Inogen, Inc. (INGN) Q3 2017 Earnings Report, Transcript and Summary

Good afternoon everyone and welcome to the Inogen 2017 Third Quarter Financial Results Conference Call. All participants will be in a listen-only mode. [Operator Instructions]. After today's presentation there will be an opportunity to ask questions. [Operator Instructions]. Please also note that today's event is being recorded. At this time, I'd like to turn the conference call over to Mr. Matt Bacso, Investor Relations Manager. Please go ahead.

Thank you for participating in today's call. Joining from Inogen is CEO, Scott Wilkinson and CFO and Co-Founder, Ali Bauerlein. Earlier today, Inogen released financial results for the third quarter of 2017. This earnings release and Inogen's corporate presentation are currently available in the Investor Relations section of the company's website. As a reminder, the information presented today will include forward-looking statements, including statements about our growth prospects, hiring, marketing expectations, European growth, manufacturing developments, and projected financial results for 2017 and 2018. The forward-looking statements in this call are based on information currently available to us. These forward-looking statements are only predictions and involve risks and uncertainties that are set forth in more detail in our most recent periodic reports filed with the Securities and Exchange Commission. Actual results may vary significantly, and we disclaim any obligation to update these forward-looking statements except as maybe required by law. We have posted historical financial statements in our third quarter investor presentation on the Investor Relations website under SEC Filings and News & Market Information, respectively. Please refer to these filings for more detailed information. During the call, we'll also present certain financial information on a non-GAAP basis. Management believes that non-GAAP financial measures taken in conjunction with U.S. GAAP financial measures provide useful information for both management and investors by excluding certain noncash items and other expenses that are not indicative of Inogen's core operating results. Management uses non-GAAP measures internally to understand, manage and evaluate our business and make operating decisions. Reconciliations between U.S. GAAP and non-GAAP results are presented in tables within our earnings release. For future periods, we are unable to provide a reconciliation of our non-GAAP guidance to the most directly comparable GAAP measures without unreasonable effort, as discussed in more detail in our earnings release. With that, I'll turn the call over to Inogen's President and CEO, Scott Wilkinson. Scott?

