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Tactile Systems Technology, Inc. (NASDAQ:TCMD)
Q3 2018 Earnings Conference Call
Nov. 5, 2018, 5:00 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good afternoon, ladies and gentlemen, and welcome to the third quarter 2018 earnings conference call for Tactile Medical. At this time, all participants have been placed in a listen-only mode. At the end of the company's prepared remarks, we will conduct a question and answer session. Please note that this conference call is being recorded and that the recording will be available on the company's website for replay shortly.

Before we begin, I would like to remind everyone that our remarks and responses to your questions today may contain forward-looking statements that are based on the current expectations of management and involve inherent risks and uncertainties that could cause actual results to differ materially from those indicated, including those identified in the risk factors section of our most recent annual report form 10K filed with the Securities and Exchange Commission as well as our most recent 10Q filing.

Such factors may be updated from time to time in our filings with the SEC, which are available on our website. We undertake no obligation to publicly update or revise our forward-looking statements as a result of new information, future events, or otherwise. This call will also include references to certain financial measures that are not calculated in accordance with generally accepted accounting principles or GAAP.

We generally refer to those as non-GAAP financial measures. Reconciliations of those non-GAAP financial measures to those most comparable measures calculated and presented in accordance with GAAP are available in the earnings press release on the investor relations portion of our website. I would now like to turn the call over to Mr. Jerry Mattys, Tactile Medical Chief Financial Officer. Please go ahead, sir.

Jerry Mattys -- Chief Executive Officer

Thanks, operator. Good afternoon and welcome to our third quarter 2018 earnings call. I'm joined on the call today by our Chief Financial Officer, Brent Moen. Let's begin with a quick overview of the topics we intend to discuss on today's call. First, I'll start by reviewing some of the key highlights of our financial performance during the first nine months and third quarter of 2018 with a brief discussion of the primary drivers of our revenue performance in each period. I'll also update you on a few operating highlights from the quarter including the commercialization of our new products, Flexitouch Plus, and Flexitouch Head and Neck, a new contract with the VA, and the license agreement with Sun Scientific that we announced in October.

Following that discussion, Brent will walk through our financial results in greater detail and review our financial guidance for 2018, which we updated in our earnings press release this afternoon. I'll conclude today's prepared remarks by providing a few thoughts on our outlook for the balance of 2018 before we open the call for questions. We achieved an impressive sales performance over the first nine months of 2018, generating revenue of $97.3 million representing 31% growth year-over-year. Sales of our Flexi Touch systems continue to be the primary driver of our growth, increasing 31% year-over-year to $89.2 million. We also saw positive contributions from sales of our Entre and Actitouch systems, which increased 25% year-over-year to $8.1 million.

Our growth over the first nine months of 2018 continued to benefit from the impact of three primary drivers of growth that we have outlined in previous earnings calls this year. These growth drivers include the significant expansion of our field sales team, which now includes over 185 sales representatives, more than double the size since the end of 2015. Second, our strategy to maximize the productivity of our sales organization by focusing our reps on the most productive accounts. Third, the increased in-network coverage with commercial insurers that we've achieved in recent years, which further enhances the productivity of our sales team by lowering out of pocket expenses for patients, and thus making our products easier to afford.

We believe that each of these drivers was essential to our strong sales performance during the first nine months of 2018 and we expect that they will continue to fuel our growth for the foreseeable future. In addition to these primary growth drivers, our Flexitouch sales growth continued to benefit from very strong sales into the veterans administrative healthcare system. Sales into the VA over the first nine months of 2018 increased 44% year-over-year, representing approximately 20% of our total revenue compared to approximately 19% in the first nine months of 2017. Our sales performance in the VA continues to benefit from two factors.

Beginning early last year, we enhanced our selling efforts in the VA by building a team of dedicated VA sales specialists. These specialists possess a deep understanding of the VA network and their expertise has helped our local sales representatives become more effective at marketing and selling into the VA system. We also focus our sales organization more heavily on the VA during the first nine months of the year, and most notably in the first quarter. Because our VA patients do not have co-payment obligations, their purchasing activity tends to be less seasonal than patients covered by commercial insurance plans with annual deductibles. Our experiences show that by increasing the focus of our sales force in the VA early in the calendar year, we can drive higher sales productivity during the time of year when the commercial channel is seasonally weaker.

