Inogen, Inc. (INGN) Q4 2017 Earnings Report, Transcript and Summary

Good afternoon and welcome to the Inogen 2017 Fourth 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 note, this event is being recorded. I would now like to turn the conference over to 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 fourth 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, and strategy for 2018 and beyond, hiring expectations, marketing expectations, and anticipated pricing trial, European growth, manufacturing developments, the impact of CMS rate adjustments and potential legislative measures and financial guidance for 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, 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 fourth quarter investor presentation in the Investor Relations section of the Company's website. 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 non-cash 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 fourth quarter 2017 conference call. Looking at the fourth quarter of 2017, I'm very proud to say we generated strong total revenue of $63.8 million, reflecting record results in our domestic direct-to-consumer sales channel and great results in our domestic business-to-business sales channel. As we've seen in prior quarters, the expected decline in rental revenue which represented less than 10% of total revenue in the quarter was more than offset by the increases in revenue from our sales channels. Our record direct-to-consumer sales of $24.5 million in the fourth quarter of 2017 exceeded our expectations as we steadily added new inside sales representatives with most located in our new Cleveland facility. Our direct-to-consumer sales team consisted of 263 inside sales reps as of December 31, 2017 which represented an increase of 86 reps over our 2016 year-end total of 177. Our strategy is to steadily hire additional sales representatives throughout 2018 and continue to 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 we've done in the past, we also plan to execute a direct-to-consumer pricing trial in 2018 to ensure our products are optimally priced. Fourth quarter domestic business-to-business sales of $21.9 million also exceeded our expectations with growth in this channel primarily driven by purchases from our private label partner and traditional home medical equipment providers. We continue to see traditional HME providers turn to portable oxygen concentrators to lower their operating costs in the face of insurance reimbursement reductions, and they are turning to Inogen as the leader in the space. While off it's mid-teens growth trajectory through the first three quarters of 2017, international sales in the fourth quarter were flat over the same period last year primarily due to strong third quarter 2017 results and a lack of any major European tenders awarded to our provider partners in 2017 which limited growth in the fourth quarter. Lastly, the fourth quarter of 2016 included sizeable unit orders from South Korea that didn't repeat in the fourth quarter of 2017 creating a difficult comparable. As we have communicated in the past, business-to-business sales, especially International, can be lumpy quarter-to-quarter. That said, our outlook for European sales in 2018 remains optimistic as we expect tender activity increase and our partners to continue to adopt portable oxygen concentrators as a patient preferred product offering of low total cost of ownership. We believe we remain the preferred provider of portable oxygen concentrators in Europe and we expect to see a large long-term opportunity ahead as that market transitions from tank and liquid oxygen systems to non-delivery solutions. In support of our European customers, we began production of our Inogen One G3 concentrators in the fourth quarter of 2017 using a contract manufacturer, Foxconn, located in the Czech Republic. In 2018, we expect Foxconn to produce the vast majority of the Inogen One G3 concentrators required to support our European demand and we are very pleased with their productivity, cost, service and quality at this stage. We expect to maintain our assembly operations for our Inogen One concentrators and Inogen At Home concentrators at our facility in Richardson, Texas, and continue compressors and sieve bed columns assembly at our facility in Goleta, California. The Foxconn production will allow us to expand our manufacturing capacity and redirect our U.S. manufacturing activities to focus on growth domestically and on our latest product, the Inogen One G4. While still early in our relationship with Foxconn, we are already delivering improved service levels and lower costs. Turning to reimbursement updates; in December 2017 CMS released it's 2018 Medicare fee schedule that went into effect on January 1, 2018. When comparing 2018 and 2017 rates for the Top 25 HME items, the only item that saw a change was stationary concentrators built under code E1390. For suppliers in both, rural and other non-bid areas, the indicated decrease for E1390 in 2018 will be on average 1.2% compared to 2017 rates. As a reminder, this does not impact pricing in the competitive bidding areas and is an adjustment that CMS has instituted due to increased utilization of affordable oxygen concentrators and applying a budget neutrality provision to the stationary oxygen concentrator rate. The rate change will also impact our rental revenue in these areas since POCs are dual coded to include billing code E1390. We believe that the rate change will put additional pressure on HME providers to continue to convert to non-delivery solutions as the additional rate cut applies to all Medicare patients in these areas who receive stationary oxygen concentrators. With regards to the interim final rule, we still await a decision. As a reminder, if approved, the interim final rule would provide retroactive relief to non-competitive bid areas from August 1, 2017 to December 31, 2017, while also extending through 2018. Independent of the interim final rule, there is also a bill in the House of Representatives, Bill HR4229 titled 'The Protecting Home Access Act of 2017' which would provide retroactive relief to non-competitive big areas from January 1, 2017 to December 31, 2017 and extends through 2018. This bill has bipartisan support with 122 co-sponsors, there is no known timeline for voting on this bill. On the topic of competitive bidding around 2019, we have nothing new to report and await information from CMS on the next round of competitive bidding. That said, on February 12, President Trump sent Congress a 2019 budget proposal that included language on competitive bidding. Specifically, the proposal eliminates the requirement under the competitive bidding program that CMS pay a single payment amount based on the median bid price. Instead, paying winning suppliers at their own bid amounts. Additionally, this proposal expands competitive bidding to all areas of the country including rural areas which will be based on competition in those areas rather than competition in urban areas. The specific proposal was estimated to save the government $6.5 billion over 10 years. Even though this is only a proposal, we believe it provides context in this administration's view on competitive bidding. While it is still unclear if these provisions will be included in the final 2019 budget or if it will impact the pending competitive bidding round 2019, we still believe significant reductions in oxygen reimbursement rates will continue to drive providers to non-delivery solutions like portable oxygen concentrators. Finally, we wanted to provide an update on the legal proceedings with CAIRE. As a reminder, CAIRE filed a lawsuit against Inogen in September 2016 alleging infringement on one patent. We are happy to announce Inogen recently settled out of court with CAIRE for an all-in value of $1 million. The agreed upon settlement amount was paid in full to CAIRE in the first quarter of 2018 and covers both alleged, past damages and future rights to be free from all litigation with respect to the patent insuit. Although we maintain we committed no wrong doing, we believe a timely settlement agreement was in the best interest of the Company and our shareholders to remove the uncertainty, expense and distraction of a prolonged litigation. As the POC market and technology leader, we plan to defend our patent portfolio and invest in R&D to maintain our position in the market with patient preferred oxygen products. Looking ahead, I'm really proud of our Inogen associates and our progress this quarter, especially during a time when we ramped up a new European contract manufacturer and significantly expanded our direct-to-consumer sales team. While we've been engaged in these exciting initiatives to fuel future growth, we've also maintained our current growth momentum, especially in the domestic direct-to-consumer and business-to-business sales channels and I'm very pleased with the increased adoption in these markets with our best-in-class and patient preferred products. Looking at 2018, we are increasing our full year revenue guidance range from $295 million to $305 million, to $298 million to $308 million, and expect to continue to invest heavily in our sales force, marketing efforts and operations in order to drive POC adoption worldwide. With that, I will now turn the call over to our CFO, Aly Bauerlein. Aly?

