Inogen, Inc. (INGN) Q4 2015 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen. And welcome to the Inogen 2015 Fourth Quarter Financial Results Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session and instructions will be given at that time. [Operator Instructions] As a reminder, this call is being recorded. I would now like to introduce your host for today's conference Mark Klossner, Investor Relations. Please go ahead.

Thank you for participating in today’s call. Joining me from Inogen is CEO, Ray Huggenberger; President and COO, Scott Wilkinson; and CFO and Co-founder, Ali Bauerlein. Earlier today, Inogen released financial results for the fourth quarter and year ended December 31, 2015. This earnings release and Inogen's corporate presentation are currently available in the Investor Relations section of the company’s website. During the call and subsequent Q&A session, we will be discussing plans and projections for our business, future financial results and market trends and opportunities including among others, statements regarding future product releases and improvements, product launch date expectations, our strategic focus and objectives, hiring expectations, seasonality, our estimate on the impact of reductions in Medicare and insurance reimbursement rate and changes to the competitive bidding process, cost reduction expectations, expectations for private label sales growth and 2016 guidance including revenue, adjusted EBITDA, adjusted net income, net income, net cash flow, effective tax rates and tax benefits. These statements are forward-looking and are subject to substantial risks and uncertainties that may cause actual events or results to differ materially from currently anticipated events or results. Information on these and additional risks, uncertainties and other information affecting Inogen's business operating results are contained in Inogen's annual report on Form 10-K and for the year ended December 31, 2014 and in Inogen's subsequent reports on Form 10-Q and Form 8-K. Additional information will also be set forth in Inogen's annual report on Form 10-K for the year ended December 31, 2015 to be filed with the Securities and Exchange Commission. We advise investors to review these risk factors carefully. The forward-looking statements in this call are based on information available to us as of today’s date March 14, 2016, and we disclaim any obligation to update any forward-looking statements except as required by law. During the call, we will also present certain financial information on a non-GAAP basis. Reconciliation between U.S. GAAP and non-GAAP results are presented in the table accompanying our earnings release which can be found in the Investors section of our website. I'll now turn the call over to Ray Huggenberger. Ray?

Thank you, Mark. Good afternoon, everyone. And thanks for joining our fourth quarter 2015 conference call. On our call today I'll start with the financial and business highlights. Then Scott will cover our recent operational accomplishments and then Ali will review the fourth quarter 2015 financials in more detail as well as provide our updated 2016 guidance. I'll close with remarks on our 2016 strategy and then we'll open the call up for your questions. In the fourth quarter of 2015, demand for our portfolio of innovative oxygen concentrators remains strong across all of our revenue channels and exceeded our expectations. We historically have experienced some slower seasonal impact in the fourth quarter of the year due to holidays and weather. However, demand in our domestic and international business-to-business sales channels as well as the positive impact on our direct-to-consumer channel from investment made to expand our sales team drove stronger than anticipated growth. Revenues in the fourth quarter were $40.4 million which represented 38.9% growth from the same period last year. For the full year 2015, revenues were $159 million reflecting 41.3% growth year-over-year. Domestic business-to-business sales exceeded expectations and continued to be our strongest growth channel in the quarter, increasing 81.5% over the same period in the prior year. We believe the strength we saw in this channel came from several factors including private label sales which contributed to more than half of the increase at this channel in the fourth quarter of 2015 over the same period in the prior year. Private label sales did not begin until early 2015, so year-over-year comparisons reflect that additional contribution. We are optimistic that this private label business relationship will continue to provide revenue contributions in our domestic business-to-business channel. Increasing resale demand was also contributed to domestic business-to-business sales growth. As our partners have performed well in expanding their sales and marketing efforts. We also believe there is likely pull through effect from our direct-to-consumer media campaigns that demonstrate the benefits of our portable oxygen concentrator. Internationally, we saw stronger than expected sales growth in the fourth quarter of 2015 over the fourth quarter of 2014. This is particularly notable in light of the tough comparison due to French and German reimbursement for our Inogen One G3 that provided upside in the fourth quarter of 2014. Sales in Europe represented 89.5% of our total international sales. We plan to continue to focus on expanding international distributor and key account partnerships as well as directly supporting larger customers throughout Europe to drive conversion from the traditional delivery base systems to our portable oxygen concentrator. US direct-to-consumer sales and rental revenue in the fourth quarter of 2015 combined increased 34.1% over the fourth quarter of 2014 and represented 57.2% of our total revenue. Our strong direct-to-consumer sales in the fourth quarter of 2015 highlight the strength of our direct-to-consumer marketing model. Due to the anticipated reductions of Medicare reimbursement rates in 2016, we will continue to shift our emphasis towards a sale over a rental. The growth in our direct-to-consumer channels was primarily due to our expanded inhouse sales team as well as growing brand awareness. You will recall that in the third quarter of 2015, we made the decision to accelerate our pace of hiring as we felt it was an opportune time to make investments to further increase our direct-to-consumer sales force to capture the demand we expect this year and beyond. We continue to see qualified candidates throughout the remainder of 2015 and were successful in increasing our internal sales representative headcount to 166 by year end. That represents a 28.7% increase from December 31, 2014. Even with the increased investment in sales personnel and product development, we still improve profitability and delivered adjusted EBITDA of $8.1 million and net income of $3.9 million for the fourth quarter of 2015. For the full year of 2015, adjusted EBITDA and net income were $32.3 million and $11.6 million respectively. Let me turn to some product updates. Maintaining our leadership position in the portable oxygen concentrator space through a commitment to innovation and new product development is a key strategy for us. We plan to continue to make R&D investments to stay at the forefront of patient preference and product capabilities. The release to market of our enhance Inogen One G3 portable oxygen concentrator was a highlight at the fourth quarter as its upgraded features have the potential to serve more patients than the prior design. And the final design of our fourth generation portable oxygen concentrator the Inogen One G4 is on track with commercial launch plan for the second quarter of 2016. I'd now like to turn the call over to Scott Wilkinson to cover our operational highlights. Scott has been with Inogen since 2005 and has served as our Executive Vice President of Sales and Marketing since 2008. He was promoted to the role of President and COO in January of 2016. Scott?

