share data)	2018		2017		2018		2017		2019		2018
Net income	$	1,746	$	1,342	$	4,268	$	3,625
Net income (loss)									$	1,472	$	(50)
Weighted-average shares outstanding		18,344,956		17,603,293		18,166,999		17,222,072		18,746,751		17,996,672
Effect of restricted stock units, common stock options, warrants, and employee stock purchase plan shares		1,180,730		1,480,682		1,161,948		1,596,537
Effect of restricted stock units, common stock options, and employee stock purchase plan shares										833,096		—
Weighted-average shares used to compute diluted net income per share		19,525,686		19,083,975		19,328,947		18,818,609		19,579,847		17,996,672
Net income per share - Basic	$	0.10	$	0.08	$	0.23	$	0.21	$	0.08	$	0.00
Net income per share - Diluted	$	0.09	$	0.07	$	0.22	$	0.19	$	0.08	$	0.00

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The following common stock equivalents were excluded from the computation of diluted net income per share for the periods presented because including them would have been anti-dilutive:


	Three Months Ended		Nine Months Ended		Three Months Ended
	September 30,		September 30,		March 31,
	2018	2017	2018	2017	2019	2018
Restricted stock units	—	—	5,413	1,184	42,691	395,046
Common stock options	25,703	23,311	47,981	63,066	165,638	1,445,089
Common stock warrants	—	—	—	—
Employee stock purchase plan	—	—	28,996	—	—	68,114
Total	25,703	23,311	82,390	64,250	208,329	1,908,249

Note ~~13.~~15. Fair Value Measurements

We determine the fair value of our assets and liabilities based on the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value maximize the use of observable inputs and minimize the use of unobservable inputs. We use a fair value hierarchy with three levels of inputs, of which the first two are considered observable and the last unobservable, to measure fair value. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities (Level 1). The next highest priority is based on quoted prices for similar assets or liabilities in active markets or quoted prices for identical or similar assets or liabilities in non-active markets or other observable inputs (Level 2). The lowest priority is given to unobservable inputs (Level 3).

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The following provides information regarding fair value measurements for our cash equivalents and marketable securities as of ~~September 30, 2018~~March 31, 2019 and December 31, ~~2017~~2018 according to the three-level fair value hierarchy:


	As of September 30, 2018								At March 31, 2019
	Quoted Prices								Quoted Prices
	in Active		Significant						in Active		Significant
	Markets for		Other		Significant				Markets for		Other		Significant
	Identical		Observable		Unobservable				Identical		Observable		Unobservable
	Assets		Inputs		Inputs				Assets		Inputs		Inputs
(In thousands)	(Level 1)		(Level 2)		(Level 3)		Total		(Level 1)		(Level 2)		(Level 3)		Total
Recurring Fair Value Measurements:
Money market mutual funds	$	5,260	$	—	$	—	$	5,260	$	7,055	$	—	$	—	$	7,055
U.S. government and agency obligations		11,833		6,979		—		18,812		16,402		999		—		17,401
Corporate debt securities		—		3,988		—		3,988		—		3,983		—		3,983
Total	$	17,093	$	10,967	$	—	$	28,060	$	23,457	$	4,982	$	—	$	28,439


	As of December 31, 2017								At December 31, 2018
	Quoted Prices								Quoted Prices
	in Active		Significant						in Active		Significant
	Markets for		Other		Significant				Markets for		Other		Significant
	Identical		Observable		Unobservable				Identical		Observable		Unobservable
	Assets		Inputs		Inputs				Assets		Inputs		Inputs
(In thousands)	(Level 1)		(Level 2)		(Level 3)		Total		(Level 1)		(Level 2)		(Level 3)		Total
Recurring Fair Value Measurements:
Money market mutual funds	$	9,212	$	—	$	—	$	9,212	$	2,447	$	—	$	—	$	2,447
U.S. government and agency obligations		1,000		10,941		—		11,941		16,326		2,994		—		19,320
Corporate debt securities		—		8,003		—		8,003		—		6,466		—		6,466
Total	$	10,212	$	18,944	$	—	$	29,156	$	18,773	$	9,460	$	—	$	28,233

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During the ~~nine~~three months ended ~~September 30, 2018,~~March 31, 2019, there were no transfers within the three-level hierarchy. A significant transfer is recognized when the inputs used to value a security have been changed, which merits a transfer between the disclosed levels of the valuation hierarchy.

The fair values for our money market mutual funds, U.S. government and agency obligations and corporate debt securities are determined based on valuations provided by external investment managers who obtain them from a variety of industry standard data providers.

The carrying amounts of financial instruments such as cash equivalents, accounts receivable, other assets, accounts payable, accrued expenses and other liabilities approximate their related fair values due to the short-term maturities of these items. Non-financial assets, such as equipment and leasehold improvements, and intangible assets are subject to non-recurring fair value measurements if they are deemed impaired. As of December 31, 2018, we re-measured the value of our intangible assets related to the Actitouch product line to their fair value, which was deemed to be $0 using level 3 measurements. We had no re-measurements of non-financial assets to fair value in the ~~nine~~three months ended ~~September 30, 2018.~~

~~Note 14. Subsequent Events~~

On October 15, 2018, we entered into a license agreement (the “License Agreement”) with Sun Scientific, Inc. (“Sun Scientific”) pursuant to which we licensed certain intellectual property of Sun Scientific, including related to its Aero-Wrap product, in the United States 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.

~~Pursuant to the License Agreement, we paid Sun Scientific an initiation fee of $4.0 million~~ upon execution of the License Agreement. We have also agreed to pay Sun Scientific a royalty in a range of high single digits to low double digits as a percentage of the net sales of the products containing the licensed intellectual property and a contingency payment if the net sales of the Aero-Wrap product exceed $80 million within the first seven years of the term of the agreement. We have concluded as of September 30, 2018 that it is not probable the contingency payment threshold will be achieved. The contingency payment may be made, at our option, in cash or shares of our common stock.

The License Agreement will continue until the date of expiration of the last to expire or be invalidated of the licensed patents, subject to earlier termination under certain circumstances, including by either party upon a material breach, by us at any time upon six months’ prior written notice or by Sun Scientific if specified events related to sales, use and commercialization occur.

On October 26, 2018, we entered into a non-cancelable office lease agreement for approximately 80,745 square feet for new corporate headquarters space in Minneapolis, Minnesota. The initial lease term is ten years and six months, with an option to renew for two periods of five years each. The base rent increases yearly during the initial term, commencing at approximately $106,000 per month during the first year of the initial term and increasing to approximately $134,300 per month during the last six months of the initial term, and we are also obligated for certain taxes and operating expenses. We expect to begin incurring rent expense related to this lease in the first quarter ofMarch 31, 2019. ~~We are looking to sub-lease our existing building space for the remainder of our lease obligation, which ends July 31, 2021.~~

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Item 2. 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 condensed consolidated financial statements and the accompanying notes thereto included elsewhere in this report.

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~~policy-makers and insurance payers as a key for controlling rising healthcare costs. Our solutions deliver cost-effective, clinically proven, long-term treatment for ~~patients~~people with these chronic diseases.

Our proprietary products are the Flexitouch, Entre, and Actitouch 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. We derive the vast majority of our revenues from our Flexitouch system. For each of the ~~nine~~three months ended ~~September 30,~~March 31, 2019 and 2018, sales and ~~2017, sales~~rentals of our Flexitouch system represented ~~92% and~~ 91% of our ~~revenues, respectively.~~revenues.

In September 2012, we acquired our second proprietary product, the Actitouch system. The system received 510(k) clearance from the FDA in June 2013 and we began selling the product in September 2013 to address the many limitations of multilayered bandages that are worn by patients suffering from venous leg ulcers. We also introduced our Entre system in the United States in February 2013. The Entre system is sold 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 each of the ~~nine~~three months ended ~~September 30,~~March 31, 2019 and 2018, sales and ~~2017, sales~~rentals of our Entre and Actitouch systems combined represented ~~8% and~~ 9% of our ~~revenues, respectively.~~revenues. During fiscal year 2018, we recorded a $2.5 million non-cash impairment charge to fully impair the inventory and intangible assets related to our Actitouch system, and we intend to discontinue this product line in the second half of 2019. See Note 3 - “Summary of Significant Accounting Policies” in our Annual Report on Form 10-K for the year ended December 31, 2018 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 plan to begin selling the Airwear wrap in the second half of 2019.