Thanks, Scott and good afternoon everyone. During my prepared remarks, I will review our fourth quarter of 2017 financial performance, and then provide details on our updated 2018 guidance. As Scott noted, total revenue for the fourth quarter of 2017 was $63.8 million, representing 25.4% growth over the fourth quarter of 2016. Looking at each of our revenue streams, and turning first to our sales revenue, total sales revenue of $58.4 million represented 91.5% of total revenue in the fourth quarter of 2017 and reflected 37% growth over the same quarter of the prior year. Total units sold increased to 34,000 in Q4 2017, up 45.9% from 23,300 in Q4 2016. Direct-to-consumer sales for the fourth quarter of 2017 were a record $24.5 million, representing 57.5% growth over the fourth quarter of 2016, primarily due to increased sales representative headcount, increased marketing expenditures, and increased productivity. Domestic business-to-business sales of $21.9 million in Q4 2017 reflected 46.1% growth over Q4 2016, with strong demands from our private label partner and traditional HME providers. International business-to-business sales of $12 million in Q4 2017, declined 0.8% from Q4 2016. While office mid-teens growth trajectory seen in the first 3 quarters of 2017, international sales were flat compared to the same period in the prior year, primarily due to strong third quarter 2017 results and the lack of any major European tenders awarded to our provider partners in 2017 which limited growth opportunities in the fourth quarter. Lastly, the fourth quarter of 2016 included a large South Korean order that did not repeat in the fourth quarter of 2017 creating a difficult comparable. Sales in Europe represented 84.3% of international sales in the fourth quarter of 2017, up from 83.3% in the fourth quarter of 2016. With robust business-to-business sales again in the fourth 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 fourth quarter of 2017 versus 16.2% in the fourth quarter of 2016. Rental revenue in the fourth quarter of 2017 was $5.4 million compared to $8.2 million in the fourth quarter of 2016, representing a decline of 34.1% from the same period in the prior year. We saw the expected decline of rental revenue from the comparative periods primarily due to the $2 million rental benefit in the fourth quarter of 2016 associated with the 20% [indiscernible] which increased reimbursement retrospectively for some Medicare beneficiary. Turning to gross margin for the fourth quarter of 2017, total gross margin was 48.2% compared to 48.5% in the fourth quarter of 2016. The decrease in total gross margin was primarily due to the $2 million Cures Act benefit recorded in the fourth quarter of 2016 which contributed 2.1% to total gross margin in the fourth quarter of 2016. Our sales gross margin improved to 50.5% in the fourth quarter of 2017 versus 49.9% in the fourth quarter of 2016. The sales gross margin percentage improvement was 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 average selling prices. Rental gross margin was 23.2% in the fourth quarter of 2017 versus 41.4% in the fourth quarter of 2016. The decreases in rental gross margin was primarily due to the $2 million Cures Act benefit recorded in the fourth quarter of 2016 which contributed 19.2% to rental gross margin in the fourth quarter of 2016. As for operating expense, total operating expense increased to $25.6 million in the fourth quarter of 2017 or 40.1% of revenue versus $18.5 million or 36.4% of revenue in the fourth quarter of 2016. Research and development expense was $1.4 million in the fourth quarter of 2017 compared to $1.2 million recorded in the fourth quarter of 2016, primarily due to increased product development expenses. Sales and marketing expense increased to $15.2 million in the fourth quarter of 2017 versus $9.3 million in the comparative period in 2016, primarily due to higher advertising expense and sales force personnel-related expenses as we hired the majority of the full year net sales rep additions after opening the Cleveland facility in August of 2017. In the fourth quarter of 2017, we spent $4.4 million in marketing and advertising as compared to $1.7 million in Q4 2016. General and administrative expense increased to $9 million in the fourth quarter of 2017 