Greetings, and welcome to Inogen's Third Quarter 2021 Earnings Release Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Jason Somer, General Counsel. Thank you. You may begin.

Thank you for participating in today's call. Joining me are CEO, Nabil Shabshab; and CFO, Ali Bauerlein. Earlier today, Inogen released financial results for the third quarter of 2021. 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, without limitation, statements about our growth prospects and strategies for 2021 and beyond; expectations related to our financial results for the fourth quarter and full year 2021; our expectations with respect to supply challenges and cost inflation related to semiconductor chips, using our batteries and concentrators; our ability to create shareholder value by driving awareness of our products; expectations regarding our international and domestic sales channels; expectations related to our rental channel; expectations related to our prescriber sales organization, including the expansion of the sales team and implementation of health care intelligence platforms and tools through our partnership with Ashfield Healthcare, LLC; hiring expectations; expectations regarding reimbursement and regulatory changes; our expectations regarding the market for our products and the impact of the COVID-19 pandemic on our business of supplies and demand for our products in both the short term and the long term. The forward-looking statements in this call are based on information currently available to us as of today's date. 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 investor presentations 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 U.S. GAAP financial measures, provide useful information for both management and investors by excluding certain noncash items and other expenses that are not indicative of Inogen's core operating results. Management uses non-GAAP measures internally to understand, manage and evaluate our business and make operating decisions. Reconciliations between U.S. GAAP and non-GAAP results are presented in tables within our earnings release. With that, I will turn the call over to Inogen's President and CEO, Nabil Shabshab. Nabil?

Thanks, Jason. Good afternoon, and thank you for joining our third quarter 2021 conference call. We continue to make progress to revise and begin implementing clinically informed approach through innovation, product development and our go-to-market strategy. Over the last several weeks, we announced an important new partnership with Ashfield to strengthen our commercial capabilities, and we appointed Dr. Stan Glezer as EVP and Chief Technology Officer, to lead our R&D and Engineering in addition to his previous responsibility for Medical Affairs and Regulatory Affairs. At the same time, like others in the industry, we are navigating the challenges both by the supply chain disruptions that are limiting our ability to meet demand and creating an inflationary cost environment, which was partially offset by price increases across all sales channels that was effective in September 2021. In the third quarter 2021, we saw total revenue growth of 25.3% from the third quarter of 2020, primarily driven by sustained demand, improved average selling prices and the reduced impact of the COVID-19 pandemic and related public health emergency, or PHE, versus the comparative period in the prior year. In addition, we believe oxygen therapy patient diagnosis rates are returning to historical levels due to the increased pulmonologists' interactions that were reduced during the COVID-19 PHE. Due to supply chain constraints and in an effort to optimize financial results, we intentionally focused our available capacity on supplying our direct-to-consumer sales and rental channels and our international business-to-business sales channels, which you will see reflected in those results while attempting to fulfill critical orders for our domestic business-to-business partners. We are pleased by our strong rental revenue growth and our improved direct-to-consumer sales revenue in the third quarter of 2021 versus the third quarter of 2020. Direct-to-consumer sales increased due to relatively strong demand, improved…

Thanks, Nabil. As Nabil noted, total revenue for the third quarter of 2021 was $93.1 million, representing an increase of 25.3% over the comparative period in 2020. Turning to gross margin. For the third quarter of 2021, total gross margin was 51.2% compared to 44.4% in the third quarter of 2020. Our sales revenue gross margin increased to 50.1% in the third quarter of 2021 versus 43.5% in the same period of 2020. The increase was primarily due to increased average selling prices. The increase was partially offset by higher cost of goods sold per unit in the quarter, primarily due to increased labor and overhead costs and material costs. The third quarter of 2021 included $0.9 million of higher material costs associated with open market purchases of semiconductor chips used in our batteries and POCs. Rental revenue gross margin increased to 58.9% in the third quarter of 2021 versus 52% in the third quarter of 2020, primarily due to higher billable patients as a percent of total patients on service, higher Medicare reimbursement rates and lower service expense per patient on service, partially offset by higher depreciation expense per patient on service. As for operating expense, total operating expense increased to $41.3 million in the third quarter of 2021 versus $35 million in the third quarter of 2020, primarily due to increased personnel-related expense and increased advertising costs. These increases were partially offset by a $1.9 million noncash decrease in the change in fair value of the New Aera earnout liability versus the comparative period. Research and development expense increased to $3.8 million in the third quarter of 2021 compared to $3.5 million in the third quarter of 2020, primarily associated with increased personnel-related expense. Sales and marketing expense increased to $28.3 million in the third quarter of 2021…

