Inogen, Inc. (INGN) Q1 2019 Earnings Report, Transcript and Summary

Good day and welcome to the Inogen 2019 First Quarter Financial Results Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today’s, presentation there will be an opportunity to ask question. [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 me from Inogen is CEO, Scott Wilkinson; and CFO and Co-Founder, Ali Bauerlein. Earlier today, Inogen released financial results for the first quarter of 2019. 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 2019 and beyond, sales, personnel strategy changes, rental strategy changes, and the timing of an impact of such changes, hiring expectations, expectations for all sales channels, including international tender activity, marketing expectations, the rollout of Inogen One G5, expectations regarding the impact of Chinese tariffs, competitive bidding, HME strategy and expectations and financial guidance for 2019. 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 may be required by law. We have posted historical financial statements and our first quarter investor presentation in the Investor Relations section of the company’s website. Please refer to these files for more detailed information. During the call, we will also present certain financial information on a non-GAAP basis. Management believes that non-GAAP financial measures, taken in conjunction with the 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 first quarter 2019 conference call. Looking at the first quarter of 2019, we generated total revenue of $90.2 million, reflecting growth of 14.1% over the first quarter of 2018. Direct-to-consumer sales of $39 million in the first quarter of 2019, increased 35.9% over the first quarter of 2018, primarily due to increased sales representative headcount and associated consumer advertising. However, the sales reps we hired in the second half of 2018 on average took longer to come up the productivity curve than our historical target, and were not at their full potential in the first quarter. Moving forward, we plan to slow down the addition of new sales representative hires and focus on improving the productivity of our sales team. Over the last two quarters, we have also applied with it a separate rental team that will focus exclusively on new rental additions to drive overall sales productivity. And we plan to roll this out across our entire group in the coming quarters. As we continue to grow our sales staff and the associated number of required leads has grown, we have seen the cost per generated lead trend higher than historical averages. We believe, we will see increased productivity of our sales reps throughout 2019, which should reduce our overall cost per sale despite expected increased marketing spend. First quarter 2019 domestic business-to-business sales of $26.1 million decreased 7% from the first quarter of 2018, primarily to a decline in sales to our private label partner. These sales declines were a partner due to one large national home care provider who significantly reduced orders in the first quarter of 2019 as compared to the same period in 2018. Specifically this provider who we discussed in our last earnings call accounted for revenue of $700,000 in the first quarter of 2019, down from $9.3 million in the first quarter of 2018. Excluding this provider, we continue to see strong demand from traditional HME customers. We expect domestic business-to-business sales in the remainder of 2019 to be negatively impacted by significantly lower order activity from this provider for slow purchases beginning in September of 2018. Due to the ongoing restructure challenges, some HME providers face, we continue to look for ways to partner with providers to drive POC adoption. We do plan to slightly change our rental intake criteria to expect more new rental patient additions to increase access to patients who otherwise could not obtain a POC from their current home care provider. The rental reimbursement revenue is recognized monthly, compared to the mostly immediate revenue recognition of direct-to-consumer sales we don't expect a meaningful rental revenue benefit from increasing new rental setups until next year and beyond. While we expect rental revenue to take time to ramp, we believe we can improve our close rate and lead usage by slightly altering our intake criteria for rental patients. Historically, our remaining build on loan threshold was high which limited the number of patients we accepted for Medicare. Going forward, we plan to lower this threshold to improve sales representative productivity and lead users. In changing our rental intake criteria, our guidance assumes an adverse impact on near-term sales revenue in the U.S. But we believe it will lead to increased conversion rates and increased POC adoption. First quarter of 2019 rental revenue of $5.4 million decrease 1.5% compared to the first quarter of 2018, primarily due to an 11.5% decrease of patients on service, partially offset by higher rental revenue per patient. We had approximately 26,200 patients on service as of the end of the first quarter of 2019. And while we expect it will take some time to change the intake criteria and scale the separate rental teams, we do expect that rental patient count to start increasing in the back half of 2019. First quarter of 2019 international business-to-business sales were strong at $19.8 million representing as reported growth of 17.1% and 22.3% on a constant currency basis. Despite no meaningful tender activity in the quarter, underlying European demand trends remain healthy. We still expect European tenders in 2019. Although we do not include any revenues associated with these potential tenders in guidance. We also saw a strong growth in Canada, Australia and South America, although these markets are much smaller than the European market. Moving into product development. We are proud to say that we officially launched the Inogen One G5 in our direct-to-consumer channel in April. And only 4.7 pounds and six flow settings, the Inogen One G5 represents a step forward in innovation as we believe it is the highest oxygen output per pound of weight of any portable oxygen concentrator currently available in the United States. With 1260 milliliters of oxygen production capacity per minute and Inogen's standard intelligent delivery technology, the Inogen One G5 was designed to meet the clinical needs of approximately 95% of the ambulatory long-term oxygen therapy patients who contact us. Other patient preferred features include a long battery life of up to 13 hours with the optional double battery access to Inogen Connect, a large LCD screen and very quiet operation. Given these favorable product features and limited manufacturing capacity of launch, we initially priced the Inogen One G5 at a premium relative to the Inogen One G3 and G4 systems. We plan to reduce retail pricing to parity when the other Inogen One products once manufacturing can support of the volume of demand. Once volume is increased and pricing has been optimized, we still expect the Inogen One G5 to obsolete the Inogen One G3 over the intermediate term in all sales channels. We expect to roll out Inogen One G5 to the domestic business-to-business channel over the summer and then to the international business-to-business channel by the end of the year, pending standard regulatory clearances in each market. On the topic of competitive bidding around 2021, we expect the bidding process to begin in July 2019. It has been announced that oxygen equipment and supplies will be separate from CPAP equipment and supplies and respiratory assist devices which we had expected. All of the other previously announced changes to the competitive bidding program appear to be incorporated, including lead item pricing, surety bond requirements and setting the bid amounts at the maximum bid amount instead of the medium bid amount. The program has been structured to have the oxygen lead item the HCPCS code E1390 which is the billing code for stationary auction. While the other action codes are established by applying a factor by the ratio of that code to E1390 based on the 2015 Medicare fee schedule. However, due to the lead item pricing methodology being dependent on the 2015 standard Medicare fee schedule, portable add-on code reimbursement rates would be reduced even if E1390 reimbursement rates do not change. We do plan on bidding in 129 out of the 130 regions covered under the program. Although we cannot discuss our pricing strategy publicly. We don't expect winners or new pricing to be announced until 2020 based on the timing of these announcements in prior rounds. As a reminder, in the last round of competitive bidding, we won 103 of the 130 regions. So we had access to most regions covered under the Medicare competitive bidding program. Lastly, as a reminder, excluding annual inflation and budget neutrality adjustments, the 2021 competitive bidding round pricing is expected to be in effect for three years. Looking at 2019, we are reducing full year 2019 total revenue guidance to $405 million to $415 million, down from $430 million to $440 million, representing growth of 13.1% to 15.9% versus 2018 full year results. This revenue range takes into account the difficult growth comparisons we faced over the domestic business-to-business channel, restructuring challenges some HME providers are facing, the decreased planned direct-to-consumer hiring as well as our plan to increase rental setups. We plan to increase rental in a balanced fashion to not alienate the great relationships we have already created with our home care provider customers across the United States. For those providers who are adopting Inogen technology and converting their businesses, we plan to continue to support them to help fulfill that mission. And we will continue to drive patient awareness. We believe that the market for POCs remains under penetrated. And we continue to see significant demand for our product given the number of lead we're able to generate on a monthly basis. The program is beholden to the provider's ability to adopt POCs, we plan to take full advantage of our unique vertically integrated business model to increase access of our technology through our rental platform. We believe the patient demand is still very high for affordable oxygen concentrators. And it is our mission to fill this need for our home care provider partners or from Inogen through a purchase or an insurance rental. With that, I will now turn the call over to our CFO, Ali Bauerlein. Ali?