versus $8 million in the fourth quarter of 2016, primarily due to increased personnel-related expenses. While we've reported $100,000 patent litigation settlement expenses associated with the CAIRE litigation settlement in the fourth quarter of 2017, we've spent less on total legal expense when compared to our original forecast given the timing and the amount of settlement with CAIRE. The remaining $900,000 is expected to be amortized over the next five years. In the fourth quarter of 2017 our provision for income taxes totaled $6.4 million representing an effective tax rate of 110.5%. In the fourth quarter of 2016 our provision for income tax is totaled $0.6 million representing an effective tax rate of 9.8%. The increase in effective tax rate was primarily due to $7.6 million non-cash income tax provision expense associated with the revaluation of the deferred tax asset. Our effective tax rate in the fourth quarter of 2017 also included a $3.5 million decrease in provision for income taxes related to excess tax benefits recognized from stock based compensation compared to $1.7 million in the fourth quarter of 2016. Excluding both the deferred tax asset revaluation expense and the stock based compensation benefits, our non-GAAP effective tax rate in the fourth quarter of 2017 was 40% compared to 39.7% in the fourth quarter of 2016. In the fourth quarter of 2017 we reported a net loss of $0.6 million compared to net income of $5.3 million in the fourth quarter of 2016. Our reported net loss in the quarter was primarily due to the $7.6 million expense associated with the revaluation of our deferred tax assets. Loss per diluted common share was negative $0.03 in the fourth quarter of 2017 versus positive $0.25 in the fourth quarter of 2016, a decrease of 112%. Excluding the $7.6 million non-cash deferred tax asset revaluation expense, we delivered non-GAAP net income of $7 million in the fourth quarter of 2017 which represented a 10.9% return on revenue. Non-GAAP net income increased 32.5% in the fourth quarter of 2017 versus the fourth quarter of 2016 where non-GAAP net income was $5.3 million or 10.3% return on revenue. Adjusted EBITDA in the fourth quarter of 2017 was $11.6 million, which represented 18.1% return on revenue. Adjusted EBITDA increased 5.8% in the fourth quarter of 2017 versus the fourth quarter of 2016, where adjusted EBITDA was $10.9 million or 21.5% return on revenue. Cash, cash equivalents, and marketable securities were $173.9 million, an increase of $10.9 million compared to $163.1 million as of September 30, 2017. Turning to guidance, we are increasing our full year 2018 guidance range for total revenue from $295 million to $305 million, to $298 million to $308 million representing growth of 19.5% to 23.5% versus 2017 full year results. 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 rentals. As stated previously, the only known changes to Medicare reimbursement rates in 2018 are roughly 1.2% decline in monthly stationary rates in non-competitive bidding areas due to a C-schedule adjustment. Given changes to the U.S. corporate tax code, we are increasing our full year 2018 GAAP net income and non-GAAP net income guidance range to $36 million to $39 million, up from $31 million to $35 million, representing growth of 71.4% to 85.7% compared to 2017 GAAP net income of $21 million and growth of 26% to 36.5% compared to 2017 non-GAAP net income of $28.6 million. We are maintaining a guidance range for full year 2018 adjusted EBITDA of $60 million to $64 million representing growth of 18% to 25.9% versus 2017 full year results. We estimate that the decrease in provision for income taxes related to excess tax benefits recognized from stock based compensation 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 approximately 25%, down from our previous estimate of 37% due to changes in the U.S. corporate tax code. We expect our effective tax rate including stock compensation deductions to vary quarter-to-quarter depending on the amount of pre-tax net income and on the timing and sides of stock option exercises. Lastly, we're not impacted by the reinstatement of the U.S. Medical Device Excise Tax given our retail exemption. 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] The first question comes from Roby Marcus with JP Morgan.

