Strong Sell On Tactile Systems (TCMD): Bloated Stock Needs Compression Therapy

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Summary

• Tactile has sold to investors the story of a dominant player in an extremely underpenetrated market with a $5bn TAM growing at 20 – 30% annually.
• Numerous publicly available studies and claims databases suggest the addressable market is actually closer to $300mm – a fraction of what management claims in its earnings calls. In fact, Medicare has covered PCDs (Tactile’s product classification) since 1986. This is not a novel product ripe for adoption.
• Nevertheless, despite a much smaller and saturated TAM, Tactile has managed to grow revenue at an astonishing 30%+ CAGR over the last five years.
• Interviews with numerous industry stakeholders and a recent Qui Tam lawsuit filed against the company have revealed the true source of Tactile’s growth: a ‘daisy-chaining’ kick-back scheme that has resulted in rampant overprescribing and rapid market share gains at the expense of patients, insurers, and the public.
• These activities are coming to an end. Medicare has recently launched an industry-wide audit in which Tactile has been disproportionately targeted. 71% of Tactile’s claims audited so far have been denied for failure to establish medical necessity. Management has made no mention of these audits to investors.
• This is not the first time regulators have cracked down on the PCD industry – in 1995 the OIG launched a national initiative to curtail lymphedema pump fraud and abuse. By 1996, E0652 reimbursements (the type of PCD sold by Tactile) had fallen by 92%.
• Private and public payors are tightening their purses, all while stealthy changes to the risks section in Tactile’s most recent 10K suggest management is protecting themselves from the eventual fallout.
• Since 2017, Tactile has seen multiple key departures: CFO Lynn Blake, Chief Medical Officer Alan Hirsch, SVP of Reimbursement & Payer Relations Mary Thompson, VP of Reimbursement Mary Anderson, and VP of Quality & Regulatory Affairs Thomas Dold. CEO Jerry Mattys will be stepping down on June 8^th this year.
• Various insiders including the CEO, COO, and VP of Sales have sold more than 50% of their shareholdings in 2019 since the Qui Tam lawsuit was filed and Medicare audits were launched.
• Strong Sell with 70% ($15 PT) downside: Un-chastened by the reality of a limited and saturated TAM, Tactile cheats to grow. VA, Medicare, and commercial payors are catching on. Insiders are jumping ship. It’s time for investors to wake up.

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Table of Contents

• Chapter 1: Management’s Narrative
• Chapter 2: The Mouse That Roared – Why Tactile’s TAM Estimates Are Overstated by over 15x
• Chapter 3: The Scheme – A Deep Dive into Tactile’s Sales Activity
• Chapter 4: The Tightening Noose – Medicare RAC Audits
• Chapter 5: The Sleeping Giants – Commercial Payors are Waking Up to Coverage Abuse
• Chapter 6: Insiders Are Busy Protecting Themselves – Investors Should Too

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CHAPTER 1: Management’s Narrative

Tactile Systems Technology Inc. (TCMD) is a manufacturer and provider of Pneumatic Compression Devices (PCD) for patients diagnosed with chronic lymphedema in the United States.

_{[1] Note that Medicare and mst commercial payors do not even recognize clinical differences between basic and advanced devices.}

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CHAPTER 2: The Mouse that Roared – Why Tactile’s TAM Estimates Are Overstated by over 15x

The PCD market is one that is not well covered or researched. Robust data is not readily available and very few have made the effort to attempt to properly size the market. This has allowed Tactile management to mislead investors in painting an overly aggressive picture of the company’s TAM. While Tactile publicly touts a $5bn+ market opportunity, analysis of claims data, published medical studies, and state coverage mandate disclosures suggest the true TAM for the Flexitouch product is only ~$300mm.

The true addressable market for Flexitouch is significantly lower for two reasons:

1. The incidence rate of lymphedema is much lower than management claims, and
2. Only a fraction of lymphedema patients are eligible for advanced PCDs from both a medical and a reimbursement perspective.

In graphical terms:

1—The True Incidence Rate of Lymphedema is Lower Than Management Claims

The addressable market can be looked at in two ways: flow (diagnoses per year) and stock (total cumulative patients). This report looks at an overview of both followed by a discussion of the different source materials used to triangulate market size.

Incidence (FLOW): While Tactile claims there are 1.3mm lymphedema diagnoses p.a., the true figure is likely between 300,000 and 500,000 – a third of management’s estimate.

Prevalence: A second way to look at the market size is how many total patients suffer from lymphedema at any given point in time. Management estimates this figure to be between 5 and 10 million patients. Research suggests the true figure is closer to 2 million—a fourth of management’s estimate.

Table 1 below summarizes the results of an extensive review of multiple medical studies (some funded by Tactile itself), state and federal disclosures, and private pay-for-use claims databases.

Several of these datasets require some adjustment: (1) and (4) are limited to ages below 65 while (5) and (6) measure PCD usage prevalence and not all lymphedema. This report addresses the main data sets and attempts to make adjustments below.

(1) Feb-19 – Health & Economic Benefits of APCD Study (linked here): A Tactile-funded study analyzing claims data to determine economic and clinical outcomes following Flexitouch usage. The study analyzes the Blue Health Intelligence (BHI) research database covering >165mm members of individual Blue Cross Blue Shield plans from across the US. Notably, Tactile has been using BHI for some of their claims data analysis since at least 2018.