In addition to our revenue growth, we also maintained our strong gross margins during the first nine months of 2018 and generated significant improvements in our profitability. With our operating profit up $1.9 million year-over-year and our adjusted EBITDA improving to $9 million compared to approximately $3.1 million in the same period last year. Moving to a review of our performance in the third quarter. We achieved revenue of $36.3 million for the third quarter of 2018, which represented 28% growth year-over-year. Our revenue growth was driven by sales of our Flexitouch systems, which grew 27% year-over-year to $33.3 million in the third quarter. Sales of our Entre and Actitouch system also contributed to our Q3 performance growing 44% year-over-year to $3 million.

Our Flexitouch sales performance in Q3 was propelled by the same drivers I detailed earlier, specifically our expanded sale force, our targeted selling strategy, the increased commercial coverage for our Flexitouch system, and our continued progress in the VA channel. Our Q3 Flexitouch growth also benefited from the early market adoption of our latest generation Flexitouch system, the Flexitouch Plus, which we launched at the beginning of the second quarter. The clinician and patient response to the benefits of the Flexitouch Plus continues to be very positive and we view the next generation product to be a significant tailwind to our future growth. We complemented our strong Q3 revenue growth with 72% gross margins and a 30% increase in net income with adjusted EBITDA of $4.6 million compared to $2.5 million in the third quarter of last year.

In addition to our strong financial performance, we also had a productive quarter in terms of operational highlights. First, with respect to the commercialization of our other new product, Flexitouch Head and Neck. Since our full commercial launch of the Head and Neck system in May of last year, our sales team has been focused on selling Flexitouch Head and Neck only in our relevant existing call points, specifically lymphedema clinics in the VA. The clinician response continues to be very positive and we are happy to report that we have now hired a dedicated marketing and sales professional who is charged with leading the development and execution of our longer-term goal of expanding the commercialization of Flexitouch Head and Neck to new call points.

We are also continuing to invest in building our portfolio of clinical evidence to support our long-term reimbursement strategy for this unique treatment option for patients suffering from lymphedema in this region of the body. We expect publication of another clinical study of Flexitouch Head and Neck in the coming months and look forward to discussing the details of this study once the results are available. Moving to other highlights of the quarter, we credit our reimbursement team for delivering on a critical milestone earlier than expected, specifically, we were awarded a new federal supply scheduled contract for our Flexitouch system by the National Acquisition Center, United States Department of Veteran Affairs.

This is an important milestone that enables us to begin offering the features and benefits of a Flexitouch Plus to our clinician customers in the VA and the patients that they serve. Being included in the FSS contract makes it much easier for VA clinicians and staff to order the device thereby allowing veterans access to our Flexitouch Plus more quickly. We expect this new contract to be an important tailwind to our growth beginning in the first quarter of 2019 when our sales mix shifts toward the VA channel. Before turning the call over to Brent, I would like to comment on an announcement we made subsequent to quarter end, our exclusive license agreement with Sun Scientific.

We acquired the intellectual property of their Aero-Wrap compression therapy product in the United States and Canada for an initial cash payment of $4 million and a royalty based on future sales. Sun Scientific developed a unique patented and FDA cleared technology that provides gradient compression to the lower leg while overcoming the known shortcomings of conventional compression stockings and wraps. The strategic rationale and benefits of this acquisition are clear. First, the Aero-Wrap represents unique and differentiated technology. In fact, this agreement gives us exclusive rights to what we believe is the most innovative static compression product available today.

Second, the Aero-Wrap is highly complementary to Tactile's current products. Our current products apply dynamic intermittent compression, a treatment that's applied for about one hour per day. The Aero-Wrap is a wearable compression product that can be used during the rest of the day. Third, the Aero-Wrap fits directly into our current selling model and call points. Almost all the patients that we serve today use some form of static compression to manage their condition. The clinicians that we call on are already recommending our prescribing static compression products similar to Aero-Wrap.

Finally, and perhaps most importantly, this agreement also gives us the ability to access patients suffering from lymphedema, chronic venous insufficiency and chronic wounds earlier in their treatment pathway. There are millions of people in the US with lymphedema, venous ulcers, and chronic venous insufficiency. This license agreement allows us to gain access to a larger portion of patients earlier in their disease progression. Many of these patients may be current or future candidates for our Flexitouch Entre or Actitouch products.