To support the growth of our business, we invest heavily in our commercial infrastructure, consisting of our direct salesforce, home 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 salesforce has grown to a team of over ~~185 people~~210 employees as of ~~September 30, 2018~~March 31, 2019, compared to over ~~150 people~~160 employees as of ~~September 30, 2017.~~March 31, 2018. This model allows us to directly approach patients and clinicians, whereby we disintermediate the traditional durable medical equipment channel, allowing us to capture both the manufacturer and distributor margins. We also utilize over ~~500~~560 licensed, independent healthcare practitioners as home trainers who educate patients on the proper use of our systems. We invest substantial resources in our ~~reimbursement~~Reimbursement Department, which was reorganized in 2018 to improve operational efficiencies and enhance individual payer expertise, while continuing our strategic focus of payer development. The Reimbursement Department, composed of over

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75 employees, now consists of our Payer Development and Reimbursement Operations groups. Our Payer Development group is composed of both strategic and analytical teams, with focus on payer decision-maker relationships and education, payer policy development and revision, payer contract negotiations, and payer relations team, which consists of over 120 people. The reimbursement group focuses on verifying case-by-case benefits, obtaining prior authorization, billing and collecting payments from payers, and providing customer support services.data analysis. Our ~~payer relations~~experienced Reimbursement Operations group is responsible for ~~developing relationships with~~verifying patient insurance ~~payer decision-makers to educate them on our product efficacy, developing overall payer coverage policies~~benefits, individual patient case development, prior authorization submissons, case follow-up, and ~~reimbursement criteria, managing Medicare patient claims and contracts with payers, and serving as an advocacy liaison between patients, clinicians and payers throughout the~~ appeals ~~process. Our patients are reimbursed by government and private payers for the purchase of our products pursuant to established rates with each payer.~~when necessary. We also have a clinical team, consisting of a scientific advisory board, in-house therapists and nurses, and a medical director (part-time), that serves as a resource to clinicians and patients and guides the development of clinical evidence in support of our products.

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.

~~Table~~In February 2016, the FASB issued ASU No. 2016-02, “Leases” (Topic 842), which supersedes the existing guidance for lease accounting, “Leases” (Topic 840). ASC 842 requires lessees to recognize a lease liability and a right of ~~Contents~~use asset for all leases that extend beyond one year. As a result of our change in filing status, we adopted this standard using the modified retrospective transition approach at the adoption date of January 1, 2019. This approach does not require restatement of previous periods. We completed a qualitative and quantitative assessment of our leases from both a lessee and lessor perspective. As part of our process, we elected to utilize certain practical expedients that were provided for transition relief. Accordingly, we did not reassess expired or existing contracts, lease classifications or related initial direct costs as part of our assessment process for either lessee or lessor leases. Additionally, we elected the practical expedient to treat lease and nonlease components of fixed payments due to the lessor as one, and therefore no separate allocation was required on the initial implementation date of January 1, 2019, and thereafter. The adoption of this standard, from a lessee perspective, resulted in us recording ROU operating lease assets and liabilities of approximately $3.1 million on the Condensed Consolidated Balance Sheet as of January 1, 2019, with no impact to retained earnings. In addition, we elected as an accounting policy, not to record leases with an initial term of less than 12 months. From a lessor perspective, the application of ASC 842 to our rental revenue, which was recognized as month-to-month, cancelable leases in accordance with ASC 840 through December 31, 2018, resulted in recognizing rental revenue as a sales-type lease under ASC 842 thereafter. Rental sales agreements that commenced prior to December 31, 2018, will continue to be recognized as month-to-month, cancelable leases until they are completed, as we elected the practical expedient to not reassess the lease classification for leases in existence upon adoption. As such, rental agreements commencing after January 1, 2019 were recorded as sales-type leases with the associated revenue and cost of revenue recognized on the lease commencement date and a corresponding net investment in leases on the Condensed Consolidated Balance Sheet. (See Note 10 – “Commitments and Contingencies” and Note 12 – “Revenue” for additional information and required disclosures.)

As a result of our adoption of ASC 842, our rental revenue is such that, beginning with the three months ended March 31, 2019, rental revenue, cost of rental revenue and gross profit - rental revenue are presented as line items separate from sales revenue, cost of sales revenue and gross profit - sales revenue, respectively, in our Condensed Consolidated Statements of Operations. Our adoption of ASC 842 under the modified retrospective transition approach did not require restatement of previous periods, and therefore rental revenue, cost of rental revenue and gross profit - rental revenue for the three months ended March 31, 2018 were determined under ASC 840, inclusive of rental garments, but have been presented as separate line items in this report to conform to the current year presentation.

For the three months ended ~~September 30, 2018,~~March 31, 2019, we generated revenues of ~~$36.3~~$37.6 million and had net income of ~~$1.7~~$1.5 million, compared to revenues of ~~$28.3~~$26.8 million and a net ~~income~~loss of ~~$1.3~~$0.1 million for the three months ended September 30, 2017. For the nine months ended September 30, 2018, we generated revenues of $97.3 million and had net income of $4.3 million, compared to revenues of $74.4 million and net income of $3.6 million for the nine months ended September 30, 2017. March 31, 2018.

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

We operate in one segment for financial reporting purposes.

~~Results of Operations~~

~~Comparison of the Three and Nine Months ended September 30, 2018 and 2017~~

~~The following tables present our results of operations for the periods indicated.~~

Three Months Ended

September 30,

Change
(Dollars in thousands)

2018

2017

$

%
Condensed Consolidated Statement of

% of

% of

Operations Data:

revenue

revenue

Revenues

$
36,322

100
%

$
28,283

100
%

$
8,039

28
%
Cost of goods sold

10,141

28
%

7,528

27
%

2,613

35
%
Gross profit

26,181

72
%

20,755

73
%

5,426

26
%
Operating expenses

Sales and marketing

15,632

43
%

10,915

38
%

4,717

43
%
Research and development

1,223

3
%

1,116

4
%

107

10
%
Reimbursement, general and administrative

7,956

22
%

7,551

26
%

405

5
%
Total operating expenses

24,811

68
%

19,582

68
%

5,229

27
%
Income from operations

1,370

4
%

1,173

5
%

197

17
%
Other income

128

—
%

85

—
%

43

51
%
Income before income taxes

1,498

4
%

1,258

5
%

240

19
%
Income tax benefit

(248)

(1)
%

(84)

—
%

(164)

195
%
Net income

$
1,746

5
%

$
1,342

5
%

$
404

30
%

Nine Months Ended

September 30,

Change
(Dollars in thousands)

2018

2017

$

%
Condensed Consolidated Statement of

% of

% of

Operations Data:

revenue

revenue

Revenues

$
97,303

100
%

$
74,397

100
%

$
22,906

31
%
Cost of goods sold

27,060

28
%

20,186

27
%

6,874

34
%
Gross profit

70,243

72
%

54,211

73
%

16,032

30
%
Operating expenses

Sales and marketing

42,641

44
%

31,726

42
%

10,915

34
%
Research and development

3,949

4
%

3,699

5
%

250

7
%
Reimbursement, general and administrative

22,799

23
%

19,815

27
%

2,984

15
%
Total operating expenses

69,389

71
%

55,240

74
%

14,149

26
%
Income (loss) from operations

854

1
%

(1,029)

(1)
%

1,883

183
%
Other income

351

—
%

204

—
%

147

72
%
Income (loss) before income taxes

1,205

1
%

(825)

(1)
%

2,030

N.M.
%
Income tax benefit

(3,063)

(3)
%

(4,450)

(6)
%

1,387

(31)
%
Net income

$
4,268

4
%

$
3,625

5
%

$
643

18
%

~~“N.M.” Not Meaningful~~

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Results of Operations

Comparison of the Three Months Ended March 31, 2019 and 2018

The following table presents our results of operations for the periods indicated:


	Three Months Ended
	March 31,								Change
(In thousands)	2019				2018				$		%
Condensed Consolidated Statement			% of				% of
of Operations Data:			revenue				revenue
Revenue
Sales revenue	$	30,831	82	%	$	23,647	88	%	$	7,184	30	%
Rental revenue		6,786	18	%		3,201	12	%		3,585	112	%
Total revenue		37,617	100	%		26,848	100	%		10,769	40	%
Cost of revenue
Cost of sales revenue		9,412	25	%		6,409	24	%		3,003	47	%
Cost of rental revenue		1,947	5	%		900	3	%		1,047	116	%
Total cost of revenue		11,359	30	%		7,309	27	%		4,050	55	%
Gross profit
Gross profit - sales revenue		21,419	57	%		17,238	64	%		4,181	24	%
Gross profit - rental revenue		4,839	13	%		2,301	9	%		2,538	110	%
Gross profit		26,258	70	%		19,539	73	%		6,719	34	%
Operating expenses
Sales and marketing		17,391	47	%		12,557	48	%		4,834	38	%
Research and development		1,281	3	%		1,437	5	%		(156)	(11)	%
Reimbursement, general and administrative		9,388	25	%		7,372	27	%		2,016	27	%
Total operating expenses		28,060	75	%		21,366	80	%		6,694	31	%
Loss from operations		(1,802)	(5)	%		(1,827)	(7)	%		25	(1)	%
Other income		161	—	%		91	—	%		70	77	%
Loss before income taxes		(1,641)	(5)	%		(1,736)	(7)	%		95	(5)	%
Income tax benefit		(3,113)	(8)	%		(1,686)	(7)	%		(1,427)	85	%
Net income (loss)	$	1,472	3	%	$	(50)	—	%	$	1,522	N.M.	%