• Incidence: During the period studied (2012 – 2016), 81,366 patients were found to have been diagnosed with non-filarial lymphedema, defined as ≥1 inpatient or 2 outpatient claims with the relevant ICD codes. 81,366 diagnoses out of the 165mm covered population implies a 0.05% incidence rate. Note that the 81,366 figure is over four years, so the annual incidence would be even lower.
• Adjustments: An individual intimately familiar with the study indicated in a private interview that BHI data disproportionately skews towards the 45 – 64 age group and has a lower than proportional share of the 65+ demographic where incidence rates for lymphedema are much higher. An older UK study (linked here) suggests the total 65+ incidence rate is ~8x the rest of the population. Adjusting for this (0.05% × 275mm population younger than 64 + 0.05% × 8x × 52mm population older than 65) arrives at ~340,0000 implied US diagnoses per year.

(2) Dec-14 – Lymphedema Prevalence & Treatment Benefits in Cancer Study: Tactile’s then Chief Medical Officer Alan Hirsch was a co-author of this study. The study conducts retrospective analysis on health claims data from Optum Insight Inc. between 2007 and 2013 that covered >34mm individuals each year.

• Incidence: The study provides the number of diagnoses per year, defined as one or more medical claims with the relevant ICD codes. In the most recent year, 2013, the study found 14,775 patients diagnosed with lymphedema out of 34mm. This figure suggests an incidence rate of ~0.04% or ~140,000 total US diagnoses per year.
• Adjustments: According to the study, “the age and gender distribution of the [database] is similar to that reported by the US Census Bureau for the commercially insured and the Medicare Managed care population.” Since the data is from 2013, growing the 140,000 at a 10% CAGR yields ~250,000 implied US diagnoses per year.

(4) Apr-05 – California Health Benefits Review Program: A state-level analysis of healthcare coverage for lymphedema in California. The analysis references uses a regional claims database covering 7mm insured base.

• Incidence: Analysis of the claims database by the authors found that 0.07% of patients within the insured population suffered from lymphedema.
• Adjustments: The claims database only included individuals under the age of 65. Adjusting for age demographics using the same methodology as in (1) and growing the base at a 10% CAGR yields ~1.8mm patients cumulatively in the US with lymphedema today.

(6) Definitive Healthcare Data: Definitive Healthcare manages a claims database covering ~210mm patients. This dataset looked at PCD claims only and is therefore not comparable to total lymphedema diagnoses estimates. Nevertheless, it suggests the PCD market is highly saturated, and Tactile alone has achieved a penetration rate of over 59%.

• Incidence: For the CY2019 period, Definitive’s database found ~57,500 PCD claims out of a 210mm insured base, suggesting a PCD incidence rate of ~0.03%. Extrapolating to the total US population implies a market size of ~87,600 PCD units per year. This compares to a total of 53,000 Flexitouch and Entrée devices shipped during the same period—a market saturation rate of over 59%.

(Side Note) Failing the Smell Test:

A basic sanity check can be helpful to show just how implausible management’s TAM estimates are. Based on the trailing twelve month lymphedema diagnoses from management, approximately 5.6mm have been diagnosed with the disease just in the last 6 years alone. This means at least ~2% of the US population suffers from lymphedema.

Management’s data would mean one in fifty people you see on the street have this debilitating condition.In fact, management’s claim of 1.3mm lymphedema diagnoses would compare to ~1.8mm new cancer patients per year in the US.

Alternative methodology: A senior member of one of the largest lymphedema education centers in the country offered a different perspective. There are approximately 5,000 lymphedema therapists nationwide of which ~20% are lymphedema-only. On average, therapists treat ~50 – 60 patients per year. 5,000 therapists × 60 patients = ~300,000 patients per year.

The bottom line: Multiple external, 3^rd party sources—including those used by the company itself—suggest that Tactile’s lymphedema diagnoses statistics are significantly overstated. The real figure is likely to approximate 300,000 to 500,000 diagnosed patients per year.

It’s not comforting that the company itself appears to be confused about what the right numbers are:

(Side Note)
In yet another classic example of Tactile management’s TAM exaggeration, the company has recently begun touting the results of a recent study as proof of the addressable market:

“The new study suggests that the prevalence of lymphedema due to CVI is approximately 16 million individuals in the United States. This…increases the total prevalence estimates four-fold to over 20 million individuals.” – May 4, 2020 1Q20 TCMD Earnings Press Release (8K) (emphasis added)

“[The] February Study published in the Journal of Vascular Surgery…suggested that chronic venous insufficiency induced lymphedema afflicts as many as 16 million individuals in the United States.” – TCMD Jerry Mattys, Prepared Remarks, 1Q20 Earnings Conference Call“

“The clinical literature has continually cited a U.S. lymphedema prevalence at between 3 to 5 million,’ said lead author Steven M. Dean. ‘That citation is based solely on 2003 data generated in Europe by Moffatt et al. …it is gratifying to be able to now support significance for a broader patient population.’ Whereas cancer is probably responsible for nearly 4 million U.S. patients, the phlebolymphedema population is likely four times greater.” – Feb 13, 2020 Announcement Press Release by Tactile (emphasis added)

Based on these comments alone, Tactile would have investors believe a breakthrough study now suggests the real addressable market is 4x greater than previously estimated. Here is a link to the actual study. As it turns out, the study itself only covered 440 patients and had little to do with estimating prevalence. The 16 million figure is only mentioned in passing and derived by referencing another study: a European study from 2015 that suggested a 5% prevalence rate (which multiplied by US population gets 16 million). This study, in turn, references another,Canadian study which was published in 2003. In fact, that study actually had this to say:

Eight population-based prevalence studies used clinical validation and reported prevalence rates of open ulcers ranging from 0.12% to 1.1% of the population; the prevalence rate of open or healed ulcers was reported to be 1.8%.