[Operator Instructions] Our first question comes from the line of Robbie Marcus with JPMorgan. Please proceed with your question.

I was wondering maybe you could start, do you have any sense of where demand would be if you didn't have supply issues now? And if there's any way to quantify what the demand side is? We know what the supply side is, but just trying to figure out what's going on in the underlying demand and what the delta is?

Yes. Sure, Robbie. I can take that question. We're not quantifying the specific backlog that we had as of the end of the quarter, but the backlog certainly was the largest in our domestic business-to-business channel. We are prioritizing our direct-to-consumer business. So that channel had minimal backlog as of the end of the quarter. Of course, that channel was impacted by having the lower availability of batteries for sales. But outside of that, there's minimal impact to that channel. And our international business-to-business channel also had a backlog as of the end of the quarter, but it was smaller than our domestic business-to-business backlog. One of the challenges that we have, Robbie, in providing that number is that it does appear like this is across the entire industry that there are these shortages of oxygen therapy products. And so we believe that it has led to customers placing orders across multiple manufacturers to see what products would get filled first that may overstate the actual demand of products just given the backlog and the lead times to fulfilling orders right now across the industry. But it was quite large at the end of the quarter, and we've continued to see strong demand going into the fourth quarter as well.

So you were able to, this year, control expenses pretty well to account for some of the top line. Do you plan to wait until second quarter to start the direct-to-consumer advertising, start that sales engine again preemptively? Or is it one of those you're going to wait to see when demand starts to catch up again? Just trying to think how we can, once supply resumes what sort of recovery we can start to look forward to?

So Robbie, I'll take that one. Thanks for the question. So as we said, the situation is very slow. We are actually continuing to see the underlying demand to be strong and healthy. We are going to be monitoring things very closely and then decide accordingly in terms of -- we're not stopping advertising. We're going to continue to nurture that growth that we're seeing, but we're very cautious about managing the supply on a week-by-week basis in all honesty, and then we'll make those decisions accordingly.

Our next question comes from the line of Margaret Kaczor with William Blair. Please proceed with your question.

This is Maggie Boeye on for Margaret today. I wanted to ask one just kind of building off of what Robbie asked. So based on what you're seeing today, do you expect that the current demand will be sustainable through next year? Because of the supply constraints, what are patients doing when they are unable to get a POC?

So most patients, Maggie, if they're unable to get a POC, they are receiving tank-based oxygen therapy today. Of course, that also is the mass majority of the market as we were talking about in the market specifics. So it is limiting the ability to convert to POCs from the tank-based systems and new patients are continuing to receive more tank-based systems than we would like. But that's really what most patients are receiving today.

And then I wanted to ask one on the Ashfield partnership you guys announced. So how does this help accelerate your efforts to focus on the prescriber? And can this have a material impact on 2022? And then why is this the right time to do it given that there are supply chain constraints limiting your ability to fill some of the demand?