We expect to be given a limited market release of the Aero-Wrap with a handful of our top sales reps following our national sales meeting in the first quarter of 2019 and look forward to sharing more details on our expectations for this product on our fourth quarter conference call. With that, I'll turn the call over to Brent for a review of our third quarter financial results and our updated guidance for 2018. Brent?

Brent Moen -- Chief Financial Officer

Thanks, Jerry. Total revenue for the third quarter increased $8 million or 28% year-over-year to $36.3 million. Our revenue performance in the quarter was driven by Flexitouch system sales, which increased $7.1 million or 27% year-over-year to $33.3 million. The increase in Flexitouch system sales was largely driven by expansion of our sales force, growth in the veterans administration channel, increased physician and patient awareness of the treatment options for lymphedema, and expanded contractual coverage with national and regional insurance payers. Flexitouch sales accounted for 92% of our total revenue in the third quarter of 2018 compared to 93% last year.

Entre and Actitouch systems sales increased by approximately $900,000 or 44% year-over-year to $3 million in the quarter. This performance was better than expected and reflects an increase in productivity related to our strategic shift to managing Entre and Actitouch orders in-house. We now have a team of internal experts overseeing these activities and they are leveraging their Medicare reimbursement experience to reduce the time necessary to process these orders. Gross profit increased $5.4 million or 26% year-over-year to $26.2 million in the third quarter of 2018. Our gross margin rate decreased by approximately 130 basis points year-over-year to 72.1% compared to 73.4% in the prior year period.

As anticipated, the current period gross margin rate was impacted by the continued launch of Flexitouch Plus. The third quarter gross margin rate was also impacted by incremental pricing headwinds related to a new contract with a large commercial payer in the period. Operating expenses increased by $5.2 million or 27% year-over-year to $24.8 million. The increase in operating expenses in the third quarter was primarily driven by an increase of $4.7 million or 43% year-over-year in sales and marketing expenses due to continued investment in field sales team expansion and marketing initiatives and increased commissions on higher revenue.

The increase in total operating expenses for the third quarter of 2018 also included a $1.4 million increase in stock compensation expense compared to the prior year. Our third quarter operating income increased by approximately $200,000, an improvement of 17% year-over-year to $1.4 million compared to operating income of $1.2 million in the third quarter of last year. Operating margins decreased 30 basis points year-over-year to 3.8% in the third quarter of 2018. Operating margin performance was flat on a sequential quarter basis. We recorded an income tax benefit of $248,000 for the third quarter of 2018 compared to an income tax benefit of $84,000 for the third quarter of 2017.

The tax benefit recognized in the third quarters of 2018 and 2017 was driven by the impact of tax-deductible stock-based compensation activity in both periods. Net income for the third period of 2018 increased approximately $400,000 year-over-year to $1.7 million or $0.09 per diluted share compared to net income of $1.3 million or $0.07 per diluted share for the third quarter of 2017. Weighted average shares used to compute diluted net income per share were 19.5 million and 19.1 million for the third quarters of 2018 and 2017 respectively. Third quarter adjusted EBITDA increased approximately $2.1 million or 83% to $4.6 million compared to adjusted EBITDA of $2.5 million in the third quarter of 2017.

Adjusted EBITDA margins improved approximately 370 basis points year-over-year to 12.6% in the third quarter of 2018. As a reminder, we have provided a reconciliation of GAAP net income to adjusted EBITDA in our earnings press release. At September 30th, 2018, cash, cash equivalents, and marketable securities were $45.9 million compared to $43.9 million at December 31st, 2017. The company had no outstanding borrowings on its $10 million revolving credit facility at September 30th, 2018. As a reminder, on August 3rd, 2018, we entered into a credit agreement with Wells Fargo Bank for a senior secured credit facility in order to provide the company with increased financial flexibility to pursue its gross strategies over time.