And by the way, lead author Dr. Steven Dean is a member of Tactile’s Medical Scientific Board and part of the physician speakers bureau for the company. And the study was sponsored by Tactile.

Tactile literally paid for an entire study to be done just so it could reference a 2003 study from Canada to further inflate its already ludicrous TAM estimates. What the company also failed to inform investors is that changes to Medicare’s LCD several years ago mean CMS will no longer reimburse E0652 products for CVI patients—only 651 ($500 device). So much for multiplying patient population by $4,000.

2—Only a Fraction of Lymphedema Patients are Treated with and Eligible for Advanced PCD

Putting aside the overstated incidence rate of lymphedema, PCDs (and especially advanced PCDs) are not even the first line of treatment for lymphedema. While hard figures are difficult to come by, research suggests less than 15% of lymphedema patients are ultimately treated with advanced PCDs.

Pneumatic compression devices are NOT the first line of treatment for lymphedema. In fact, PCDs are considered a treatment of last resort by both practitioners and payors. For diagnosed patients, Complete Decongestive Therapy (CDT) is the universally accepted method of treatment and involves Manual Lymph Drainage (MLD), concurrent compression therapy (compression bandaging, not PCD usage), and exercise. “Complete Decongestive Therapy (CDT) is the gold standard for lymphedema management.” (Lymphcare USA, link)

Typically, PCDs are reserved for patients for which CDT was ineffective or not practical (e.g. rural areas without nearby clinics). To be eligible for a basic PCD, both public and commercial payors require medical documentation demonstrating compliance to a 4+ week course of CDT that was insufficient in reducing symptoms.

On top of that, advanced PCDs (from which Tactile earning 90% of its revenues and can be charged at 10x the cost of basic devices) require further proof that a 1-to-3-month course of basic PCD treatment was similarly insufficient or impractical (e.g. area of swelling not addressable by basic). Note that Medicare and most commercial payors do not even recognize clinical differences between basic and advanced devices. Below is an excerpt from Anthem’s coverage documentation:

The typical treatment funnel of lymphedema patient that eventually receives an advanced PCD looks something like this:

Figures on the breakdown of each stage of the funnel are hard to come by. There are a couple of clues:

• The Feb-2019 study (1) using BHI data narrowed down to a ~1,065 study population that were pursuing continuous lymphedema treatment. Of these patients, 860 were on “active” treatment only (i.e. CDT, conservative therapy), 34 used basic PCD only, and 171 patients were on advanced PCDs (roughly half of which were Flexitouch). This would imply ~20% of patients receive a PCD (either basic or advanced), and about ~83% of PCD patients eventually go on to receive an advanced PCD.

• In the 2014 study (2), the claims data indicated that between 2008 and 2012, 21,104 patients made claims for either a basic or advanced PCD. During this same period, the claims data found a total of 59,812 lymphedema diagnoses, or a PCD treatment penetration rate of ~35%.

• Using Definitive Healthcare (6) data, of the 49,177 PCD claims for CY2019, 28,838 were for advanced devices under the HCPCS code E0652. This suggests ~58% of PCD patients receive advanced PCDs.
• More anecdotally, interviews with various lymphedema clinics and specialists yielded PCD recommendation ranges between 10 to 50% of patients. From the current owner of a lymphedema clinic who had also previously worked with Tactile for over 5 years:

“I would mention it to no more than 25% of my patients. 75% of the patients I trained I think don’t use the product anymore…. The sales people were just selling it to anybody, including people who couldn’t use it… Obese patients have a hard time getting it on. Elderly and arthritis patients have a hard time with hands attaching and un-attaching the hoses.”

Ultimately, it appears likely that ~30% of lymphedema patients eventually receive PCDs, of which ~60%+ go on to receive advanced PCDs.

3—Putting It All Together

400,000 patients p.a. × 30% PCD usage × 60% advanced PCD share = 72,000 advanced PCDs shipped p.a.

72,000 advanced PCDs × $4,000 Flexiouch ASP = $288mm revenue opportunity for Flexitouch

• This compares to management’s estimate of a $5bn market opportunity.
• This also compares to existing Flexitouch revenue of ~$170mm as of FY2019.
• Medicare has covered PCDs since 1986. The market is not as underpenetrated as the company claims.

“…everybody knows the database. [Tactile is] saying [they’ve] only touched the tip of the iceberg…only hit X number of doctors and there are thousands more out there. That’s a complete lie. Because everyone’s going after the top decile doctors… If there is a pool of 100 doctors, let’s say. There’s one 10, three 9s, there’s four 8s, and then you get down and there’s like 40 that are ones…they’re all chasing the top one…to say they’ve hardly even touched on it…it’s not true.”

Senior Executive, Lymphedema Product Supplier

So how has Tactile been able to grow at 20 – 30% without TAM and market saturation constraints?