Thanks, Matt. Good afternoon and thank you for joining our third quarter 2017 conference call. Looking at the third quarter of 2017, we build on our success over the past several quarters, and I'm very proud to say that we saw record total revenues of $69 million. This represented 26.8% growth over the same period last year, reflecting great results in our domestic direct-to-consumer and business-to-business sales channels and impressive performance in our international business-to-business sales channel. Overall, we saw minimal financial impact from the multiple major hurricanes that hit the United States in the third quarter of 2017, and we were glad to hear from many of our patients that our portable oxygen concentrators helped enable them to evacuate in advance of these hurricanes. As we've seen in prior quarters, the expected decline in rental revenue, which represented less than 10% of our revenue in the quarter, was more than offset by the increases in revenue from our sales channels. In the third quarter of 2017, we delivered net income of $7.3 million and adjusted EBITDA of $14.1 million, which represented 39.9% and 30.6% growth respectively over the third quarter of 2016. We continued to steadily invest in direct-to-consumer sales force additions in the United States. We also worked to optimize our new customer relationship management or CRM system, and I'm pleased that we have delivered such strong sales and solid bottom line results during the third quarter while we were still investing in training and productivity improvements in the system. Looking at our revenue streams in more detail, we saw strong demand for our portfolio of innovative oxygen concentrators across all our sales channels in the third quarter of 2017. Our direct-to-consumer sales in the third quarter of 2017 increased 43.5% over the third quarter of 2016, also exceeding our expectations. We continued to steadily add new inside sales representatives in the third quarter of 2017, primarily in our new Cleveland area facility, and we are pleased with our sales team's performance. Our strategy is to hire additional sales employees in the fourth quarter of 2017 and throughout 2018 and invest in marketing activities to increase consumer awareness as we believe this is still our most effective means to drive growth of direct-to-consumer sales. As I mentioned briefly, we launched our new CRM system in June, and we are still in the optimization phase of the rollout. We believe this system will help improve productivity of our sales, customer service, and billing departments especially as we look into 2018. Although our third quarter 2017 direct-to-consumer sales numbers were strong due to increased sales headcount and improved productivity compared to the third quarter of 2016, we did see the expected productivity impact in the direct-to-consumer sales department while we work through the new CRM system learning curve. Due to the productivity improvements already gained since the third quarter of 2016, we were still able to show overall improvement in our direct-to-consumer productivity in the third quarter of 2017. We are very pleased with our domestic business-to-business sales in the third quarter of 2017, which increased 41.7% over the third quarter of 2016, exceeding our expectations. Growth in this channel was primarily driven by purchases from traditional home medical equipment providers and strong private label demand. Revenue from our private label partner and traditional HME providers combined represented more than half of the domestic business-to-business channel's total sales revenue in the third quarter of 2017. We continued to see traditional HME providers turn to portable oxygen concentrators to lower their operating costs in the face of reimbursement reductions, and they are turning to Inogen as the leader in the space. International business-to-business sales also performed nicely in the quarter, reflecting 14.9% growth over the same period of last year. We are pleased with this result, especially compared to a very strong third quarter of 2016 and in spite of the fact there were no new major tender contracts in the third quarter of 2017. As you might recall, we acquired our former distributor, MedSupport Systems, in May 2017, to be our new center of European commercial operations. I'm happy to report that the integration of this organization continues to proceed according to plan. We believe we are the preferred provider of portable oxygen concentrators in Europe, and we see a potential large, long-term opportunity ahead as that market transitions from tank and liquid oxygen systems to non-delivery solutions. In support of our European sales, we are targeted to begin production of our Inogen One G3 concentrators in the fourth quarter of 2017 using a contract manufacturer, Foxconn, located in the Czech Republic, to improve our ability to service our European customers. For those of you not familiar with Foxconn, it is the largest and one of the most well-respected contract electronic manufacturers in the world, with multiple manufacturing facilities around the globe and relationships with some of the most influential companies in the world. Our manufacturing partner is expected to ramp capacity in 2018 to produce Inogen One G3 concentrators required to support our European demand. We expect to maintain our assembly operations for our Inogen One concentrators and Inogen At Home concentrators at our facility in Richardson, Texas and we'll continue to assemble compressors and sieve bed columns at our facility in Goleta, California. This will allow us to expand our