Thanks, Scott, and good afternoon everyone. During my prepared remarks, I will review our first quarter of 2019 financial performance and then provide more details on our updated 2019 guidance. As Scott noted, total revenue for the first quarter of 2019 was $90.2 million representing 14.1% growth over the first quarter of 2018. Turning to gross margin. For the first quarter of 2019, total gross margin was 49.2% compared to 47.7% in the first quarter of 2018. Our sales gross margin was 50.4% in the first quarter of 2019 versus 49.8% in the first quarter of 2018. The sales gross margin increase was primarily due to a favorable mix shift towards higher gross margin direct-to-consumer sales versus business-to-business sales and a reduction in cost of goods sold per unit compared to Q1 2018. The favorable mix was partially offset by lower average selling prices in both the international business-to-business and direct-to-consumer channels, while domestic business-to-business average selling prices were flat. Rental gross margin was 30.8% in the first quarter of 2019 versus 20% in the first quarter of 2018. The increase in rental gross margin was primarily due to increased rental revenue per patient on service and lower depreciation expense. As for operating expense, total operating expense increased to $39.6 million in the first quarter of 2019 or 43.8% of revenue versus $29 million or 36.7% of revenue in the first quarter of 2018. Research and development expense increased to $1.7 million in the first quarter of 2019 compared to $1.4 million recorded in the first quarter of 2018, primarily due to increased product development expenses. Sales and marketing expense increased to $28.2 million in the first quarter of 2019 versus $18 million in the comparative period in 2018, primarily due to increased advertising expenditures and increased personnel-related expenses, primarily at our Cleveland facility. In the first quarter of 2019, we spent $10.2 million in advertising as compared to $4.8 million in Q1 2018. We saw an improved efficiency on a sequential basis in advertising expenditures as a percent of direct-to-consumer sales at 26.2% in Q1 2019 versus 29.4% in Q4 2018. General and administrative expense increased to $9.7 million in the first quarter of 2019 versus $9.6 million in the first quarter of 2018, primarily due to increased personnel-related expenses and partially offset by decreased bad debt expense resulting from the adoption of ASU 2018-19 that requires reclassification of rental bad debt expense to be charged to rental revenue. Operating income for the first quarter of 2019 was $4.9 million which represented a 5.4% return on revenue. Operating income declined 44.2% in the first quarter of 2019 versus the first quarter of 2018 where operating income was $8.7 million or an 11% return on revenue. The reduction in first quarter 2019 operating margin compared to first quarter of 2018 was primarily due to higher sales and marketing expense. In the first quarter of 2019, we reported an income tax expense of $0.8 million compared to a $1.1 million income tax benefit in the first quarter of 2018. Our income tax expense in the first quarter of 2019 included a $0.6 million decrease in provision from income taxes related to excess tax benefits recognized from stock-based compensation compared to a $3.3 million decrease in the first quarter of 2018. Excluding the stock-based compensation benefit our non-GAAP effective tax rate was 23.1% in the first quarter of 2019 versus 22.5% in the first quarter of 2018. In the first quarter of 2019, we reported GAAP net income of $5.3 million compared to GAAP net income of $10.8 million in the first quarter of 2018. Earnings per diluted common share was $0.24 in the first quarter of 2019 versus $0.48 in the first quarter of 2018. Now turning to guidance, as Scott mentioned, we are reducing full year 2019 total revenue guidance to $405 million to $415 million, down from $430 million to $440 million representing growth of 13.1% to 15.9% versus 2018 full year results. While we still expect direct-to-consumer sales to be our fastest-growing channel, we expect we will be slowing the pace of hiring in 2019 and primarily focusing on sales representative productivity. We continued to expect international business-to-business sales to have a solid growth rate, but now expect domestic business-to-business sales to have a slightly negative growth rate. Given the difficult growth comparisons we faced in the domestic business-to-business channel the restructuring challenges of some providers and our rental plans, we expect negative growth in the domestic business-to-business channel in Q2 2019 compared to Q2 2018 with modest growth in the back half of 2019 compared to the back half of 2018. Despite planned increase net new rental additions, we continued to expect rental revenue to grow modestly in 2019. We are reducing our full year 2019 GAAP net income guidance range to $36 million to $38 million down from $40 million to $44 million compared to 2018 GAAP net income of $51.8 million. This decrease in GAAP net income guidance range is primarily due to the estimated reduction in revenue and a decrease in estimated benefit in provision for income taxes related to excess tax benefits recognized from stock-based compensation from $4 million to $1 million due to our current stock price and fewer expected option exercises in 2019. When excluding the benefit from the estimated $1 million decrease in provision for income taxes expected in 2019 from stock-based compensation deductions, we still expect the non-GAAP effective tax rate of approximately 24% in 2019. Assumed guidance is a tariff associated with imported Chinese materials and products stay at a cost of 10% for full year 2019. And these tariffs are increased from 10% to 25% we estimated additional cost to be approximately $400,000 per quarter at the revenue, guidance range listed. Going forward, we plan to continue to monitor any new tariff proposals and economic policy changes and take the necessary steps to protect our financial interests and reduce our standard material cost risks. We are also reducing our full year 2019 operating income guidance range, to $42 million to $44 million, down from $46 million to $50 million representing growth of 10.8% to 16.1% versus 2018 full year results. And we are also reducing our full year 2019, adjusted EBITDA guidance range to $66 million to $68 million down from $67 million to $71 million, representing growth of 7.7% to 11% versus 2018 full year results. We still expect net positive cash flow in 2019, with no additional capital required to meet our current operating plan, in spite of an additional investment in rental assets. However, we expect lower cash flow than in 2019, as we increase rental investments. And expect lower cash provided by stock option exercises. With that, Scott and I will be happy to take your questions.