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CHAPTER 3: The Scheme – A Deep Dive into Tactile’s Sales Activity

The recent Qui Tam lawsuit suggests Tactile is employing borderline to potentially illegal marketing schemes to induce sales growth and share gains. This lawsuit was followed by a sharp decline in VA sales as well as a Medicare audit that has disproportionately targeted Tactile. The audit is addressed in a later section of this report.

On August 20, 2018, a Houston based competitor Veterans First Medical Supply (VFMS) filed a Qui Tam civil suit against Tactile. Qui Tam suits are filed on behalf of the US Attorney General and the typical legal route for whistleblowers to expose fraud, particularly as it relates to healthcare and public payor reimbursement.

Central to the lawsuit is its allegation of Tactile’s use of unlawful financial incentives and marketing schemes to induce sales and share gains. A copy of the complaint can be found on Pacer as Case 4:18-cv-02871. Some of the claims related to speaker fees, physician dinners, etc. are sadly a fact of life in the healthcare industry. What is noteworthy, however, is VFMS’ description of Tactile’s relationship with its contractors:

While some investors are aware of the lawsuit, they may not be aware of the imminent legal, regulatory, and knock-on effect risks from the scheme described above. In fact, management and sell-side appear to have largely allayed investor concerns in private conversations by making the following claims:

• VFMS is a disgruntled competitor. Tactile hired one of their sales reps who brought business relationships with him.
• Contractor nurses and therapists have contractual relationships with Tactile – they are not allowed to train patients from any facilities that they are affiliated with.
• Nurses and therapists rarely sign prescriptions – this is the responsibility of physicians. This means they are removed from the decision making on PCD treatment for patients.

Based on interviews with multiple senior executives in the lymphedema industry, however, Tactile appears to be downplaying what industry participants describe as a willful and premeditated ‘daisy-chaining’ kickback scheme. This is described below.

The Scheme

“Say [Therapist A] is a lymphedema therapist in [County A], and you’ve got [Therapist B] who’s a lymphedema therapist in [County B], and they’re just going back and forth with their patients. [Therapist A] would set up all of [Therapist B’s] patients and [Therapist B] will set up all of [Therapist A’s]… That drives a lot of their business.”

Senior Executive, DME Distributor

“If you look at their employee breakdown, in addition to sales, they also have clinical trainers. Many of these trainers are actually therapists. So therapists have an incentive to sell Tactile’s product and get paid for home visits for those sales.”

CEO, Lymphedema Product Manufacturer & Supplier

From discussions with industry stakeholders, it appears Tactile’s contract training program is not as innocent as the company claims:

• Nurses & Therapists are Key Decision Makers: Unique to the lymphedema industry, diagnoses are made by physicians, but treatment decision making is commonly made by nurses and therapists. This means Tactile is offering financial rewards directly to key decision makers that recommend their product to patients.

“While the prescribers, yes, that’s true; they’re not involved [in the scheme], but they’re not involved in recommending the product in the first place. It’s kind of strange over here. So if you have lymphedema, you go to your GP which is the prescriber a lot of times over here. But they’re sending patients out for lymphedema treatment, and then whatever treatment protocols the lymphedema therapist or nurse draws up, the prescriber just signs off on it. So they’ll send them out for treatment. The therapist or nurse will say, “Okay, this patient needs compression garments and a compression pump.” And then that would be written in the patient notes, and then you would get a script for both devices and the Doctor just signs off on it. So a lot of times they’re not even involved in the conversation.”

Senior Executive, DME Distributor, emphasis added

“Everyone in the industry knows that they are violating what they call a Stark Law violation. They are incentivizing doctors; they are incentivizing clinicians to prescribe their products. They are paying employees that work at clinics and hospitals to go set up devices as set up clinicians… So, if you’ve got a doctor’s office who’s making the decisions. A lot of times it’s the second layer down [the nurse] that says, ‘Hey, this patient needs a pump, Doc. Go see that. And I think they need a Flexitouch.’ …Now the doctor’s writing the prescription so she’s kind of cleaned her hands of the whole thing.”

Senior Exec, Lymphedema Product Supplier, emphasis added

• Quid Pro Quo Dynamics for Participants: Industry sources suggest therapists and clinicians are at the very least indirectly aware of the quid quo pro nature of their contractor relationship with Tactile—the number of lucrative ‘patient demonstrations’ they receive ($150+ per hour plus gas) is directly related to the number of patients they recommend Flexitouch to. In fact, older SEC filings from the company have even indicated that trainers are identified through the company’s sales and marketing interests.

“And I talked to [a therapist] who said he’s referring out about [mid-teens] patients a month for a Tactile device. And then I asked him, ‘How many setups are you doing then in turn?’ And he said he’s probably doing about the same in setups, and he gets $150 per… It’s meant a lot for his family…”

Senior Executive, DME Distributor, emphasis added

“[The scheme] has brought in other therapists… and they feel like they’re part of the entire sales process. They actually get reimbursed to set up a device. Now, they can get around that by saying, they’re not setting up a device for their own patient. They’re setting up somebody else’s device or another clinician’s patient. They go hand in hand. If you get a request to set up a patient, you get paid for that. If you order a pump for a patient, another therapist that you’re working with, they do it in tandem.”