I wanted to start with the sales reputations that you did to the direct-to-consumer channel in 2017; they came at $263 million, roughly up almost 50%, well more than I think people were expecting. So can you talk about what the historical correlation has been from adding new sales reps and how they translate into sales growth going forward? And what that might mean in terms of growth rates in '18 in the DTC channel?

You're right, we did hire a little more heavily once we have the Cleveland office opened, than we have done in the past, it's been a good market for us. As you might imagine, we are new to a community, there is a lot of excitement and in the early going, it's a little easier to hire. We saw the same thing when we opened the Texas facility. Our traditional approach is that we want to hire in as linear a fashion as possible, so that's still our approach but we were kind of the beneficiary of the new office. And as Aly mentioned in her comments, more than half of the folks that we had hired throughout the year were hired in the Cleveland office in the last 4 months of the year, so it was a little backend loaded. As far as that stacks up to drive growth, it's 4 to 6 months for a sales rep -- and inside sales rep to get to what we call steady state or kind of their end of curve. Now they will contribute some before that, they -- basically we see contributions in month two and three but end of curve is 4 to 6 months, so we feel like we're in a good spot and that's reflected in our guidance this year.

It has closely correlated with overtime the sales growth in that direct-to-consumer sales channel. So we would expect that as we've added those additional sales capacity outside of that first 4 to 6 months investments that you have for new hires that you will see that growth on the direct-to-consumer side associated with us increasing that sales capacity because as you know, our limit to growth in creating additional consumer awareness is really tied to how much sales capacity we have. So as we add that additional sales capacity, we spend more in marketing to drive more leads to fill that sales capacity and that's our plan going forward as well, and we do plan to continue to add reps going into 2018 as well as we still we're a long way from full saturation on the direct-to-consumer sales side of the business.

So with continued hiring in '18, should we be expecting second half DTC growth rates to be stronger than first half?

Yes, we do think that given the typical seasonality that we see in the business is that in the summer months you see stronger demand than in the colder months associated with when patients are travelling. However, as we saw in 2017, a big impact on our actual direct-to-consumer sales results is also the level of sales capacity that you have, so as you saw in 2017 there was sequentially increasing direct-to-consumer sales throughout 2017, we expect with the timing of when reps are hired in back half of 2017 and then into 2018 that that could also be sequential increases throughout 2018, even though the fundamental underlying dynamics of when leads convert at a stronger basis in the warmer months is still true and we expect that to be true in 2018 as well.