Thank you. [Operator Instructions] Our first question comes from Margaret Kaczor of William Blair. Please go ahead.

Hey! Good afternoon guys. Thanks for taking my question. Maybe to start, you can walk us through why you think now is the right time to change the rental intake criteria you describe earlier? And it seems that underlying growth outside that one large provider we're still up over 30% based on a rough math. But it seems relatively good so maybe walk us through that, and then, if not for that change intake criteria growth of over 30 to continue? Or something else change in the market as you guys look at it?

Yeah. Margaret it's a good question. This is Scott. I'll take that one. And you're right. If you peel back the purchases from a national provider that slow down net purchases. The rest of the domestic B2B channel is growing nicely in the mid-30s. And we're very pleased with that. But, when we assess the overall situation there's, a couple of things that really go into this. One, you do have a slowdown of the larger player. And they do represent a fair piece of the market. Now, while the rest of the channel is growing nicely. They're just aren't able to completely absorbed all the demand that the other provider that was taking. So, there's an access issue and frankly, I call it an opportunity, if you want to look at it that way. That's certainly the way we're looking at it. Now, let's also couple that with some other comments that I made, that we increase our advertising spend but we just aren't satisfied it with the productivity of our sales team. So, we've got some opportunities there to improve their productivity. We are already are paying for literally tens of thousands of leads every month. And when you focused primarily on retail sales, you're leaving a lot of money on that tree by not taking it more rentals. So when we coupled, our goals to improve our sales team productivity, also to address the issues in the market regarding access. The result of that our assessment was us relaxing our intake criteria, and taking on some more rentals, satisfied both of those issues or I guess all three of those issues if you will. So that's, how we landed at that point of we're going to accept some more rentals, drive productivity in the sales team, harvest more of the leads that we have already paid for. And we don't have to increase our marketing spend to have access to those leads we just have to use them. And then, create better access for the patients, which is consistent with our mission and vision.