Senior Executive, DME Distributor, emphasis added

• Skirting the Letter: Medicare coverage guidelines have changed multiple times in an attempt to clamp down on these activities within the industry. Each time, Tactile has attempted to skirt the letter of the law through technicalities. Industry participants question how long this can go on.

“…the most important recent change is in Medicare. The new regulation [2017] no longer allows someone with financial incentive to oversee the basic pump trial process before advanced is allowed; it has to be a therapist or surgeon, not a Tactile rep… but Tactile is in a grey area…because a big portion of the ‘trainers’ they employ are also therapists.”

VP, Lymphedema Pump Manufacturer, emphasis added

“…I thought these incentives for therapists would be going away after the recent Medicare regulations but it hasn’t…”

CEO, Lymphedema Product Manufacturer & Supplier

“With Medicare guidelines you can’t have somebody that’s a contractor going into the home to do a setup representing your company. You have to have a full time employee… In Medicare’s guidelines, they say, ‘To do a setup, you have to be an employee of the organization.’… and [Tactile] has been pretty clever in wording this. They’ve worded these patients as patient demonstrations… they’re not doing setups; they’re simply doing demonstrations.”

Senior Executive, DME Distributor, emphasis added

• Extreme Measures: Multiple former reps at Tactile have expressed frustration at the boiler room culture and aggressive, growth-target driven mindset. These high stakes appear to have driven sales staff to extremes. With the symbiotic relationship between Tactile and doctors (speaker fees, dinner functions, etc.) as well as therapists (training fees), some industry participants suggest sales reps have resorted to inducing aggressive prescribing behavior at the clinics themselves. The Medicare audit, discussed in a later section of the report, may have been launched as a result of some of these activities. In an effort to preserve anonymity of industry sources, specific examples are not being disclosed. However, allegations include the below. Many of these activities are illegal. Multiple industry sources indicate they have documented evidence of many of the below. They are not included here but will likely be uncovered during discovery for the Qui Tam lawsuit.
  
  • Tactile reps encouraging patients and therapists not to take CDT or basic devices seriously, that way they can get the advanced device later.
  • Medicare LCD changes in 2017 restricted reimbursements for E0652 unless abdominal and truncal swelling is present. Tactile patients coincidentally have high rates of abdominal and truncal swelling.
  • Providing pamphlets to prescribers and therapists on how to fill out paperwork to get approvals
  • Sending pre-filled prescriptions via fax to prescribers.
  • Fudging timelines to superficially meet coverage requirements
  • The Qui Tam Lawsuit makes similar allegations:

Tactile’s legal liability here is perhaps best left to Tactile itself: (from the company’s FY2019 10K)

Veteran’s Affairs (VA) Case Study – A Roadmap for Other Channels:

The evidence doesn’t just come from what some might perceive to be ‘sour grapes’ quotes (they aren’t) from disgruntled competitors and therapists. While the Qui Tam lawsuit is expected to reach jury trial by April next year, the VA has already clamped down on PCD spending since the lawsuit was filed. Studying the VA offers a potential roadmap for the rest of the industry, including Medicare and the commercial channel.

As VFMS primarily services the VA, many of its allegations are related to Tactile’s practices revolving around this particular channel. This may be why the VA has been ahead of the curve on cracking down on Tactile reimbursement. A closer look at publicly available VA spending data on HCPCS codes E0651 (basic) and E0652 (advanced) suggest the following:

• VA spending patterns appear to corroborate many of VFMS’ allegations around the timeline of Tactile’s aggressive marketing activities
• Even in the early innings of the court case, VA decision makers appear to be taking the allegations seriously—growth in VA spending dramatically slowed immediately following the filing of the Qui Tam lawsuit and Tactile has lost significant share.

From the lawsuit, VFMS alleges that Tactile began its aggressive marketing scheme in 2017:

VA spending data on E0652 corroborates this finding, with significant acceleration starting in 2017:

This growth was clearly in large part driven by Tactile:

More importantly, the filing of the Qui Tam lawsuit coincided with a significant fall off in VA spending on E0652 devices:

This is especially noticeable when looking at Tactile’s VA revenue. VA decision makers are clearly sensitive to these allegations and may clamp down further as more details arise out of the discovery and trial processes. Tactile has lost disproportionate share in the VA channel since the lawsuit.

Note that VA reimbursements during the 1Q20 period actually increased 6% YoY while Tactile just witnessed its worst VA revenue quarter in history (down 8% YoY). Tactile is losing share and Covid-19 is not an excuse (see below).

The worst is yet to come. The lawsuit, filed in August 2018, was severely delayed owing to a change in judge. Proceedings resumed at the end of 2019 and on February 21, 2020, Tactile’s motion to dismiss the suit was denied. The discovery deadline has been set at November 2020 with the jury trial to be held in April 2021. Not to mention the apparent impact Covid-19 will have on their results. Since PCDs have a long lead-time for reimbursement, the impact of the pandemic did not show up until April. Just look at the VA data—while Jan – March 2020 were normal, April reimbursements were down nearly 60%.

A favorable outcome from VFMS may also encourage copycat lawsuits from other veteran owned or VA focused distributors—Tactile’s collusion with VA hospital decision makers has squeezed out the very Small-Disabled Veteran-Owned (SDVO) businesses the VA is legally obligated to prioritize.