Thank you. As Ray mentioned, we are committed to continuous product innovation and maintaining our leadership position by delivering the best portable oxygen concentrator we can to the market. Our recently released upgraded Inogen One G3 provides five flow setting and a 25% increase in total oxygen production with no added size or weight, giving it the highest oxygen output of any portable oxygen concentrator of the same weight in the market today. In addition to increased oxygen production, the sound level of Inogen One G3 has been lowered from approximately 42 decibels to 39 decibels and the product cost was also reduced. Shipments of the upgraded Inogen One G3 and our direct-to-consumer sales and rental channels began in December 2015 at product launch. In the first quarter of 2016, we expanded the sale of the upgraded Inogen One G3 product for our domestic and international business-to-business channels. Our Inogen One G4 is expected to be smaller, lighter and less expensive to manufacture than our current Inogen One G2 and G3 products. We are excited about this product launch as we believe it will provide the opportunity to increase freedom in mobility to millions of oxygen patients worldwide. I'd also like to comment on some reimbursement updates. We've not received additional information from CMS on the single payment amount associated with the round two re-compete which will be applied to approximately 50% of the Medicare markets on July 1, 2016. This will also have an impact on the amounts paid in the approximately 40% of the markets covered in the national application of competitive bidding rates that began in January of 2016. In January of 2016, the rates to apply to the areas that weren't subject to competitive bidding were calculated using the average of 2015 Medicare standard allowable and the existing regional average single payment amounts based on round one and round two competitive bid area. In July of 2016, the rates will be recalculated based on the existing regional average single payment amounts based on round one and the updated round two rate. We continue to expect the total revenue headwind in 2016 associated with these Medicare reinvestment rate reductions to be 2.5% to 3.5%. As we received more information from CMS, we'll provide updates as necessary. In addition, it has been proposed to subject stationary oxygen services to prior authorization requirement for Medicare patients. This is not unique to portable oxygen concentrator but if this is enacted we would be subject to this requirement. We do not know when or if this will be implemented but it could create a small delay in processing new Medicare rentals depending on the length of time it takes to get prior authorization. We already procured the necessary documentation to meet Medicare requirements before we deploy equipments to our patients. So this is already part of our intake process. In the long run if this is implemented properly, it could be beneficial as we could reduce denials currently received post billing. Moving to a quick regulatory update. In March 2016, an inspection was conducted by the FDA at our California facility. Their audit scope included reviewing our manufacturing procedures and equipment maintenance records, customer complaint handling procedures, the corrective action program and the design control process. We are pleased to report that there were no findings reported to us during this inspection. We continue to strive to maintain strict compliance with the FDA regulations and to continuously improve our quality and manufacturing processes. I'll now turn the call over to Ali to cover our financial performance and guidance.