As you guys think about your rental business here, it was -- it took a hit last year, roughly flat this year, probably flattish outlook going forward. How do you think about this business now fitting in with Inogen? Is there any way to monetize this business or sell it or trade it to someone else because it is hitting your growth profile and I can't imagine that the return is terribly fantastic here. Thanks.

I mean, you're right, in the past as we've kind of all of the providers and Inogen included has taken on competitive bidding, with the rate reductions we had to grow through that in our other channels and we've done a pretty good job with that. This year as Aly said, there are no significant rate reductions, so we don't have the headwinds this year that we've had in the past but there will be competitive bidding rounds in the future, still don't have clarity on it but we'll see rate reductions as we go forward; so it will continue to be challenged. As you know, we've deemphasized that but we haven't given out bounded or set at a side what it does from a strategic standpoint is it opens up access to our product to patients because there are still some patients that do want to use their benefit and we don't want to completely screen them out, it does set us up to continue to walk in the other providers footsteps, so we better understand their business and I think that we become a better resource to help them through navigation of conversion to a non-delivery model. It set us up to build partnerships for those that want to work with us because of our expertise. And if you think about it, you know, if you go way out into the future and we talk about a conversion to POCs which we believe will happen although it's going to take -- we've always quoted that 7 to 10 years. If everybody is able to get a POC from their traditional homecare provider for ten years out, it will be more difficult to sell somebody a POC from a retail standpoint. So, we do see rental as still our long-term future at least in oxygen therapy. Now what that does is that sets up once we hit a conversion point with POCs then we’ll need to back fill with other disruptive products that we can leverage the expertise of that sales force and still drive growth. But long-term we still see rental as an important strategic opportunity for the company. But you're right, in the short term it's probably, it hasn't been a positive contributor other than the knowledge and the partnerships that we've been able to forge.

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

Hi, good afternoon guys. Thanks for taking the time for the call and the questions. First one for me is maybe a broader market question in relation to adoption of POCs by the channel. You've talked about having kind of 50% market share at this point which is up maybe from 40% the year before and you're still taking share. So maybe, can you walk us through where the share is coming from whether it's from other competitors or is it just from peer market growth from DMEs that previously maybe didn't have a presence in POCs and does that change with the competitive environment as we go out through 2018?

Yes, it's a good question Margaret. I mean our share gain is clearly coming from other competitors. Now our overall growth is coming from market growth as well as share gain. But if you look at and you said that correctly, we estimate that we've moved from low forties to about 50% over the last couple years. That’s gain in share from other POC manufacturers.

And so, as you kind of look at that 40% going to 50%, so is that coming from mom-and-pop POCs or some of the more blue-chip POC manufacturing, and how do you see that change in 2018 if at all?

Yes, I am going to answer your question with kind of what I’ll say a logical answer, because I don’t have exact data on it. But I mean there's several other POC manufacturers in the marketplace and some are stronger than others. Some have a stronger sales force, some have a little better products than others. So logically, you know I would expect were taken from the weaker players.

Yes, and just to add to that. I think that we've also had a great partnership with our private label partner and creating relationships with DME’s of all sizes and really showing the benefits of non-delivery. But we also have that strong consumer demand and as we've been ramping up our inside sales team by 50% or almost 50% in the last year that really has allowed us to invest more in consumer awareness. So, you have both sides both the consumer is being more and more aware of POCs and demanding an Inogen POC and then you also have providers who are working with both us and our private label partner to figure out how to convert their business and that that marriage has really worked well in driving overall market penetration for us with what we see as the best in class product on the market.

Got it. So, as we kind of take that conversation a little bit further. Our patience switching DME is in order to be able to gain access to your product. And then as you look at your guidance for B2B domestic growth as you go into 2018, you guys guided a kind of solid growth. But can you split up for us how much of that you think is share gain versus just pure market adoption of POCs. Meaning that are you assuming anything beyond the traditional 100 to 150 basis points of share gains of POC in the market? Thanks.