The VA is not alone: other channels are following suit and will likely experience the same trajectory over time. In fact, knock-on effects from the lawsuit and Tactile’s aggressive behavior have already begun showing up in other channels—especially Medicare.

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CHAPTER 4: The Tightening Noose – Medicare RAC Audits

Aggressive sales and marketing activity by Tactile and other participants in the industry appear to have caught the ire of Medicare, paving the way for potential clampdowns on Tactile’s business.

On January 23^rd, 2019, the Region-5 (i.e. Durable Medical Equipment) RAC auditor for Medicare, Performant Recovery Inc., quietly announced the following CMDS approved audit issue (link):

Since 2018, only 20 Region-5 audits have been performed. Of the 157 RAC audits performed by Performant Recovery since its selection as RAC, only 70 have been complex reviews—meaning doctors or specialists hand review each claim as opposed to automated reviews. One industry executive even described the RAC audit as a once in a generation event. While the rest of the industry was scrambling, Tactile chose not to inform its investors of this significant development.

The RAC audit process was announced in January 2019. Prior to this, zero audits had been conducted on either E0651 or E0652 claims by Performant. By December 2019, Performant had conducted 1,415 reviews on E0651 claims, for which 813 demand letters were sent. Notably, despite Tactile being a smaller player in the E0651 space (Tactile’s focus is on E0652), the company still represented 10% of all reviews conducted so far:

In fact, despite not having had the most claims audited, Tactile reserves the spot for having the most audits denied for medical necessity. 71% of all Tactile’s claims have been flagged for issues. These are not denials for clerical reasons. Performant is claiming that Tactile has fundamentally failed to establish grounds for medical necessity on 71% of all its Medicare claims.

This is billings fraud.

Claim audits also appear to be accelerating for both the industry and Tactile specifically. Note that the data shows claim audits by date of finding or denial letter and not the audit request (and therefore come out in batches).

Data from 2020 has not been included as audit results have not yet been finalized (and are therefore undated). Nevertheless, despite the impact of Covid-19, Performant has conducted another 491 audits through March of 2020 (i.e. run-rating at above 2019). Results of these audits are currently pending.

Multiple industry participants believe Tactile is to blame for the audits.

“The RAC is being very aggressive about claims, and asking for money back. It is my belief that the entire reason that this RAC audit started is Tactile Medical. They’re after them. We all know it. And so, when you see some of the data, which you can get your hands on. I mean, there’s this thing called an HME data bank, and you can buy this data about who’s prescribing pumps under the 651 and 652 categories, through Medicare each year. Tactile on the 52s files more claims with Medicare than every other DME in the country combined. So, who do you think they’re after. So, this RAC audit started.”

Senior Executive, Lymphedema Product Supplier, emphasis added

“The amount of money that they’re spending on these pumps. Because they’ve gone back over and over again to revise the LCD. Like that LCD is crystal-clear, it’s very well done, it is pretty fair. But I’m sure they’re seeing this code getting pushed up higher and higher by different companies, and I’m sure that’s what’s prompting the audits. And it all comes down to money in these situations with the government.”

Senior Executive, DME Distributor, emphasis added

“…there is a lymphedema clinic in [removed]. And that lymphedema clinic sells, refers Tactile Pumps. So they don’t sell them…they’re a clinic that treats patients for lymphedema and then they authorize pumps for their patients via Tactile…they authorize a pump for just about every patient…Just about every patient that ever needs stockings, coming from that clinic, has a pump…it appears that just about every patient gets a pump and…that’s probably not appropriate….that’s probably being encouraged by Tactile. [Removed] believe that the reason they are being audited is it’s not really because of their activity, but because of the other account. They believe all that volume of pump business…may be the reason that the audit’s going on in [removed].”

Senior Executive, Compression Garment & Pump Manufacturer

“…the industry is such that nobody has ever had a ton of pump business until Tactile got in and really, really went after it strong and went after it very aggressively with the types of relationships that they have. And as you know, from that lawsuit, there are people who are questioning some of the relationships. So again, we’re going to be very cautious. We’re not going to operate the way we believe Tactile is, because we think that’s probably causing damage and harm long-term to pump coverage if it keeps blowing up.

Senior Executive, Compression Garment & Pump Manufacturer, emphasis added

Note that the audit is still in the early innings. While the RAC audit was launched in January 2019, most industry contacts indicate the process did not begin in earnest until mid-2019, with the main wave of audit requests coming near the end of 2019. Conversations with DME distributors suggest the audit process is still ongoing and accelerating.

The three-year lookback period of these audits and restrictions on the number of audit requests allowed (number or percentage of claims per month per provider) means the RAC auditor will likely start with earlier claims and accelerate into more recent years.

More importantly, industry sources suggest the E0651 audits are paving the way for a wave of E0652 claims. This makes sense. RAC auditors have financial incentives to maximize clawbacks and E0652 claims are worth 4 – 8x more than E0651 claims.

So far, Performant has only conducted 33 audits on E0652 claims through November 2019. Of these 30 audits, 25 (i.e. more than 75%) have been claims requested from Tactile.

Investors should note that these audits appear to have already impacted Tactile’s financials. While the company has continued to book Medicare revenues as usual, receivable days for Medicare related accounts receivable have increased nearly 40% in the wake of the audit results.