The credit agreement provides for a $10 million revolving credit facility with the three-year maturity. It also includes a $25 million accordion feature, which could allow the company to expand total commitments to up to $35 million. Let me now turn to a review of our 2018 revenue guidance, which we updated in our earnings release this afternoon. For the year ending December 31, 2018, we now expect total revenue in the range of $136 million to $137 million, which represents growth of 25% to 26% year-over-year compared to the revenue of $109.3 million in 2017. This revised outlook compares to our prior revenue guidance range of $134 million to $135 million.

This revenue guidance assumes sales of our Flexitouch products increase by 25% to 26% year-over-year in 2018, consistent with our prior guidance range expectations. Sales of our Entre and Actitouch products increased approximately 18% to 19% year-over-year compared to our prior guidance expectation of a 5% increase year-over-year. Additionally, for the full year 2018, we expect our gross margin to remain in the low 70% range. Adjusted EBITDA margin to be in excess of 11% including expectations of a non-cash stock compensation expense of approximately $8 million. And lastly, for the purposes of calculating earnings per share, we expect our fully diluted weighted average share count for the year to be approaching 20 million shares. With that, I'll now turn the call back to Jerry for some closing remarks. Jerry?

Jerry Mattys -- Chief Executive Officer

Thank you, Brent. In summary, we're proud of our strong operating and financial performance over the first nine months of 2018, including sales growth of 31% year-over-year and improved profitability. We now have increased our revenue guidance for the third time this year and now expect to grow 25-26% in the fiscal year 2018 compared to our original expectation of 20-22% the start of the year. Our Flexitouch Plus system remains our primary driver of growth and we're confident in our ability to continue driving strong growth as we maximize a powerful combination of an expanding sales force, a focused selling strategy targeting high volume accounts in the veterans administration channel, and our expansion of in-network coverage with commercial insurers.

In addition, we will continue to enhance the quality of life for our patient customers by providing them with an expanded range of clinically proven at-home treatments for their chronic conditions as we look to introduce the Aero-Wrap product early next year. We believe we are incredibly well positioned to continue our leadership of the US lymphedema market and grow our share of the $4+ billion market opportunity that it represents. Thank you all for our participation in today's call. Operator, we will now open the call for questions.

Questions and Answers:

Operator

Thank you. If you would like to ask a question, please signal by pressing *1 on your telephone keypad. If you are using a speakerphone, please make sure your mute function is turned off to allow your signal to reach our equipment. We do ask that you limit yourself to one question and one follow-up. If you would like to ask additional questions, we invite you to add yourself to the queue again by pressing *1. And our first question will come from J.P. McKim from Piper Jaffray. Please go ahead, your line is open.

JP McKim -- Piper Jaffray -- Analyst

Hi, good afternoon, and thanks for taking the questions. I just wanted to start this with kind of the implied guidance for Q4 given how strong you guys grew through the first nine months of the year, I think -- if my math's right -- it's around 12-15% growth. I just wanted to make sure there's nothing from the payer side that we should be thinking of. I understand there's more seasonality coming into Q4 with your focus of the sales force but I wanted to just make sure there's nothing that we should be looking out on in terms of tailwinds that are more pronounced in Q4 than we had earlier this year.

Jerry Mattys -- Chief Executive Officer

Hey, J.P. Jerry here. Thanks very much for the question. As you point out, we've upped our guidance again. It's 136-137 million, which is up 25-26% year-over-year. It does imply guidance of about $39-40 million in revenue in the fourth quarter. We are very confident in our growth expectations implied by this new guidance. In fact, growth is driven by the primary drivers, which continue to be larger field sales team. We're now up over 185 sales reps from 150 a year ago. Improving our productivity with targeting and continuing to see success in the VA.

You're correct in saying that the Q4 mix does shift more toward commercial payers in the fourth quarter, that year-end deductible dynamic is what drives that behavior. I think the thing that we want to make sure is well understood is that this growth will be paced by the ASP impact of signing this large commercial payer, which we did effective July 1 of this year. That could be as big as a $2 million in the fourth quarter on both revenue and gross margin. So that's one of the headwinds that we're up against for Q4.

JP McKim -- Piper Jaffray -- Analyst

Understood. I guess just looking out -- I know you guys don't give 2019 guidance now -- but we always thought about your guys' 20+% grower as you expand the sales force and I just want to make sure nothing changes on that front other than some of these one-time payer headwinds you alluded to.