manufacturing capacity and redirect our U.S. manufacturing activities to focus on growth in the U.S. and on our latest product, the Inogen One G4. I would also like to comment on the recently released Medicare market data from CMS for the full year 2016. While the CMS information has some limitations when used to assemble a picture of the oxygen therapy market, such as the absence of brand or manufacturer information, we believe that the information can serve as a proxy for the entire oxygen therapy market. Based on this data set, we estimate that the share of portable oxygen concentrators in Medicare oxygen therapy grew from 8.0% in 2015 to 9.1% in 2016. However, this estimate does not include patient cash sales or private insurance transactions. Our direct-to-consumer cash sales in 2016 grew significantly faster than rentals. So we believe that this data from CMS may represent a conservative estimate of actual portable oxygen concentrator market penetration. That said, POCs were still the fastest-growing modality in oxygen therapy based on the CMS data and still have a significant growth opportunity before reaching full market saturation. Turning to reimbursement updates, a Bipartisan Bill with 50 original cosponsors was introduced in the House of Representatives on Thursday that would provide relief from competitive bidding in non-bid areas. The Bill would extend a retroactive delay of a second round of reimbursement cuts from January 1, 2017 to January 1, 2019, as well as address a double-dip reimbursement cut to oxygen therapy. While there's no specific date as to when this Bill could pass, HME industry participants have been busy gathering data to support the Bill. Specifically in late August, AAHomecare presented survey data to support this legislation. Data presented to the Office of Management and Budget indicated that patient access to home medical equipment has dropped significantly. Specifically, a survey conducted by Dobson DaVanzo & Associates stated that 66% of Medicare beneficiaries found it difficult to find a local HME supplier. Of those who were forced to change DME providers, approximately 50% stated they did so because their prior HME provider either went out of business, no longer accepted Medicare, or did not win the local bid. When narrowing it down to oxygen-only patients, approximately 81% of respondents stated that they have increased complaints regarding access and have also increased out-of-pocket expenses to acquire HME supplies. Lastly, the data showed the majority of case managers, 41 out of 73, reported elevated patient readmissions due to lack of access to oxygen therapy. Based on this data, we have two takeaways; one, the data suggests the lack of access to at least a portion of the patients, which we believe could lead to pricing relief in rural areas. However, it is unclear how this would be funded. And two, with the lack of access, the delivery model was struggling to service patients' basic needs, resulting in elevated hospital readmission rates and higher overall healthcare costs. We believe this further validates POCs as the superior therapy option and should result in continued market conversion. We note that any rural reimbursement rate adjustment is not factored into our guidance at this time. Further, there's not been any additional announcement from CMS on competitive bidding around 2019. However, we expect bidding to begin in the coming months for rates to be effective January 1, 2019. Finally, we wanted to provide an update on the legal proceedings with regards to the Separation Design Group, or SDG. As a reminder, SDG filed a lawsuit against Inogen in October 2015, alleging infringement of two patents, misappropriation of trade secrets, and breach of contract. Inogen counterclaimed with allegations of inequitable conduct by SDG in obtaining the patents. We are happy to announce, Inogen recently settled out of court with SDG for an all-in value of $3 million. These damages have been paid in full to SDG in the fourth quarter of 2017 and cover both alleged past damages and future rights to be free from any lawsuit with respect to the two patents in suit and future patents that may issue in this patent family. Included in the third quarter of 2017 is $600,000 of general and administrative expenses associated with this settlement for estimated alleged prior damages. The remaining $2.4 million is expected to be amortized over the next five years. Although Inogen maintains a committed no wrongdoing, we came to a settlement agreement as we believe it to be in the best interest of the company and our shareholders to remove the uncertainty, expense, and distraction of a prolonged litigation. I'm really proud of our Inogen associates on our progress this quarter, especially during a time when we continued the integration of our international operation, added a direct-to-consumer-focused facility in the U.S., and improved our new customer relationship management system. While we've been engaged in all of these exciting initiatives to fuel future growth, we've also maintained our current growth momentum, especially in the direct-to-consumer and business-to-business sales channels. And I'm very pleased with the increased penetration we are seeing in these markets with our best-in-class and patient-preferred products. Looking at 2018, we expect to remain a high-growth company, as portable oxygen concentrators are still in the early stages of adoption worldwide and our sales force continues to grow. As a result, we expect 2018 revenue of $295 million to $305 million. With that, I will turn the call over to Ali. Ali?