“N.M.” Not Meaningful

Revenues

Revenues increased ~~$8.0~~$10.8 million, or ~~28%~~40%, to ~~$36.3~~$37.6 million in the three months ended ~~September 30, 2018,~~March 31, 2019, compared to ~~$28.3~~$26.8 million in the three months ended ~~September 30, 2017. Revenues increased $22.9 million, or 31%, to $97.3 million in the nine months ended September 30, 2018, compared to $74.4 million in the nine months ended September 30, 2017.~~March 31, 2018. The growth in revenues was attributable to an increase of approximately ~~$7.1~~$9.6 million, or ~~27%~~39%, in sales and rentals of our Flexitouch system and an increase of approximately $1.2 million, or 51%, in sales and rentals of our Entre/Actitouch systems in the three months ended ~~September 30, 2018 and an increase of approximately $21.3 million, or 31%, in sales of our Flexitouch system in the nine months ended September 30, 2018.~~March 31, 2019. The increase in Flexitouch system sales and rentals was largely driven by expansion of our salesforce, growth in the ~~Veterans Administration~~Medicare channel, increased physician and patient awareness of the treatment options for lymphedema, and expanded contractual coverage with national and regional insurance payers. The increase in Entre/Actitouch systems sales and rentals was largely driven by the continued benefit from managing orders in-house and expanded contractual coverage with payers. Additionally, the adoption of ASC 842 contributed 10 percentage points to our year-over-year total revenue growth for the three months ended March 31, 2019.

Revenues from the Veterans Administration represented ~~19%~~20% and ~~20%~~23% of total revenues in the three months ended ~~September 30,~~March 31, 2019 and 2018, ~~and 2017, respectively. Revenues from the Veterans Administration represented 20% and 19% of total revenues in the nine months ended September 30, 2018 and 2017,~~ respectively. Revenues from Medicare represented ~~10%~~11% and 6%10% of total revenues in the three months ended ~~September 30,~~March 31, 2019 and 2018, ~~and 2017,~~ respectively. ~~Revenues from Medicare represented 8% and 9%~~

Table of ~~total revenues in the nine months ended September 30, 2018 and 2017, respectively.~~Contents

The following ~~tables summarize~~table summarizes our revenues by product for the three ~~and nine~~ months ended ~~September 30,~~March 31, 2019 and 2018, ~~and 2017,~~ both in dollars and percentage of total revenues:

Three Months Ended

September 30,

Change
(Dollars in thousands)

2018

2017

$

%
Revenues

Flexitouch system

$
33,330

$
26,202

$
7,128

27 %
Entre/Actitouch systems

2,992

2,081

911

44 %
Total

$
36,322

$
28,283

$
8,039

28 %

Percentage of total revenues

Flexitouch system

92 %

93 %

Entre/Actitouch systems

8 %

7 %

Total

100 %

100 %


	Nine Months Ended							Three Months Ended
	September 30,				Change			March 31,				Change
(Dollars in thousands)	2018		2017		$		%
(In thousands)								2019		2018		$		%
Revenues
Flexitouch system	$	89,216	$	67,936	$	21,280	31 %	$	34,109	$	24,530	$	9,579	39 %
Entre/Actitouch systems		8,087		6,461		1,626	25 %		3,508		2,318		1,190	51 %
Total	$	97,303	$	74,397	$	22,906	31 %	$	37,617	$	26,848	$	10,769	40 %

Percentage of total revenues
Flexitouch system		92 %		91 %					91 %		91 %
Entre/Actitouch systems		8 %		9 %					9 %		9 %
Total		100 %		100 %					100 %		100 %

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 ~~sales~~revenues in the third and fourth quarters of the year as a result of patients having paid their annual insurance deductibles in full, thereby reducing their out-of-pocket costs for our products, and because patients often spend the remaining balances in their healthcare flexible spending accounts at that time. 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

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deductibles over the course of the plan year or do not have plans that include patient deductibles for purchases or rentals of our products.

Cost of ~~Goods Sold~~Revenue and Gross Margin

Cost of ~~goods sold~~revenue increased ~~$2.6~~$4.1 million, or ~~35%~~55%, to ~~$10.1~~$11.4 million in the three months ended ~~September 30, 2018,~~March 31, 2019, compared to ~~$7.5~~$7.3 million in the three months ended September 30, 2017. Cost of goods sold increased $6.9 million, or 34%, to $27.1 million in the nine months ended September 30, 2018, compared to $20.2 million in the nine months ended September 30, 2017.March 31, 2018. The increase in cost of ~~goods sold in each of the three and nine months ended September 30, 2018 compared to the same periods in 2017~~revenue was primarily attributable to an increase in the number of Flexitouch systems ~~sold,~~sold/rented and ASC 842 leasing impact as well as additional manufacturing headcount to support increased volumes.

~~Gross~~Sales gross margin was ~~72%~~70% of sales revenue in ~~each of~~ the three ~~and nine~~ months ended ~~September 30, 2018. Gross margin was~~March 31, 2019, compared to 73% of sales revenue in ~~each of~~ the three ~~and nine~~ months ended ~~September 30, 2017. The current period~~March 31, 2018. Rental gross margin ~~rate~~ was ~~impacted~~71% of rental revenue in the three months ended March 31, 2019, compared to 72% of rental revenue in the three months ended March 31, 2018. The gross margin decreases were primarily attributable to negative pricing effects related to the new large private insurer contract we entered into in July 2018, the composition of sales mix by payer and by product in comparison to the ~~launch of Flexitouch Plus, as well as a payment rate reduction associated with a national payer contract that became effective July 1, 2018.~~prior year, and amortization expense related to the newly licensed assets from Sun Scientific, Inc.

Sales and Marketing Expenses

Sales and marketing expenses increased ~~$4.7~~$4.8 million, or ~~43%~~38%, to ~~$15.6~~$17.4 million in the three months ended ~~September 30, 2018,~~March 31, 2019, compared to ~~$10.9~~$12.6 million in the three months ended ~~September 30, 2017.~~March 31, 2018. The ~~year-over-year~~ increase was primarily driven by a ~~$3.2~~$3.3 million increase in personnel-related compensation expense due to increased sales and marketing headcount, including $0.5 million of incremental stock-based compensation expense. In addition, other sales and marketing expenses increased $1.5 million, driven by increased spending associated with field sales meetings, travel and entertainment, recruiting, ~~consulting~~ and patient training ~~expenses, including training associated with the full commercial launch of the Flexitouch Plus that began in April 2018.~~

Sales and marketing expenses increased $10.9 million, or 34%, to $42.6 million in the nine months ended September 30, 2018, compared to $31.7 million in the nine months ended September 30, 2017. The year-over-year increase was primarily driven by a $7.5 million increase in personnel-related compensation expense due to increased sales and marketing headcount, including $1.2 million of incremental stock-based compensation expense. In addition, other sales and marketing expenses increased $3.4 million, driven by increased spending associated with field sales meetings, travel and entertainment, recruiting, consulting and patient training expenses, including training associated with the full commercial launch of the Flexitouch Plus that began in April 2018.expenses.

Research and Development Expenses

Research and development (“R&D”) expenses ~~increased $0.1~~decreased $0.2 million, or ~~10%~~11%, to ~~$1.2~~$1.3 million in the three months ended ~~September 30, 2018,~~March 31, 2019, compared to ~~$1.1~~$1.4 million in the three months ended ~~September 30, 2017.~~March 31, 2018. The ~~year-over-year increase~~decrease was primarily attributable to ~~increased product development costs.~~

~~R&D expenses increased $0.3 million, or 7%, to $3.9 million in~~ the nine months ended September 30, 2018, compared to $3.7 million in the nine months ended September 30, 2017. The year-over-year increase was primarily attributable to increased product development costs, partially offset by decreasedtiming of clinical studies ~~expenses.~~projects.