Jerry Mattys -- Chief Executive Officer

You are right in thinking of us as a 20+% grower. The ASP impact that I talked about was effective July 1 and it will remain in effect as a headwind until we lap that contract, which will happen at the end of Q2 next year. The good news about the contract is it's the last of the five largest payers that we've now signed a direct contract with. We accessed some of their plans through a buying group previously.

But we are now directly contracted with this top five payer. What that does for us is give us access to all of their plans, which is long-term gonna be a big driver of volume for us. But short-term has this headwind of gross margin and price impact. So the new contract brings the ASP for this particular payer down in line with what we're paying what other large payers are paying so it's a big impact. It's absolutely the right strategy for us to pursue because of the long-term gain in volume that we expect from this payer.

JP McKim -- Piper Jaffray -- Analyst

That's helpful. The last one from me is just on -- you started to hire some people for Head and Neck, it sounds like you have one person in place. Can you help us size up that? I guess your plans for the Head and Neck opportunity; are we talking zero to ten people or more or really depends on how things see uptake into '19? Thank you.

Jerry Mattys -- Chief Executive Officer

On the Head and Neck specifically, this was another great quarter of growth for that product by bringing on a marketing and sales executive focused on solely the success of that product line. We do expect and are very excited about the prospects for growth in 2019 for the Head and Neck product, which will certainly provide an update on our Q4 call.

We don't have a specific number of reps that we think will be necessary to reach out beyond the call points that we're calling on today but we're having very good success in those call points so we're very excited about the contributions that she can make in terms of helping us sort through how to get after the rest of that market.

Operator

Your next question comes from the line of Malgorzata Kaczor from William Blair. Please go ahead, your line is open.

Malgorzata Kaczor -- William Blair -- Analyst

Hey, good afternoon, guys. Thanks for taking the question. First of all, I'm gonna kind of keep going on the fourth quarter implied guidance here. The last few times you guys saw a change in price in the commercial payer, it seemed like it was more than offset by volume either from that payer or from payers. So first of all, is that assumed in the guidance that you guys gave and why wouldn't it be the case this time around?

Jerry Mattys -- Chief Executive Officer

Thanks, Malgorzata, and we welcome the question. We do expect to see volume improve over time from this particular vendor as they get the details of our contract in place with all other different plans. Having said that, it has taken us in the past when we signed one of these big five payers a couple of quarters to actually see the volume.

They're very good at getting the pricing on their computer quite quickly but the coverage policies don't and the terms of the agreement don't always make it in there quite as fast. So we do expect to see volume come from this payer but the impact on price is pretty material for Q4 and we wanted to point that out on the call.

Malgorzata Kaczor -- William Blair -- Analyst

So let's maybe take it from the other direction. You've got the headwind of the price but on the same token, you're referencing your sales rep ads or your sales rep field force be up 23% year-over-year by my math. And you've got a brand new product in Flexitouch Plus. You've got an easier year-over-year comp in the fourth quarter relative to the third quarter. And then you've got the lack of a headwind that's associated with training trainers on Flexitouch Plus. So maybe kind of walk us through -- again, maybe what's implied in your numbers or not. Maybe you're not assuming very much of a benefit from those things.

Jerry Mattys -- Chief Executive Officer

We actually feel better about the fourth quarter now than we did at the beginning of Q3. And that is reflected in our guidance. We have trained 90% of the contract trainers that are -- at the end of the quarter, we were up to 90% trained. We still have 10% to go in terms of those trainings but don't factor that in as a big headwind. Frankly, we think we can do that in the normal course of business.

We did surprisingly get on the federal supply schedule early. As you may remember, when we launched Flexitouch Plus to the commercial -- to clinicians who dealt with commercial in Medicare patients -- there was some headwind in terms of introducing them the product. We expect to have a little of that headwind in Q4. So that's also reflected in the guidance that we've given. But again, we feel very good about 136-137 million for the year.

Malgorzata Kaczor -- William Blair -- Analyst

Just kind of the last question to focus more on Flexitouch Plus, which in weeks we've been pretty excited about. Did you, in fact, see a headwind maybe related to training trainers this quarter? And then, if you kind of look at the growth in prescriptions at existing accounts of Flexitouch Plus, can you give us a little bit of sense of the mix of those Flexitouch Plus systems and whether or not you've actually seen some of your accounts push more prescriptions into new patients than maybe previously they wouldn't prescribe Flexitouch because of the lack of certain features? So, all that said, how's Flexitouch Plus doing in terms of awareness and growth? Thanks.