Yes. So, I'll take that one. Really what we're assuming is continued adoption from the HME community apple [ph] levels that we've been seeing. So, we aren’t assuming a major acceleration of POC adoption, while we've said over time we do expect that to accelerate and it has to in order to reach full penetration in seven to ten years. Inherent and guidance is continuing to incrementally that 100 to 150 basis point increase in penetration of POCs as a category and we’re not assuming any material change in our market share penetration or percent at that 50% or so level. As we’ve said in the past, when we look at our guidance particularly on the B2B side, we want to make sure that we don’t get out ahead of the market conversion and while we very passionately believe where the market will get to. We also know that there is a lot of challenges for providers to get from where they are today with a tank-based system and to actually implement a non-delivery system. Inherent and guidance just as its been for the many years that we’ve been public now, we don’t want to get out ahead of that market conversion and so we’re more cautious on the B2B side. Although as you said, we still do expect solid growth just because it does seem like there are many players where the conversion has started to non-delivery based system.

Great. Thank you, guys.

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

Hi this is David Saxon on for Mike this afternoon. Thanks for taking our questions.

Hello.

Hi. Just wanted to get a little more color around what you're thinking around the international business. And then if you can point to any markets in particular?

Yes, when we said that our short-term focus will continue to be on Europe. It's still the largest market today outside of the United States. We did a couple things last year to improve our position in Europe. One is we bought one of our key distributors if you recall back in May MedSupport Systems that was something to really shore up frankly our support and service of the customers that we already had. As these customers continued to scale their business with POCs and it became a bigger part of their budget their expectations for service also continued to increase. So, we said alright, we're going to one way or another, we're going to set up shop on European soil so that we can do the repairs there that people can call, talk to people in their own language in their own time zone and we executed that through that acquisition. And I will tell you that our key direct customers are very pleased with that. They have expressed appreciation, I think that's one of the things that keeps us in the preferred provider position for the key big customers in Europe. Later in the year, we started our contract manufacturing partnership with Foxconn so that cuts the lead time from the shipment basis, it also gives us an opportunity to drive down some cost. It’s a relatively small amount, but we avoid considerable shipping expense shipping across the pond and the Europeans are grateful for the shorter lead time. So again, we've improved our competitive in-service position there and that's the focus short term. If you look way out long-term, and I mean way out like a 10-year horizon then China and we said China shouldn’t be theoretically a huge market. You've got a large population a large percentage of smokers and poor-quality issues, so as that country continues to develop usually healthcare systems will improve as countries develop. Today there's no reimbursement for portable oxygen therapy in China, but long term we expect that that would be established. In the short-term there could be a retail opportunity, so we are right now working on registration for China but that is a long-term growth opportunity. That's not something that's going to change our growth trajectory over the next couple of years, so it's a longer-term play. So hopefully that answers your question of kind of a short term versus the long-term focus.

Yes, that's helpful. And then just with some competing products coming to market what are you thinking about pricing pressure this year and then if I can just ask if you've heard anything about ResMed Mobi?

You want to respond and I’ll talk on ResMed Mobi.

Sure. So, starting with the pricing side as we’ve seen over the last couple of years, we do expect average selling prices to decline over time particularly in the B2B side of the business as we see volumes increase. This is a price sensitive industry and with the competitive bidding pricing, continuing reimbursement pressures, we expect that to translate into manufacturing pricing pressure as well. That is already built into guidance that we would expect that to continue and when we look at competitive approaches price is a very common point for us to compete on and we have been able to maintain a small premium versus the competition, because our product is perceived to be of higher value both from a patient preference side as well as the reliability standpoint. So, we would expect to be able to maintain that going into 2018. But we have continued to build ASP pressure into our model and into our guidance. We also continue to expect to be able to take cost out as we continue to add volume here, we expect to be able to leverage that into lower materials and labor costs and to offset that ASP pressure.