Increasing Medicare receivables sends a strong signal suggesting Medicare is taking the results of the RAC audits seriously and likely withholding cash reimbursement to Tactile as a result. Yet Tactile has continued to book Medicare revenues without informing the market of the RAC audit results.

Investors can look to history for a roadmap of what comes next. This is not the first time the industry has been investigated for abuse. A July 1998 report from the Office of Inspector General (OIG) offers some insight into the last time a major wave of audits and clampdowns hit the industry (link). Spoiler: E0652 reimbursements fell 92% from ~$107mm in 1995 to ~$9mm in 1996. (Yes. 25 years ago this market that Tactile claims to be $5bn+ was a $100mm revenue industry. And that was at its peak before the OIG crackdown.)

One example of Medicare abuse called out by the OIG stands out in particular:

When pressed on why Tactile is able to earn 90% of its revenue from advanced (E0652) products when the rest of the industry sits at 10 – 40%, management actually conceded that many of their pump patients do not receive the basic (E0651) pump first.

The bottom line: Medicare RAC audits will only accelerate and Tactile is already being disproportionately targeted. As Performant begins to take action on E0652 claims, Tactile sits in an extremely precarious position with significant exposure. The results also bode poorly for its existing Qui Tam lawsuit.

Moreover, in addition to clawbacks from Medicare, it is likely that commercial payors, therapists, doctors, and nurses will also respond to industry noise generated from these audits. Substantial evidence exists that this is happening already.

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CHAPTER 5: The Sleeping Giants – Commercial Payors Are Waking Up to Coverage Abuse

As mentioned above, one key issue here is the fact that Tactile earns 90% of its revenue from Flexitouch (advanced PCD, E0652) devices. No other DME distributor has been able to achieve such a high share of E0652 volume. Reimbursements for E0652 are significantly more stringent and require extensive documentation proving prior use of CDT and basic, E0651 devices.

While Medicare has clamped down significantly on E0652 reimbursements over time, commercial payors have been looser on adherence to coverage requirements. This appears to be changing as a result of rapid growth in reimbursements for these codes:

“…in the past year, six months to a year, commercial plans have certainly been changing to follow the Medicare guidelines a lot more strictly. What we’ve been finding is that where it used to be very easy for us to process an E0652 or an expensive item through a commercial plan, it’s no longer. They want the same or similar requirements. They want you to do authorization, or they want you to do a three-month trial with pre and post measurements. So, everywhere, it’s getting kind of stringent…But definitely in the past six months, I would say, all of the health plans have really just … They did a mid-year update, and they kind of really tightened their grasp on everything. So, they’re really making it more along the lines of Medicare…”

VP of Reimbursement, West Coast DME Distributor, emphasis added

“…there are a number of private insurance companies that follow the Medicare LCD, but that doesn’t mean they’re going to follow the RAC audit. But I believe it will become public knowledge if they have real issues of violating the way they’re filing claims, and other people may start looking at them…Blue Cross Blue Shield has totally just redone their policy, and filing a 52 claim in [Midwest US state]…has become almost impossible. And things like that are going to really start to hurt Tactile as well. I think what’s going on in Blue Cross Blue Shield…is starting to trickle down to other places as well, and I wouldn’t be surprised if it had an impact on [the industry].”

Senior Executive, Lymphedema Product Supplier

“My team doesn’t even consider applying for the 652 if the patient is a Medicare patient… some of the commercial companies are catching up. United stopped reimbursing for E0652 in the last 6 months or so and I tell my team to go straight for the 51 for United patients… Humana has also started doing auditing over the last 18 months… they’re coming in after the approvals for 52 and saying they should not have approved it…”

Reimbursement Specialist, DME Mfg. & Distributor, emphasis added

“I’m not saying that from a competitor’s standpoint. I’m saying that from the people that are paying the claims. [Tactile] have a target on their back.”

Senior Executive, Lymphedema Product Supplier

Conversations with industry participants, including a former Medicare auditor, suggest commercial payors could accelerate these clampdowns as a result of the Qui Tam lawsuit and RAC audits.

Unsurprisingly:

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CHAPTER 6: Insiders Are Busy Protecting Themselves – Investors Should Too

Insider departures: While the Medicare RAC audit and Qui Tam lawsuit may have been a long time coming, insiders at Tactile appear to have been wary of the risks. Since 2017, Tactile has witnessed a spate of senior exec departures—many of which would have had firsthand knowledge into Tactile’s marketing strategy and regulatory liability:

• VP of Quality & Regulatory Affairs: Thomas Dold
• VP of Reimbursement: Mary Anderson
• SVP of Reimbursement & Payer Relations: Mary Thompson
• Chief Medical Officer: Alan Hirsch
• Chief Financial Officer: Lynn Blake
• Chief Executive Officer: Jerry Mattys (stepping down on June 8^th, 2020)

While CEO Jerry announced his intention to retire in January 2020, one would have expected him to at least stay through the Covid-19 crisis. Instead, he has recently revealed he will be stepping down only 5 months later on June 8^th—forcing the firm to transition management in the middle of a once-in-a-century pandemic that has had a seismic impact on prescribers, payors, and patients. His successor, Dan Reuvers, is set to step in barely two weeks after the company’s announcement of Jerry’s departure date.

Why is Jerry in such a hurry to leave? Changes in company disclosure detailed below suggest the outgoing management may be saddling incoming CEO Dan Reuvers with significant legal and regulatory risks and liabilities he may not be aware of.