Jerry Mattys -- Chief Executive Officer

Happy to comment on Flexitouch Plus. Overall, we're ahead of expectations on transitioning all Flexitouch orders to our Flexitouch Plus. I would say that it was well over 90% of orders that shipped out non-VA orders that shipped out in the third quarter were of the Plus rather than the Classic. We were still running both product lines simultaneously in that quarter as we had talked about that as a gross margin headwind frankly.

But overall, the experience that patients are having with the Plus is a very positive one. Anecdotally, we have seen clinicians who didn't use us to treat their bilateral patients now prescribe the Plus for those bilateral patients as well. So we are picking up additional prescribers that we just didn't have access to before. So all in all, ahead of the expectation of getting to the Flexitouch Plus in terms of shipments and we think more good things to come in 2019.

Operator

Your next question comes from the line of Chris Pasquale from Guggenheim. Please go ahead, your line is open.

Chris Pasquale -- Guggenheim -- Analyst

Thanks and congrats on the strong quarter. Jerry, to start with, I just wanted to clarify one item with regard to the guidance update. The contract went into place in the start of July so you guys were dealing with that headwind throughout 3Q as well, is that correct? And is there any reason it should impact you more in the fourth quarter than it did in the third quarter?

Jerry Mattys -- Chief Executive Officer

Hey, Chris, and thanks for joining the call and for the question. Yes, there is a reason that it will be more impactful in Q4 than in Q3 and you're correct. We did start dealing with this in the third quarter as well. It did take them some time. It took the payer some time to get the contract pricing in place.

So for the first part of the quarter, we were actually shipping on the old pricing and the new pricing came into effect throughout the quarter. This Q4 will be a full quarter of that new price. It's now in their system and that is the price that we are charging them for their members. So that's the main difference.

Chris Pasquale -- Guggenheim -- Analyst

Okay. That's helpful. And then you talked a little bit about how Aero-Wrap fits into your existing portfolio. It sounds like there's some overlap though between what that product does and what Actitouch is designed to do. Can you speak to that and talk about whether you're targeting the same patients here, you see those as being complementary or somewhat substitutable with one another?

Jerry Mattys -- Chief Executive Officer

That's a really good question and a good observation on your part. Aero-Wrap we believe is a very complementary product to our whole range: Flexitouch, Entre, and even our Actitouch even though they look similar. Our current products are deliver intermittent compression and that's how they're reimbursed. Almost every payer has as a requirement that a trial of conservative therapy before they'll move onto a more advanced therapy like an Entre, Actitouch, or Flexitouch. And the Aero-Wrap meets that definition of conservative therapy. So we can get access to patients earlier in their treatment paradigm.

As I mentioned on the call, almost every patient that utilizes one of our intermittent devices also uses a static compression product, whether that's compression hosiery, stockings, or compression wraps. And the Aero-Wrap can be a solution for many of those patients. So we do look at it as a complement to our current products, not something that's going to disrupt the current mix of products that we have. And we're planning to get a limited market release in the first quarter of next year after our national sales meeting, our usual cadence with new products is to do the limited release with our top reps first and then expand to the whole sales organization. And that should happen in 2019.

Operator

Your next question comes from the line of Jason Mills from Canaccord Genuity. Please go ahead, your line is open.

Cecilia Furlong -- Canaccord Genuity -- Analyst

This is actually Cecilia Furlong on for Jason. I just wanted to follow-up on Flexitouch Plus after getting in on the federal supply schedule. What kind of timing are you looking at in terms of being to fully shift to a single production line? And then just looking out to 2019, the impact this could have on margins offsetting ASP, the impact that you're seeing too?

Jerry Mattys -- Chief Executive Officer

Great, Cecilia. Thanks for the question on Flexitouch Plus. A couple of things. First, we are very excited to now have the Flexitouch Plus on the federal supply schedule. It gave us the opportunity to go to some of our vendors, some of our supply chain, and actually, convert orders that we had placed for the classic to orders for the Plus. So because we got that federal supply schedule earlier than anticipated, we were able to shift some of that future production to the Flexitouch Plus.