Thanks, Scott and good afternoon everyone. During my prepared remarks, I will review the details of our third quarter of 2017 financial performance, and then I will review our guidance for 2017 and 2018. As Scott noted, total revenue for the third quarter of 2017 was $69 million, representing 26.8% growth over the third quarter of 2016. Looking at each of our revenue streams, and turning first to our sales revenue, total sales revenue of $63.1 million represented 91.5% of total revenue in the third quarter of 2017 and reflected 33.8% growth over the same quarter of the prior year. Total units sold increased to 36,000 in Q3 2017, up 35.3% from 26,600 in Q3 2016. Direct-to-consumer sales in the third quarter of 2017 were $23 million, representing 43.5% growth over the third quarter of 2016, primarily due to increased sales representative headcount, increased marketing expenditures, and increased productivity. Domestic business-to-business sales of $22.9 million in Q3 2017 reflected 41.7% growth over Q3 2016, with strong demand from our traditional HME providers and our private label partner. We also demonstrated impressive international business-to-business sales of $17.2 million in Q3 2017, which reflected 14.9% growth over Q3 2016. Sales in Europe represented 90.1% of international sales in the third quarter of 2017, which was down slightly from 90.8% in the third quarter of 2016 due to the sales growth in other international markets. With robust business-to-business sales again in the third quarter of 2017, average business-to-business selling prices declined over the same period in the prior year, primarily due to the shift in sales towards traditional home medical equipment providers and private label sales and additional discounts associated with the increased sales volumes worldwide. Rental revenue represented 8.5% of total revenue in the third quarter of 2017 versus 13.3% in the third quarter of 2016. We saw the expected decline of rental revenue in the third quarter of 2017 versus the third quarter of 2016, primarily due to the previously discussed reimbursement reduction. Rental revenue in the third quarter of 2017 was $5.9 million, representing a decline of 18.7% from the same period in the prior year. Turning to gross margin, for the third quarter of 2017, total gross margin was 48.1% compared to 46.2% in the third quarter of 2016. We saw an increase in our overall gross margin, primarily due to lower cost of goods sold per unit and increased mix towards direct-to-consumer sales, partially offset by declining rental gross margin. Our sales gross margin was 50.3% in the third quarter of 2017 versus 48.6% in the third quarter of 2016. Sales gross margin percentage improved primarily associated with increased mix towards direct-to-consumer sales and lower cost of goods sold per unit, mostly due to lower material costs, partially offset by declining business-to-business average selling prices. Rental gross margin was 24.3% in the third quarter of 2017 versus 30.7% in the third quarter of 2016. The decline in rental gross margin was primarily driven by the reimbursement rate reductions and partially offset by lower cost of rental revenue, which was mainly associated with lower depreciation. As for operating expense, total operating expense increased to $24.8 million in the third quarter of 2017 or 36% of revenue versus $19.7 million or 36.3% of revenue in the third quarter of 2016. Research and development expense was $1.4 million in the third quarter of 2017 compared to $1.4 million recorded in the third quarter of 2016. Sales and marketing expense increased to $13.1 million in the third quarter of 2017 versus $9.7 million in the comparative period in 2016, primarily due to higher advertising expense and sales force personnel-related expenses. General and administrative expense increased to $10.4 million in the third quarter of 2017 versus $8.7 million in the third quarter of 2016, primarily due to a $0.6 million patent litigation settlement expense, increased personnel-related expenses, and increased patent defense legal costs. In the third quarter of 2017, our effective tax rate was 16.8% compared to 3.7% in the third quarter of 2016. The effective tax rate in Q3 2017 included a $1.7 million decrease in provision for income taxes related to excess tax benefits recognized from stock-based compensation associated with Accounting Standards Update, ASU 2016-09, compared to $1.8 million in the third quarter of 2016. The decrease in provision for income taxes associated with ASU 2016-09 lowered our effective tax rate by 19.7% in the third quarter of 2017 and by 32.9% in the third quarter of 2016 as compared to the U.S. statutory rate. Our net income in the third quarter of 2017 was $7.3 million compared to $5.2 million in the third quarter of 2016, an increase of 39.9% versus the comparative period in the prior year and a return on revenue of 10.6% versus 9.6% in Q3 2016. Earnings per diluted common share were $0.33 in the third quarter of 2017 versus $0.25 in the third quarter of 2016, an increase of 32%. Adjusted EBITDA for the third quarter of 2017 was $14.1 million, which represented a 20.4% return on revenue. Adjusted EBITDA increased 30.6% in the third quarter of 2017 versus the third quarter of 2016, where adjusted EBITDA was $10.8 million or 19.8% return on revenue. Cash, cash equivalents, and marketable securities were $163.1 million, an increase of $18.9 million compared to $144.2 million as of June 30, 2017. We received payments in the third quarter associated with the 21st Century Cures Act of $1.4 million, and we expect Medicare to finish processing these claims in the fourth quarter of 2017. Turning to guidance, we are increasing our 2017 revenue guidance to a range of $244 million to $248 million, which represents year-over-year growth of 20.3% to 22.3%. This compares to our previous guidance of $239 million to $243 million. We continue to expect direct-to-consumer sales and domestic business-to-business sales channels to be our strongest growing channels and to have similar growth rates in full year 2017, and international business-to-business sales to have a more modest growth rate in full year 2017 where the strategy is expected to be focused on the European market. However, we are mindful that international sales can be lumpy over time due to the timing of tender contracts and business-to-business customer buying pattern. We expect that rental revenue will decline in 2017 compared to 2016 by approximately 32% based on lower average rental revenue per patient and a focus on sales versus rentals. We are maintaining our guidance range for full year 2017 net income of $25 million to $27 million, which represents 21.8% to 31.6% year-over-year growth. We still estimate that the impact of ASU 2016-09 will lead to a decrease in provision for income taxes of approximately $8 million in 2017 based on forecasted stock activity, which will lower our effective tax rates. Excluding this $8 million decrease in provision for income taxes expected in 2017 from stock compensation deductions, we expect an effective tax rate of approximately 36% to 37% for full year 2017. We are increasing our guidance range for the full year 2017 adjusted EBITDA to $49 million to $51 million, representing 12.9% to 17.5% growth over 2016 full year adjusted EBITDA. This compares to previous guidance of $48 million to $50 million and includes the patent settlement amounts previously discussed. We are continuing to invest in our new Cleveland area facility, European facility, and our CRM system while also continuing to ramp our direct-to-consumer sales reps and the related media investments, which we expect will contribute to 2018 revenue growth. We are confirming our expectation for net positive cash flow for 2017, with no additional equity capital required to meet our current operating plan. We are also providing a full year 2018 guidance range for total revenue of $295 million to $305 million, representing 19.9% to 24% growth over the 2017 guidance midpoint of $246 million. We expect direct-to-consumer sales to be our fastest-growing channel, domestic business-to-business sales to have a significant growth rate, and international business-to-business sales to have a modest growth rate where the strategy will still be focused on the European market. We expect rental revenue to be relatively flat, meaning plus or minus 5% in 2018 compared to 2017 due to our continued focus on sales versus rental. There are no known changes in Medicare reimbursement rates in 2018. We are providing a full year 2018 net income estimate of $31 million to $35 million, representing 19.2% to 34.6% growth over the 2017 guidance midpoint of $26 million. We are providing a guidance range for the full year 2018 adjusted EBITDA of $60 million to $64 million, representing 20% to 28% growth over the 2017 guidance midpoint of $50 million. We estimate the impact of ASU 2016-09 will lead to a decrease in provision for income taxes of approximately $8 million in 2018 based on forecasted stock activity, which would lower our effective tax rate as compared to the U.S. statutory rate. Excluding the $8 million decrease in provision for income taxes expected in 2018, we expect an effective tax rate of 37%. After considering the ASU 2016-09 benefit, we expect our effective tax rate, including stock compensation deductions, to vary quarter-to-quarter depending on the amount of pretax net income and on the timing and size of stock option exercises. We also expect net positive cash flow for 2018 with no additional equity capital required to meet our current operating plan. With that, Scott and I will be happy to take your questions.