Okay. So just to follow-up on that intake criteria then it sounds like the changes you're making are maybe more minor? Obviously, you can go out more aggressive on that. But what are the steps that you're looking for to push them out into the field? Are you look at improvement in close rates? As what other metrics are you looking at? And how should we look at that long-term profitability within rental, given the lower gross margin profile of rental today?

Yeah. It's another good question Margaret. And you are right on target in it. This is a subtle shift. It's not a wholesale change of why I would call a dramatic shift over rentals. But we are going to relax the last criteria up front. When we talk about that criteria, we've got a minimum number of billable months remaining for a rental patient or an insurance patient that we require to consider bringing them on service and deploying the POC. So we can relax that criteria and it creates more a bigger portion of the leads that come in every month become rental candidates. So that's what we'll be doing. But it's not a massive shift. It is a subtle change. Now in order to execute that, I had mentioned that we had piloted this rental intake team. They are much more efficient going forward because you drive more of the volume through a narrower group of people that are experts in this area as opposed to our wholesale sales team that they may do a rental or two here and there a month and they're just not as proficient at it. So the results of these trials have been very positive to improve our efficiency, but it will take I’ll say, the rest of this year to kind of roll that out. And we will scale as we will go. But it will be a slow shift, but a steady shift. And that should drive efficiency. Now you mentioned close rates. Yes it should A, improve our close rates with some of the trainings re-scripting focusing on leveraging the benefits of the G5 with the sales team, more training for the management that is responsible to help bring the reps up to speed. All of that should improve our close rate. Another thing that we have piloted that is a best practice in other industries is we’ve actually started letting a better performing reps and better performing reps generally up higher close rates. They can earn more leads. So once you get to a base level of leads that everybody gets a higher close rate people as a high performer. We can give you more leads. And so if you give a bias of more leads to the higher closers, you’re de facto close rate ultimately improves. So it becomes even better utilization of the marketing spend in the leads. Now you mentioned on the rental gross margin. Yes, we've made some great progress in the past year there. We've got a lot of opportunities to continue to improve that. And we do need to do that. You got to remember that right when you look at the gross margin associated with the entire rental pool, there's a pretty substantial number of folks that are in the cap in there that you subsidize. So, out of the gate as we start to take on a higher level of newer patients, none of them are in the cap to start. Now ultimately they'll hit that cap, but it certainly gives us some runway to continue to focus on driving up our utilization of assets, reducing denials further, optimizing our business and improving that gross margin, which is something that is at the top of our list of things that we need to do if we're going to do more rentals in the future. Ali, do you have anything to add on that?

I think mostly you covered it from a rental gross margin side. I do want to note though just with the sequential decline in rental gross margin, there were a few drivers of that associated with the additional rate cuts that was effective January 1st of 3.9%. But we also have an accounting change associated with the new lease standards where we needed to move that bad debt expense from a G&A expense of up to a top line expense. So that does impact gross margin, but it doesn’t impact the net margin of the rental business. We also tend to see higher servicing costs in the first quarter of the year versus other quarters of the year, so winter tends have a higher death rate in the pool as well as you also have insurance changes in that period. So we're very focused on improving their gross margin over time. But as Scott said, what's really great about the rental side is that you don't need to spend more on sales and marketing to drive the interest or the leads associated with that. You can leverage the leads that you're already getting. So on an incremental cost basis, there's very little additional operating expenses. It's just using the operating expenses you already have to drive incremental revenue in the business. But obviously the rental gross margin is lower than our overall corporate gross margin. We you have multiple initiatives in play to drive improvements in that over time and we do expect to see sequential increases in rental gross margin throughout 2019.

Just to kind of wrap it up, I guess. If your rental criteria changes, they’re going to be minor. It's going to take more time to input those into your numbers. You guys took a pretty big hit to guidance assuming you will see that impact on the HME side that's adverse. So walk us through why is that? Is that the right assumption versus something above or below that? And maybe drawn way -- how confident are you in the overall guidance at this point? Thanks.