Maybe I'll take that one. So it will have -- so as we said, we expect to staff -- the team to be staffed and trained in the first half of next year. We also acknowledge that there is a ramp-up in terms of productivity, so this is the right time to do it. We also believe that simultaneously, the supply chain concerns are going to start easing up as of the back half of the year. So it would be very timely in the sense that these sales people who have been in the field who have established relationships and are getting up to productivity, which typically is in the 9-plus months. So it's absolutely the right time to make the investment. We also believe that it will have a material impact in the years to come, but starting in 2022 and the back half of the year, as people come up to that productivity that we're expecting. And as a result of a couple of things, the ability to scale, the higher discipline and all the insights-driven approach in terms of targeting and selection to make sure we're calling on absolutely the right targets from a prescriber perspective, are all going to be net-net positive versus how we're doing things today.

Our next question comes from the line of Danielle Antalffy with SVB Leerink. Please proceed with your question.

And congrats on a solid quarter despite the supply constraint issues. I had a question on the B2B domestic side of things. And just curious about how you guys see this evolving once we come out on the other end of COVID, which who knows, but hopefully happens somewhat in the near future. And I ask that question because you know a lot of these service providers and things like that are cash constrained and COVID's really hit everyone and you have the whole dynamic of the investment in the infrastructure to shift to more of a POC versus stationary model. I mean anything you can comment on that about how we should be thinking about the B2B business ramping back up on the domestic side once COVID is hopefully in the rearview mirror?

Yes. So thanks, Danielle. I'll take that. So let me start with a little bit of context first. We believe that the B2B is actually in backlog not only from us but from multiple suppliers because we are all in the same situation from a backlog perspective. And by the way, we are balancing like all the other manufacturers. We're balancing the channel mix a little bit, just to make sure that we continue to supply B2B, but we also are optimizing our ability to hit the revenue growth number that we have, as you've seen in the quarter. So on the back end of it, as we are one of the major suppliers, we believe that we'll be in a better position to start resupplying that channel as much as we can ahead of other suppliers. And as things normalize, getting it back to where it used to be from a contribution to the overall sales that we have.

Danielle, we have seen improving reimbursement rates in oxygen therapy as well as the new NCD, which expands patient access to oxygen therapy. So I do think that those are two positive trends for both us and our partners on the B2B side that will allow people to continue to be interested in the oxygen therapy space and expanding the patient population. It has not been announced yet. Usually, it's announced in December what the inflation adjustment will be for oxygen therapy. So that's something to look for to as well as. Obviously, cost increases have hit the providers across the board as well. And then, of course, there's a proposed ruling of what they're going to do once the PHE is over with pricing in oxygen therapy. So we hope that the industry voice is heard that those rates should continue to increase given the value of oxygen therapy and the very low cost of reimbursement that's in place today. I would hope that those would be positive trends for the overall market over time as well.

And then just one quick follow-up, and I apologize if I missed this. But in the direct-to-consumer and in the cash sale and rental business, did you guys talk about the rep productivity and how that's trending, really thinking about lead generation and then more specifically, lead closure rates and just how that's trended. I appreciate you're operating under supply constraint dynamic, but anything you can provide there?

Danielle, I can take that. So on the productivity side, we have seen improved productivity of the direct-to-consumer team as we've kind of lapped the COVID headwind. So obviously, during COVID, we have seen a reduction in close rates and also a reduction in interest in additional accessories and lifetime warranties. Those trends did rebound starting late in the first quarter of 2021, continued very strong in the second quarter. As you know, our business has normal seasonality in it. So we did see that normal seasonality pattern where the third quarter came down from the second quarter in terms of close rates in the period. But in both the second and third quarters, those close rates were an improvement -- a significant improvement year-over-year for that channel.

So Danielle, in addition, as we said in the prepared remarks, this is a major focus for us. And what we're going to actually -- we are actually working on it actively now. We're bringing together a combination of insights, plus tools plus heightened sales management discipline that will continue to focus on driving the productivity. We believe that there is room for growth by just continuing to focus on these areas and do them a little bit more with rigor and discipline.

Our next question comes from the line of Mike Matson with Needham & Company. Please proceed with your question.