[Operator Instructions]. And our first question today comes from Robbie Marcus from J.P. Morgan. Please go ahead with your question.

Hi, and congrats on a great quarter. Wanted to start in what happened in third quarter, and DTC and U.S. B2B both did much better than, I think, even the best estimates out there. So maybe you can just help us understand what exactly is going on in DTC, what hits productivity, what offset it, and how we should be thinking about rolling that into 2018.

Yes, sure. I'll take that one, Robbie. So really, the success that we saw in the third quarter was associated with the increased headcount that we saw on the DTC side. We have continued to hire throughout 2017, as we've said. That's really the factor that allows us to grow our direct-to-consumer. Marketing spend is up, having the sales capacity to work with the leads when they do call in. So we have been able to increase that. We also mentioned that we have been able to improve productivity year-over-year in the cash sales side. So our reps have become more productive, and that's in spite of the headwinds that we saw on the CRM implementation. So we knew that we would take a small step-back associated with the implementation of a new system and people coming up the learning curve on that. That did happen. But even in spite of that, our productivity in the third quarter of 2017 was improved compared to the productivity in the third quarter of 2016. So we're really proud of our sales team's ability to both hire and train the sales personnel. We've been able to continue to add to our Cleveland site as well. And while you know that those sales reps take four to six months to come up to productivity, we are starting to see the contributions from the people we have hired in the first half of the year, and we expect the people that we hired in the second half of the year to really contribute more materially going into 2018. And that's really why we still expect in 2018 direct-to-consumer sales to be the fastest-growing channel in our business because we are continuing to invest there. And that's why we really expect that to continue to be the key driver to our sales growth.

Now historically, you've always commented that with DTC, since you're in control of the process, you can always guide a little more aggressively because you have more visibility into that channel. Is that how we should be thinking about the initial guidance for 2018 that DTC, you have the most confidence in? And then U.S. B2B, maybe you still have a lot of confidence. You accelerated sales growth from second to third quarter, that maybe you're taking a bit more of a conservative stance just because you're once removed from the process?

Yes. I certainly think that, that's still the case, Robbie. I mean, the closer we are to the end consumer, the more visibility we have, the more sales analytics. And we have -- know the number of sales reps and we can predict their curves of coming up to speed and the media spend, so that is much more predictable in terms of response rate. And it's more down to how many new people do you hire and what's the productivity of that team. On the business-to-business side, we still continue to be more cautious there, just because of the underlying dynamics of how they will end up converting their business model to POCs. And while we have become more optimistic on that over time and we've kind of shifted from being, what I would call, very conservative there to more seeing the high level of growth and putting that into guidance, we still are more cautious there than we are in the direct-to-consumer side of the business. So that guidance philosophy is the same as we have had previously.

Okay. And then just last for me, there has been some rumblings from competitors about product launches. Is there anything that you'd like to point out in terms of new product launches or anything on the horizon that you think we should be aware of? Thanks.

Yes. Thanks, Robbie I'll take that one. I mean, we -- as I think you folks know, the engine for growth for us is really having a patient-preferred product. And we've got a lot of things going on, I'll say, behind the curtain right now on the R&D pipeline to make sure that we maintain that patient preference. That's what drives our direct-to-consumer engine and has really built our brand over the last 10 years. But today, it's still a little early to unveil exactly what and when we're going to roll out the next generation. I will tell you, and I think I've said this in the past, our engineers were working on what I'll loosely call a G5 pretty much the day after we launched the G4. So we've got a robust product pipeline, but it's still far enough away that we don't want to give away anything to the competition and tip our hand.

Great, thanks a lot.

Our next question comes from Margaret Kaczor from William Blair. Please go ahead with your question.

Hey, good afternoon guys. Thanks for taking the questions. First off, as we look at the B2B domestic side, can you talk about some of the tailwinds that you've seen the growth and more specifically, your share of HME placements at this point is probably, you tell me, bit over 40%, so how much of a benefit has share been relative to market adoption rates accelerating? And as you look out into 2018, what does your guidance imply for share relative to accelerating market adoption of POCs on the market?

Yes, so I'll take that one, Margaret. I mean, our -- I guess, let's kind of take your question in order. So right now we have said in the last quarter that we're going to say that there's a conversion in process that people have talked about a trial, but sometimes people were actually in the middle of a conversion before they even realize it. I think the strength of what we saw in the third quarter is just really confirms what we said that there's a conversion in process. When you look at the reimbursement rates, I mean, they're certainly not going up. If we see some temporary relief in rural areas, it's not going to be enough to change the inherent dynamics that the delivery model just really isn't sustainable at these rates. So I'll say again, we think there's a conversion in process, that's still a long-term play. It's a 7 to 10 year play and our estimate could be a little faster, could be a little longer. There's all those dynamics out there of managing cash flow and credit that are barriers; and then to the providers, purchasing efforts. But we certainly think that we're climbing a mountain, and that really just goes to the results of the third quarter. I think, in our mind, it confirms that. Now as far as where we are, our goal, if you look at our growth goals and the guidance that Ali just talked about and those growth percentages, those percentages are a little higher than what we've seen as far as the market growth of POCs. So in the past and our expectation in the future is that we're going to grow at a higher rate than the conversion rate is, at least right now, unless it were to step up at a considerably faster rate. So that means at the core, if you just look at the numbers, that we're actually taking share. Our, I think, success again is built on patient preference but also built on the reliability in our product, and that's what's really necessary for this product or this modality to be used in a non-delivery scenario. You just can't have products that break down, it kind of blows up the whole model. I think if we go back to Inogen, eight, nine years ago, actually, running our own oxygen homecare business ourselves and walking in those very shoes for the last eight, nine years that now providers have started to walk in, in the last, say, one to two years, we've built the product for HME and for non-delivery success, even though we were focused on the end user as our go-to-market strategy. But we've proven ourselves that this product works in a non-delivery scenario. I think that's one of the reasons that the provider community turns to us because we've proven that, we've done it on a large scale. And as they go out there and look at changing their business and, frankly, taking some risks in operating a completely different business model, one way to mitigate that risk is to go with a proven product. And like I said, we're the product that's been used eight, nine years in that scenario. So hopefully, that answers your question as far as the growth rates and why we are where we are.