Yes. So I want to highlight that the change in guidance is not just associated with B2B. It's also on the direct-to-consumer side. So remember when we're talking about this rental shift. If you have a patient that previously would bought for cash that you're now -- they're now going to be able to use the rental benefits, you're going to recognize that revenue monthly over time versus the mostly immediate revenue recognition that you have on the B2C side. So that's certainly a component that whatever portion of the sales that you would have driven on these incremental changes that you do lose on the direct-to-consumer immediate revenue recognition. We also have a slowing of the B2C hiring that is a part of that lowering of the guidance range. And that's really associated with slower hiring and focusing on our productivity improvements and making sure that we get the return on the investments that we made last year. We do expect on the B2B side that there is some impact associated with our change in rental intake criteria. But we believe the major challenges for the HMEs is still overall or just restructuring their business. Obviously, this is just a large change to guidance. And -- but we do still feel good that these numbers that we can achieve these revised numbers. And that we have taken into account what we're currently seeing from the market forces across the entire business.

Our next question comes from Robbie Marcus of JPMorgan. Please go ahead.

Hi. This is actually Christian on for Robbie. Thanks for taking the questions. I wanted to start may be on the DTC side. I think that was more of an unknown issue going into the quarter. It sounds like the incremental return on higher, isn't as high as you view it towards the end of 2018 when you have a large hiring? Is that just what the marketing getting too saturated? And how can you drive better rep productivity from here? Just any color on your view the productivity of what changed and both hiring at the end of 2018 to now leading to the revision in guidance and lower outlook for hiring?

Yes. Let me back up to probably the first half of 2018 is kind of a benchmark. We started to hire at a heavier rate than historical in the first half of the year. And things I'll say, met to even exceeded our expectations. As we continued and actually cranked up hiring to an even higher rate as we went into the third quarter that's where things didn't meet our expectations. And as I said in my prepared remarks, when we look at productivity of reps they no longer were matching what we have seen from a historical productivity standpoint. We got a little bit ahead of ourselves on management. I think we mentioned that in the previous call that we had to shore up our management, but we found we still need to invest in further training on management, so that they're even better resource for the new reps that we have. If you look at most of the incremental hiring is in our Cleveland facility. That's where we have space. So that's why most of the hiring is there. But the folks are not surrounded by five year better reps there. It's a relatively new facility. So we need to make it even bigger investment into training and support of those new reps to drive that productivity. As I said yes, it's falling short of our expectations in the second half. We were little trapped into going into the first quarter because -- the first quarter is always seasonally slow. So you're kind of assess things and you're trying to assess is to what’s traditionally a seasonally slow period. But we come to the conclusion and analyzing rates and looking at the classes and historical proofs that we just not where we should be in, where we are convinced that where we can be. So it's going to take some time to do that as you imagine when you're hiring at a higher rate that does take a lot of resources just to execute that. We think of where we are right on and some of the opportunities that we see we should redeploy those resources into investing in the team that we have rather than adding more folks to the pool. That could potentially continue to be below our expectations from a productivity standpoint. So that's the plan as we're going to reinvest our resources into training and other programs. I don't want to share every initiative that we have. As you guys know there's some other force in the space that are also trialing direct-to-consumer initiatives. So, we're not going to try that out every detail of every improvement idea things that we're trialing. But suffice to say we see an opportunity to dramatically improve our efficiency going forward if we invest in that way. And there's the decision that we made.

Got it. So, I guess, just taking the fact that DTC is seasonally slow in the first quarter. I still think the numbers that you guys put up in the quarter is relatively in line with expectations and in line with first quarters in the past. And the guidance reduction actually implies DTC to decelerate over the course of the year. So, what's changing between your results in 1Q? And the adjustment to guidance going forward that has gotten incrementally worse?

Yeah. So, we're not expecting in guidance that there is a significant slowdown versus the growth rates that we saw in Q1 in the B2C channel. So, however, we also aren't assuming guidance that there is a significant acceleration of those growth rates which is -- what the models were showing previously. So that's really the differences that we essentially are focusing on productivity and not focusing on repetitions. We are instead kind of leveling off of that growth rate for this year.

Got it. Thank you.

Our next question comes from Danielle Antalffy from SVB Leerink. Please go ahead.

Hey, good afternoon, guys. Thanks so much for taking the question. Just a follow-up on the B2C business. I am just curious if you could get a little bit more color on how this works from a rep productivity perspective and the lease? Because the reps are at a call center and they're taking incoming calls, like how do you ensure from a B2C advertising spend perspective that the leads that are coming in are good leads? Like how you target advertising, I guess is the first question? And the second question is, where did rep productivity start to take a step down? Is it because they weren't able to -- what would have been good leads? Was that the leads coming in were not good? Can you give a little bit more color there? And then I have a follow-up.