Yes. I wanted to ask about pricing. I joined the call a little late, so maybe there were some comments earlier in the call, but I think on the last call, you talked about raising prices in response to the cost pressures. So one, did you do that? Two, what was the timing? And three, how has it sort of received across the different channels that you're selling into?

Mike, thank you for the question. So on pricing, we actually did exactly what we had laid out on the call last quarter. We took pricing in September. We took a low double-digit price increase across all channels. We had indicated before that we believe about 70% of it will actually stick due to either contractual commitments and/or timing. We've seen that actually become a reality. And also from a context perspective, we've seen multiple competitors actually follow us in the price increase because everybody is under the same pressure like we were. So it so far extend out exactly like we planned it.

And then if you're looking at sort of $74 million, roughly speaking, in the fourth quarter. Is that -- I know you're not giving guidance for next year, but is that kind of your quarterly capacity-constrained run rate? And so should we be modeling something similar to that kind of for the early part of 2022?

Yes. So -- we're not going to be giving 2022 guidance today, frankly, just given the uncertainty on the supply chain, it still is a very fluid situation. And we do expect that our supply will continue to ramp from here. So while we see Q4, that should certainly be a low point in terms of our expectations, and we do expect to get to -- back to growth in 2022 at a high level.

So Mike, maybe I'll add a couple of comments. Mike, you see from our results is very slow, but we're managing through it. However, it's like a weekly conversation. There's multiple updates every week. We're like putting a lot of pressure on suppliers. So once these things clear out, we'll get back to that place where everybody likes us to be in terms of guiding. But for the time being, for very valid reasons, we're managing on a week-by-week basis. And while being very judicious, that's the way it is now.

Our next question comes from the line of Matthew Mishan with KeyBanc. Please proceed with your question.

I just wanted to start with trying to reconcile the material costs in the prepaid expenses and make sure I understand the change in profitability from 3Q to 4Q. When you say that you have $5 million to $7 million of higher material costs for semis and batteries, including $1 million in 3Q, does that mean the remainder of that is coming through in the fourth quarter? And then how does that reconcile with the $12 million in prepaid expenses you were talking about? Is that included in that? Or is that separate?

Yes, great question. Thanks for allowing us to clarify this. So yes, in the third quarter, we incurred $0.9 million of higher material costs associated specifically with the semiconductor chips. And as we talked about in the guidance, we expect $5 million to $7 million of higher material costs for the full year associated with chips for our batteries and POCs. So if you took $0.9 million or approximately $1 million off of that, that's what you would expect in the fourth quarter since there were no costs incurred in the first or second quarter of 2021 associated with these higher material costs. Now as you rightly referred to, we talked about the cash utilization of using -- having additional cash associated with these chip shortages. And that is because we are also buying some of these chip shortages for usage in 2022. So that additional cost would eventually have to be recognized on the P&L in higher cost going into 2022.

Okay. I understand. And then Nabil, I understand you have the agreement with Ashfield coming online, that's going to take a while. But I think you already had 20 or 25 direct-to-physician reps already in the system. How are you prioritizing demand to support that sales force as this occurs over the next couple of quarters? And just how are they doing with the recovery in patient diagnosis as well as your focus on making sure that this is an important driver for the future of Inogen?

Yes. So I think you've said the most important thing at the end. It's a major driver for the future. We've talked about the strategy moving forward. Let me address the first question about demand. How are we going to be able to meet the demand? The bulk of the referrals that we get there are going to be filled from a rental perspective. And that's one of the channels that we're prioritizing. So as the current sales force plus the additional 20 get up to speed, we are going to be in a position to prioritize that channel to make sure that we meet the demand in it. Back to the conversation around, okay, so what's the plan moving forward in terms of the coverage that we have? And I think we've had that discussion a little bit before. We believe that today, the total universe is about 14,000 to 15,000 prescribers, but the bulk of them are pulmonologists and cardiologists. We plan on covering about 1/3 of the health deciles just to make sure that eventually, with the combined sales forces and the concierge service, we cover about 1/3 of that market. So that's the plan moving forward. And that's why we believe that, that is going to become one of the significant pillars for our growth. And then we had indicated before that as we see the results starting to come through, we are -- we've always said that we're going to get that sales force a little bit further up north of the number that we have today, but that's the plan moving forward. But I will stress one thing. I think if you do some math in your head, we're going to get to doubling the current coverage we have, but actually getting to a -- by only increasing 50% of the sales force that we have.