Yes, on the ResMed Mobi. We still don't know anything about their specifications. So, we're just as anxious with all of you to understand the product better. It's hard to comment on how it's going to compete until you can actually lock down the specs and get one in our hand. So, we're not there yet. What we do is anytime there's a new product launched by anybody whether its ResMed or any other competitor, we go out and buy a few of those and test them and we’ll do that this time around. I think whether it's ResMed or one of the other players, I mean we expect people are going to continue to launch new products and we’re going to do that as well. We are hard at work on our G5 and we haven’t really said much about it and I don’t really plan to tell you much about it today other than that development of that product started about the day after we launched G4, because product innovation and staying at the forefront of patient preference is key to our success. It’s what’s put us in the driver seat now and we believe that’s what will keep us there. I will say though for ResMed, they are a great blue-chip company. I think they continue to add credibility to our thinking that the future in oxygen therapy is POCs. And they could actually with a decent product could help convert the market at a faster rate and that could benefit us as well as the market leader. Right now, the real opportunity is in converting tanks to POCs, not in going out and converting one POC to another. Now we get down to the end of the road and the market has converted than that dynamic changes. But for the foreseeable future, tanks or who we really see as our primary competition as well as opportunity for growth.

Great. Well congrats on the quarter and thanks for the questions.

Thank you.

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

Hi guys, good afternoon. Thank you so much for taking the questions. Congrats on a really great quarter yet again. A question on the profile of the business over time. So, Scott, I know you've talked in the past it was 10% to 12% penetration I think you said for POCs today. That has a lot of room to move forward, and I would imagine and tell me if I'm wrong that, for that penetration to move to call it, you know I am going to put numbers out there 30%, 40%, 50% penetration. The HME has to be a significant part of that and I’m just curious, as we see ramping penetration -- how you would expect your business mix to change over time? And then Ally, I don’t know if you can talk a little bit about what that could mean for margins and maybe even your approach to the market specifically thinking about the direct-to-consumer and where that continues to fit in? Thank you so much. Sorry for the long question.

Yes, it's a good question Danielle. Let me answer it first in the context of oxygen therapy, because I think in the big picture it's a little different. But if you look at just oxygen therapy, as we said when we get to a market conversion point where the providers are also using POCs, we think that our retail POC business would be I'll call it less robust. Right now, there's a lot of opportunity as there are so many patients that are dragging tanks around, it's frankly relatively easy to sell somebody a unit if they have the money because it's hard to put a price on freedom. But that'll change over time when they're all holding POCs from their current provider. So, it will swing from an oxygen therapy standpoint, rental could play a more prominent role in the future and certainly again in the context of oxygen therapy, the providers would play a bigger role. Now in our overall business, what that means is we've built and are continuing to build this outstanding sales force that is very adept. It's selling products to patients that have unique needs. So, we've got a backfill products with more unique solutions so that we can continue to have, strong retail sales component to our business. But that won't be necessarily in portable oxygen concentrators. It may not even be necessarily in respiratory, but it does need to be unique in disruptive products that offer unique solutions to people, products that we can use to serve in people's homes. We’re not an acute care focused company today, products that we can easily deliver using our delivery partners which are FedEx and UPS. Our unique solution that takes a flat-bed truck to deliver probably doesn’t fit our model. So, I think it'll change with respect to oxygen, but what that does is it frees up sales time for us to add other disruptive products. And we're looking at that all the time, I think we're in a great spot when you look at our balance sheet to either form partnerships or make acquisitions to add those products. But right now, I will say is I've said over the last really year, year and a half we’re very careful about that because there is a delicate balance between opportunity and distraction. And so while I painted a picture of what the future will look like in 10 years, that's not where we are today, the opportunity today is still using our sales team to convert oxygen patients, so that's what we're focused on.

Just to be clear, any incremental sort of move-in in new therapies; that's far off, you're really talking about a multi-year timeframe before we're even at that point where oxygen is penetrated?

Is multi-year before -- we think that our growth through POCs starts to slowdown.

We still expect to be long-term high growth company and the oxygen therapy market is a very large and growing market; so for the foreseeable future we see POCs as being the primary market opportunity for us and if we've added something it would be more opportunistic in nature if the right thing came along at the right time. And just getting back to your first question on the margin side, as the mix in the business changes, it could impact the difference between gross profit and operating margins but on a net basis, the B2B side and the direct-to-consumer business are very similar operating margin profile. So that's why we don't necessarily give any gross profit guidance and more focused on making sure that if there is a sales opportunities that we are the market leader in that sales opportunity and that we capture as many of those as we can and where it checks out on the P&L between gross margin and operating expenses, kind of will work out depending on the channel and we're looking to continue to grow the topline and also have shown nice profits in the business but very similar operating margin profile.

The next question comes from JP [ph] with Piper Jaffrey.