Yeah. So the way we distribute leads are -- we've got -- our computer algorithm that does that. And we measure the close rates and the cost per sale of all the different lead forces. And we have an internal marketing team that's always trying to optimize that. And part of that optimization is you have to keep things fresh. When you can't -- you can't advertise, referencing the ad in the same channel or the same print periodical over and over. You've got to mix it up and keep it fresh. And you're always doing that by measuring your close rates, your results and making the necessary changes. So the team is always doing that. You're always looking for some new outlets to keep things fresh as well. So we kind of target in the past that we'll spend 10% of our media mix. We said, let's try it and put that into new ideas or new things to test them out to try and keep things fresh. Again, that's driven by our marketing team. Now the leads they're distributed by our CRM system. So everybody should get the base amount of leads. Everybody gets a mixture of lease from all the sources. So, we don't give all the leads from one source to a certain group of reps, that's kind of randomly distributed. Some leads close better than others. Some leads cost more than others. So where the rubber really meets the road is the cost per sale. As you can imagine it may be -- money well spent to pay more for lead if it has significantly higher close rate. So, we always measured that in terms of the cost per sale. As I mentioned earlier, we are giving in the high-performing reps an opportunity to kind of earn more leads, so if you are in a higher close, we can give you more leads than the number of base leads. And that should ultimately -- when you look at mix, it should enhance our close rate allow us to better use our media spend.

Yeah. And just to add on that Danielle, before your second question. When we look at productivity, we look at both the season reps and reps still coming up the productivity curve. So if it was broad-based where you saw productivity challenges across the wholesale team that’s when you would assume that there was some either challenge with the leads or competitive forces or something like that. But when it is primarily associated with just where the reps are in the productivity curve coming up to speed then it's not usually going to be a lead issue or market issue. It's going to be just the training and getting those sales reps are performing at the expected close rates.

Okay, got it. And then my second question is around the B2B business. I am curious what you're seeing as B2B becomes a bigger piece of the business as they ramp adoption, are they redeploying -- just trying to get a sense of the longer term market opportunity there? Are they redeploying devices back into the system once the patient's expires? How do we think about how many patients one device can serve that's purchased by CME? Thanks so much.

Yeah. So on the rental side, know Danielle, Inogen does the same thing by the way on our owner rental business, but so all of the other providers. That asset is owned by the provider and it is redeployed. So they may put a new unit out on the patient. Let's say, that patient lives for a couple of years. When the patient expires that provider owns that asset. They will bring back in is defected, they'll test it. It might get a new battery with it before it goes out to the next patient and it's redeployed. We look at these assets as a five-year asset for us. That's how we depreciate the devices. Other companies may have their own depreciation schedules, whatever they see fit. But we've always referred to these as a five-year asset. And it could be on one to several patients through the asset life. The key to -- really drive the more out of an asset for a provider, and again Inogen is in that same bucket. It becomes an asset utilization exercise. You want to keep this thing rented for as many months as possible, realizing that it will probably be on the patient's through the asset's life that's in the cap over 60 months. If you are able to keep an asset rented 50 out of 60 months, I think you've got some pretty darn good results. But that's kind of the game that they play. That's not a new game for them. It's the same with stationary concentrators, and frankly tanks and everything else. They reuse those assets on people.

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

Hi. Thanks for taking my questions. Just wanted to start with the challenges that some of the HME companies are having with the transition to the POCs model. Have you seen customers that have been able to do that successfully? In other words, is there some kind of structural issue here that would prevent these companies from being able to completely make the transition or is it just a certain one-time executing in the proper way?

Yeah. Mike, it's a good question. And let me answer it from two different ends of the spectrum. Maybe first I should answer your overall question. We haven't seen anybody that's fully converted yet. There is -- I mean, Inogen is running a complete remote model. But we didn't have a restructured challenge. We started with the white sheet of paper, and as we've grown our business, we've added assets. But we don't have trucks and drivers out there. But other than ourselves, people are, what I would call in a transition state. Nobody has navigated all the way through that. At least not that we know of. If somebody is out that there's pretty small player that's not in our radar screen. Now if you look at the challenges, again two ends of the spectrum. If you're a larger player, it's a bigger restructure exercise because you de facto have got economies of scale on the delivery side that you probably got many branches in many trucks and many drivers, and really make the model work. If you're going to save money in five POCs, you also need to eliminate the cost associated with deliveries. So the challenge is to knock out that delivery infrastructure. We've seen some companies out there that have a good plan. They're executing along the plan. They're not done yet, seems to be going pretty well. You do have to make some tough decisions on how you're going to reduce that structure. Are you going to redeploy it to other areas of your business or you're going to literally let people go and dispose off trucks. That's probably the bigger challenge that the larger players have. They tend to have more or less access to capital, so that they can purchase the assets. It’s the restructure that they kind of choke off. If you go to the other end of the spectrum, the smaller what we call mom and pop providers. Obviously, they don't usually have many, many branches they may have couple of branches or couple of trucks. So the restructure exercise is not nearly as daunting. But their access to capital is a lot tougher than the big guys. So they tend to be constrained on just the credit of purchasing the assets. They've got other issues in their business. Some times the driver you want to restructure out might be your brother-in-law in mom-and-pop business. So there are some other nuances there. A little bit different challenges at both ends of the spectrum. It's why we always said that, this is a process not an event. Nobody can really bite this off in a year or two, its several years. In our last call, we have said – in our view from where we are today, it's at least five more years. We really didn't put a cap on it. So it's going to take a while. It's an exercise. And I think the good news for us, when we look at our business is we continue to see strong demand throughout the lead that we generate. We know there is demand for POCs out there. Probably, our challenge becomes – because we have the best product and there is demand, it becomes a fulfillment exercise of how you’re going to get the product in the end users hand, what role is the current provider going to play? And how can we help them and support them and be their partner? And then in addition, how can we pick-up some of the slack and harvest some of the opportunity without trampling on our good customers and partners?