And one of the follow-ups to that is this idea of maybe fleet upgrades and existing POCs that are already on to -- in the market, that are your competitor POCs. Are you seeing maybe an acceleration in those POCs being replaced with yours and maybe it doesn't necessarily have to do with patient adds accelerating, but you are seeing a benefit from that as well?

It's hard to really have visibility on that. So I mean, anything we would say there would be more anecdotal in nature. We know that certainly a portion of it is a replacement cycle of POCs. But the majority certainly is tied to these patient additions or people converting their existing patient fleet. But it's hard to say how much is really tied to a POC replacement due to the life cycle.

Okay. And then just as a second topic, in terms of your international growth, obviously, very strong results on a tough comp this quarter. So is that related to your integration of med supplies? Are you seeing some kind of tender wins or just stable underlying market growth? Thanks.

Yes. Overall, I'd say it's more stable underlying market growth. You're right and that it was a tough comp for third quarter 2016. If we look at the sales, though, it's pretty well diversified across our European customers and partners. I think certainly bringing MedSupport into Inogen helps, but I wouldn't say that's the key driver. It's -- we saw growth across the board throughout Europe, and I'm pleased that we're in a position to harvest that. And I'll say again, we're pretty happy with that result because we knew it was a tough comp going into the third quarter. So to post the almost 15% growth that we did, I think it's 14.9%, we're certainly pleased with that result.

Yes, and Margaret, just to answer directly there were no major tender offerings in the third quarter. So this wasn't tied to a specific tender that drove that increase.

Great, thanks guys.

Our next question comes from Danielle Antalffy from Leerink Partners. Please go ahead with your question.

Hey, good afternoon guys. Congrats on another very good quarter. Yeah, sure, no problem. So I was hoping to get a little bit more color on this rep productivity, how to think about the reps that are coming online here in Q3 and Q4 at the Cleveland facility, when you think they'll start to really contribute to the top line, number one? Number two, how we think about -- as your DTC business gets bigger, it is very much tied to sales rep productivity and the number of sales force hired, so just how we think about incremental operating leverage. And maybe I can ask the question this way, why didn't we see even more positive leverage given the amount of the top line beat that you had this quarter, is it pricing, what's going on that's offsetting some of that? That's my first question. Thanks

Okay, I'll take it. I think it's more like three questions, but I'll try and take them all. So let me know if I missed any of them, though but -- so first, just starting in the quarter and with the operating leverage. I'll take the last one first. We did continue to invest heavily in the third quarter. So when you look at sales expense, we are expanding both the marketing spend as well as the number of new hires. And so we are really continuing to see this as we said, 2017 is an investment year and that's really what we're executing on. It's setting ourselves up for that strong 2018. So from an operating expense leverage, as we saw this increased sales coming in, we saw it was a great opportunity for us to continue to invest in the direct-to-consumer side to create that long-term value. Now on the rep side, they still take about four to six months to come up to productivity, but they start contributing in the first couple of months. So they certainly start making some sales and then ramp to that full productivity in months four through six. So it's a relatively quick turn from when a rep is hired to when they start producing. But when you hire a rep, it's not just the rep hiring costs that you're hit with, it's also the marketing costs. So they tend to not be as productive with leads initially out of the gate, so you have to spend more in marketing for those new hires. So, all of that is factored into our guidance for 2017 and 2018 and us continuing to grow that side of the business.

Okay, that is very helpful. Oh, sorry.

And when we do look at going forward into 2018, I know you were kind of asking about operating leverage going forward, we still see 2018 as really an investment year, where we're continuing to build out that sales force. So we're not maximizing for operating leverage going into 2018. And I know we don't give specific guidance on operating leverage. The other thing I would point out is that the more you have direct-to-consumer growing faster, you'll see less operating expense leverage because you have more investment in the SG&A side, but you also have higher gross margin. Now if you see the opposite of B2B growing faster, you see a lower gross margin profile but lower operating expenses associated with it. So that certainly factors into how you see operating leverage over time and kind of key to why we don't give specific gross margin or operating leverage guidance and focus on both top line and bottom line instead.

Okay, that's fair. And then just a question on the B2B side of things, are you seeing some of these home care providers getting more aggressive overall on putting patients on POCs, so even just outside of your own product, what are your sort of seeing in the environment out there? And then also, on top of that or because of that, are you seeing any of your competitors get more aggressive on price in the B2B channel? Thanks so much.

Yes, I'll take that one, Danielle. So I think what we've seen in the third quarter is pretty consistent with what we've seen in the last four or five quarters that providers, they've expanded the use of POCs. And in some cases, that's maybe a little bit different segment of patient that they're now going to use a POC on. In others, maybe expand to other branches within their organization. I think at 30,000 feet, the message is and the results are that they're using them more and more, whether that's across different branches or a broader segment of patients. And that's why you're seeing the growth that we're seeing, and that's all part of what I'll call the market conversion. So that's, I'll say, everywhere, more patients, more branches, more locations, etcetera. What was the second part of your question?