Just two quick follow-ups for me. First, on the revenue guidance, you mentioned that you didn't want to get ahead of the changing market dynamic, a little bit on pricing. I look at the numbers and although the range went up, did the growth rate get trimmed a little bit there, in between you just posted a great quarter. Just curious, if we could walk through the pieces of those numbers and is the Company just making in some conservatism here? Is there something specific in the growth outlook that has changed for next year? Thanks.

The growth rate is basically the same expectations we had when we put out guidance initially. So at the low and high end of guidance, it was before 20% to 24%, now it's 19.5% to 23.5%. So to us, that's materially the same, it's just where the rounding came in; so still we expect to see 20% plus growth and I think that we've set ourselves up nicely with the investments that we made on the direct-to-consumer side of the business and then also the success we've seen on the B2B side. So I wouldn't say that there is any difference in the conservatism level, however, I also want to say that we still are very early in the year and earlier we are in the year, the more cautious we are just because you haven't yet seen enough of the history. So while we feel very good about the guidance range and the guidance philosophy that we've used, we've used a very bottoms-up approach to budgeting and making sure we really understand the potential pluses and minuses to our growth rates, with direct-to-consumer we're much more in control of our success there. So we tend to be able to have greater visibility there than we do on the business-to-business side where we tend to be more cautious in putting out numbers and we do think it's important to put out guidance that is achievable and we still think that this guidance range is very achievable for us for 2018.

Secondly, we talked a bit about the sales force more broadly, I apologize if I've missed this. But I wanted to frame up where the Company is at in hiring in Cleveland specifically? Whether that's just a ballpark figure, what percentage is the Company at of the overall target? And within that target range, would it -- would demand increase that rate or is it pretty set within one specific range? Thanks.

We have said that off the 86 net hires, over half of them were in the Cleveland facility, so that means at least 43 of them are in the Cleveland facility in the first 4 months of us putting that facility up in place; and we have said overtime we want to add about 240 people in that facility with over half of those being sales reps. So we have gotten off to a very solid start with putting over 35% of that sales force together, now that number may increase depending on how -- where we get on the sales capacity side and results. If there is continued -- our ability to hire there, we may look to hire more overtime but we first need to get through this first 120 or so for us to see -- really understand the productivity of that sales force and understand what the additional market capacity is, but we still feel like there is a lot of room for us to add sales capacity overtime.

[Operator Instructions] The next question comes from Ramgopal [ph] with Sidoti.

Scott, if you can give me a sense in terms of what's going to be different with the sales force in Cleveland versus California, for example, would there be a different geographic focus or any color there would be appreciated?

One of things that we've done right out of the gate is, we don't assign territories to the inside reps. We've got leads coming in everyday from all over the USA and they are distributed more or less evenly across the sales force. So the way we manage the sales team is, every rep is going to get X number of new leads every month. By not assigning territories, it's made it really easy for us to scale because if you think about it, we did have more territories then you've got to rebalance and recut your sales territories, really almost every month the way we've scaled the sales team. So every inside rep, their territory is the USA and they are getting leads all month from all over the country, it makes it easy the scale.

Aly, I know you highlighted advertising expenses ticked up a little in the fourth quarter, I was just wondering in terms of how you're thinking about that for 2018 if you intend to be even more aggressive on that front?

Yes, we do. As you saw in the fourth quarter, we did see an increase in advertising expense upto $4.4 million, and what I do want to highlight there is that when we have high number of new reps in that pool, when they are in that 4 to 6 months productivity ramp, they actually use more leads, so investing in more media in that time should be expected when we have a higher percent of new reps in the field. So main driver of that was increased sales capacity and the fact that you had such a high proportion of newer reps in the pool, in the quarter. And so given the fact that we are continuing to invest heavily in that team, we do expect the advertising spend to increase going into 2018, both for the existing sales reps but also the new sales reps.

This concludes our question-and-answer session. I would like to turn the conference back over to Scott Wilkinson for any closing remarks.

Yes, I'd like to close with a few comments on our strategy for 2018. We expect to seek ways to accelerate the global adoption of portable oxygen concentrators. 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, and where we see portable oxygen concentrators continuing to grow and becoming the standard-of-care for ambulatory patients in the next 7 to 10 years. Thank you for your interest in Inogen.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.