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Reimbursement, General and Administrative Expenses

Reimbursement, general and administrative expenses increased ~~$0.4~~$2.0 million, or 5%27%, to ~~$8.0~~$9.4 million in the three months ended ~~September 30, 2018,~~March 31, 2019, compared to ~~$7.6~~$7.4 million in the three months ended ~~September 30, 2017.~~March 31, 2018. This increase was primarily attributable to a ~~$1.3~~$1.2 million increase in personnel-related compensation expense as a result of increased headcount in our reimbursement operations, payer ~~relations~~development and corporate functions, including ~~$0.9~~$0.7 million of incremental stock-based compensation expense, of which $0.6 million was related to the continued vesting of equity awards held by a former executive. These equity awards will continue to vest into the first quarter of 2019. The identified increases were partially offset by a $0.8 million year-over-year decrease in sales and use taxes due to a one-time charge in the prior year period.

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Reimbursement, general and administrative expenses increased $3.0 million, or 15%, to $22.8 million in the nine months ended September 30, 2018, compared to $19.8 million in the nine months ended September 30, 2017. This increase was primarily attributable to a $2.9 million increase in personnel-related compensation expense as a result of increased headcount in our reimbursement operations, payer relations and corporate functions. This increase included $1.1 million of incremental stock-based compensation expense, of which $0.6 million was related to the continued vesting of equity awards held by a former executive. These equity awards will continue to vest into the first quarter of 2019.expense. The increase in reimbursement, general and administrative expenses was also attributable to a ~~$0.9~~$0.7 million increase in professional fees, legal expenses, ~~recruiting,~~ facilities, and ~~volume-based service charges. The identified increases were partially offset by a $0.8~~depreciation as well as $0.1 million ~~year-over-year decrease~~ in ~~accrued sales and use taxes due~~legal expenses specifically related to ~~a one-time charge~~the defense of the ongoing lawsuit described in ~~the prior year period.~~“Legal Proceedings” in this report.

Other Income, Net

Other income was ~~$128,000~~$0.2 million and ~~$85,000~~$0.1 million for the three months ended ~~September 30,~~March 31, 2019 and 2018, ~~and 2017, respectively, and $351,000 and $204,000 for the nine months ended September 30, 2018 and 2017,~~ respectively. The increase in other income was primarily due tothe accretion of discounts on purchases of ~~investment income earned on our~~ marketable securities.

Income Taxes

We recorded an income tax benefit of ~~$0.2~~$3.1 million and ~~$0.1~~$1.7 million in the three months ended ~~September 30,~~March 31, 2019 and 2018, ~~and 2017, respectively. We recorded an income tax benefit of $3.1 million and $4.5 million in the nine months ended September 30, 2018 and 2017,~~ respectively. The continued significant tax deductions related to tax benefits realized from the vesting of restricted stock units, the exercise of non-qualified stock options, and the disqualifying dispositions of incentive stock options and ESPP shares contributed to our net income for the three ~~and nine~~ months ended ~~September 30, 2018.~~March 31, 2019. The increase in the current period income tax benefit was due to increased tax-deductible share-based compensation activity recognized in the three months ended March 31, 2019.

Liquidity and Capital Resources

Cash Flows

At ~~September 30, 2018,~~March 31, 2019, our principal sources of liquidity were cash and cash equivalents of $~~23.1~~23.5 million, marketable securities of $~~22.8~~21.4 million and net accounts receivable of $~~20.2~~23.8 million, and the borrowing capacity available under our Credit Agreement.

The following table summarizes our cash flows for the periods indicated:


	Nine Months Ended				Three Months Ended
	September 30,				March 31,
(In thousands)	2018		2017		2019		2018
Net cash provided by (used in):
Operating activities	$	3,684	$	33	$	1,273	$	(2,173)
Investing activities		(5,228)		(13,193)		3,725		4,568
Financing activities		712		2,112		(1,549)		(1,050)
Net decrease in cash and cash equivalents	$	(832)	$	(11,048)
Net increase in cash and cash equivalents					$	3,449	$	1,345

Operating Activities

Net cash provided by operating activities during the ~~nine~~three months ended ~~September 30, 2018~~March 31, 2019 was ~~$3.7~~$1.3 million, resulting from net income of ~~$4.3~~$1.5 million and non-cash net income adjustments of ~~$7.1~~$1.5 million, which were ~~partially~~ offset by a net increase in operating assets and liabilities of ~~$7.7~~$1.7 million. The non-cash net income adjustments ~~primarily~~ consisted of ~~$5.6~~$2.8 million of stock-based compensation expense and ~~$2.5~~$1.0 million of depreciation and amortization ~~expense.~~expense, partially offset by deferred income tax changes of $2.3 million. The uses of cash related to changes in operating assets primarily consisted of increases in net investment in leases of $3.4 million, right of use operating lease assets of $3.4 million and income taxes receivable of $1.0 million, partially offset by a decrease in accounts receivable of $2.7 million. The changes in ~~net~~ operating ~~assets~~liabilities consisted of increases in right of use operating lease liabilities of $3.5 million and ~~liabilities were primarily due to a $2.1~~accounts payable of $0.7 million, increase in income taxes, driven by the current period tax benefit associated with tax-deductible stock-based compensation activity, and a $3.9 million increase in inventories, associated with the commercial launch of our Flexitouch Plus.

partially

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offset by a decrease in accrued payroll and related taxes of $0.6 million. These changes occurred primarily due to the adoption of ASC 842.

Net cash ~~provided by~~used in operating activities ~~during~~in the ~~nine~~three months ended ~~September 30, 2017~~March 31, 2018 was ~~$33,000,~~$2.2 million, resulting from a net ~~income~~loss of ~~$3.6~~$0.1 million and ~~non-cash~~a net ~~income adjustments~~increase in operating assets and liabilities of $4.1 million, ~~including $3.1 million of stock-based compensation expense and $1.1 million of depreciation and amortization expense. This was~~ partially offset by ~~a $7.7 million increase~~non-cash operating expenses of $2.0 million. The changes in net operating assets and liabilities ~~primarily~~were primarilty due to a $3.6 million increase in inventories, associated with the commercial launch of our next-generation Flexitouch system; a $1.8 million decrease in accrued payroll and related ~~to increases in income~~ taxes, ~~receivable~~driven by the payment of ~~$5.6~~2017 bonuses; and a $1.8 million ~~and inventory of $3.8 million. The~~ increase in income taxes receivable, ~~was a result of~~driven by the ~~significant~~ tax ~~benefits recognized in the period~~benefit associated with tax-deductible ~~share-based~~stock-based compensation ~~activity.~~activity in that period, partially offset by a $3.4 million decrease in accounts receivable. The ~~increase in inventory was driven largely by the increased sales volume as well as purchases associated with product development~~non-cash operating expenses primarily consisted of $1.5 million of stock-based compensation and ~~new product introductions.~~$0.5 million of depreciation and amortization of equipment, leasehold improvements and patents.

Investing Activities

Net cash ~~used in~~provided by investing activities during the ~~nine~~three months ended ~~September 30, 2018~~March 31, 2019 was ~~$5.2~~$3.7 million, primarly consisting of ~~$1.8~~$4.5 million in ~~net purchases~~maturities of marketable securities ~~$1.5 million in purchases of rental and demonstration equipment, $1.1 million related to the acquisition of patents and other intangible assets and $0.8~~partially offset by $0.7 million in purchases of product tooling and computer and manufacturing equipment, leasehold improvements and furniture and fixtures.

Net cash ~~used in~~provided by investing activities during the ~~nine~~three months ended ~~September 30, 2017~~March 31, 2018 was ~~$13.2~~$4.6 million, consisting primarily of ~~$11.1~~$5.0 million in ~~net purchases~~sales and maturities of marketable securities, ~~and $2.0~~offset by $0.4 million in purchases of product tooling and computer and manufacturing ~~equipment, and leasehold improvements.~~equipment.

Financing Activities

Net cash ~~provided by~~used in financing activities during the ~~nine~~three months ended ~~September 30, 2018~~March 31, 2019 was ~~$0.7~~$1.5 million, consisting of ~~proceeds from the issuance of common stock under the ESPP of $1.4 million and proceeds from exercises of common stock options of $1.2 million, partially offset by $1.9~~$2.4 million in taxes paid for the net share settlement of restricted stock ~~units.~~

~~Net cash provided~~units, offset by ~~financing activities during the nine months ended September 30, 2017 was $2.1 million, consisting of proceeds from the issuance of common stock under the ESPP of $2.2 million and~~ proceeds from exercises of common stock options ~~and warrants~~ of ~~$0.7~~$0.9 million.