That we should be onto a single production line here as we come into 2019. So I think that's going to bode very well for our gross margins improvement and offsetting some of these average selling price impacts that we've been talking about pretty consistently in terms of our expectations on ASP declining in the mid-single digits over the next few years. We think we can keep pace with that and maintain our 70+% gross margin going forward. I don't know if that answered your question in its entirety or not.

Cecilia Furlong -- Canaccord Genuity -- Analyst

That's great, that's very helpful. And then, I guess, just also if you could touch on sales force hiring trends? Q3 seems a lot stronger. And just what you're looking at in Q4; the turnover you're seeing and what type of reps you're targeting right now to continue to grow and just your outlook for 2019 as well would be great?

Jerry Mattys -- Chief Executive Officer

We did report that we are now up over 185 reps; that's specialists and associates in the field. That's a big step up from where we were at the end of Q2. I would say that the turnover has returned more to normal levels and we're not seeing exits like we did in the first quarter. And we've frankly put a lot more resources behind our hiring efforts. So going aggressively at bringing on new folks into the company. We expect to be able to hit that number of a 20% increase in our field sales organization by the end of the year as we had stated at the beginning of the year. And we're on a much better pace to get there, frankly. We expect that that's going to be a big driver for growth in 2019 as we bring these people up to speed on how to sell our products.

Operator

Your next question comes from the line of Suraj Kalia from Northland Securities. Please go ahead, your line is open.

Suraj Kalia -- Northland Securities -- Analyst

Good afternoon, everyone. Thank you for taking my questions. Can you hear me alright?

Jerry Mattys -- Chief Executive Officer

I can, Suraj, thank you. Welcome.

Suraj Kalia -- Northland Securities -- Analyst

So, Jerry, forgive me, just juggling in between calls. Did you mention the VA contribution in the quarter?

Jerry Mattys -- Chief Executive Officer

We talked about VA being about 19% of our revenue for the quarter versus about 20% last year. So it remains a significant contributor to the company's growth.

Suraj Kalia -- Northland Securities -- Analyst

Got it. What about the contribution from the Head and Neck product, Jerry?

Jerry Mattys -- Chief Executive Officer

Suraj, we didn't call that out specifically. We expect to be able to provide an update on our progress with that particular product as we come into guiding for 2019. We had previously talked about that in the low to mid-single digit percentage of total fiscal year revenue. And it's tracking exactly as we had anticipated.

Suraj Kalia -- Northland Securities -- Analyst

Got it. And Jerry, I know you're not giving FY19 guidance currently and I understand this question might be a little tricky but this impact from the top five contracts. How should we think about -- would Q4 be sort of a slow through into FY19 from a pricing perspective or do you think the second half of '19 volume would more than compensate? I guess maybe what I'm trying to get at is; how should we look upon FY19 numbers? Should we temper it? Any color there to the extent that you can provide would be greatly appreciated. Thank you for taking my questions.

Jerry Mattys -- Chief Executive Officer

First off, we're not giving guidance for '19. Having said that though, what we've seen with this payer contracts is once we get on board directly with the payer we certainly give up some price, which is a temporary phenomenon we expect to have an impact in the first half of '19. And then we pick up volume because we have accessed all their plans and all their members. We have been guiding previously to slow to mid-single-digit price erosion and anticipated that as part of our price changes, this particular contract was not anticipated at the beginning of the year because we had access to this payer through a buying group.

But they elected to scuttle the buying group and we got a direct contract in place. So the fact that we can access all of their plans long-term, this is a terrific strategy for our company and it will give us a big driver of volume starting in 2019. The short-term pain, if you will, is that there's an ASP, an emerging headwind that we have to overcome.

Operator

Again, if you would like to ask a question, please press * then the number 1 on your telephone keypad. Your next question comes from the line of Mitra Ramgopal from Sidoti. Please go ahead, your line is open.

Mitra Ramgopal -- Sidoti -- Analyst

Good afternoon, Jerry. I just wanted to come back to Flexitouch Head and Neck. I know you said the focus initially was on the traditional call points of the lymphedema clinics and the VA and now you're looking to target some new call points. I was wondering if you can expand or give us a sense of what those might be?