Thanks, Scott, and good afternoon everyone. During my prepared remarks, I will review the details of our fourth quarter financial performance and then I will provide updated guidance for 2016. As Ray noted, total revenue for the fourth quarter of 2015 was $40.4 million, representing 38.9% growth over the fourth quarter of 2014. We saw better than anticipated revenues in a historically seasonally slower fourth quarter. Looking at each of our revenue streams and turning first to our sales revenue. Total sales revenue was $28.9 million, reflecting 57.7% growth over the same quarter of the prior year and representing 71.6% of total revenue. Total unit sold increased to 14,500 in the fourth quarter of 2015, up 62.9% from the fourth quarter of 2014. Domestic business-to-business sales were $8.9 million in the fourth quarter of 2015 and it was our fastest growing channel in the quarter for the growth rate of 81.5% over the same period in the prior year, primarily due to increasing private label and reseller demand for our portable oxygen concentrator. International business-to-business sales exceeding our expectations at $8.5 million representing 21.2% growth versus the same period in the prior year primarily due to continued strong demand from our European partner. International average selling prices in the fourth quarter of 2015 declined over the same period in the prior year due to currency headwinds and additional discount associated with the increased sales volume. Direct-to-consumer sales for the fourth quarter of 2015 were $11.6 million representing 79.5% growth over the fourth quarter of 2014 primarily due to the increased inside sales headcount as the staff added in the fourth quarter 2014 began to contribute meaningfully in the second half of 2015. Now turning to rental revenue. Direct-to-consumer rental revenue in the fourth quarter was $11.5 million representing 6.8% growth over the same period in the prior year. Rental revenue represented 28.4% of total revenue in the quarter. We continue to shift sales focused towards consumer sales versus rental primarily due to the anticipated additional Medicare reimbursement cut in 2016. Rental revenue in the fourth quarter of 2015 was relatively flat when compared to the third quarter of 2015. This is primarily due to lower rental revenue per patient on service. At the end of the fourth quarter of 2015, we had 32,800 rental patients on service, a 15.5% increase over the number of patients on service as of December 31, 2014 and 1.2% increase over the number of patients on service as of September 30, 2015. Turning to gross margin. For the fourth quarter of 2015 total gross margin was 49.5% compared to 47.4% in the fourth quarter of 2014, up approximately 210 basis points. Our sales gross margin was 48% in the four quarter of 2015 versus 43.7% in the fourth quarter of 2014. The improvement in sales gross margin percentage was primarily related to a shift in sales mix towards higher margin direct-to-consumer sales which accounted for 40% of total sales revenue in the fourth quarter of 2015 versus 35.2% in the fourth quarter of 2014, as well as the reduction in cost to good sold per unit stemming from lower material, labor and freight costs. Combined these two factors with the primary enablers to more than offset the decline in business-to-business average selling prices. Rental gross margin was relatively stable at 53.4% in the fourth quarter of 2015 versus 53.8% in the fourth quarter of 2014. Lower service cost per rental patient enabled us to mostly offset lower net revenue per rental patient. In terms of operating expenses, operating expense was $16.6 million in the fourth quarter of 2015 versus $12.4 million in the fourth quarter of 2014. The increase was primarily due to strategic investments made in additional sales force headcount and support personnel. Operating expense, the percent of revenue decreased to 41% in the fourth quarter of 2015 from 42.5% in the fourth quarter of 2014. As we continue to demonstrate our ability to achieve operating leverage. For research and development expense, we had $1.2 million in R&D expenditures for the fourth quarter of 2015 versus $0.7 million in the same 2014 period. The increase was primarily associated with additional personnel and engineering product development expenses primarily related to the Inogen One G3 upgrade and the Inogen One G4 development. For selling, general and administrative expenses or SG&A, total SG&A expenses increased 30.9% to $15.3 million in the fourth quarter of 2015 versus $11.7 million in the same 2014 period, primarily due to the additional investments made in 2015 in sales and support staff that we expect will facilitate our growth in 2016 and beyond. Sales and marketing expense was $8.7 million for the fourth quarter of 2015 versus $6.4 million in the same 2014 period, primarily due to increase direct-to-consumer sales force addition, customer and clinical service personnel and media expenses. General and administrative expense was $6.6 million for the fourth quarter of 2015 compared to $5.3 million in the same 2014 period. The increase was primarily related to increased personnel and bade debt expense. In the fourth quarter of 2015, we reported income tax benefit of $0.5 million compared to a benefit of $0.2 million in the fourth quarter of 2014. In the fourth quarter of 2015, our effective tax rate was negative 16.3%, primarily due to the tax benefit adjustments of $1 million mainly related to a decrease in the valuation allowance related to California net operating losses and increase in equity compensation deduction. Excluding these tax benefit adjustments, the effective tax rate for the fourth quarter of 2015 would have been 14.3% which was lower than the rest of 2015 primarily due to benefit associated with the Federal R&D tax credit and the timing of stock disposition in the fourth quarter of 2015. As a result, our net income in the fourth quarter of 2015 exceeded expectations primarily due to strong revenue, improved gross margin and a lower effective tax rate. Net income for the fourth quarter of 2015 was $3.9 million compared to $1.5 million in the fourth quarter of 2014, an increase of 154% in the comparative period and representing a return of revenue of 9.5%. Earning per diluted common share was $0.19 in the fourth quarter of 2015 versus $0.07 in the fourth quarter of 2014, an increase of 171.4%. Earnings per diluted common share for the full year 2015 were $0.56 versus $0.30 for the full year 2014, an increase of 86.7%. Moving to our cash balance, we ended 2015 with $82.9 million of cash, cash equivalents and short term investments, an increase of $8.8 million from September 30, 2015. In the fourth quarter of 2015 we made investments in property and equipment of $2.7 million primarily for our rental fleet addition. As of the end of the fourth quarter of 2015, we had no bank debt outstanding and our entire $15 million credit facility was available. In addition, I would like to cover some key non-GAAP financial measures. Adjusted net income in the fourth quarter of 2015 rose 125.5% to $2.8 million from $1.3 million in the fourth quarter of 2014. The tax benefit adjustments excluded from adjusted net income were $1 million in fourth quarter of 2015 versus $0.3 million in the fourth of 2014. Adjusted EBITDA for the fourth quarter of 2015 was $8.1 million, which was a 20.1% return on revenue. Adjusted EBITDA increased 63.8% in the fourth quarter of 2015 versus the fourth quarter of 2014, for adjusted EBITDA with $5 million. Turning to our guidance, we are providing updated guidance for the full year 2016. We now expect total revenue of $187 million to $191 million, representing 17.6% to 20.1% growth over the 2015 revenue of $159 million. This compares to our prior guidance of $177 million to $183 million. This revenue growth is in spite of the additional revenue headwinds expected in 2016 and associated with the national application of competitive bid prices to Medicare area currently not subject to competitive bidding. We continue to expect total revenue headwinds from Medicare competitive bidding national rollout of 2.5% to 3.5% in 2016. While we do not provide quarterly guidance, we should note that we historically experienced a seasonally slower Q1 and Q4 with higher Q2 and Q3 resulting from the warmer month and when patients are more likely to travel. And we expect similar trends in 2016. However, due to the anticipated timing of the Inogen One G4 launch in the second quarter and the full impact of the reimbursement changes to become effective in the second half of this year, we could see even more pronounced seasonality in 2016. We expect direct-to-consumer sales to be our fastest growing channel in 2016. Adjusted EBITDA guidance for 2016 is $37 million to $39 million representing an increase of 14.6% to 20.7% over 2015. We are basing these anticipated results on several factors including increasing direct-to-consumer sales as a portion of total revenues as investments in our sales force produced return, lower cost to good sold following the launch and rollout of the Inogen One G3 upgrade and the Inogen One G4 product and continued operating expense discipline. We expect these factors will mostly offset the reimbursement declines expected in the Medicare market on an adjusted EBITDA and net margin basis. Adjusted net income is expected to be $12 million to $14 million, representing 19.8% to 39.8% growth over 2015. Net income guidance for 2016 is $12 million to $14 million, representing an increase of 3.6% to 20.8% over 2015. We expect an effective tax rate in 2016 of approximately 35% compared to an effective tax rate of 32% in 2015 excluding the tax benefit adjustments of $1.6 million that are not expected to recur in 2016. We expect a higher effective tax rate primarily due to lower tax deductions for equity compensation as a percentage of pretax income which is not expected to have as much impact on the 2016 effective tax rate as it did in 2015. We also expect a higher effective tax rate in the first half of 2016 versus the second half of 2016. In addition, we continue to expect net positive cash flow for 2016 with no additional equity capital required to meet our current operating plan. I'd now like to turn the call back to Ray for some closing remarks.