Net cash used in financing activities during the three months ended March 31, 2018 was $1.1 million, ~~partially offset by the purchase~~consisting of ~~treasury stock to fund taxes from restricted stock award vesting of $0.5~~$1.2 million ~~and~~in taxes paid for the net share settlement of restricted stock units, offset by proceeds from exercises of ~~$0.3~~common stock options of $0.1 million.

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 and a Waiver and Second Amendment dated March 25, 2019 (collectively, the ~~Credit Agreement,~~“Credit Agreement”), which expires on August 3, 2021. The Credit Agreement provides for a ~~$10,000,000~~$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 ~~$25,000,000,~~$25.0 million, subject to satisfaction of certain conditions. As of ~~September 30, 2018~~March 31, 2019, 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 ~~September 30, 2018,~~March 31, 2019, we were in compliance with all financial covenants under the Credit Agreement. For additional information on the Credit Agreement, see Note 89 – “Credit Agreement” to the condensed consolidated financial statements in this report.

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Adequacy of Capital Resources

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

sales and marketing resources needed to further penetrate our market;

expansion of our operations domestically and/or internationally;

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responses 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 revenues, operations and personnel, and we anticipate that our expenditures will continue to increase as we expand our business.

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

Inflation and changing prices did not have a material effect on our business during the ~~nine~~three months ended ~~September 30, 2018,~~March 31, 2019, and we do not expect that inflation or changing prices will materially affect our business infor at least the ~~foreseeable future.~~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.

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Contractual and Commercial Commitments Summary

Our contractual obligations and commercial commitments as of ~~September 30, 2018~~March 31, 2019 are summarized below:


	Payments Due By Period										Payments Due By Period
			Less Than						More Than				Less Than						More Than
(In thousands)	Total		1 Year		1-3 Years		3-5 Years		5 Years		Total		1 Year		1-3 Years		3-5 Years		5 Years
Purchase commitments (1)	$	16,686	$	11,526	$	5,160	$	—	$	—	$	19,505	$	19,505	$	—	$	—	$	—
Operating lease obligations (2)		3,692		1,109		1,787		796		—		3,694		1,290		1,653		751		—
Future product royalties (3)		6		6		—		—		—		3		3		—		—		—
Total	$	20,384	$	12,641	$	6,947	$	796	$	—	$	23,202	$	20,798	$	1,653	$	751	$	—

(1)

We issued purchase orders ~~in 2017~~prior to March 31, 2019 totaling ~~$1.7~~$19.5 million for ~~items~~goods that we expect to receive between ~~October~~April and December of ~~2018. We issued purchase orders in 2018 totaling $15.0 million for items that we expect to receive in~~ 2019.

(2)

We currently lease approximately 52,000 square feet of office space atfor our corporate headquarters in Minneapolis, Minnesota, under a lease that expires in July 2021 and ~~an additional 38,520~~44,000 square feet of office, assembly and warehouse space at ~~a second~~another leased facility in Minneapolis, Minnesota, under a lease that expires in ~~November 2023.~~February 2024. We entered into a lease in October 2018 for approximately 110,000 square feet of office space for our future corporate headquarters in Minneapolis, Minnesota, which will commence upon our move, which is expected to occur in the fourth quarter of 2019. That lease expires in February 2030. As of March 31, 2019, we have lease commitments of $19.9 millions related to our future headquarters that are not included in the table above, since we have not

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yet recognized it as an operating lease. As the lessee, we are involved in providing guidance to the lessor for related improvements, however these improvements are managed and owned by the lessor. We entered into a fleet vehicle program for certain members of our field sales organization in 2016. At March 31, 2019, we had 40 vehicles under this program with current lease commitments. Furthermore, we lease office equipment from time-to-time based on our needs and these commitments are classified as operating leases.

(3)

We are required to make quarterly royalty payments to a ~~third party~~third-party for our Actitouch system ~~revenues~~revenue through August 2023. Beginning in September 2017, the payments are equal to 6% of our quarterly revenues attributable to our Actitouch system. In any year that these revenues exceed $40.0 million, we are required to pay 7% on revenues over $40.0 million and 6% on revenues of $40.0 million and under. Because our revenues attributable to our Actitouch system, and therefore the amount of royalty payments we will be required to pay in the future, are unknown, this amount only reflects royalties due associated with a portion of our ~~2018~~2019 Actitouch revenues.

Off-Balance Sheet Arrangements

We do not have any off-balance sheet arrangements, investments in special purpose entities or undisclosed borrowings or debt. Additionally, we are not a party to any derivative contracts or synthetic leases.

Recent Accounting Pronouncements

Refer to Note 3 - “Summary of Significant Accounting Policies” of our condensed consolidated financial statements contained in this report for a description of recently issued accounting pronouncements that are applicable to our business.

JOBS Act

~~We currently are~~Prior to December 31, 2018, we were an “emerging growth company” as defined by the JOBS Act. The JOBS Act provides that an emerging growth company can take advantage of the extended transition period for complying with new or revised accounting standards. This allows an emerging growth company to delay the adoption of certain accounting standards until those standards would otherwise apply to private companies. We elected to avail ourselves of this exemption prior to December 31, 2018, and as a result, our financial statements prior to that date may not behave been comparable to the financial statements of issuers who are required to comply with the effective dates for new or revised accounting standards that are applicable to public companies. Section 107 of the JOBS Act provides that we can elect to opt out of the extended transition period at any time, which election is irrevocable. However, as of the last business day of our second fiscal quarter of 2018, the market value of our common stock that was held by non-affiliates exceeded $700 million, and as a result, we will no longer qualify as an emerging growth company as of December 31, 2018 and will no longer be able to take advantage of the extended transition period.

Subject to certain conditions, as an emerging growth company we ~~currently are relying~~also were able to rely on certain of the exemptions and reduced reporting requirements of the JOBS Act, including without limitation, from providing an auditor's attestation report on our system of internal control over financial reporting pursuant to Section 404(b) of the Sarbanes-Oxley Act of 2002 and from complying with any requirement that may be adopted by the Public Company Accounting Oversight Board regarding mandatory audit firm rotation or a supplement to the auditor's report providing additional information about the audit and the financial statements, known as the auditor discussion and analysis. Because the market value of our common stock that was held by non-affiliates as of the last business day of our second fiscal quarter of 2018 exceeded $700 million, we ~~will be~~were deemed a large accelerated filer ~~as of December 31, 2018~~ and ~~will~~ no longer qualify as an emerging growth ~~company.~~company as of December 31, 2018. As a result, we ~~will~~ no longer beare able to take advantage of the extended transition period for the adoption of certain accounting standards or of the reduced disclosure and other

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benefits available to emerging growth companies, ~~after that date,~~ including our exemption from providing our auditor’s attestation on our system of internal control over financial reporting, ~~pursuant to Section 404(b) of~~which was included for the ~~Sarbanes-Oxley Act of 2002. See Part II, Item 1A., “Risk Factors” of this Quarterly~~first time our Annual Report on Form ~~10-Q~~10-K for ~~further discussion~~the year ended December 31, 2018.

Table of ~~these matters.~~Contents

Critical Accounting Policies and Estimates

A “critical accounting policy” is one that is both important to the portrayal of our financial condition and results and requires management’s most subjective or complex judgments, often as a result of the need to make estimates about the effect of items that are inherently uncertain. For additional information, please see the discussion of our significant accounting policies under “Critical Accounting Policies and Significant Estimates” in Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the year ended December 31, ~~2017.~~2018.

Item 3. 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 ~~goods sold,~~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 revenues, if the selling and rental prices of our products do not increase as much or more than these increased costs.

Credit Risk

As of ~~September 30, 2018~~March 31, 2019 and December 31, ~~2017,~~2018, our cash, cash equivalents and marketable securities were maintained with three financial institutions in the United States. We have reviewed the financial statements of these 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.

Our accounts receivable primarily relate to revenues from the sale and rental of our products to patients in the United States. As of ~~September 30,~~March 31, 2019 and 2018, ~~and 2017,~~ our accounts receivable and net investment in leases were ~~$21.2~~$27.2 million and ~~$17.4~~$17.2 million, respectively. We had accounts receivable from three ~~insurance companies~~insurers representing approximately ~~28%~~30%, ~~16%~~14% and ~~11%~~8% of accounts receivable as of ~~September 30, 2018,~~March 31, 2019, and we had accounts receivable from three insurance companies representing approximately ~~28%~~25%, 17% and 6% of accounts receivable as of ~~September 30, 2017.~~

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March 31, 2018.

Foreign Currency Risk

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

Item 4. Controls and Procedures.