Jerry Mattys -- Chief Executive Officer

Thanks, Mitra. I'd be happy to do that. As we've launched our Flexitouch Head and Neck to the call points that were already exposed to specifically lymphedema clinics and the VA hospital system, we find that patients with head and neck lymphedema are cared for by other specialties ranging from speech therapists because the swelling interferes with and impacts the patient's speech, to surgical oncologists who work on trying to rehabilitate that patient back to a more normal lifestyle, all the way to radiation oncologists who deliver the therapy to try to address cancer.

So we are seeing other clinicians involved in the care of these patients and that's why we wanted to bring on someone with some specific marketing and sales expertise looking at how we might access those other call points, whether it's through our current sales force and layering on top a head and neck series of specialists or whether it's setting up a separate sales channel to go after that particular piece of the business. That's the challenge in front of our newest sales and marketing executive.

Mitra Ramgopal -- Sidoti -- Analyst

That's great. Secondly, as you look at your overall product offering now with Aero-Wrap and the earlier -- back in June you acquired some patent rights. I was just wondering if we should be expecting some of those types of announcements going forward or you're pretty happy with what you have to offer right now?

Jerry Mattys -- Chief Executive Officer

Thanks for the questions. I do think we will continue to be opportunistic about products that might fit into our sales team's basket or might go to the call points that we're calling on today. The intellectual property that we picked up last quarter and then the Aero-Wrap product I think are both good examples of the kind of opportunities we're looking for or looking at. And we would expect to continue to look to supplementing our current offering with some future additions.

Operator

Your next question comes from the line of Sean Lavin from BTIG. Please go ahead, your line is open.

Marie Thibault -- BTIG -- Analyst

Hey, this is Marie Thibault on for Sean Lavin, thanks for taking the questions. I had just one quick one. Congrats on the timing of the VA, the FSS, getting the supply schedule a little bit early. I was just curious why that benefit wouldn't start to hit here at the end of the year instead of in the first quarter of 2019? I understand a lot of the focus on the VA in the first three quarters of the year, but given the early timing, why wouldn't we start to see a little bit in the fourth quarter?

Jerry Mattys -- Chief Executive Officer

Great question, Marie. Thanks for joining the call. The federal supply schedule contract that we signed does give us access to the VA going into a quarter of the year where our sales force is very focused on serving their commercial patients. The reason for some of the seasonality in our commercial business is because deductibles and co-payments are often met by this time of the year for many of our patients because of their consumption of other healthcare dollars and therefore the cost of our equipment drops pretty dramatically by year-end. That's an expiring benefit for these patients so if they don't get our product by the end of the year, they reset all of those deductibles and co-payment obligations and we start over the year with commercial business dropping off.

So that's the first reason. The first reason is, our sales force is serving the commercial payer more in the fourth quarter than the VA patient because of that dynamic. The second reason is, now that we have the contract in place, we have to go introduce the product to that clinician like we did when we got our approval and actually launched our Flexitouch Plus on the commercial side of our business. That takes extra time. So in this fourth quarter, which is our largest quarter by far every year, we don't see our sales reps spending a lot of time introducing something in the VA in that quarter. So that's why we don't forecast a large contribution. We certainly think there will be significant VA business for us but it's not gonna be a concerted effort until Q1. Hope that answered your question.

Marie Thibault -- BTIG -- Analyst

Yeah, so even there you do have a kind of a VA focused team, I understand obviously the seasonality around commercial sales. There's just not enough bandwidth and the fact they need to introduce the product.

Jerry Mattys -- Chief Executive Officer

I think that sums it up well.

Operator

That does conclude our conference for today. Thank you for your participation.

Duration: 51 minutes

Call participants:

Jerry Mattys -- Chief Executive Officer

Brent Moen -- Chief Financial Officer

JP McKim -- Piper Jaffray -- Analyst

Malgorzata Kaczor -- William Blair -- Analyst

Chris Pasquale -- Guggenheim -- Analyst

Cecilia Furlong -- Canaccord Genuity -- Analyst

Suraj Kalia -- Northland Securities -- Analyst

Mitra Ramgopal -- Sidoti -- Analyst

Marie Thibault -- BTIG -- Analyst

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