All right. Thanks Ali. I'll close with just a few comments on our strategy for 2016. We will continue to seek ways to mitigate the impact of reductions in our rental reimbursement business resulting from the anticipated changes that emerge from competitive bidding later this year including the ongoing shift and emphasis towards cash sales. During 2016, we expect to commit further resources to increasing our sales force as we identify qualified candidates while at the same time ramping marketing programs to educate physicians and patients alike on the benefits of POCs. Finally, we expect to launch our new Inogen One G4 in the second quarter of 2016 as well as continue to advance innovation and product development. In addition, we plan to continue to identify additional efficiencies to reduce our cost of good sold per unit and increase overall operating expense leverage in order to preserve net adjusted EBITDA margins. With that Scott, Ali and I would now be happy to take your questions.

[Operator Instructions] Our first question comes from the line of Mike Weinstein with JPMorgan. Your line is open. Please go ahead.

Thank you. And congratulations, guys, on another very nice quarter. Let me ask you, you're now 2.5 months basically into the new year. And when you initially gave your 2016 guidance, really, part of the message was, we really need to see how the B2B business was going to continue to play out. It obviously did much better than expected in 2015. But you said let's just be cautious, going into 2016, because we just don't know how much is going to repeat, and whether we can continue to expect to see such great growth. Now that we're 2.5 months into the year, do you have any incremental insights? And how do you think about the B2B business -- and I mean both the US and international for 2016?