Evaluation of Disclosure Controls and Procedures

Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures as of ~~September 30, 2018.~~March 31, 2019. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or

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submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on the evaluation of our disclosure controls and procedures as of ~~September 30, 2018,~~March 31, 2019, our Chief Executive Officer and Chief Financial Officer concluded that, as of such date, our disclosure controls and procedures were effective at the reasonable assurance level.

Changes in Internal Control over Financial Reporting

There ~~were~~was no ~~material changes~~change in ~~our~~the Company’s internal control over financial reporting, as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act, that occurred during the ~~three months~~quarter ended ~~September 30, 2018~~March 31, 2019 that ~~have~~has materially affected, or ~~are~~is reasonably likely to materially affect, our internal control over financial reporting.

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PART II—OTHER INFORMATION

Item 1. Legal Proceedings.

From time to time, we ~~may be~~are subject to various claims and legal proceedings arising in the ordinary course of ~~business. We are not currently a party to any legal proceedings that, in the opinion of our management, are likely to have a material adverse effect on our~~ business. Regardless of outcome, litigation can have an adverse impact on us because of defense and settlement costs, diversion of management resources, and other factors.

On February 13, 2019, we were served with a sealed amended complaint venued in the United States District Court in the Southern District of Texas, Houston Division, captioned United States ex rel Veterans First Medical Supply, LLC vs. Tactile Medical Systems Technology, Inc., Case No. 18-2871, which had been filed on January 23, 2019. The complaint was unsealed on March 20, 2019. The complaint is a qui tam action on behalf of the United States brought by one of our competitors. The United States has declined to intervene in this action. The complaint alleges that we violated the Federal Anti-Kickback Statute claiming that we submitted false claims and made false statements in connection with the Medicare and Medicaid programs, and that we engaged in unlawful retaliation in violation of the Federal False Claims Act. The complaint seeks damages, statutory penalties, attorneys’ fees, treble damages and costs. We filed a motion to dismiss on April 5, 2019. We believe that the allegations in the lawsuit are without merit and we intend to continue to vigorously defend against the lawsuit.

Item 1A. Risk Factors.

In addition to the other information set forth in this Quarterly Report on Form 10-Q, you should carefully consider the factors discussed in “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, ~~2017~~,2018, which could materially affect our business, financial condition or future results. ~~Except as set forth below, there~~There have been no material changes in our risk factors from those disclosed in that report. ~~The following risk factors are revised or added:~~

~~Changes in United States or Chinese trade policy, including the imposition of tariffs and the resulting consequences, may have a material adverse impact on our business and results of operations.~~

The United States government has indicated its intent to adopt a new approach to trade policy and in some cases to renegotiate, or potentially terminate, certain existing bilateral or multi-lateral trade agreements. It has also initiated or is considering the imposition of tariffs on certain foreign goods, including certain raw materials that are included in our products, or on our products directly. Changes in U.S. trade policy could result in one or more of its trading partners adopting responsive trade policy making it more difficult or costly for us to export our products to those countries in the future or import our products or raw materials utilized in making our products. These measures could result in increased costs for goods imported into the United States. Since our prices are often fixed due to the reimbursement policies of, and arrangements with, third party payers, this could result in lowering our margin on products sold.

China has announced a plan to impose tariffs on a wide range of U.S. products in retaliation for new U.S. tariffs. Additional tariffs could be imposed by China in response to proposed increased tariffs on products imported from China. There is also a concern that the imposition of additional tariffs by the United States, including the increases proposed for raw materials utilized in our products, or our products themselves, could result in the adoption of tariffs by other countries. The resulting trade war could have a significant adverse effect on world trade and the world economy. To the extent that trade tariffs and other restrictions imposed by the United States increase the price of, or limit the amount of, the raw materials and products we import into the United States, the costs of our raw materials may be adversely affected and the demand from our customers for products and services may be diminished, which could adversely affect our revenues and profitability. In addition, our margins could be significantly impacted.

We cannot predict future trade policy or the terms of any renegotiated trade agreements and their impact on our business. The adoption and expansion of trade restrictions, the occurrence of a trade war, or other governmental action related to tariffs or trade agreements or policies have the potential to adversely impact demand for our products, our costs, our customers, our suppliers, and the United States economy, which in turn could adversely impact our business, financial condition and results of operations.

~~Increases in our operating costs could have an adverse effect on our financial condition and results of operations.~~

Reimbursement rates are established by fee schedules mandated by private payers, Medicare, the Veterans Administration and certain Medicaid programs and are likely to remain constant or decrease due, in part, to federal and state government budgetary constraints. As a result, with respect to Medicare and Medicaid related revenues, we may not be able to offset the effects of general inflation on our operating costs through increases in prices for our products. In particular, labor and related costs account for a significant portion of our operating costs and we compete with other healthcare providers to attract and retain qualified or skilled personnel and with various industries for administrative and service employees. This competitive environment could result in increased labor costs. As such, we must control our operating costs, particularly labor and related costs, and failing to do so could adversely affect our financial conditions and results of operations.

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~~Our operating costs may fluctuate significantly in the future as a result of a variety of factors, many of which are outside of our control. These factors include:~~


			~~increased sales and marketing costs to increase awareness of our products;~~
			~~costs to develop new and enhanced features for current products and research and development costs for new products;~~
			the time, resources, and expense required to develop and conduct clinical trials and seek additional regulatory clearances and approvals for additional treatment indications for our products and for any additional products we develop;
			~~the costs of preparing, filing, prosecuting, defending, and enforcing patent claims and other patent related costs, including litigation costs and the results of such litigation;~~
			~~any product liability or other lawsuits related to our products and the costs associated with defending them or the costs related to the results of such lawsuits;~~
			~~the costs to attract and retain personnel with the skills required for effective operations;~~
			~~the costs associated with being a public company, which will increase further once we no longer qualify as an emerging growth company as of December 31, 2018; and~~
			~~costs associated with entering international markets.~~

~~Our failure to anticipate and minimize the impact of these costs could adversely affect our business and results of operations.~~

~~We may be unable to manage our growth effectively.~~

Our past growth has provided, and our future growth may create, challenges to our organization. As of September 30, 2018, we have over 460 employees. We intend to continue to grow and may experience periods of rapid growth and expansion. Future growth will impose significant added responsibilities on management, including the need to identify, recruit, train, integrate, retain and motivate additional employees. In addition, rapid and significant growth will place a strain on our administrative personnel, information technology systems and other operational infrastructure. Any failure by us to manage our growth effectively could have an adverse effect on our ability to achieve our development and commercialization goals.

Successful growth is also dependent upon our ability to implement appropriate financial and management controls, systems and procedures. In order to manage our operations and growth, we will need to continue to improve our operational and management controls, reporting and information technology systems and financial internal control procedures, which will become more complex once we no longer qualify as an emerging growth company as of December 31, 2018. If we are unable to manage our growth effectively, it may be difficult for us to execute our business strategy and there could be an adverse impact on our business.

~~We currently are an emerging growth company, and the reduced disclosure requirements applicable to emerging growth companies may make our common stock less attractive to investors.~~

We currently are an emerging growth company, as defined in the JOBS Act, but, based on the market value of our common stock held by non-affiliates as of the last business day of our second fiscal quarter of 2018, we will no longer qualify as an emerging growth company as of December 31, 2018. For so long as we remain an emerging growth company, we are permitted and intend to rely on exemptions from certain disclosure requirements that are applicable to other public companies that are not emerging growth companies. We have taken advantage of reduced reporting burdens in previous

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reports and filings, as well as in this report. We cannot predict whether investors will find our common stock less attractive while we continue to rely on these exemptions. If some investors find our common stock less attractive as a result, there may be a less active trading market for our common stock and our stock price may be reduced or more volatile.

In addition, the JOBS Act provides that an emerging growth company can take advantage of an extended transition period for complying with new or revised accounting standards. This allows an emerging growth company to delay the adoption of these accounting standards until they would otherwise apply to private companies. We have elected to avail ourselves of this exemption and, as a result, our financial statements may not be comparable to the financial statements of issuers that are required to comply with the effective dates for new or revised accounting standards that are applicable to public companies. We cannot predict whether investors will find our common stock less attractive while we continue to rely on these exemptions. If some investors find our common stock less attractive as a result, there may be a less active trading market for our common stock and our stock price may be reduced or more volatile.