Disclosure changes: Subtle but material changes to the company’s most recent FY2019 10K offer some insight into the company’s precarious position. While the company may have felt legally compelled to make these adjustments in its annual report, management has chosen not to relay these risks (particularly as it relates to the RAC audits) to investors.

• Changes Relevant to Qui Tam Lawsuit: (removals in red and strike through)

Removed claim contract trainers are independent. Removed statement that trainers are in fact solicited by the sales and marketing teams at Tactile. No longer disclosing the fact that the individuals trying to push the product onto decision makers are the ones selecting who gets lucrative training contracts.

Removed various statements and assertions to compliance with key legislation such as the Anti-Kickback Statute and Stark Law.

• Changes Relevant to RAC Audits: (additions in blue, underline and removals in red, strike-through)

Added new language noting risk of clawbacks from regulatory or audit actions.

Changed and added language on risk of audit investigations.

Insider Selling: Finally, insiders have been aggressively cashing out.

• While CEO Jerry Mattys currently owns ~240,000 shares, he has sold ~350,000 shares since the beginning of 2018 (including derivative exercise sales), of which ~130,000 shares were in 2019 alone. The largest transaction in which he sold 50,000 shares (16% of his then share holdings excluding options) occurred on February 13/14, 2019…three weeks after the RAC audits were announced.
• In total, insiders have sold ~900,000 shares (or ~$46mm worth) since 2018.
  • COO Robert Folkes has reduced his shareholdings by a little under 50% since the end of 2018
  • VP of Sales Bryan Rishe has sold ~48% of his stock since the end of 2018.
  • Mary Thompson, former VP of Payor Relations, held ~24,000 shares at the beginning of 2019. She currently holds ~3,700 shares, a reduction of nearly 85%.

Investors (and incoming CEO Dan Reuvers) should be asking themselves, if Tactile is truly best-in-breed in an underpenetrated $5bn market that is growing at 20%+ annually:

• Why has the CEO (only 60) decided to retire this year in the middle of the Covid-19 crisis?
• Why have so many senior executives, particularly those knowledgeable about reimbursement and regulatory affairs, left over the last few years?
• Why have virtually all insiders reduced their stakes by high double-digit percentages?

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Valuation & Financials

Since 2013, Tactile has grown its revenue more than five-fold from $37mm to $190mm, or a CAGR of ~31% over six years. During this time, the company has demonstrated ZERO operating leverage. In fact, its EBITDA margin today as of FY2019 is exactly the same as it was six years ago in FY2013.

Comparing FY2013 with FY2019, major cost centers COGS and Sales & Marketing have both increased as a percentage of revenue. As it turns out, the main source of operating leverage has actually come from Research & Development. In other words, Tactile has had to cut its proportional share of research spending just to keep its margins flat… the one cost item investors don’t want to see cuts in for a company that purports product leadership in the market.

Ultimately, even the unit economics of the business point to everything this report addresses—that Tactile is a “push” business and revenue growth is overwhelmingly the result of aggressive sales tactics, marketing schemes, and reimbursement appeals. All of these activities require Tactile to spend money to buy growth. In short, it’s hard to find operating leverage in a business built on kickbacks.

Since FY2013, the company has cumulatively generated a total of $24mm in Cash Flow from Operations while spending $16mm in Capital Expenditures. A whopping $8mm in total cash generation over six years.

Without operating leverage, Tactile will need to grow its revenue to over $700mm (or another 4x) just to trade at 15x EBITDA at today’s share price. That’s twice the estimated TAM.

More realistically, $250mm of forward revenue at 8% EBITDA margins and a 12x multiple yields a share price of ~$15 for 70% downside. This is without taking into consideration any potential legal liabilities, clawbacks, or revenue shrinkage due to the regulatory and legal actions against the company.

Author’s Note: The author applauds Tactile’s efforts in raising lymphedema awareness and bringing compression treatment to patients’ homes. Lymphedema is a chronic, often debilitating condition that dramatically lowers quality of life. Nevertheless, doctors and therapists should make decisions optimized for treatment outcome rather than personal financial gain. Similarly, investors should be made aware of all the facts before choosing to invest in Tactile’s shares.

Disclosures: The author of this report has a short position in TCMD and may buy or sell the Company’s securities at any time. This report is for informational purposes only. Under no circumstances should this report or any information herein be construed as investment advice, or as an offer to sell or the solicitation of an offer to buy any securities or other financial instruments. This report is based on publicly available information, industry expert interviews and the author’s due diligence and analytical processes. To the best of the author’s belief, all information contained herein is accurate and reliable, and has been obtained from public sources.  However, such information is presented “as is,” without warranty of any kind, whether express or implied.  The author makes no representation, express or implied, as to the accuracy, timeliness, or completeness of any such information or with regard to the results to be obtained from its use. This report expresses the opinion of the author and includes a significant number of assumptions and forward-looking statements.  All expressions of opinion are subject to change without notice, and the author does not undertake to update or supplement this report or any of the information, analysis and opinion contained in it.

The lymphedema industry is small. Certain pronouns, locations, names, and titles have been paraphrased or adjusted to preserve the anonymity of industry insiders quoted in this report. During the course of research, more than thirty individuals across the lymphedema industry, Medicare, and commercial payors were interviewed nationwide over multiple hour+ long conversations.