On pricing, what you're seeing from your competitors.

So yes, I mean, as you're seeing providers purchase more, I mean, we certainly see the competitive pressures from everybody else in the market. Price tends to be the language that primarily, I'll say, the homecare providers speak. Although if you go back to what I have said in an earlier question about providers, when they're changing their business model, they're taking some risk because they're using a product or relying on a product category that they haven't relied on. So there's a little bit of risk in that. So I think there's probably more of an emphasis on product quality than there are on products that, frankly, are commodities, like tanks and the run-of-the-mill delivery products. So I think that's where our quality has really helped us to stay in that driver seat. As you recall from the last conference call that we had, we announced that we expanded our warranty from three to five years in the business-to-business channel domestically. And that was for two reasons. One, we've got confidence in our own product quality, so we thought that we could do that at minimal expense on our side of the equation. But two, on the other side of the equation, it offers tremendous value and takes risk out of their side of that conversion. So while people do come after you with price, I think when you've got a model conversion, there's other things than price at play. And our quality is a big part of our -- and reliability is a big part of our success.

Got it, thanks so much.

Our next question comes from Mike Matson from Needham & Company. Please go ahead with your question.

Yeah, hi, thanks for taking my questions. I guess, just had a couple on the reimbursement situation. So first, with regard to around 2019, what are your thoughts around the timing of that, do you still expect it to happen during 2019, I guess? And then on this Bill that was introduced, do you view that as positive, negative or neutral for Inogen given that, on the one hand, it would help your rental business; on the other hand, if you relieve some of the strain on these rural HMEs, they might be less likely to switch to POCs, which could hurt the B2B business maybe? So I don't know, just your thoughts on those things.

Yes, so starting with competitive biddings around 2019. We really don't have any additional visibility, so we've been waiting to hear more from CMS. There's been no indications that they're going to delay the round. But it is getting to the point where we need to see them begin the bidding process within the next month or two, otherwise I think it will be tough for them to do an accelerated bidding process. So we certainly are watching that closely to see what comes out there and if there will be any changes to the bidding process, but we don't have any visibility on what those may be at this point. On the side -- on the rural rate relief side, this legislation, we do view as a potential actual benefit to us not just on the rental side of the business, but in the rural areas, it is more expensive to deliver oxygen versus the competitive bid areas. So we do think that now the rates are basically the same with the competitive bid areas and the non-competitive bid areas in oxygen because of the adjustments that was done at the beginning of 2017. And so giving a little bit of additional reimbursement to these providers, while that does take away some of the urgency to replace tanks, it doesn't change the underlying dynamics that POCs are a better business model and that, that will save them money over time. So we think that, that additional little bit of money may actually help them make the conversion in their business models because we know that this is an industry that is chronically undercapitalized. So we actually see that as a positive because it doesn't change the fundamental underlying dynamic that tanks are challenged in profitability over time.

Okay, thanks. And then the B2B, you've talked about how that growth is being driven by more HME purchases both from -- directly from Inogen and through your private label partner. So I was just curious, if you had any feel for how much of those units are being actually used for rental with patients that have insurance, primarily Medicare, I guess, or cash sales because I know that HMEs are kind of hungry for more cash sales. So I guess, it would be DTC but through one of the HMEs. So I mean, maybe you're not able to determine that, but I was just curious, I mean, when you see them buying these things, do you believe that they are really converting or is it just cash sales?

Yes, so we believe that the vast majority of those sales are being used for rentals. We've got our own group of online resellers that we manage pretty closely. And the private label partner, they've done just a terrific job of going out and calling on HMEs. They've got finance programs to help the HMEs through this process and educational programs. But our private label partner does not have access to online resales. That's outside of their territory rights. So at least the sales that go through the private label partner, those products cannot be sold online for cash. A provider could sell them in a one-on-one transaction in their showroom for cash, but that's a pretty small amount. So given the private label partners' territory, given our own dialogue with the customers that we have direct sales and relationships with, we're confident that the vast majority of those sales are going into the rental channel.

Okay, thanks, yes. I was kind of getting at the end of the cash sale in the -- setting. So you don't think that's a big part of what's happening right now? Is that...

Providers love to do that when they can, but that's really not how they've built their business and where they have expertise. I mean, their whole go-to-market strategy is based on calling on physicians and driving referrals their way. So while certainly, if they have a walk-in patient that's interested in a cash sale, they're going to avail themselves of that opportunity to make that sale, that's really small potatoes in the big picture in the mix here.

Okay, understand. And then my final question, just seems like a couple of your competitors now -- admittedly, I don't think the products are as good as what you're offering, but they are kind of pushing this idea of connectivity and cloud software, etcetera. And I'd imagine, your ResMed is probably going that direction at some point too. So I know you've gotten this question before but one, can you give us some confidence that you can -- you're headed in that direction as well, just given being a smaller player maybe even ResMed or Respironics, for example, do you feel like you've got the engineering and software capability in-house to set something like that up? That's all I have, thanks.