And then my last question, as you kind of exit '21, the balance sheet still seems to be very strong. You're not bleeding cash to any extent, even with the supply chain issues. What do you need to see with your business? What are the prerequisites for you to be able to sort of pulling the trigger on some strategic M&A and some in fact that help you guys out and broaden out the product portfolio?

Yes. So Matt, we've always talked about sort of two parallel runways. We're working hard on increasing the productivity and getting the basics read showed up on the core business, but we're simultaneously in parallel are looking for opportunities to diversify the portfolio, of course. So that is an ongoing effort. We continue to look at potential additive components or targets that strategically set a very strict criteria that we've developed. So we are openly looking at that as we continue to fix the core business. And as you see increasing productivity and making sure that we deliver on the promises we have.

Our next question comes from the line of Mathew Blackman with Stifel. Please proceed with your question.

Apologies in advance, I've been around calls here, so some of these questions may have been addressed. But I'll give a shot anyway. Just curious on the supply chain, just how dynamic is sort of the environment? Does it change daily or weekly? And how much sort of visibility or how much more visibility perhaps do you have today versus, let's say, several months ago? And I'm not necessarily talking about visibility towards a more normal environment, but just visibility on what you're going to be able to get your hands on in the next couple of weeks or months, just your belief to forecast?

So Matt, I'm going to take that one. So I don't want to dramatize, so I'm going to call it weekly. But even though we have conversations on a daily basis, sort of the average time that we look at changes is on a weekly basis. And I'm going to point to two things basically. We're trying to work actively through can I get the sources? Are they available and will be shipped as promised? And are they authentic or not? Because we're sourcing all our needs today from the open market. The dynamics have not so far changed in terms of regular supply channels. So I think you asked the question about the outlook. Just recently, in the last few days, we've seen a little bit of more willingness to be transparent in terms of the regular supply channels. It doesn't mean that we've had the firm commitments on that, but we're beginning the conversations around trying to nail down some of the promises in terms of shipment dates. We'll see where we were out. So it's dynamic in nature. We might go through the conversation and end up being a little bit disappointed, but we're working in that channel. And then on the open channel, we're seeing now after a little bit of a very tough period, we're seeing some relaxation in terms of available quantities. Now the other two criteria when they ship on time as promised and are they authentic, which we go through a very, very thorough evaluation process. Those two things are always variable within the sort of the weekly milestones that we look at.

Okay. I really appreciate that color. And then maybe, Ali, rental gross margins continue to march higher. Where can those ultimately go, I think this is the question I'm asking.

Yes. We're really proud of the fact that we've been able to continue to show improving rental gross margin percentage. I think given the current rates, I think we'll continue to see small incremental improvements there, but we are looking to see what -- as we talked about in a prior question, what will happen with inflation adjustments and pricing after the PHE is over. So those are the two, I'd say, major potential changes in gross margin, but we are very proud of the impact we've had and continue to expect incremental improvement there.

There are no further questions in the queue. I'd like to hand the call back to management for closing remarks.

Okay. Thank you. I'm encouraged by the revenue growth we saw in the third quarter of 2021. And I believe the strong underlying demand for our industry-leading solutions, coupled with a multiyear investment that we are making will position us to reach our vision of becoming a global market leader with innovative evidence-based chronic respiratory care solutions. Thank you for your time today, and I look forward to engaging conversations with our investors as we make progress on our strategy to build a stronger Inogen. Have a good day.

Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation. You may disconnect your lines at this time, and have a wonderful day.