~~As of December 31, 2018, we will no longer be an emerging growth company and, as a result, we will have to comply with increased disclosure and compliance requirements.~~

As a result of the market value of our common stock held by non-affiliates exceeding $700 million as of the last business day of our second fiscal quarter of 2018, we will be deemed a large accelerated filer and we will no longer qualify as an emerging growth company as of December 31, 2018. Accordingly, we will be subject to certain disclosure and compliance requirements that apply to other public companies but did not previously apply to us due to our status as an emerging growth company. These requirements include:


			the requirement that our independent registered public accounting firm attest to the effectiveness of our internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act of 2002;
			~~that we adopt new or revised accounting standards when they are applicable to public companies, instead of delaying their adoption until they are applicable to private companies;~~
			compliance with any requirement that may be adopted by the Public Company Accounting Oversight Board regarding mandatory audit firm rotation or a supplement to the auditor's report providing additional information about the audit and the financial statements;
			~~the requirement that we provide full and more detailed disclosures regarding executive compensation; and~~
			~~the requirement that we hold a non-binding advisory vote on executive compensation and obtain stockholder approval of any golden parachute payments not previously approved.~~

We expect that the loss of emerging growth company status and compliance with the additional requirements of being a large accelerated filer will increase our legal and financial compliance costs and cause management and other personnel to divert attention from operational and other business matters to devote substantial time to public company reporting requirements. In addition, if we are not able to comply with changing requirements in a timely manner, the market price of our stock could decline and we could be subject to sanctions or investigations by the stock exchange on which our common stock is listed, the SEC, or other regulatory authorities, which would require additional financial and management resources.

We are incurring increased costs and are subject to additional regulations and requirements as a result of being a public company, which costs and requirements will increase in connection with us no longer qualifying as an emerging growth company, which could lower our profits or make it more difficult to run our business.

As a public company, we have incurred, and are continuing to incur, significant legal, accounting and other expenses that we did not incur as a private company, including costs associated with public company reporting requirements and costs associated with the Sarbanes-Oxley Act and related rules implemented by the SEC and Nasdaq. These expenses and costs will increase as we prepare for, and following, us no longer qualifying as an emerging growth company as of December 31, 2018. These expenses could lower our profits or make it more difficult to run our business.

Furthermore, if we are unable to satisfy our obligations as a public company, we could be subject to delisting of our common stock, fines, sanctions and other regulatory action and potentially civil litigation.

~~Table of Contents~~

If we fail to maintain proper and effective internal control over financial reporting, our ability to produce accurate and timely financial statements could be impaired, which could harm our operating results, investors' views of us and, as a result, the value of our common stock.

Pursuant to Section 404 of the Sarbanes-Oxley Act, our management was required to report upon the effectiveness of our internal control over financial reporting beginning with our Annual Report on Form 10-K for the year ended December 31, 2017. Since we will be a large accelerated filer, and we will cease to be an emerging growth company, as of December 31, 2018, our independent registered public accounting firm will be required to attest to the effectiveness of our internal control over financial reporting beginning with our Annual Report on Form 10-K for the year ending December 31, 2018. The rules governing the standards that must be met for management and our independent registered public accounting firm to assess our internal control over financial reporting are complex and require significant documentation, testing, and possible remediation. In connection with our and our independent registered public accounting firm’s evaluations of our internal control over financial reporting, we may need to upgrade our systems, including information technology; implement additional financial and management controls, reporting systems, and procedures; and hire additional accounting and finance staff.

Any failure to implement required new or improved controls, or difficulties encountered in their implementation, could cause us to fail to meet our reporting obligations. In addition, any testing by us or our independent registered public accounting firm conducted in connection with Section 404 of the Sarbanes-Oxley Act may reveal deficiencies in our internal control over financial reporting that are deemed to be material weaknesses or that may require prospective or retroactive changes to our financial statements or identify other areas for further attention or improvement. Inferior internal controls could also cause investors to lose confidence in our reported financial information, which could have a negative effect on the trading price of our common stock. Internal control deficiencies could also result in a restatement of our financial results in the future. We could become subject to stockholder or other third-party litigation, as well as investigations by the SEC, the stock exchange on which our securities are listed, or other regulatory authorities, which could require additional financial and management resources and could result in fines, trading suspensions, payment of damages or other remedies. Further, any delay in compliance with the auditor attestation provisions of Section 404 could subject us to a variety of administrative sanctions, including ineligibility for short-form resale registration, action by the SEC and the suspension or delisting of our common stock, which could reduce the trading price of our common stock and could harm our business

~~Our credit facility contains covenants that restrict our business and financing activities, and the property that secures our obligations under the credit facility may be subject to foreclosure.~~

Our revolving credit facility contains a number of restrictions and covenants, which, among other things, restrict our ability to acquire or merge with another entity, dispose of our assets, make investments, loans or guarantees, incur additional indebtedness, create liens or other encumbrances, or pay dividends or make other distributions. The Credit Agreement also requires us to maintain compliance with a maximum leverage ratio and a minimum liquidity covenant. These provisions impose significant operating and financial restrictions on us and may limit our ability to compete effectively, take advantage of new business opportunities or take other actions that may be in our best interests. Our ability to obtain additional or other financing or to dispose of certain assets could also be negatively impacted because we have pledged substantially all of our assets as collateral in connection with the credit facility.

Our ability to comply with the provisions under the Credit Agreement may be affected by events beyond our control, and our inability to comply with any of these provisions could result in a default under the Credit Agreement. If such a default occurs, the lenders may elect to declare all borrowings outstanding, together with accrued interest and other fees, to be immediately due and payable, and they would have the right to terminate any commitments they have to provide further borrowings. If we are unable to repay outstanding borrowings when due, the lenders under the Credit Agreement also have the right to proceed against the collateral, including substantially all of our assets, granted to them to secure the indebtedness under that facility. If our indebtedness under the Credit Agreement were to be accelerated, we cannot assure you that our assets would be sufficient to repay in full that indebtedness. The occurrence of any of these events could have a material adverse effect on our business, financial condition, results of operations and liquidity.

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Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

Recent Sales of Unregistered Securities

(a)

Issuances of Preferred Stock

None.

(b)

Issuances of Common Stock

None.

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Use of Proceeds from Registered Securities

On August 2, 2016, we issued and sold 4,120,000 shares of our common stock in the initial public offering at a public offering price of $10.00 per share, for aggregate gross proceeds of $41.2 million. All of the shares issued and sold in the initial public offering were registered under the Securities Act of 1933, as amended, pursuant to a Registration Statement on Form S-1 (File No. 333-209115), which was declared effective by the SEC on July 27, 2016. The offering terminated on August 2, 2016.

The net offering proceeds to us, after deducting underwriting discounts of approximately $2.9 million and offering expenses paid by us totaling approximately $2.9 million, were approximately $35.4 million. No offering expenses were paid directly or indirectly to any of our directors or officers (or their associates) or persons owning 10% or more of any class of our equity securities or to any other affiliates. We also paid $8.2 million in cumulative accrued dividends to our Series A preferred stockholders from the issuance proceeds.

At ~~September 30, 2018,~~March 31, 2019, the net proceeds from our initial public offering were held in a diversified portfolio of bank deposits, government money market funds, government securities (U.S. Treasury and U.S. government agency securities), and high-grade short-term corporate bonds. All investments were in compliance with our Investment Policy and are highly liquid, with liquidity and capital preservation being the primary investment objectives. There has been no material change in our planned uses of the net proceeds from those described in the Prospectus dated July 27, 2016.

Item 3. Defaults Upon Senior Securities.

Not applicable.

Item 4. Mine Safety Disclosures.

Not applicable.

Item 5. Other Information.

On November 1, 2018, the Compensation and Organization Committee of our Board of Directors approved and adopted the Tactile Systems Technology, Inc. Executive Employee Severance Plan (the “Severance Plan”). Employees who are designated by our Board of Directors or a committee thereof are eligible to be participants in the Severance Plan. Each of our executive officers (Gerald R. Mattys, Brent A. Moen, Robert J. Folkes, Bryan F. Rishe and Mary M. Thompson), as well as certain other employees, have been designated as participants in the Severance Plan, effective upon the termination of the individual’s employment agreement with us (if any) and the entry into a Confidentiality, Assignment of Intellectual Property and Restrictive Covenants Agreement with us. None.