Yes, so let me start my answer with revisiting product pipeline again. Remember, I said we had a robust product pipeline, but we weren't at a point today that we wanted to try out all the intricacies of that. I can assure you that we have got people that are quite capable of helping us launch a wireless program, if that's really what is going to have value for the providers. But I think if you go back to what's really important when you're converting your model; number one, is you got to have the right reliability and the right price. So that's what we've focused on. We've continued to focus on patient preference as well and patients don't really have a burning need for connectivity right now. So again, I think these wireless launches that you're seeing or discussions that people are having on the competitive front, I still think it's a solution that's a little ahead of its time. I think that reliability and the right price are paramount to that. And you've also got to look at -- you don't have the compliance requirements today in oxygen that you do have in some other products like CPAP. So while ResMed has a very robust wireless program for CPAP and it really helps with the problem of compliance, it's -- in oxygen, it becomes the solution without a current problem. Now do I think that long-term there will be a place for wireless and connectivity in oxygen, I absolutely do. I've said that in the past, and that's why we have engineers that are working on that. We've also built our products so that it would be relatively easy. They're, what I'll call, connectivity ready, if you will. So we're not ignoring that. We just don't think it's the most important thing right now. And I guess, at the risk of sounding a little arrogant, I think the results that we have kind of showed some substance to what I've said as far as what people are really valuing.

Alright, thank you.

Our next question comes from Michael Martin from Michael J. Martin & Associates. Please go ahead with your question.

Congratulations and thanks for taking my call. I was wondering if you could tell us a bit about your corporate culture, how you attract, train, and motivate people, how you share the wealth, what's your turnovers like, if you can give us some color on that, I'd appreciate it?

Yes, let me take that one. So we try and run our company according to five core values and I'll tell you what they are right now, and you can digest that. We have these core values posted in every conference room, it's pretty much in every person's desk. It's what we call out in meetings, it's what we use when we make tough decisions, and I'll tell you what I found is when you have a really tough decision to make, if you refer back to our core values, usually, the decision is pretty obvious. So, the first one is self-responsibility. We look for people to drive themselves. We look for them to monitor their own results and to manage themselves. That's number one. And that's the type of person that we look for, somebody that embraces that responsibility. Number two is open communication. We're pretty transparent with our employees and what our plans are and our results and our expectations. We expect them to be transparent with each other. If there's issues, we confront them directly. We don't sweep them under the rug. And direct and open communication is valued in our organization even if the risk of maybe turning somebody off, that's better than ignoring an issue or sweeping it under the rug. Number three is continuous improvement. We expect every area of our business to improve year-over-year. We have productivity goals in every department. We have productivity goals with each individual. Staying the same is unacceptable in our organization. You've got to be a fast mover and you've got to have a passion for getting better day in and day out and year in and year out. Number four is integrity. We honor commitments with each other, we own up to our mistakes, and our motto is we do the right thing; we don't do the easy thing. And lastly, service. We are a patient-focused business, so we look for every opportunity to meet and exceed not only patient expectations, but all of our customer expectations, internal and external. So with those five things, that's what we measure new hires against, that's what we preach in our company, and that's kind of the template that we use to model behavior and -- for the right behaviors that we're looking for as far as young leaders that we're going to move up in the company. As far as some of your other questions, we don't specifically disclose our turnover. We have said in the past, though, since we've said it, I'll say it again our turnover in our direct-to-consumer sales are similar with what you would see in a typical call center. So there's nothing that's out of the ordinary there. But other than that, that's -- those aren't numbers that we disclose.

Okay, and what kind of financial incentives do you use throughout the organization?

Yes, we've got people that -- everybody can participate in our bonus program, there's different levels, but we try and share the wealth. And that's outlined in our prospectus as far as what those parameters are. But everybody is able to share in our financial results, if they're great, everybody is able to share in that and if they're not, then everybody is going to take a hit together.

That's great, appreciate your help.

Sure, thank you.

And ladies and gentlemen, at this time, we've reached the end of today's question-and-answer session. I would like to turn the conference call back over to management for any closing remarks.

Thank you. I'd like to close with a few comments on our strategy for 2018. We expect to seek ways to accelerate the adoption of portable oxygen concentrators worldwide. We're working with providers worldwide to convert to a non-delivery model, increasing our direct-to-consumer investments in the United States, and pursuing product registration in new and emerging markets. At the same time, we're still focused on developing innovative oxygen concentrators to stay at the forefront of patient preference and reducing costs to manufacture our product as we gain additional scale. We're excited about the future of oxygen therapy industry, where we see portable oxygen concentrators becoming the standard of care for ambulatory patients in the next 7 to 10 years. And we thank you for your interest in Inogen.

Ladies and gentlemen, that does conclude today's conference call. We do thank you for attending. You may now disconnect your lines.