Okay. Thanks. And then just back to the rep productivity issues. So can you maybe comment on the productivity of the new Cleveland-based reps versus your kind of your legacy or existing reps? I would assume based on what you're seeing that productivity issues were really confined to these new reps and existing reps kind of saw stable productivity levels? So in other words, it's not without these vertical sign, it's not a saturation issue or some other issue. It's really just a confined to Cleveland with the training or not?

Yes. I mean, Mike it's - you're right. The newer reps and where we have lesser seasoned support structure to help them along. That's where we need to continue to make investment. And yeah, that's primarily in Cleveland. As far as giving the actual numbers, we don't give that publicly. Again, there are some things I just – I don't want to say, what's a good number or a bad number when one other people are trying to work through this curve potentially themselves. All I'll say is, they're below our expectations and they're below historical what we have been able to post. But you mentioned, the term saturation. Our issue isn't a saturation issue. We wouldn't have the tens of thousands of leads that come in every month, if there weren't many, many thousands of people still dragging the tank around the one POC. So saturation are full penetration of the market is not our challenge today.

Yeah. Okay. I mean, I wasn't looking for the numbers. I guess, I just wanted to know, if it's the - productivity have they consisting reps as being more stable? Or is this issue is really limited to kind of the newer reps you hired more recently?

Yeah. And the answer to that is yeah. It's more of the rep. A newer rep issue/opportunity.

Okay. All right. And then finally just one if you could comment on the pricing? It sounds like – I think I heard you said that the DTC channel saw some price decline as well as a domestic B2B which I think is normal, but could you see that product have been more stable in the past?

Yeah. So if you recall – remember, we did a pricing trial last Q2. And then, we put 8% pricing decline in place a couple of points after that trial. So we were still lapping the comps in Q1 associated with that pricing trial change.

Okay. Got it. Thank you.

Our next question comes from JP McKim of Piper Jaffray. Please go ahead.

Hi. Thanks for taking the question. I just wanted to circle back on the DTC because I feel like the B2B softness was well telegraphed. But it sounds to me like it's not a lead generation issue. It's a lead close issue. And how confident are you in just you need to train these folks better versus the leads being weaker than before?

Yeah. So, if it would have just been the lead being weaker as we said earlier, you would have seen that across the whole sales force. Now, obviously, we're still seeing higher lead generation cost just looking at our marketing spend as a percent of the B2C revenue. Now, that's a mix of both having the lower close rate as well as increased marketing spend. But we do believe we can get the B2C, or direct-to-consumer, sales cost to decline over time, really associated with us being able to improve the productivity there. So that’s what we’re focused on, but we do believe the primary area that we are focused on improving in 2019 is that -- is the productivity of the sales force and driving incremental sales there. If you would have just had a lead quality issue, again, it would have just been more broad-based across the wholesale team.

Okay. That's helpful. And then one on the rental side. Is there anything around the competitive bidding outlook with all the changes that, Scott, you alluded to do that, that make you want to make this move more to rentals? Or is it just purely an access issue? And then just -- can you just give us confidence around, I mean, it's a tight rope to tiptoe. And you don’t to anger any B2B customers and you don’t want your sales reps to diverting all the leads to rentals and when you still sell those units outright. So how do you -- what's your confidence? And how do you make sure you can tiptoe on that line properly? Thank you.

That's why you have to make that change gradually. You don't want to step change in your criteria. But, I mean, we do expect this to be important to the long-term strategy anyway and this is just a slight change in criteria now to drive more, which does have some impact on B2C sales in the period and also some potential blowback on B2B side. But we know that there are access issues to get -- to patient getting POCs. So we think it's the right time to make that decision. Nothing specifically tied to competitive bidding in our strategy. Obviously, we think that the changes that they're making to the billing program overall are positive changes that should lead to a better bidding approach than what we've seen in the past. But we won't know the outcome of the bidding or how people will bid until probably sometime mid to late next year. So it will be sometime before we really understand what that next round of competitive bidding will look like, but in that case, no matter what happens with rates, we do think POCs are the future and the only way that people will be able to compete in this, both reimbursement environment as well as patient preference site, will be to convert max majority of their volumes to POCs. And as they struggle to do that, we want to make sure we just help patient access as much as possible. But for the partners that we have that are going to drive POC adoption you're right. We absolutely want to maintain those relationships and work with those providers and make sure we minimize the overlap of our efforts versus their efforts in driving POC conversion.