Yes. Sure, Mike. I'll take that question. So first of all just talking a little bit about 2015, obviously, it was great year for us, domestic business-to-business increased a little over $15 million and the majority of that was associated with addition of the private label sales that had no base in 2014 because we didn't start that till the first quarter of 2015. So while that was a great growth driver for us in 2015, when we look at 2016, we think that growth rate of domestic B2B will slow substantially because of that year-over-year comp and that the private label sales going into the base line. We still with business-to-business in general have less visibility and the same thing with international. International increased almost $11 million year-over-year in 2015 versus 2014 and a large driver of that was the additional reimbursement that we got in France and Germany for the G3 product in the second half of 2014 and also did continue strong relationships and partnership with distributors and the large gas companies primarily in Europe. When we look to 2016, international growth rate is the hardest for us to predict because we are depended on the success of our partners and how they deploy POC. We also looking at 2016 don't expect that Inogen One G4 product to have a significant impact in the international market until 2017 because they typically go through a longer product review cycle as well as the additional regulatory requirement to get it approved in the various markets. So internationally we expect the driver to still be the Inogen One G3 upgraded product and when we talk about guidance and the guidance range that we've given, it really still assuming that direct-to-consumer cash sale will be our fastest growth channel for 2016 because is where we have the most control and we've been assumed slower growth rate for both domestic and international versus the direct-to-consumer areas. We have not assumed any material new market or reimbursement decision in the guidance and we've also not assumed any large national adoption or any additional private label relationship, those be accretive to guidance and clearly until we have facility on those things, it wouldn't be prudent to include those in guidance.

Understood. Let me ask you this relative to G4, and I'm thinking back to when you guys launched G3. And one difference at this point is -- there are a few differences, but obviously, your sales force is much larger today than it was when you launched the G3 product. You're in a completely different place, and the B2B business is obviously much more developed. Can you just talk about how you think about that launch versus what we saw when you launched G3?

Yes. This is Scott. I will take that one. I think you will see a similar trend in process as with previous launches. If you look at G3 compared to G2, we got a product that smaller and lighter and I'll say more patient preferred. So we expect positive things from that. But when we look at the transition, we always start with a new product and we kind of got a formula that's tried and tested it worked for us. We start with the consumer channel; we sell directly to the consumers with our inhouse sales team. Once we scaled our manufacturing to point where we are comfortable, we go to the next phase that will be the business-to-business channel that includes both the homecare companies as well as internet resellers. And then the last phase in expansion would be the international market. And as Ali just mentioned the international markets with new products, there is typically a lot more testing required for product adoption, country by country sometimes we have to seek reimbursement in those channels or in those countries. So international tends to be a little bit slower adoption and it's now at the end of a curve. But I think given that this is fourth product launch, we feel pretty comfortable with what's going to happen, it's reflected in our guidance for this year and we are still on track for a second quarter launch for G4.

Scott, the 183 internal reps you have as of year end, what percentage of those have been for less than six months? I thinking about the productivity of the new rep hire. So 183 internal sales reps you have now, what percentage of them come on recently essentially I use the timeframe in the last six months. Do you have a sense with that?

Yes. So just to clarify we have 166 reps, the 183 that includes sales management admin support et cetera. So with 166 internal reps, as we mentioned in the past, we did kind of ramp up in hiring in the second half of last year so it wasn't linear our adds last year, there are still reps that are coming up the curve that we added in December and it is four to six months ramp to study state for reps. So we still got those reps added at the tail end of last year that are coming up the curve. If you look at productivity improvement, generally there is some small productivity improvement across the board, we try and drive efficiency year-over-year but you've also got to remember that from a Medicare standpoint they usually throw some more curve balls at you, so we try and offset those curve balls with the productivity improvement. Now going into the second quarter as Ali mentioned from a seasonally standpoint, that every year is our high watermark. So we are going to be launching of G4 in a period that is from the seasonally standpoint are usually our best time of the year. We'll see how things play out but it will be -- it's difficult to sort out the impact of G4 seasonality and new reps because they are all kind of in that mix but it's a good time to be launching a new product in our best time of the year.

Understood. Okay. I'll ask one last question, and I'll let somebody else jump in. Ali, the sales mix was pretty comparable, 3Q to 4Q, but your sales gross margin was about 300 basis points higher. Why was that?

Yes. So I mean the big driver when you look at it as we've talked about lowering our cost to good sold and that is something that was a driver in the fourth quarter versus the third quarter with the launch of the upgrade to the Inogen One G3 product as well as continued savings on our labor and freight side. So outside of just sales mix lower cost to good was the primary driver.

Thank you. Our next question comes from the line of Margaret Kaczor with William Blair. Your line is open. Please go ahead.

Good afternoon, guys. So the first question I have is on the sales force and sales force productivity piece. I know Scott you just addressed a little bit but again your productivity seemed to improve in 2015 over 2014. Why shouldn't we expect productivity increase again as you guys launch the upgrade G3, the nextgen G4 both of which should improve your close rate? And then even with the changes that you guys had discussed earlier on the DTC sales over to rental as that reimbursement gets pushed out. That should drive more DTC sales. Again Scott I know some of that gets offset with reimbursement cut but you do get more front end revenue by moving over there. And then just to wrap it all up I guess with the sales reps up 30% why shouldn't we see DTC growth be over 30%.