Under the Severance Plan, a participant will be entitled to receive the specified severance benefits if his or her employment is terminated (i) at our initiative other than for Cause (as defined in the Severance Plan) or (ii) by the participant for Good Reason (as defined in the Severance Plan) (each such type of termination, a “Qualifying Severance Event”). A Participant who experiences a Qualifying Severance Event will be eligible to receive certain severance benefits under the Severance Plan, including:

~~Table of Contents~~

~~if the Qualifying Severance Event occurs prior to a Change in Control (as defined in the Severance Plan), payment of:~~

an amount equal to two times (for our Chief Executive Officer) or one times (for all other participants) his or her annualized base salary as of the termination date, payable in accordance with our regular payroll schedule for 24 months (for our Chief Executive Officer) or 12 months (for all other participants) thereafter; and

the portion of the premium costs that we would have paid, if the participant had remained employed by us, for any continued group health insurance coverage following the termination date, at the same level of coverage, for a period of 18 consecutive months (for our Chief Executive Officer ) or 12 consecutive months (for all other participants) after the termination date (or until group health or dental coverage from another employer is received, if earlier); and

~~if the Qualifying Severance Event occurs within 12 months after a Change in Control, payment of:~~

an amount equal to two times (for our Chief Executive Officer) or one times (for all other participants) the sum of (i) his or her annualized base salary as of the termination date, plus (ii) his or her target incentive bonus as of the termination date, payable in a lump sum on the first payroll date occurring more than 60 days after the termination date; and

the portion of the premium costs that we would have paid, if the participant had remained employed by us, for any continued group health insurance coverage following the termination date, at the same level of coverage, for a period of 18 consecutive months (for our Chief Executive Officer) or 12 consecutive months (for all other participants) after the termination date (or until group health or dental coverage from another employer is received, if earlier).

~~In addition, if a participant experiences a Qualifying Severance Event and the termination date occurs:~~

before a Change in Control, then with respect to any equity-based award that has been granted to him or her under one of our equity plans and is outstanding and not fully vested on such termination date (an “Equity Award”), a pro rata portion of the unvested portion of such Equity Award will vest as of the date the participant’s release of claims becomes irrevocable; and

within 12 months after a Change in Control, then the unvested portion of any Equity Award that is outstanding on such termination date will vest as of the date the participant’s release becomes irrevocable.

In either case, if such Equity Award is a stock option or stock appreciation rights award, it will remain exercisable to the extent so vested for one year after the termination date. The Severance Plan also specifies the treatment of performance-based Equity Awards under these circumstances.

To receive benefits under the Severance Plan, a participant must sign and not rescind a release in a form approved by us. Payment of severance benefits under the Severance Plan is also subject to other conditions, and will be terminated if the participant violates his or her ongoing obligations with respect to non-disclosure of confidential information, assignment of intellectual property, non-competition and non-solicitation.

The foregoing description of the Severance Plan does not purport to be complete and is qualified in its entirety by reference to the full text of the Severance Plan, a copy of which is filed as Exhibit 10.2 to this report and is incorporated herein by reference.

Effective November 1, 2018, the employment agreements that we had in place with each of Messrs. Mattys, Folkes and Rishe and Ms. Thompson were mutually terminated in order for the executive officer to become eligible to participate in the Severance Plan. The termination of these employment agreements did not affect the individual’s employment status or position with us. Brent A. Moen, our Chief Financial Officer who was appointed as such effective September 2, 2018, does not have an employment agreement with us.

~~Table of Contents~~

Also effective November 1, 2018, each of our executive officers entered into a Confidentiality, Assignment of Intellectual Property and Restrictive Covenants Agreement (“Restrictive Covenants Agreement”) with us. The Restrictive Covenants Agreements provide that, among other matters, while the executive officer is employed by us and for a period of 12 months thereafter, he or she will not (i) engage in competitive business, subject to certain exceptions; (ii) solicit, hire or engage our employees or contractors, or certain former employees; and (iii) solicit, request, advise or induce customers, suppliers or other business contacts of ours to cancel, curtail or otherwise adversely change its relationship with us. Under the Restrictive Covenants Agreements, each executive officer also agrees to disclose and assign to us any and all improvements and inventions that he or she conceives or reduces to practice during his or her employment. In addition, the Restrictive Covenants Agreements contain customary confidentiality provisions.

The foregoing description of the Restrictive Covenants Agreements does not purport to be complete and is qualified in its entirety by reference to the full text of the form of Restrictive Covenants Agreement, a copy of which is filed as Exhibit 10.3 to this report and is incorporated herein by reference.

Item 6. Exhibits.

The exhibits filed as part of this Quarterly Report on Form 10-Q are set forth on the Exhibit Index below.

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EXHIBIT INDEX

Incorporated by Reference

Exhibit

File

Exhibit

Filed

File

Exhibit

Filed

Number

Description of Exhibit

Form

Number

Date of Filing

Number

Herewith

Description of Exhibit

Form

Number

Date of Filing

Number

Herewith

3.1

Fourth Amended and Restated Certificate of Incorporation

S-1

333-209115

06/09/2016

3.1

Fourth Amended and Restated Certificate of Incorporation

S-1

333-209115

06/09/2016

3.1

3.2

Amended and Restated By-laws

S-1

333-209115

05/06/2016

3.2

Amended and Restated By-laws

S-1

333-209115

05/06/2016

3.2

10.1*

License Agreement, dated as of October 15, 2018, by and between Tactile Systems Technology, Inc. and Sun Scientific, Inc.

10.1

First Amendment to Credit Agreement, dated as of February 12, 2019, by and among Tactile Systems Technology, Inc., the lenders party thereto and Wells Fargo Bank, National Association

10-K

001-37799

02/28/2019

10.33

10.2

Tactile Systems Technology, Inc. Executive Employee Severance Plan

Waiver and Second Amendment to Credit Agreement, dated as of March 25, 2019, by and among Tactile Systems Technology, Inc., the lenders party thereto and Wells Fargo Bank, National Association

10.3

Form of Confidentiality, Assignment of Intellectual Property and Restrictive Covenants Agreement

Form of Restricted Stock Unit Award Agreement under the 2016 Equity Incentive Plan (to be used for awards beginning in 2019)

10.4

Credit Agreement, dated as of August 3, 2018, by and among Tactile Systems Technology, Inc., the lenders from time to time party thereto and, Wells Fargo Bank, National Association

10-Q

001-37799

08/06/2018

10.1

Form of Performance Stock Unit Agreement under the 2016 Equity Incentive Plan (to be used for awards beginning in 2019)

10.5

Separation and Consulting Agreement between Tactile Systems Technology, Inc. and Lynn L. Blake, dated as of August 1, 2018

8-K

001-37799

08/06/2018

10.1

Non-Employee Director Compensation Policy

10-K

001-37799

02/28/2019

10.21

31.1

Certification of Principal Executive Officer pursuant to Rule 13a-14(a) / 15d-14(a) of the Securities Exchange Act of 1934, as amended

31.2

Certification of Principal Financial Officer pursuant to Rule 13a-14(a) / 15d-14(a) of the Securities Exchange Act of 1934, as amended

32.1

Certification of Principal Executive Officer pursuant to 18 U.S.C. § 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

Certification of Principal Executive Officer pursuant to 18 U.S.C. §1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

32.2

Certification of Principal Financial Officer pursuant to 18 U.S.C. §1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

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101.1

The following condensed consolidated financial statements from the Company’s Quarterly Report on Form 10-Q for the quarter ended ~~September 30, 2018,~~March 31, 2019, formatted in XBRL: (i) Balance Sheets (unaudited), (ii) Statements of Operations (unaudited), (iii) Statements of Comprehensive Income (unaudited); (iv) Statements of Stockholders’ Equity (unaudited), (v) Statements of Cash Flows (unaudited), and (vi) Notes to the Condensed Consolidated Financial Statements.

Application has been made to the Securities and Exchange Commission to seek confidential treatment of certain provisions of this exhibit. Omitted material for which confidential treatment has been requested has been filed separately with the Securities and Exchange Commission.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


	Tactile Systems Technology, Inc.

Date: ~~November 5, 2018~~May 6, 2019	By:	/s/ Brent A. Moen
		Brent A. Moen
		Chief Financial Officer
		(Principal financial and accounting officer)

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	PART I—FINANCIAL INFORMATION

Item 1.	~~Condensed Consolidated~~ Financial Statements ~~(unaudited)~~	3
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	2123
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	2931
Item 4.	Controls and Procedures	3031

	PART II—OTHER INFORMATION

Item 1.	Legal Proceedings	3132
Item 1A.	Risk Factors	3132
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	3532
Item 3.	Defaults Upon Senior Securities	3533
Item 4.	Mine Safety Disclosures	3533
Item 5.	Other Information	3533
Item 6.	Exhibits	3733


			Computer/Office		Fleet Vehicle
(In thousands)	Buildings		Equipment		Program		Total
2018 (October 1 - December 31)	$	227	$	14	$	55	$	296
2019		948		51		85		1,084
2020		954		34		—		988
2021		701		3		—		704
2022		352		—		—		352
Thereafter		268		—		—		268
Total	$	3,450	$	102	$	140	$	3,692