Yes. And I think -- let me add to that for a second. A lot of the key to success initiatives is just good communication with your customers. We have similar, if not the same goals. They want to take care of patients. We want to take care of patients. We want to give them a product that's going to give them a better freedom than dragging a tank around. And from what we've seen, for the most part the majority of the HME community wants to do that as well. They're just struggling with how much they can bite off one step at a time. So our goals in helping patients are alive. When you -- but you got to sit down with them, which we've already had, some discussions with some of our key customers before this call today, to share with them, look, here's the conundrum we have. We've got thousands of leads coming in every month. These people want to POCs. They’re qualified for POCs. Somehow we got to figure out how to service them. Either you got to service them or we got to service them. But it doesn't serve anybody to deny these people the benefits of our POC. And that's working hand-in-hand with the provider partners to make that happen. But will we play a little bit bigger role going forward on the rental side than we have in the last year or so. Yes, is it a whole sales shift that we're just throwing out to the provider community and we’re going our own way. Absolutely not. And that's not the plan at all.

Thank you.

Our next question comes from Matthew Mishan of KeyBanc. Please go ahead.

Great and thank you for taking the questions. The POCs are typically rented or reimbursed in tandem with stationary auction of concentrators. I guess, can you guys manufacture and ship your stationary concentrators to receive an adequate return to current reinvestment? And how does it work with somebody else would reimbursed from a base station or accident concert and you be potentially reimbursed for the POC?

Yeah. So to be clear, POCs are dual quarter for both E1390 and E1392 reimbursement. So that means as long as the physician has written a prescription for both stationary and ambulatory oxygen, you can deploy our POC and receive the full reimbursement for both codes, so you do not need to deploy our stationary concentrators. Now some providers have chosen to continue to deploy a stationary concentrators as well and then it's up to them to decide if they are going to dual code and build the POC for both courts or build them separately, but the reimbursement you can't get incremental reimbursement if you deploy stationary concentrators on top of our POC. So when we built as provider, we built in both codes for the POC reimbursement. We do deploy our stationary concentrators as well but that product is really designed for the retail sales from a cost perspective, it is higher than the typical stationary concentrators. So it doesn’t make it a natural fit for the price-sensitive HME community as a product standpoint.

And then is 30% of business-to-business sales a good proxy for what that D&E, the problem D&E was throughout 2018?

So, the dollar headwind was the highest in Q1 versus the rest of the year. Q2 was also very high. So, similar to Q1 in size but slightly smaller. And then it takes a step down in Q3 and then the easiest comp for us will be Q4 of 2019. So, it does step down throughout the year. And particularly much lower in the back half of 2019 from a comp perspective.

Our next question comes from Mathew Blackman of Stifel. Please go ahead.

Good afternoon. Thanks for taking the questions. I just wanted to ask you directly. Although your comments about the rep productivity issues being isolated to newer reps seem to be answered, but Scott you did bring up competition in DTC. I just want to understand whether you're also seeing competitive pressures in that channel?

Yes. It’s nothing that I would say as why we’re revising anything. I mean you always hear somebody's got a new program out there. We haven't really seen any significant new products. I mean we've been the one that launch new products recently. So, he took the best product and made it better. So we feel we're in a very strong position from a competitive standpoint. We haven't seen anything wild on the pricing side. So, no -- and I appreciate you're asking it directly, Matt to give us a chance to address that but right now we're in a stronger position as I think we have been in from our competitive standpoint with the launch of the G5 and then pairing that up with the G4 that's a sub-free pump product.

Okay. I appreciate that. And then maybe to end on a more positive note, we did have another really strong international performance. So I'm hoping you could talk about how sustainable this type of growth is? And more broadly, what inning you think you're in in terms of the runway for growth? And that's all I have. Thanks.

Yes. And thanks for the comment on international. It oftentimes gets lost in the shuttle. If you look at Europe, they don't have the downward pressure on reimbursement. So we don't see this struggle to make the delivery model work, but we also on the opposite side of that, it seems like in Europe, people tend to have more bias for a product that is what patients want, whereas in the U.S. with the fix reimbursement, there's a lot of focus on price first. In Europe, it’s not quite as dramatic. So we've had some good success in Europe. We've had strong growth over the last 10, even 12 year period when we first broke into Europe. I think if you look at year-over-year, we kind of expect it is going to trend about as it is trending. I don't think you're going to see a big change in the adoption unless you see reimbursement changes that drives some change their. It is going to take -- I think will lag to U.S. in terms of conversion, but we also think in Europe that ultimately the end game is POC's. Again it just doesn't make sense to deliver tanks when you have a POC, there is patient provider is a better cost model. Now as you know, we tend to be more conservative on our international guidance just we're even further away from the customers. And we're delighted with the demand that we saw in the first quarter. We continue to think, it would be a great market for us. As I said an unsung market and then we're looking as we said in the past calls opportunities in the emerging markets for even higher growth when you look at just the sheer population and say our market like China. But that is beyond Europe and we will be probably talk about that a little -- talk about that in 2020 when we expect to enter China.

Okay. That’s all I had. Thank you.

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

Thank you. We believe the market for POCs remain under penetrated and we believe this is from patient demand for our products. Given our unique vertically integrated business model to drive patient access, it is our mission to fill this need either through our provider partners or from us directly. Thank you for your time today.

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