Yes. Margaret you got to remember if you look back over the last couple of years that we have migrated in a shift towards emphasizing cash sales away for rentals to better diversify away from the Medicare reimbursement reduction. So as you get cash sales, you get all of the revenue upfront versus on a rental sales, that payment comes over two years or more. So you inherently -- if you just study the financial numbers, you'll see what could look like a productivity improvement in financials driven by the direct-to-consumer channel, there really is more of a shift of migrating to the cash sales. Hopefully that makes sense just because of the front end loading of every cash sales that you get versus the impact on a rental sale. Certainly, we expect from a G4 standpoint, we expect that to be, I'll call it a more preferred product from a patient perspective versus previous versions of the product. Our study have shown and it's not rocket science that patients like smaller, lighter things that are easier to carry and a smaller and lighter POC as we've launched version after version, the smaller and lighter we go the more success that we had. So we certainly expect that G4 is going to be patient preferred and will be our flagship product in our line. It doesn't necessarily open up the market per se as far as number of patients but it will make conversion we expect perhaps a little bit easier. There are patients that maybe in the past would have said, oh G2 or G3 might be a little heavy now with the smaller, lighter product, it could be a product where they say now I am going to make the change. But time will bear that out. We don't have the product in the market yet so have to see what happens once we launch.

Yes. And just to expand a little bit on that, we are saying at the midpoint it's about 19% increase in revenue so and we are also saying that direct-to-consumer cash sales will be our fastest growing channel of that and you are offsetting a pretty significant reimbursement decline. So not to say specifically what we expect in terms of the growth rate of that direct-to-consumer channel but in order for the numbers to work out it has to be faster than 20%. So in that 20% to 30% -- is certainly feasible, a lot will also have to do with the timing of when the Inogen One G4 is launched in terms of earlier or later in the second quarter since there is ramp up period and you are hitting right at peak seasonality. So it can have a big impact on how many G4 you are really getting at the peak seasonality which could have an impact on our overall direct-to-consumer growth rate for the full year.

Sure. No, that's helpful. And Scott I meant more on a kind of revenue per rep rather than a patient added per rep, but I guess both may go hand in hand. And then just to move to growth margin and follow up on something Mike had asked. How much of the improvement did a product was a matter of mix and launching that upgraded G3 device and then maybe another way of saying is that is how many of the upgraded G3 devices that you sell versus the older devices in the quarter and then as round three gets implemented with G4 coming out in 2016, how does that play out net-net for gross margin as we look up?

Yes. So we didn't breakout specifically what the contribution was of cost to good sold versus other drivers. The upgraded G3 as you recall was just launched in December so it did not have the full impact and it was only launched in the direct-to-consumer cash sale segment so it was not included in any of the business-to-business sales. So the volume was certainly lower than what you would expect to see on a full quarter. But when you look at cost to good sold and the reductions that we've seen is a combination of lower product cost and lower labor cost and freight cost. So the labor cost and freight costs are seen across all of our product not just upgrade to G3.When we look at 2016 and that gross margin obviously we don't give gross margin guidance. It really is very sales mix depended. We do expect the launch of these products both upgraded G3 as well as the upcoming G4, as well as continuing to focus on cash sales will mostly offset the reimbursement decline on that adjusted EBITDA margin basis that you see in our guidance, they were offsetting that but we don't give specific gross margin guidance and obviously there are a lot of moving parts this year with both improving sales gross margin and declining rental gross margin.

Okay. And then the last one for me is maybe a more strategic one for Ray. Ray, how do you see the role that ATIT has in next generation devices, whether it's product differentiation? Maybe what advantages or disadvantages do you guys have in the ATIT ballgame, given your exposure to the consumer segment? And you guys are also an HME, so how would you use it as an HME? Can you save further costs? Maybe you guys know more than some of the other new players that don't have the advantage of being a manufacturer as well as an HME. Thanks.

Okay. There are like three questions somehow in there. So I am going to try pull them apart because they kind of require different answers. Start with the private label first. I mean we are right now we are very happy with our private label relationship. It has clearly exceeded our expectations in its first year. And at this point we are not really out there proactively seeking other partners. And if opportunities present themselves we would carefully consider and weigh the pros and cons and carefully consider if we would enter into other relationship from either that this partner would be reaching beyond the capabilities of our existing partnership. So that's the private label. Relative to us using the G4 and G3 as a HME provider, it's really no different than what we would see most HME providers if they decide to switch to oxygen business to POCs. We don't really see that we are operating fundamentally different than we would those other HME providers operate. And kind of the formula has been over the last four-five years has been refined and fine tuned and it is working for us and there is no magic bullet that we have that couldn't be used by other HME providers assuming that they switch their modality to POCs and take the subsequent action of kind of managing their infrastructure cost out.

Thank you. Our next question comes from the line of Danielle Antalffy with Leerink Partners. Your line is open. Please go ahead.

Hey, good afternoon, guys. Thanks so much for taking the question. Just wanted to dig a little bit deeper into the sales rep productivity. I mean clearly it was better in the quarter, curious if you can quantify how much of the beat was due to higher rep productivity versus new rep as and then in the same context as we think longer term, with each quarter that you guys deliver a strong beat, do you -- how do you think about long-term rep productivity? I assumed as the bar continues to move higher or do you still feel like your reps sort of level off? I guess I am trying to get a sense of how much incremental leverage is left in the existing rep based versus revenue growth going forward needing to be driven by new bodies in the seats or more bodies in the seats?

Yes. Let me tackle your -- I'll say the historical productivity question first. So last year as you know we added a significant amount of reps, it was very backend loaded. At the same time, throughout the year we continued to emphasize cash over rentals. So you got two things moving at the same time last year. Both of those have a contribution to the productivity of that entire sales force. Now migrating to cash has a productivity impact on per rep basis obviously adding more reps doesn't have any impact on per rep basis but both of those things have an impact on the output of that sales team and our results throughout the year and particularly in the fourth quarter because the additions were backend loaded. I'll just say that both of them have an impact. I mean we don't really breakout which one has a greater impact, but I'll say that both have an impact that is noticeable, both for adds and migrating the cash. If we look ahead this year, we will continue to add reps this year. One of the things that we will do it will be at least our plan is to have be less lumpy than it was last year. We would like to add the reps and I'll say a more linear fashion throughout the year. A lot of it depends though on if we were able to find reps that meet our qualifications. So that's one of the key as far as if we are going to reps or not. They've got to meet our criteria. We will continue to drive productivity improvements throughout the sales team. That's part of one of our core values in the company is continuous improvement. But as you might expect we are in year six, seven of this program and I'll say a lot of the low hanging fruit as far as productivity improvements have already been rinsed out. So the amount of those productivity improvement on a percent basis year-over-year, they get a little smaller each time around. But it should be greater than zero and our expectations that they are greater than zero from a productivity improvement standpoint.

Yes. One thing I would just add to that because I want to be a little careful here on assuming what we did in the fourth quarter of 2015 is repeatable going forward. I want to remind people what happened in the fourth quarter of 2014. In the fourth quarter of 2014 if you recall that's when we added a significant number of sales reps for 2014. And so we had all throughout 2014 up until the fourth quarter our sales reps were actually slightly declining with just normal attrition. And then we had the big hire round in the fourth quarter which increased our sales rep staff year-over-year and allowed us to really drive into 2015. So the comp was particularly easy for us versus the fourth quarter of 2014 when we had significantly fewer seasoned fully trained reps versus where we are now with the fourth quarter of 2015 where you have both the productivity of the fourth quarter 2015 add as well as starting to ramp up the reps that we've added throughout 2015 particularly the third quarter of 2015, those reps really did contribute in the fourth quarter of 2016 as well. So there is also a comparison factor here that the fourth quarter of 2014 was a particularly easy comparison for us and was one of our slower growth rate in the fourth quarter of 2014 was that direct-to-consumer sales because of the factors of the sales force. So that always needs to be taken into account when you are looking at the year-over-year increase.

And I want to make sure that what Scott said earlier doesn't kind of fall by the way side and that is when you replace a rental with a cash sale, your revenue productivity of that rep automatically goes up, the number of unit that they sell may not go up but the revenue productivity of that rep goes up because you are recognizing the entire revenue at the time of sale not over the next two years. And there is a limited amount of airspace that we can push the cash sales where we can push rental to cash and we are getting -- the air is getting a lot thinner. So I wouldn't use historical numbers to extrapolate for the future because clearly the fruits -- the low hanging fruits were much more bountiful one or two years ago.

Okay. Great. That's really helpful color. And then Scott I think you touched on it in your prepared remarks but just as it relates to the prior authorization, so you mention the impacting and delaying processing but how do we think about that translating into revenue and what's baked into the current newly raised 2016 sales guidance?

You know it's hard to say because they haven't even rolled out the definition of the program yet. It's just in phases of discussion. I think the good news of Inogen is that our policy has always been that we collect everything that we needed upfront before we deploy product for a patient. So we don't really see this as a big curve ball for us, where it will be curve ball is for the patients because the patients are going to have to wait on the response from CMS to get an answer on whether they qualify or not. And that will be squeezed in the middle but for us, our policy is already all right in line with that for the most part. But to comment further we need to have some definition on exactly how they are going to roll the program out. We don't have that yet.

Yes. And just to be clear obviously this only impacts the Medicare business. Portion of the private insurance is we already go through this prior off process depending on the insurance company. So it would be incrementally the Medicare business which is about 21% of our total business that could be subject to this prior authorization and because we already get all the documentation and feel like these be good claim, it's just a matter of now getting this additional step. We don't think it would change materially the number of new rental patient that we would add in a period. And because so much of the rental revenue that you generate is associated with patient you already have on service and the new patient contribute a very small amount when you look at total revenue dollar, I don't think it will be material either way. You may see it in a specific quarter that is implemented that the net new patient set up are slightly lower than what it would be without that. But I don't think that you really see any type of material impact on the rental revenue side directly tied to a prior authorization requirement.

Thank you. Our next question comes from the line of Mike Matson with Needham and Company. Your line is open. Please go ahead.

Hi, thanks for taking my questions. I guess I just wanted to ask about the private label agreement with Applied Home Healthcare. So if I'm doing the math correctly, based on what you said, I think it would have added about $2 million into your sales in the quarter. So one, is that correct? And then two, do you have a sense for how much of that is -- reflects what they actually sold in the quarter? Or is some of that like a stocking order or something?

Yes. So on the first statement basically what we said was the majority of the increase. So that's about $2 million at the bottom end. We haven't given a specific number of what it could be but obviously the total increase in the quarter was about $4 million so it's anywhere from $2 million to $4 million would be the contribution of that business. We don't believe that are any specific stocking orders that we are aware of. It's very quick delivery that we do with the private label partner. And so we have no reason to believe that. Although what you don't know with any private label parter is not what they stock but their customer stock and that's where we have no visibility on the stocking levels and it's the product is truly being deployed into the channel or not.

Okay. Thanks. And then just on the round two re-bid. So I know you commented that you haven't yet seen the single payment amounts. But I'm just wondering, what is your assumption that you have baked into your guidance, around the decline that we would see? Are you assuming that it's flat or down slightly, versus the original round two? And then how big of a decline would we have to see, for it to cause you to lower your guidance?

Yes. So that is the reason why we gave a range of total revenue headwinds of 2.5% to 3.5% because we don't know. If it's flat it's probably on the 2.5% side of total revenue headwinds, if it is decline depending on how big that declines it could be as big as the 3.5% of the total revenue headwind. That would have to be pretty hefty additional decline though given that Medicare is only 21% of our total business. So we feel like the rate should come within that range. Obviously, we have no visibility on what those rates are or when they will announce them. They did say that they would be coming in winter of 2016 and it feels like we are nearly the end of winter 2016 but of course we don't have information at this point.

Okay. Thanks. And then just on the -- I think, Ali, you made a comment about some increased bad debt expense. I was wondering if you could just explain that.

Yes. So we did have a slight increase in bad debt expense in the period. It wasn't particularly strong on a dollar basis. If you look at total bad debt expense as a percentage of total revenue for the year of 2015 it was 1.7% compared to 1.5% in the year ended 2014, so it was up slightly, both of those were down from 2013 where we saw bad debt expense of 2.7%. In the fourth quarter specifically our bad debt expense was about 2.1% of total revenues versus 1.7% in the fourth quarter of 2014. So it was slightly bigger impact in the quarter comparison year-over-year. Although we still think it's at reasonable levels given our business.

Thank you. And our next question comes from the line of Tom Carroll with Stifel. Your line is open. Please go ahead.

Yes, hi, thanks. Just to follow up on the prior authorization comments, as well, do you think that that potentially could be good for your D to C business, in that it's an additional Medicare hurdle that's not there today?

Yes. Tom I think it could be. I wouldn't say but I think it will be it could be, we have to wait and see. It's certainly as you rightly pointed out it's an extra hurdle for a patient to get product or any question equipment deployed to them and any time that there is barrier, it could help our D to C cash business, yes.

Okay. Thank you. And then how did your sales rep attrition change for 2015? I think you said from 2013 to 2014, it was about 20%. Did that stay the same, go up, go down?

Yes. We didn't disclose the attrition for 2015 but we do expect going forward that we will continue to see attrition at -- for the inside sales team at equivalent inside sales team types of attrition level. So we don't expect to be materially different than other call center sales team, correct.

What was the 20% number you've given us before though? I think you mentioned a churn -- I think you called it a churn number in your sales reps?

We did mention attrition for 2014 of 22.1% previously yes, we did disclose that previously.

So you're not disclosing it for 2015. Is that what you're saying?

We didn't specifically disclose at this point.

But it hasn't changed materially?

We don't think that it's --

We are not disclosing it, we can't really say yes or no to that. And Tom if you look at call center sales forces, their attrition, clearly one of issues that every call center sales force had in every industry. The benchmark hovers somewhere between 20%, 30% or 35%.

Anywhere from the mid 20s to mid 30s, typical.

So in 2014 we actually were very proud of our sales because we did really well relative to the benchmark. We decided not to disclose it going forward. But what we were expecting and what's baked into our forecast and our guidance is that our attrition would be equal or no better no worse than what the applicable benchmarks are.

Thank you. And I am showing no further questions at this time. I'd like to thank everyone for participating in today's conference. This does conclude today's program. You may all disconnect. Everyone have a great day.